By: Brittany DeDiego, Fall 2014 Student Intern
The flexibility of self-directed IRAS also comes with a higher risk of fraud. The SEC first alerted investors to this risk in September 2011. An Individual Retirement Account (IRA) is a form of retirement account that provides investors tax benefits for their retirement savings. All IRAs are held by custodians or trustees for the investor. Custodians or trustees can include banks, trust companies, and any other businesses approved by the IRS. A self-directed IRA is also held by a trustee or custodian, but it permits the account holder to invest in a broader set of assets such as real estate, promissory notes, tax lien certificates, and private placement securities. These investments carry risks, such as a lack of liquidity and disclosure, that might not be present in an IRA. In a non-self directed IRA, investments are limited to firm-approved stocks, bonds, mutual funds and CDs.
Self-directed IRAs also carry an additional risk of fraud. Fraudsters target these accounts for Ponzi schemes and other scams because the self-directed IRA permits investors to hold unregistered securities, and the custodian or trustee most likely will not investigate the background of the individual offering the unregistered investment.
The most common ways fraudsters promote the weaknesses and misperceptions of self-directed IRAs to commit fraud include:
- Misrepresentations regarding custodial responsibilities
- Exploitation of tax-deferred account characteristics
- Lack of information for alternative investments
For example, in SEC v. United American Ventures, the SEC charged two companies and four individuals for allegedly promising guaranteed returns in investments in medical technologies and raised money for their alleged scam through self-directed IRAs. The individuals charged allegedly used self-directed IRAs to raise money for their scam through bonds, and they raised almost $3.5 million through these bonds. On March 2, 2012, a federal court in New Mexico found in favor of the SEC and ordered United American Ventures liable to disgorge $8,652,942 and pay prejudgment interest of $426,430. The court also assessed civil penalties of $1,000,000 against two of the individuals involved. For the court’s full decision go here.
To avoid this type of fraud, avoid unsolicited investment offers, ask questions, be wary of guaranteed returns, and do your homework. For more information on this alert, go here.