SEC Info About Self-Directed IRAs and the Risk of Fraud

The SEC’s Office of Investor Education and Advocacy has issued an Investor Alert about the risk of fraud in self-directed IRAsi. Because the self-directed IRA allows the investor to invest in a broader array of assets and to have more control, there have been fraudulent schemes designed to take advantage of them. High fees and volatile performance are also prevalent.

The bulletin explains the basics of Self-Directed IRAs this way: “An Individual Retirement Account (IRA) provides investors with certain tax benefits for retirement savings.  Some common examples of IRAs include the traditional IRA, Roth IRA, Simplified Employee Pension (SEP) IRA, and Savings Incentive Match Plan for Employees (SIMPLE) IRA.  All IRA accounts are held for investors by custodians.  Custodians may include banks, trust companies, or any other entity approved by the Internal Revenue Service (IRS) to act as an IRA custodian.  Most IRA custodians limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds, and CDs.  

A self-directed IRA is an IRA held by a custodian that allows investment in a broader set of assets than is permitted by most IRA custodians.  Custodians for self-directed IRAs disclaim most duties to investors and may allow investors to invest retirement funds in “alternative assets” such as real estate, promissory notes, tax lien certificates, and private placement securities.  Investments in these kinds of assets may have unique risks that investors should consider.  Those risks can include a lack of disclosure and liquidity — as well as the risk of fraud.”

One scheme involves “digital assets.” These include crypto currencies. The allure of things like Ethereum and Bitcoin make it easier for fraudsters to lure investors with inflated profit projections. It is a wild, wild west type of situation with these crypto accounts.

Because self-directed account custodians have limited duties regarding investigating assets, it opens opportunities for fraudsters to take advantage. Ways in which they do this include:

  • Exploiting Account Characteristics – If there is a fraudster attacking an account, they can have an advantage due to the lack of oversight of the account. Many investors fear penalties for incorrect transactions, so they tend to leave the account alone to avoid them.
  • Custodial Responsibilities Misrepresentations – At times, fraudsters have misrepresented to investors that there is a greater level of oversight of their account and protection from losses.
  • Limited Information About Investments – Due to limited requirements for checking out investments by custodians, investors can be fooled into poor or even fraudulent investments.

These are areas of weakness that are exploited with fraud.

Avoidance Methods

To reduce your risk of fraud in a self-directed retirement account:

  • Unsolicited offers should be avoided. Fraudulent offers are usually received unsolicited.
  • When you view statements, verify the current value of the investment as best you can.
  • Question actively. Ask about everything related to the investment and the offeror. Are they licensed or registered? Is the investment registered with the SEC or other appropriate agency?
  • Guaranteed returns are always suspect. Especially suspect are investments purported to be low risk but high return. Generally, the return on an investment tracks with the risk. The higher the risk the higher the return.
  • Consult with professionals. If a professional investment advisor or consultant is not familiar with the investment and approves of it, be wary.

Everyone wants the best performance from their investments, but do not succumb to offers that seem too good to be true. Investigate everything.

i Investor Alert: Self-Directed IRAs and the Risk of Fraud, SEC.gov

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