Risk of Using Self-Directed IRAs
Investors may be intrigued by self-directed IRAs for various reasons, but it is important to also be aware of the risk that they can pose, particularly when it relates to investment fraud. This risk is significant enough that the Securities and Exchange Commission (SEC) published an Investor Alert to warn of the danger. While it is possible to pursue legal action against an individual who commits fraud, many scammers use custodians to give themselves a veneer of credibility.
What are Self-Directed IRAs?
An Individual Retirement Account (IRA) is a vehicle for saving for retirement while offering certain tax benefits. Custodians or trustees are responsible for holding IRA accounts for the investor. Some examples of custodians or trustees include banks or trust companies.
A self-directed IRA is different because the range of potential investments is much greater than a normal IRA. As opposed to ordinary IRA custodians, which are limited to investing in their firm-approved stocks, bonds, mutual funds, and certificates of deposit, custodians of self-directed IRAs can invest in real estate, promissory notes, and private placement securities. The downside of self-directed IRAs is there are different risks, including the potential for fraud.
The large amount of money held in self-directed IRAs (estimated at $94 billion in 2011 by the Investment Company Institute) makes them a popular target for fraudulent behavior. Individuals can commit fraud by misrepresenting the responsibilities of custodians in order to falsely lead investors to believe that their investments are protected against loss. Frequently, this is accomplished by leading investors to believe that self-directed IRA custodians complete an investigation of every investment. However, custodians frequently do not have to evaluate the quality of investments. Further, it is common for agreements to explicitly state that custodians are not responsible for the performance of investments.
Another way in which individuals can commit fraud in relation to self-directed IRAs is by taking advantage of limited information available to investors. This is because self-directed IRAs allow for investment in real estate, mortgages, precious metals, and private placement securities. These securities are not publicly traded and, as a result, do not have as much information readily available to investors. Further, even if information is made available, self-directed IRA custodians often do not verify whether this information is accurate or not.
There are numerous ways for investors to help protect themselves against fraud, including:
- Staying away from unsolicited offers: regardless of who the offer comes from, investors should use caution when someone claims to have a great investment opportunity. This is particularly true if the investment involves moving from a traditional IRA to a self-directed IRA;
- Gathering information: determine whether the person offering is licensed and the investment registered;
- Being cautious of guarantees: remember that all investments carry some level of risk. Further, high rates of return come with higher levels of risk. Promoters of investments who make promises of large returns, without discussing the risks, should be a red flag for investors.
For more information about the legal remedies for investment losses related to fraudulent behavior, contact an experienced securities law attorney today. At the Silver Law Group, we represent individuals through the process of arbitration and mediation, as well as in state and federal court.
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