While every investment carries some degree of risk, alternative assets held in self-directed IRAs have some risks that differ from standard IRAs offered by registered broker-dealers and investment advisors (i.e. Vanguard, Merrill Lynch, etc.) that tend to offer only traditional investments such as publicly traded stocks, bonds, and mutual funds. Custodians for self-directed IRAs may allow investors to invest retirement funds in “alternative assets” such as real estate, precious metals, cryptocurrency, private placement securities, promissory notes, and tax lien certificates. Investments in these kinds of assets have unique risks that investors should consider. Those risks can include the lack of legal and regulatory protection, lack of information and liquidity, and a heightened risk of fraud. However, as long as investors consistently practice due diligence and work with credible custodians, the benefits of a self-directed IRA far outweigh the potential risks.
WHAT IS A SELF-DIRECTED IRA?
A self-directed IRA is an IRA held by a custodian or trustee (“custodian”) that offers investors the opportunity to invest in alternative assets and the power to take more control of their retirement goals. A self-directed IRA means that the investor has complete decision-making power on the investments held in the IRA. Unlike a stock, bond, or mutual fund, where others either manage or control the investment, the IRA holder is in total control of choosing the investments. The investor’s freedom of choice regarding his/her own investments comes with a large responsibility: Due Diligence. Researching and vetting investment opportunities is paramount to a self-directed IRA holder’s success. It’s also a crucial step for the investor to avoid fraudsters who work to exploit self-directed IRA holders.
WARNING: FRAUDSTERS HAVE USED SELF-DIRECTED IRA CUSTODIANS TO EXPLOIT SELF-DIRECTED IRA HOLDERS
Occasionally, an IRA investor is approached by, or is working with, an investment sponsor/precious metals dealer/advisor/broker/salesperson (“promoter”) who is offering an investment opportunity not available through the investor’s current IRA custodian. The promoter directs the investor to transfer funds from the original IRA to a self-directed IRA custodian to facilitate the transaction. Fortunately, a majority of these investment opportunities are legitimate and transferring funds from the original IRA to a self-directed IRA is just part of the process. However, because self-directed IRAs allow for alternative asset investment, they are more prone to fraud than standard IRAs. Fraud promoters who want to engage in Ponzi schemes or other fraudulent conduct may exploit self-directed IRAs because custodians of these accounts permit investors to hold unregistered securities and the custodians of these accounts likely have not investigated the securities or the background of the investment sponsor. Fraudsters may misrepresent the custodian’s duties by falsely claiming that because a legitimate custodian holds the self-directed IRA that the investments within it have been validated, approved, and protected by the self-directed IRA custodian. In reality, the custodian only handles the administrative work and does not verify the investment’s legitimacy. Using a legitimate custodian to buy an investment DOES NOT make that investment legitimate. Fraudsters might still attempt to sell you fraudulent investments through legitimate custodians.
WHAT A SELF-DIRECTED IRA CUSTODIAN DOES:
While self-directed IRAs can be a safe way to invest retirement funds, investors should understand that self-directed IRA custodians have limited duties to investors. Generally, these duties include:
- Processing applications to establish IRAs.
- Holding and administering the assets in the account.
- Executing investment directions from the IRA owner.
- Simply serving as an independent third party between the IRA owner (investor) and the issuer of the investment.
- Performing the many custodial and administrative duties that are necessary to preserve the tax-deferred status of an IRA.
- Providing IRA statements to the account owner which include transactions and assets held in the account.
- Perform tax reporting of IRA Forms 1099-R and 5498 as required by the IRS.
WHAT A SELF-DIRECTED IRA CUSTODIAN DOES NOT DO:
- Provide tax or legal advice.
- Have a fiduciary duty to IRA holders.
- Recommend, guarantee, or endorse investments.
- Sell investment products or provide investment advice.
- Furthermore, most custodial agreements between a self-directed IRA custodian and an IRA investor explicitly state that the self-directed IRA custodian has no responsibility for investment performance.
- Recommend or endorse investment sponsors or precious metals dealers.
- Perform due diligence on any investment or investment sponsor (agreeing to custody an investment is not an endorsement or approval of the investment, or that the investment sponsor is safe or “legitimate”.)
- Verify the accuracy of any financial information that is provided for an investment in the IRA.
- Determine the suitability of any investment for the IRA owner.
- Verify the accuracy of the information on the investor’s statement, including the value of the investment (even though an account statement provided by a self-directed IRA custodian may show an increase in the value of the investments in the account, this information has NOT been verified for accuracy by the custodian).
SELF-DIRECTED IRA INVESTORS HAVE THE SOLE RESPONSIBILITY FOR EVALUATING AND UNDERSTANDING THE INVESTMENTS IN THE IRA
The potential for greater returns comes with greater risk. Understanding the crucial trade-off between risk and reward can help investors separate legitimate opportunities from unlawful schemes.
COMMON SIGNS OF POTENTIALLY FRAUDULENT INVESTMENTS
- Guaranteed high returns with little to no risk.
- All investments carry some level of risk. Claims of “risk-free”, “safe”, or “guaranteed” high returns are a major hallmark of fraud.
- Pressure to act immediately.
- Promoters may use aggressive or high-pressure tactics to create a false sense of urgency. A legitimate financial professional will never rush an investor into a major decision.
- Unsolicited offers.
- Be extremely cautious of any unsolicited investment offers received via cold calls, emails, or social media, especially those promoting a self-directed IRA.
- Lack of licensing or registration.
- Always verify that both the person offering the investment and the investment itself are properly registered with regulators like the SEC or a state securities regulator. Alternatively, verify that the investment is exempt from registration.
- Vague or complex details.
- If a promoter can’t clearly explain how the investment works, where your money is going, and how it will generate a profit, it’s a red flag. Legitimate professionals should provide clear information.
- “Inside” information on an investment.
- Never trust “inside” information. Do not act on rumors, “hot tips”, or promises of special access to exclusive investments.
WHAT SHOULD SELF-DIRECTED IRA OWNERS DO WHEN EVAULATING AN INVESMENT OPPORTUNITY?
Fraudsters are counting on investors not to investigate before they invest. Self-directed IRA owners should do their own due diligence. It’s not enough to ask for more information or for references – fraudsters have no incentive to set you straight. Take the time to do your own independent research.
- Invest in what you know – Do you understand the investment?
- Never invest in something you don’t understand.
- Research the validity of the asset.
- Review the website.
- Read the prospectus, private placement memorandum, or other offering documents carefully for professionalism and degree of sophistication of the parties involved.
- Are there typos?
- Does it look professional? Is the document all in the same font, etc.?
- Are there other errors in the document? Does another company’s name appear in the document? If so, the investment sponsor may have used another company’s document and missed updating the company name.
- Does the document list all of the risks, name the attorneys and accountants they are working with, and explain the purpose of the investment funds, etc.?
- The greater the sophistication of the documents and the website, the lower the potential risk.
- Research the investment thoroughly.
- Complete an internet search on the name of the investment with key terms such as “complaints”, “lawsuits” or “fraud” (ex. ABC, LLC complaints – ABC, LLC lawsuits – ABC, LLC fraud).
- Check for negative news, complaints regarding fraud, non-payment, or not being able to get in touch with the investment sponsor, etc.
- Complete a Better Business Bureau (“BBB”) search on the investment sponsor and check their BBB rating, complaints and reviews.
- Ask the person offering the investment if the investment is registered, then check out the answers with an unbiased source, such as the SEC or your state securities regulator.
- Check to see if the investment is registered with the SEC or is exempt from registration. Search the SEC’s EDGAR database https://www.sec.gov/edgar/searchedgar/webusers.htm.
- Understand the possibility of a lack of information and liquidity.
- Self-directed IRAs allow investors to hold alternative investments that may only provide limited disclosures, financial and otherwise. Even when financial information is available, it might not be audited by a public accounting firm. In addition, alternative investments might also lack liquidity either because of extended holding periods, restrictions on redemptions, limited markets or some combination of these factors. This can make it difficult for investors to easily sell these investments when wanted or needed, including when you retire or when you have to take RMDs.
- Research the Principals of the investment (i.e. general partner of the limited partnership, president of the company, manager of the LLC, etc.).
- Do an internet search on all of the Principals of the asset with key terms such as “complaints”, “lawsuits” or “fraud” (ex. Joe Principal complaints – Joe Principal lawsuits – Joe Principal fraud). The name of the asset may need to be included in the search to narrow down the results.
- Know the salesperson
- Spend some time checking out the person offering the investment before investing – even if you already know the person socially.
- Ask the salesperson offering the investment if he/she is licensed.
- Verify whether the salesperson is licensed to sell securities in your state and whether they or their firms have had run-ins with regulators or other investors.
- Investor.gov has a free and simple search tool https://www.investor.gov/introdution-investing/getting-started/working-investment-professional/check-out-your-investment-professional
- Be wary of affinity fraud. This common scheme involves fraudsters who infiltrate a tight-knit community, such as a religious or ethnic group, to build trust. They then use that trust to pitch fraudulent investments to group members.
- Consult a professional. Consider getting a second opinion from a trusted financial advisor or an attorney.
- Carefully review each account statement and follow up with questions to the investment sponsor if you do not understand it or something does not make sense or seems suspicious.
- Verify custodian legitimacy.
- Self-directed IRA custodians must be IRS-approved. Before opening an account, research your custodian and ensure they are appropriately licensed and approved by the IRS.
- Trust your gut.
- If something feels off, you should ask additional questions and further your due diligence. If you cannot get yourself comfortable with the investment, you should probably walk away.
ADDITIONAL CONSIDERATION FOR PRECIOUS METALS DEALERS
- There are 2 main things to be wary of:
- Excessive commissions and overcharging of metals.
- Non-delivery of purchased metals.
- Compare the price of the metals that are being sold to you vs. the spot price or prices on public websites such as bullionvalues.org.
- PM dealers do charge commissions and are in business to make a profit, but are the commissions and mark-ups excessive?
- Do an internet search on the precious metals dealer with key terms such as “complaints”, “lawsuits” or “fraud”.
- Complete a Better Business Bureau (“BBB”) search on the precious metals dealer and check their BBB rating, complaints and reviews.
- Are there complaints about non-delivery, excessive costs, not being able to get in touch with the dealer, or clients not receiving return phone calls?
CONCLUSION
Investing in alternative assets through a self-directed IRA can be safe and lucrative. Self-directed IRA investors should understand the unique risks involved and be committed to completing their own due diligence on the investment itself and the person offering the investment. Knowledge is power in choosing an appropriate investment and avoiding risk.