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Scammers Are Targeting Your Retirement Funds

Be careful investing with self-directed IRAs, a new favorite of con artists

By Robert Powell | MarketWatch | August 25, 2014

At a time when it’s almost impossible to earn much interest on bonds, and equities seem too risky, some retirement savers are investing their Individual Retirement Accounts in nontraditional investments. But beware of schemes that threaten your retirement, particularly through self-directed IRAs.
 
The North American Securities Administrators Association (NASAA) reports that self-directed IRAs pitched by con artists are now among the top 10 threats facing investors.
 
To be sure, self-directed IRAs can be a safe way to invest retirement funds, NASAA said in issuing the warning. But investors should be mindful of potential fraudulent schemes when considering a self-directed IRA.

(MORE: The Growing Danger of Penny Stocks)

What is a Self-Directed IRA? 
 
By way of background, a self-directed IRA is “an IRA held by a trustee or custodian that permits investment in a broader set of assets than is permitted by most IRA custodians,” according to the Securities and Exchange Commission (SEC). “Most IRA custodians are banks and broker-dealers that limit holdings in IRA accounts to firm-approved stocks, bonds, mutual funds, and CDs. Custodians and trustees for self-directed IRAs, however, may allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, tax lien certificates, and private placement securities.” 
 
These sorts of investments are not inherently bad, but NASAA, SEC and others warn that such investments have unique risks, such as lack of disclosure and liquidity, that must be considered.
 
What’s more, NASAA is warning investors that “fraud promoters pushing a Ponzi scheme or other investment fraud can misrepresent the responsibilities of self-directed IRA custodians in order to deceive investors into believing that their investments are legitimate or protected against losses.”
 
For the record, custodians and trustees of self-directed IRAs may have limited duties to investors. “While a scam artist may suggest that self-directed IRA custodians analyze and validate investments, those custodians only hold the assets in a self-directed IRA and generally do not evaluate the quality, value or legitimacy of any investment,” NASAA said.

(MORE: How to Identify and Prevent Investment Fraud)

Beware Requests to Transfer Self-Directed IRAs
 
In some cases, NASAA said, fraud promoters convince investors to move assets from an existing self-directed or traditional IRA into a fake self-directed IRA held by a supposed custodian (created and owned by the scam artist).
 
Fraudsters also exploit the tax-deferred characteristics of self-directed IRAs, knowing that the financial penalty for early withdrawal may cause investors to be more passive or to keep funds in a fraudulent scheme longer than those who invest through other means, NASAA said.
 
Meanwhile, IRA experts say there is plenty that investors who want to use self-directed IRAs can do to avoid dealing with scam artists.
 
How to Stay Safe
 
The first item on your punch list when thinking about self-directed IRA is this: Does the investment fit in with your overall plan?

“Be sure your IRA investment is consistent with your investment goals, risk tolerances and experiences,” said James Jones, founder and CEO of the Self-Directed IRA Investment Institute and vice president of business development for Kingdom Trust Co.

(MORE: Best Ways to Invest an IRA)
 
Jeremy Rettick, an investment adviser representative of BCM and the chief marketing officer of Covenant Reliance Producers, says it’s essential that the investment fits your risk profile.

“As the old saying goes, ‘Don’t put all your eggs in one basket,’” said Rettick. “If you decide that a self-directed IRA is the right option for you, consider only placing a portion of you total retirement dollars within the plan. As always, consider how much risk you are taking on and if it is in line with your overall risk tolerance.”
 
Invest Time Before Investing Your Money
 
Next, spend some time vetting everything and anything having to do with your self-directed IRA — the investment, the adviser and the custodian — before  investing your money.
 
Consider first what Rettick calls the “Warren Rule.”
 
“As Warren Buffett said, ‘Never invest in a business you can’t understand,’” said Rettick. “This philosophy has worked well for Mr. Buffett and could pay dividends to the investor. There are many nontypical investments available within self-directed IRAs. Bottom line: investors need to understand what they are investing in.”
 
Jones holds that same point of view. “The most important advice I give investors of self-directed IRAs is: You should know your alternative asset class and, more specifically, the actual investment better than your financial planner knows stocks, bonds and mutual funds.”
 
Whether you plan to invest your self-directed IRA in real estate, private equity or debt, crowdfunding or precious metals and the like, Jones said “you should already be investing in these categories with good knowledge, experience, networks and advisers.”

Be Vigilant About All Investments
 
Rob Spalding, the founder and senior adviser with Alternative Solutions Group, noted: “Investors should always be vigilant about any investment they make, whether with mutual fund fees or due diligence on a private investment offer involving a self-directed IRA. Ultimately, investors need to be mindful of the investments they make inside or outside of self-directed IRAs.”
 
Rettick said investors also need to be mindful of the following:
 
Liquidity: Do you have to keep money invested for a certain period to avoid any early withdrawal penalty?
 
Investment values: Ask how the value of your investments will be calculated on your statements. Custodians may list the value as reported to them by the promoter but the price may not accurately reflect the price at which the investment could be sold.
 
“Guaranteed” returns: Is the investment FDIC-insured? If not, what is guaranteed and how is it guaranteed?
 
Fees and Commissions: The salesperson must tell you about any commissions or fees. Make sure you know how much you are paying and whether the amount is competitive with what others charge for a similar investment.
 
Tax consequences: Talk to an accountant to understand them. The IRS has numerous prohibited transactions that could disqualify the IRA’s tax-deferred status, forcing you to pay income taxes on the full value of the IRA.
 
Jones also recommends asking a trusted professional, such as your accountant, lawyer or financial adviser, for a second opinion about the proposed self-directed IRA investment. Have this pro review the investment offering or subscription agreement.
 
Know Your Custodian
 
Besides knowing your investment, it’s imperative that you get to know your custodian and the people behind the investment.

“Remember, you are now the investor and adviser,” said Jones. “Do your own extensive due diligence of not only the investment offering, but the company and its officers. You should only invest in asset classes you know, with people that you know. You should never invest with strangers.”
 
Rettick also recommends you make sure your funds will be held by a credible independent trustee/custodian. “Typically you can talk to your bank, credit union or a well-known custodian,” he said. “If the promoter holds the funds directly, that is a huge red flag.”
 
The trustee/custodian isn't required to conduct due diligence with respect to the quality or suitability of the investment. So "ask your IRA custodian what fraud detection measures they have in place, such as checking the company’s good standing with regulators and authorities in the state they do business,” said Jones.
 
What’s more, Jones noted that neither your IRA custodian nor any governmental agency endorses or guarantees non-FDIC insured investments. “While IRA custodians can educate investors on alternative asset classes, they can never advise, direct or steer them to an investment,” said Jones. “If an investment sponsor is promoting self-directed IRAs, check with that IRA custodian to see if they in fact have a relationship.”

Vet Your Investments and Advisers
 
Additional resources for investors who want to vet their custodians for self-directed IRAs can be found at the Retirement Industry Trust Association, a trade association for custodians that aims to enhance industry best practices and fight investor fraud.
 
The self-directed IRA business has been around for a while, but it’s growing rapidly and there are plenty of newcomers to the business. That’s why Spalding recommends that you work only licensed and regulated advisers.
 
“Beyond healthy skepticism, self-investigation and asking the investment sponsor for substantial due diligence items, investors should consider working with licensed financial advisers, especially registered investment advisers (RIAs) who have experience with financial due diligence and alternative investments,” Spalding said. RIAs are generally regulated by the SEC or their state securities division.
 
At a minimum, the SEC suggests that you make sure your brokers, investment advisers, and investment adviser representatives have not had disciplinary problems or been in trouble with regulators or other investors before you invest or pay for any investment advice. Resources for background checks include: the SEC, NASAA and the Financial Industry Regulatory Authority.
 
Watch for Red Flags
 
Jones also suggests looking out for red flags including such as an unknown solicitation coming to you, "guaranteed" investment returns, high-pressure sales techniques, short investment decision timelines requiring immediate action to complete the transaction and too-good-to-be-true statements.

“Scam artists know investors decide too often on emotional decisions and not careful analysis,” said Jones. “Be prepared to walk away from every deal, and trust your gut.”
 
Additionally, with the pending Federal JOBS Act legislation and the formalization of equity-based crowdfunding, Spalding said the need for investors to be watchful of their investments is only going to intensify.
 
After You Invest
 
Once you’ve opened a self-directed IRA, Jones recommends that you carefully review each account statement and follow up with questions to the investment sponsor if you do not understand it or something doesn't make sense or seems suspicious. “Review these statements with your advisers and never alone,” he said.
 
Remember too that the IRA custodian maintains your account and forwards account information to you but it is not responsible for any profits or losses on your investments, said Jones.
 
And, if you ever suspect suspicious activity related to the investments in your self-directed IRA, Jones says, report it to your IRA custodian as well as state and federal authorities.
 
Robert Powell is a MarketWatch Retirement columnist. He has been a journalist covering personal finance issues for more than 20 years. Follow him on Twitter @RJPIII.