Increased Flexibility Means Added Risk for IRAs

Self-directed Individual Retirement Accounts (IRAs) have become a favorite among investors looking to gain flexibility and increased control over their retirement portfolios. In fact, investments in the products have gone up by 25 to 50 percent over the past few years, according to some estimates. Unfortunately, investors interested in adding flexibility for the sake of higher yields are also taking on more risk, including the risk of investment fraud - a fact some investors may not know.

While, the market for the flexible IRAs is small (a mere 2 percent of the general IRA market), the products are quickly becoming a favorite among Ponzi schemers and con artists. To help alert investors to the possibility of fraud, the NASAA recently announced that complaints against the products are on the rise. And, last month, the SEC issued an investor alertthat warned investors interested in the products about the increased possibility of fraud, such as the alleged fraud that occurred in the United American Ventures case.

In SEC v. United American Ventures, the SEC alleged that the defendants "promised guaranteed returns in purported investments in medical technologies and raised money by convincing investors to invest through self-directed IRAs and steering them to custodians who offered the self-directed IRAs." A little over one-third of the $10 million in bonds sold through the alleged scheme came from funds in self-directed IRAs.

According to the SEC, fraud promoters are particularly drawn to self-directed IRAs because they allow people to invest in unregistered securities while the account trustees have not had the chance to investigate the investment or individual promoting the investment.

To protect themselves, the SEC recommends investors watch out for the following marketing tactics:

Misrepresentations regarding custodial responsibilities. Custodians of self-directed IRAs simply hold and administer assets, rather than evaluating things like quality or legitimacy of the investment.

Exploitation of tax-deferred account characteristics, which can cause self-directed IRA investors to stay in a fraudulent scheme longer than other investors because they do not want to pay the financial penalties for early withdrawal.

According to the OIEA and NASAA,

Lack of information for alternative investments. Self-directed IRAs usually allow investors to hold alternative investments such as real estate, mortgages, tax liens, precious metals, and private placement securities. Unlike publicly traded securities, financial and other information necessary to make a prudent investment decision may not be as readily available for these alternative investments. Even when financial information for these alternative investments is available, it may not be audited. Furthermore, self-directed IRA custodians usually do not investigate the accuracy of this financial information. This lack of available information for alternative investments makes them a popular tool for fraud promoters' schemes.

For additional tips on how to avoid investment schemes, read our article on scam-proofing your portfolio here.


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