Someday a stranger or even someone you think you know well and trust may offer you a “can’t miss” investment opportunity promising high returns with “little or no risk,” to be owned and held in your self-directed Individual Retirement Account. Run the other way.
All IRA accounts are held for investors by custodians or trustees, typically a bank, trust company or broker-dealer. Custodians of conventional IRAs usually limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds and CDs.
Conversely, custodians of self-directed IRAs will permit a broader universe of investments, such as real estate and unregistered securities. Because it is unlikely the custodian will investigate whether the unregistered security or promoter are legitimate, you can see why fraud promoters love self-directed IRAs.
In response, the Securities and Exchange Commission and the North American Securities Administrators Association (Indiana Securities Commissioner Chris Naylor is a board member) issued a joint investor alert in September 2011, “Self-Directed IRAs and the Risk of Fraud,” which can be found on the SEC’s Investor.gov website.
The alert lists three areas a fraudster can exploit:
• Fraud promoters can misrepresent the responsibilities of the custodian by stating or suggesting the custodian validates the investment and promoter. This is almost never the case.
• Since there is the same early withdrawal penalty as with other tax-deferred retirement accounts, investors may be induced to keep funds in a fraudulent scheme longer.
• Unregistered securities may have comparatively little readily available information needed to make a prudent decision.
To avoid fraud:
• Understand custodians often list the value of alternative investments as the original purchase price or a price provided by the promoter, neither of which may reflect the price at which the investment could be sold, if at all.
• Ask if the person offering the investment is licensed and whether the investment is registered or exempt by statute from registration. Go to the “education” tab at www.SEC.gov or the Indiana Securities Division website at www.IN.gov/sos/securities.
On Aug. 23, 2013, the SEC charged John K. Marcum of Noblesville with defrauding at least 37 investors of more than $6 million in a Ponzi scheme. Marcum is accused of telling potential investors he could earn big returns day-trading stocks and that their principal would be guaranteed. According to the complaint, Marcum assisted many of his investors in setting up self-directed IRA accounts at several trust companies and provided them with fictitious statements indicating annual returns of 20-percent plus, with no monthly losses.
The SEC charged what little trading Marcum did was unsuccessful. In addition, the agency said, Marcum used investors’ money as collateral for a line of credit that was used to finance several startup businesses, including a bridal store, a bounty hunter reality TV show and a soul food restaurant operated by the bounty hunters. Marcum is also accused of using more than $500,000 of investor funds on personal expenses, including $50,000 to Mercedes-Benz.•
Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or email@example.com.