Beware of Investments that Require a New IRA Custodian

About twelve summers ago, I sat out on the veranda of an old Victorian house in Kannapolis, North Carolina. The lady of the house, Mrs. B., had set up a card table for us to work on and had placed at the center a bulging brown accordion file. It held every paper Mrs. B had saved that related to her investment in a Ponzi scheme called “ETS Payphones.” She told me that an engaging insurance salesman she met through the church had visited one day to explain to her how she could double the money in her IRA by investing in ETS Payphones. A couple years after Mrs. B’s money went in, ETS crashed and burned, as Ponzi schemes inevitably do. It has been hard times for her ever since. She had taken a part-time job at a pharmacy and had been trying to sell her house, all at age 67.

Mrs. B. brought two tall glasses of ice tea out to the veranda and we bent to the task of sifting through the wreckage of her financial security. We came across a separate folder in her brown accordion ETS file, an inch of papers all bearing the stately name and logo of “The Dependable Fidelity Trust Company” (I vividly remember the company’s real name, but I’m not using it here). After we leafed through the documents in the “Dependable Fidelity” folder, we had this discussion:

Me: What’s this Dependable Fidelity Company?

Mrs. B: I don’t exactly know, except they keep sending me statements about ETS and charging me a fee for whatever it is they’re doing for me.

Me: Looks like you moved the retirement money in your IRA from your bank here to these ‘Dependable Fidelity’ people in Chicago, to be the new IRA custodian. Why did you do that, I wonder?

Mrs. B: It certainly wasn’t my idea. The ETS salesman said that’s just what they do. When you’re putting IRA money into the ETS Payphone program, they need for the money to come in through Dependable Fidelity. He had the Dependable Fidelity forms with him, and so I just signed all those at the same time I signed up for ETS.

Since that summer afternoon in Kannapolis, I have leafed through the files of many Ponzi scheme victims and am not much surprised to see the stately names and logos of “self-directed IRA custodian” firms like Dependable Fidelity. Here’s what I’ve learned:

• An IRA custodian is a financial institution like a bank, trust company, or a securities brokerage firm that holds the customer’s IRA assets, performs the custodial and administrative duties needed to preserve the IRA’s tax-deferred status, and follows directions from the IRA owner about how to invest the IRA holdings.
• “Traditional” IRA custodians will follow the IRA owner’s instructions to invest IRA assets in firm-approved stocks, bonds, mutual funds, and CDs, but may decline to follow an owner’s instructions to buy “non-traditional” investments like promissory notes, tax-lien certificates, and private placement securities. Investments in these kinds of assets may involve risks such as lack of disclosure and liquidity, and fraud.
• A “self-directed” IRA custodian—as opposed to a “traditional” IRA custodian–is an IRA custodian who will permit the owner to invest in a broader range of “alternative” investments that may include promissory notes, precious metals, tax lien certificates, private placements, and the like.

So, the ETS Payphone salesman who pitched Mrs. B. needed to get her transfer her IRA from the “traditional” IRA custodian—that is, her bank in Kannapolis (which might have balked at an instruction from her to buy ETS using her IRA money) to “Dependable Fidelity”- a “self-directed IRA custodian” that would follow her investment instructions and process the purchase of ETS Payphones for her IRA.

The Securities Exchange Commission has noticed “a recent increase in reports or complaints of fraudulent investment schemes that utilized a self-directed IRA as a key feature” and “has brought numerous cases in which promoters of fraudulent schemes steered investors to self-directed IRAs.” In September 2011, the SEC issued an Investor Alert on this topic. Here are some excerpts from that Alert:

• …fraud promoters who want to engage in Ponzi schemes or other fraudulent conduct may exploit self-directed IRAs because they permit investors to invest in unregistered securities and the custodians or trustees of these accounts likely have not investigated the securities or the background of the promoter. There are a number of ways that fraud promoters may use these weaknesses and misperceptions to perpetuate a fraud on unsuspecting investors. For example: fraud promoters can misrepresent the responsibilities of self-directed IRA custodians to deceive investors into believing that their investments are legitimate or protected against losses.

There are about 45 firms out there providing custodial services for self-directed IRAs. Among these are Vantage IRA, Equity Trust, Provident, Millennium Trust, Entrust, and Advanta. Please note that the SEC’s “Investor Alert” does not state or imply that these kinds of firms are breaking any law or cheating or defrauding their customers or the investing public, or that they are knowingly in league with anybody who is. Nor am I stating or implying any such thing. Instead, the SEC’s message to investors, which is important, timely and worth repeating here, is:

While self-directed IRAs can be a safe way to invest retirement funds, investors should be mindful of potential fraudulent schemes when considering a self-directed IRA.

The attorneys at ChapmanAlbin have been representing investors of investment fraud since 1998. If you have lost money due to your broker’s negligent or fraudulent investment advice, contact us for a free, no obligation consultation.