Concerns about potential risks, lack of transparency, liquidity and possible fraud of self-directed individual retirement accounts will likely lead to tougher restrictions by regulators on broker/dealers that market and sell the products. On Sept. 23, both the Securities and Exchange Commission (SEC) and the North American Securities Administrators Association issued an investor alert warning about investing through self-directed IRAs.
As reported Oct. 2 by Investment News, self-directed IRAs are different from traditional IRAs because they allow owners of the products to invest their retirement savings in a variety of unusual investment vehicles. Those vehicles can include real estate, promissory notes, tax lien certificates, and private-placement securities. Investors in traditional IRAs are generally limited to stocks, bonds and mutual funds.
Private placements in particular have become a cause of concern for investors recently. In 2009, the SEC filed fraud charges against two issuers of failed private placements: Medical Capital Holdings and Provident Royalties LLC. Investors who held private placements in the two entities lost hundreds of millions of dollars. Meanwhile, the placements were allowed to be recommended into IRAs.
According to NASAA, there has been a noted recent increase in reports or complaints of fraudulent investment schemes that utilized a self-directed IRA as a key feature. State securities regulators also are investigating numerous cases where a self-directed IRA was used in an attempt to lend credibility to a fraudulent scheme.
Similarly, the SEC has brought numerous cases in which promoters of fraudulent schemes steered investors to self-directed IRAs.
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 SEC says fraudsters often exploit self-directed IRAs because owners are allowed to hold unregistered securities in them, and custodians often fail to performed adequate due diligence on the offerings.
Moreover, because there is a penalty for making early withdrawals from an IRA, investors caught in a scheme might actually be encouraged to keep the money in the account even longer.
Many big broker/dealers have already imposed restrictions or increased their due diligence on investments made through self-directed IRAs. A number of smaller and midsize firms have yet to follow suit, according to the Investment News article.
The reason is because of the higher profit margins that typically come with riskier product offerings.