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Self-Directed IRA Custodians Sued by Investors

May 2, 2012 by Tracy Z 5 Comments

Watch out note buyers!  The self-directed retirement account, a popular vehicle for purchasing notes, is under attack!

Buying-Notes-in-Retirement-AccountsTired of dismal returns in the stock market many investors turned to buying real estate, private mortgage notes, and other alternative cash flows.

They combined the power of high returns and compounding interest with the tax advantages of the IRA, Roth, Solo 401k, and other retirement accounts.

The self-directed IRA has a designated custodian that handles the paperwork and other administrative duties for the retirement account. Now these custodians are being sued by disgruntled investors reports the Wall Street Journal.

A wave of blowups in do-it-yourself individual retirement accounts has prompted some investors to go after firms that handle the paperwork.

Two custodians of self-directed IRAs were sued in U.S. District Court in Los Angeles on Monday by three investors who allege that the companies knew the investors’ money had been stolen by scam artists yet sent them reports showing their nest eggs to be intact.

Source: Article published April 17, 2012 by Kelly Green of WSJ entitled New Suits Over Do-It-Yourself IRAs.

I guess somebody missed the point of a self-directed account (and all that big bold disclaimer language on the forms the custodians make you sign)…

All investment decisions are made and directed by the account owner!

Fortunately the WSJ article went on to point this out:

Custodian firms administer the accounts, sending investment statements and transferring money from investors to investment managers. It isn’t clear how successful the suits will be, since even regulators note that custodians don’t choose the investments or take fees based on the investments’ success.

Still, the claim filed Monday underscores the recent concerns over self-directed IRAs. More such lawsuits are likely, experts say, as regulators combat a rising number of investment frauds involving older Americans’ retirement savings.

The suit accuses Equity Trust Co. and Entrust Group Inc. of touting the security and safety of self-directed IRAs without performing due diligence on the investment managers with which they do business. The claim also accuses the custodians of converting customers’ funds for improper use, conspiracy, fraud, negligence and elder abuse, among other charges.

You can read the lawsuit details in the full WSJ article but in a nutshell it appears account holders used their IRAs to make private loans to an investor that was networking through church groups. The investments matured, monies were not paid, and a suit was initially filed for alleged wrongdoing by the investor that solicited the loans and was later extended to include the custodians. The suit hopes to recover $5 million in damages and obtain class-action status.

Lessons from Buying Notes In Self Directed IRAs

After working for a corporate note buyer for ten years, I personally rolled my 401k funds over to a self-directed IRA and used the funds to purchase real estate notes at a discount.  Here are a few sample deals from past articles:

Retirement Account Purchases Texas Note

Seller Financing, Second Liens, and the 80-10-10

Seller Financing for IRA Investments

Later I taught classes approved as Continuing Education or CE credits for real estate agents on the topic of using IRAs to purchase notes and investment property.

In class we covered the details of avoiding prohibited transactions and disqualified persons. We’d start by getting a laugh out of my CPA’s joke on how the IRS views your money:

THE  IRS sees THEIRS

Next up was how the IRA let you keep a bit more of your hard-earned money for retirement making two important points when it came to using a Self-Directed account:

1. The good news?  You control all investment decisions on behalf of the retirement account. After all nobody minds your money like you mind your money.

2. The bad news? You can only look in the mirror to point blame if an investment goes bad.  So invest in something you know and perform due diligence.

Do I feel bad for the people who lost their money? Absolutely!

Should the investor that received the funds be held accountable for payment? Absolutely!

Is the custodian liable for the performance of investments? Absolutely NOT!

The outcome of this case will likely affect how custodians handle self-directed accounts going forward.  It could also lead to more regulation and possibly increased fees.

So what are your thoughts? I’d love to hear your opinion in a comment below!

Author Update 5/3/12: The Entrust Group (one of the custodians mentioned in the WSJ article) just published this article on self-directed IRA Investor Due Diligence by Hubert Bromma, Entrust CEO and Founder.

Filed Under: Note Buyers Tagged With: buy real estate notes, Do it yourself notes, note buyers, Self directed retirement account

About Tracy Z

Tracy combines her knowledge of real estate notes with the power of marketing online to help grow your business! She can be reached at Tracy@NoteInvestor.com or by calling 1-888-999-7905.

Reader Interactions

Comments

  1. David Coe says

    May 4, 2012 at 12:49 pm

    Tracy, good article. I think the issue to be determined on the pending SD IRA lawsuits has to do with negligence, not fraud. Where I think the custodians are most vulnerable is not on the investment vetting side. If you’ve ever asked a custodian for a recommendation or point of view of any kind, they are very careful to not give advice. And while the court will have to determine the custodian’s role in vetting the investment provider, I believe the term self-directed will ultimately hold up in court.

    Where they’re going to run into trouble is negligence. And not intentional negligence, but the type of negligence that surfaces when you’re in a low margin business that is expanding very quickly. Staffing and training are a real problem right now in this industry and mistakes like those described in the WSJ article are probably rampant:

    “She said she received regular account statements, first from Equity Trust and then from a second custodian, showing nearly $20,000 in the account—even after she learned that the investments had failed.”

    This wasn’t because the custodian was in on the scam. They just never received any notice that the money was gone. Why would they? It’s not their job to manage the investment or the provider, only to “custodian” the investment on behalf of the client’s IRA.

    The answer? I usually advise clients to stick to the bigger brands, although the 2 named in the article are 2 of the biggest and most established. Your best bet is to set up a Solo(k) which by law does not require a custodian and allows the owner of the account to act as their own custodian. If you don’t qualify for a Solo(k), then consider setting up an LLC in front of your SD IRA so you have direct control over you funds. You can research both options on our website at www. freedomgrowth. com.

    Thanks Tracy for sharing this.

    Reply
  2. Tracy Z says

    May 3, 2012 at 1:51 pm

    I love it when readers are inspired to comment! I also received an email comment I wanted to share (but will leave off the name out of respect since they did not choose to publicly post):

    Hi NoteInvestor – I read the original WSJ article when it appeared & couldn’t help think it was written by some PR firm for a Wall Street Investment house…it & your article seem to suggest that SD IRAs are somehow more risky…when that is not true. These lawsuits are bogus…Proves its still legal to be a moron!

    I happen to agree with these thoughts on the WSJ article and that the lawsuits against the custodians are bogus. I tried to convey that in my commentary after the WSJ excerpt.

    All investments have an element of risk but I would much rather trust my judgment then that of a stock broker or some corporate insider. That is why I personally use a self directed IRA.

    For the record…I am pro Self-directed IRA! I’m adding this comment to be sure that I adequately expressed this viewpoint.

    Thanks again for your comments and emails! It is always great to hear from readers. These type of topics usually get people talking (as they should)!

    All the best,

    Tracy Z. Rewey

    Reply
  3. Kent Anderson says

    May 3, 2012 at 11:02 am

    The lesson here is never use private investors’ money to buy notes and mortgages. Also, when you read your custodial agreement your IRA has with the custodian, there is a very good chance your IRA will have to fund the legal defense fees of the law suit brought against them. Another reason to stay away from private investors because if you blow a deal with your own money you won’t be suing yourself… just real bummed out. So, use your head and keep life simple, buy discounted notes and mortgages with your own money and stay away from all the risks and liability associated with private investors. You do NOT need their money to buy notes!

    Reply
  4. Carlton White says

    May 3, 2012 at 6:56 am

    More regulations will be introduced in this area. Too many people want to invest without risk and will use the government to protect them if they suffer a loss. If regulations become too onerous the self directed IRA as an investment will vanish. Custodians will be targeted as liable parties in failed transactions and will not want continue administering these accounts.

    Reply
    • Tracy Z says

      May 3, 2012 at 8:11 am

      Sadly, I agree your predictions could come true. The self-directed retirement account is one of the few tools that investors and the self-employed can use to save for their retirement with tax advantages. We sure know we can’t depend on Social Security.

      Reply

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