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