Self-Directed IRA Fraud: Are You A Victim?

What Are Self-Directed IRAs?

Self-directed IRAs are a type of financial instrument which allows a person to invest in a larger range of assets than a traditional IRA. Many of us are familiar with IRAs that invest in stocks, bonds, mutual funds, and certificates of deposit, but self-directed IRAs expand from these more traditional investing avenues, and also allow someone to invest in promissory notes, real estate, precious metals, private placement securities, tax lien certificates, and other investments which may not be registered.

This type of IRA is becoming increasingly popular in the United States, with about $94 billion of retirement funds invested in them. They are completely legal, when used correctly. However, some of the inherent characteristics of this financial instrument have not only attracted legitimate investments, but in addition scammers and fraudsters who use the patina of the self-directed IRAs legality to defraud investors of their life savings.

What Are The Inherent Characteristics Of Self-Directed IRAs That Make Them Susceptible To Fraud?

As with all IRAs, a self-directed IRA must be held by a trustee or custodian. However, with the more traditional IRAs the custodians are typically banks and broker-dealers who only allow investment in firm approved stocks, bonds, mutual funds and CDs. However, with a self-directed IRA the trustee or custodian has no responsibility to investigate the securities offered for investment, or the background of the promoter. Further, they also do not need to keep accurate records or perform audits. With these laxer requirements it is easy to see why those wishing to engage in fraud would be interested in using this financial instrument to perpetrate it.

The fact that this type of IRA allows investment in a broader range of assets can increase the likelihood of fraudulent behavior. For example, unregistered securities are permitted in this type of IRA. There is typically less investigation into this type of security, with less information easily available, and further there is no guarantee that any information provided has been audited. Therefore, in a situation in which more due diligence is typically required there is less opportunity to review accurate information to perform that due diligence.

In addition, the broader range of assets allowed for self-directed IRAs can create unique risks for investors that should be considered, such as lack of liquidity and difficulty in valuing assets. The result of the characteristics of these assets means that the self-directed IRA custodians will often list the value of the assets as the original purchase price, plus any gains as determined arbitrarily by the promoter. These values that are told to investors may not reflect the true value of the investment if sold on the open market. Further, because the custodians don’t have to evaluate the quality or legitimacy of the investments, and have no responsibility for investment performance, these self-promoting statements may go unchecked and unquestioned.

Finally, the fact that self-directed IRAs are a tax-deferred account can impact psychologically how much oversight an investor has over this type of investment instrument. The fact that there is a financial penalty for early withdrawal means people tend to invest in these types of accounts for the long term, when more prudent investors in these types of investments may more actively manage such accounts. This same mind set may also allow the person committing the Ponzi type scheme or other fraud to conduct their fraud longer before their misdeeds are detected.

Scott Starr, a partner in this firm, has stated, “Some of these investment advisors and stockbrokers are clearly committing malpractice and breaching their fiduciary duties” when directing individuals to invest in these self-directed IRAs. Further, he states that “It is not uncommon for these individuals to place their clients in investments that are either too high risk, carry a time horizon that is too far in the future, or fail to properly diversify these portfolios.”

Examples Of Self-Directed IRA Fraud Close To Home

Although fraudulent actions surrounding self-directed IRAs can, unfortunately, happen anywhere in the country the state of Indiana, and surrounding states, have had several instances of this type of fraud coming to light.

1.     Randell Morrison - Indiana

One of the most recent cases of self-directed IRA fraud reported in Indiana is the case of Randell Morrison, which has been reported extensively in the  Fort Wayne, Indiana Journal Gazette. http://www.journalgazette.net/article/20111120/LOCAL/311209934 On November 10, 2011, Mr. Morrison was sentenced to six years in prison, followed by a year of home detention and then one year of probation for bilking 15 investors in Indiana, mainly in the Allen County area, out of $1.4 million.

Mr. Morrison was a businessman in the community, and used his personal associations with fraud victims, including being a friend of the family, and attending country clubs, churches and social clubs with them, to gain their trust over several years. He then convinced these investors to roll their more traditional IRAs and life insurance proceeds into a self-directed IRA custodial company, called Equity Trust, with which he was associated. His victims thought they were investing their money in conservative and traditional investments, but instead once he gained control of the money he used it for his own personal use and for his businesses.

The Indiana Secretary of State, Charlie White, said, “Randell Morrison preyed on those who considered him a friend. He didn’t just gamble with their life savings, he squandered their life savings.” Many of the victims of this scheme were close to retirement age, and have now lost their entire retirement account and life savings. They have suffered not only financial losses, but also emotional and even physical distress because of the fraud perpetuated against them.

2.     Jerry Smith and Jason Snelling - Indiana

Another case in Indiana that is currently pending involves Jerry Smith and Jason Snelling, who are accused of conducting a long-running Ponzi scheme, defrauding investors in three states, Indiana, Ohio and Kentucky, of over $4.5 million. Smith and Snelling were allegedly selling unregistered securities, and neither was licensed to sell them.  

In this case the accusation is that investors were convinced and encouraged to roll over their traditional IRA accounts into self-directed IRAs at a trust company. Then, Smith and Snelling allegedly took the funds from the accounts and used them for their own personal use. The investors had no idea their money was no longer available, since they still received regular statements from the trust company, and even were billed fees on the accounts.

Smith and Snelling are charged with over 50 counts of violations of the Indiana Uniform Securities Act, and charges are pending in both Franklin County and Dearborn County, Indiana.

Things To Consider To Determine If You May Be A Victim Of A Fraudulent Self-Directed IRA

The U.S. Securities and Exchange Commission’s Office of Investor Education and Advocacy (OIEA) and the North American Securities Administration Association (NASAA) have jointly issued an Investor Alert about the potential risks associated with investing in self-directed IRAs. You can find this short PDF here. http://www.sec.gov/investor/alerts/sdira.pdf In addition, here is information you should consider if you’re concerned you may be a victim of self-directed IRA fraud.

• Verify the information in the self-directed IRA. Many of the investments that can be purchased through one of these financial instruments can be hard to value, since they are illiquid. Therefore, the statements provided will often state their value as the price you paid for it, or what the promoter is valuing it at. However, that does not necessarily reflect what the investment could actually be sold for on the open market, which may be a much lower amount.

• Was your choice to get a self-directed IRA the result of an unsolicited investment opportunity from a total stranger, or even a friend? As stated previously, self-directed IRAs are legal and there are some which may produce high rates of return for investors. However, if someone, unsolicited, asked you to invest in such a financial instrument red flags should be raised to determine if they are a legitimate individual, or instead a fraudster.

• Were you promised a guaranteed gain or rate of return, or a low-risk, high reward investments? Similarly, when someone promises you something too good to be true, it usually is. Almost nothing in life is guaranteed, and if there were legitimate low risk, high reward investments out there lots more people would be rich than are today. Too good to be true promises such as these should also raise red flags in your mind, to investigate further about whether you are the victim of self-directed IRA fraud.

• Is the self-directed IRA promoter registered in the state they are doing business, and in addition are the investments they are selling licensed? Many states, including Indiana, have laws and regulations in place which require those selling securities to be registered with the state. Further, only certain types of investments are deemed registered securities. While unregistered securities are permitted to be included in self-directed IRAs they are much riskier, and their inclusion may still violate state law, if not federal law. It is best to make sure what you are purchasing through your self-directed IRA is licensed, and the person you’re purchasing it from is registered to sell you these types of products.

• Have you contacted another professional yet for a second opinion, such as an investment advisor or attorney? Many of the investments that can be purchased through a self-directed IRA are not ones that can be purchased through a traditional IRA, generally for the reason that they are even more inherently risky, illiquid, or complex. Therefore, before investing in such financial instruments it is a good idea to get a second opinion from an independent professional, such as an investment advisor or attorney, to help you determine whether this is a good investment for you.

If You Think You May Be A Victim Of Self-Directed IRA Fraud Call A Securities Fraud Attorney

If you think you may be a victim of fraud using this financial instrument you should act quickly to try to minimize further losses, and potentially try to reclaim money you’ve lost already. To do this, it is best to contact a knowledgeable securities fraud attorney in your area to see if you have a case, and determine the best course of action for you.

If you have lost money in a fraudulent investment scheme involving a self-directed IRA or a third-party custodian or trustee, or have information about one of these scams, you should contact Starr Austen & Miller LLC to learn more about the self-directed IRAs and report your experiences. Our attorneys, Mario Massillamany and Mark Fryman are available for direct live chat every Wednesday at 5 pm.

Indiana Law Firm Investigating Securities Fraud Stemming From Self-Directed IRA Schemes

Fishers, IN, January 3, 2012 - Mario Massillamany of the Indiana law firm of Starr, Austen & Miller, LLP, announces an investigation into securities fraud scams involving self-directed IRAs.  A self-directed IRA is an IRA held by a trustee or custodian that permits an investment in a broader set of assets than is permitted by most IRA custodians. 

Most IRA custodians are banks and broker-dealers that limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds and CDs.  Custodians and trustees for self-directed IRAs, however, may allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, tax lien certificates, and private placement securities.  $94 billion of IRA retirement funds are held in self-directed IRAs making them a favorable scam for fraud promoters

Fraud promoters who want to engage in Ponzi schemes or other fraudulent conduct may exploit self-directed IRAs because they allow investors to hold unregistered securities.  Additionally, the custodians or trustees of these accounts have no responsibility to investigate the securities or the background of the promoter.  Furthermore, self-directing IRAs do not typically require the trustee or custodian to keep accurate records or perform audits.

"Some of these investment advisors and stockbrokers are clearly committing malpractice and breaching their fiduciary duties in the way they are advising their clients to invest in their self directed retirement programs such as IRA’s and 401k’s," said attorney Scott Starr.  “It is not uncommon for these individuals to place their clients in investments that are either too high risk, carry a time horizon that is too far in the future, or fail to properly diversify these portfolios."

The self-directed IRA custodial process gives the aura of protection for the investor but it is elusive. A few ways to avoid fraud with self-directed IRAs is to verify information in self-directed IRA account statements, avoid unsolicited investment offers, ask questions from the promoter, be mindful of “guaranteed” returns, and seek advice from a trained professional. 

About the law firm:

The law firm of Starr Austen & Miller LLC has over 90 years of experience in securities and class action litigation. The firm has earned a national reputation among litigators by handling cases ranging from personal injury caused by exposure to toxic chemicals to mass and class actions against national brokerage firms for securities fraud.

Legal Resources for Impacted Investors

If you have lost money in a fraudulent investment or scheme involving a self-directed IRA or a third-party custodian or trustee, or have information about one of these scams, you should contact www.starrausten.com to learn more about the self-directed IRAs and report your experiences.

Source/Contact:

Mario Massillamany

574-722-6676

mario@starrausten.com

Will The Dodd-Frank Wall Street Reform Act Make FINRA Arbitration Obsolete?

The Dodd-Frank Wall Street Reform Act shows a congressional dislike for mandatory arbitration provisions, to say the least. This Act, which was signed into law on July 21, 2010, by President Barack Obama, contains many provisions which could lead, after study, to the prohibition or limitation on these boilerplate clauses in consumer contracts. This includes arbitration provisions in client agreements with broker dealers that cause many securities fraud causes of action to be arbitrated at FINRA at this time.

Widespread Prevalence of These Arbitration Clauses

Statistically, just about everyone in the United States has knowingly, or unknowingly, agreed to a boilerplate mandatory arbitration clause in the contracts or agreements we enter into day in and day out. Some of the most common are those contained in credit card agreements, for example, in which you’ve agreed to take any disputes to arbitration instead of going to court.

The Problem with Mandatory Arbitration Provisions

Arbitration is an alternative way to resolve legal disputes outside the judicial system. Using this method a neutral third party is supposed to hear both sides of the story and then make a binding decision. When arbitration was first introduced in this country it held the promise of improving the dispute process by speeding it up, making it cheaper, and keeping parties from jumping through some of the legal hoops involved in going to court. Arbitration, when conceived, however, imagined two parties of approximately equal bargaining power voluntarily choosing to use the process. That is no longer the case.

Over the years big business has begun inserting these mandatory arbitration provisions in just about every contract they can think of. They’ve done this because they’ve figured out that these arbitration provisions tend to give them the upper hand over consumers in dispute resolution. For instance, there is no jury, no public trial, little to no review by the courts, and instead of going to your local courthouse the arbitration can be located hundreds of miles away from where you live. What makes this worse is that consumers cannot negotiate these provisions, but it is take it or leave it. That assumes, of course, that we even know the fine print clause is in the document, or understand its legal implications to begin with.

Mandatory Arbitration in the Context of Securities Fraud

Arbitration provisions have also creeped into many customer account agreements between customers and their brokers, often without the customer being aware of the provisions existence, and/or unaware of its legal implications. These agreements are typically signed when a customer first begins a relationship with a broker, and agrees that any future disputes between the party, meaning things that have not even happened yet, will be subject to arbitration by the Financial Industry Regulatory Authority (“FINRA”).

The mandatory arbitration provisions in these agreements have been just as controversial as those in credit card and other consumer agreements. Some of the criticisms leveled against FINRA arbitration include that it is biased in favor of the broker dealer, because one of the three arbitrators on the panel is from the securities industry. Further, the broker dealers themselves are the people who make up the membership of FINRA, so is FINRA really going to bite the hand that feeds it? There are those, of course, from the securities industry themselves who defend the FINRA arbitration process [link to SAM article: what is FINRA arbitration?] saying it is speedy, less expensive and fair. However, as hard as many brokers and securities firms fight to enforce these arbitration provisions, and avoid court, critics may just have a point about who is most favored between the brokers and the customers.

The Dodd-Frank Act’s Potential Blow to FINRA Arbitration

It seems Congress may finally be waking up to some of these criticisms, and showing a willingness to investigate the issue further. The language related to FINRA arbitrations in the Dodd-Frank Act is found in Section 921, which confers authority on the SEC to make rules that limit or prohibit these provisions between customers and broker dealers or investment advisors.

Specifically, the section states:

The Commission, by rule, may prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.

Currently Arbitration Clauses Are Legal and Common In Securities Fraud Cases

Of course, the Act’s language does not currently prohibit such arbitration provisions in customer agreements, and therefore the industry still includes them as standard at this time. Unless and until the SEC creates a contrary rule these mandatory arbitration provisions continue to be valid and enforceable, as a general rule.

Janus Capital Group Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011)

This year, the United States Supreme Court addressed the viability of securities fraud claims against secondary actors.  On June 14, 2011, the Supreme Court in Janus Capital Group Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), brought much-needed predictability to the securities markets by articulating a “clean line” separating “those who are primarily liable (and thus may be pursued in a private [Rule 10b-5] suit) and those who are secondarily liable (and thus may not be pursued in private [Rule 10b-5] suit).”  Id. at 2302 n.6.

The Court, in a 5-4 opinion, concluded that Janus Capital Management (“JCM”), a registered investment adviser, could not be held liable in a private Rule 10b-5 suit for drafting allegedly misleading prospectuses issued by its mutual-fund client, the Janus Investment Fund.  Instead, the Court made clear that the only proper defendant in a private Rule 10b-5 suit is the “maker” of the statement—“the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”  Id at 2302.  “Without control,” the Court explained, “a person or entity can merely suggest what to say, not ‘make’ a statement in its own right,” and therefore “[o]ne who prepares or publishes a statement on behalf of another is not its maker.”  Id (quoting 17 C.F.R. § 240.10b-5(b))...

Applying this test, the Court concluded that “JCM did not ‘make’ any of the statements in the [Janus Investment Fund's] prospectuses”--even if it may have participated in the writing and dissemination of the prospectuses--because JCM’s involvement was “subject to the ultimate control” of the Janus Investment Fund.  Id at 2305.  “There was no allegation that JCM in fact filed the prospectuses and falsely attributed them to Janus Investment Fund,” the Court noted, “[n]or did anything on the face of the prospectuses indicate that any statements therein came from JCM rather than from Janus Investment Fund--a legally independent entity with its own board of trustees.”  Id  Accordingly, the statements in the prospectuses were made by Janus Investment Fund--not by JCM.  Id at 2304-05....

Even though the opinion does not expressly address the liability of persons or entities other than investment advisers who provide services to public companies, those service providers--bankers, lawyers, accountants, financial advisers, and others--should be able to invoke the decision to defend private lawsuits based on their work behind the scenes in preparing offering documents for their issuer clients.  The issuer--not the service provider--has “ultimate authority over the statement[s]” in its offering documents, and it is therefore the only “maker of [those] statement[s]”" under the Court’s rationale.  Id at 2302..

The U.S. Supreme Court's decision in Janus Capital Group, Inc. v. First Derivative Traders has left many investment company directors wondering whether they should take additional measures either to protect their funds and themselves from liability for prospectus errors or to provide their funds' investment adviser with additional incentives to ensure the accuracy and completeness of fund prospectuses.