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Gregory Tendrich, PA Gregory Tendrich, PA

The Risks of Self-Directed Individual Retirement Accounts

Millions of Americans rely on Individual Retirement Accounts (IRAs) to save for their retirement. IRAs are a type of restricted savings account where the owner receives certain tax benefits. For example, in a traditional IRA, you may contribute a certain amount each year (up to $5,500 if you are under the age of 50) and deduct that contribution from your taxable income. Although you can withdraw from an IRA anytime, you may owe a tax penalty if you take any money out before reaching a certain age (59½ with a traditional IRA).

There are many types of IRAs, but all such accounts must be managed by a custodian or trustee authorized by the Internal Revenue Service. One unusual type is a “self-directed IRA.” Unlike traditional IRAs, which primarily invest in traditional securities like stocks and mutual funds, the custodian of a self-directed IRA may invest retirement funds in a broader range of assets, including real estate and promissory notes.

Only about 2% of all IRA retirement funds are self-directed, but that still represents almost $100 billion in assets. According to the U.S. Securities and Exchange Commission, these self-directed IRA funds are especially vulnerable to Ponzi schemes and other forms of securities fraud. In particular, the SEC warns, the financial penalty attached to early withdrawals from self-directed IRAs can lead investors “to keep funds in a fraudulent scheme longer than those investors who invest through other means.”

In the Matter of Equity Trust Company

To that end, on June 16 the SEC announced it filed an administrative complaint against an Ohio-based self-directed IRA custodian, Equity Trust Company, accusing it of enabling a Ponzi scheme. The SEC said two men, Ephren Taylor and Randy Poulson, used about $5 million of self-directed IRA funds held by Equity to purchase fraudulent promissory notes.

In Taylor’s case, the SEC said he sold promissory notes to Equity’s self-directed IRA customers which offered interest rates as high as 20%. The funds raised through these notes were supposed to finance “small, community-oriented businesses.” Instead, Taylor kept most of the money for himself. Although Taylor told Equity his notes were secured by other assets, they were in fact unsecured, meaning IRA owners recovered next to nothing. In 2014, Taylor pleaded guilty to various criminal charges associated with his scheme. He is currently serving a nearly 20-year prison sentence.

Poulson also allegedly sold promissory notes to Equity self-directed IRA owners, only he claimed the investments were secured by residential real estate investments. In fact, the SEC said, “some were not secured and others were secured by multiple mortgages on the same property.” And as with Taylor, Poulson allegedly spent a good deal of the investors’ money on himself. Poulson presently faces trial on criminal mail fraud and wire fraud charges in New Jersey.

As for Equity, the target of the SEC’s complaint, the custodian allegedly not only failed to protect self-directed IRA owners from Taylor and Paulson’s fraud, they actively “endorsed” and “assisted” them. For example, the SEC said Equity “sponsored monthly dinner events” where Poulson was a featured speaker. Equity’s sales representatives also allegedly built a close marketing relationship with both men, relying on them to bring in new customers. Accordingly, the SEC said Equity also ignored a number of “red flags” with respect to Taylor and Paulson’s promissory notes.

Keeping an Eye on Your IRA Custodian

The complaint against Equity will be heard by an SEC administrative law judge later this year. Whatever the outcome, this case should still serve as a cautionary tale. While self-directed IRAs afford investors greater flexibility when investing their retirement savings, they must also be aware of the increased risks. Scam operators promising high returns with little or no risk should always raise a red flag. IRA owners must also keep an eye on their IRA custodians to ensure they are not pushing unsuitable investment products. And if you are the victim of a Ponzi scheme or an IRA custodian’s negligence, it is important you receive independent legal advice from a qualified Florida securities fraud attorney. Contact Gregory Tendrich, P.A., in Boca Raton to speak with an attorney right away.

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