SDIRA Due Diligence

In 2012, the SEC and NASAA issued Investor Notice 5866Self-Directed IRAs and the Risk of Fraud. In the notice, the SEC and NASAA outlined how self directed IRAs can be susceptible to numerous types of fraud and how self directed IRA investors can be bilked. The notice outlined some significant cases where investors with self directed IRAs were involved and where the investors incurred significant losses as a result of fraud and misrepresentations in the companies where the self directed IRAs invested.

The due diligence issues for self directed IRAs are not any different from the due diligence issues for individual investors. The concern, however, is that for many self directed IRA investors, their retirement account is their largest source of funds. Consequently, those accounts can be targeted by crooks. The bottom-line point of the SEC Notice is that self directed IRA owners should carefully conduct due diligence before investing their self directed IRA funds.

I have my own thoughts as to appropriate due diligence, which are in accordance with the SEC Notice, and I have outlined those thoughts in the following due diligence “top ten list”.

DUE DILIGENCE TOP TEN LIST

Before you invest your self directed IRA into a “non-traditional” private business or into a real estate investment, you need to ask some hard questions to the person or business receiving your money. Here are some tips to minimize investment risks with your self directed IRA.

  1. Don’t Understand, Don’t Invest. If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
  2. Demand Documentation of Promises. If you aren’t given adequate documents outlining what has been explained to you verbally or what has been put into a presentation, then don’t invest.
  3. Don’t Accept Commissions for Raising Money if You Aren’t Licensed. If you’re told that you can get a commission for bringing others to invest into the same company and if you don’t have a license to receive such commissions, then don’t invest. If the investment sponsors are willing to violate the law to pay a non-licensed person to raise money from others, then what’s stopping them from misappropriating your IRA investment? It is only the law preventing them, which they’ve proved they will disregard.
  4. Get Security. If your self directed IRA is loaning money for a real estate venture, then demand a recorded deed of trust or mortgage on title to the property, protecting your investment. Also, make sure that you get a copy of the title report or commitment showing what position your loan is being placed into when the deed of trust or mortgage is recorded. Many savvy investors (and what all banks do) create lending instructions to the title company or attorney closing the real estate transaction that instruct the closing agent to only use the funds being loaned when the borrower signs the note/loan documents, when the closing agent verifies the priority of the deed of trust or mortgage you are getting (1stposition, 2nd, etc.), and when all other defects to title have been cleared.
  5. Research Management and Company Status. If you’re investing into a PPM, a private offering, or a crowdfunding offering, you should receive numerous documents outlining the investment, the use of funds, the background of those managing the company, and also documents regarding your rights as an investor (e.g., offering memorandum and LLC operating agreement or LP limited partnership agreement). Also, check to see if the PPM or private offering was properly filed with the SEC by going to SEC.gov and checking the company name in the SEC database. If no filing record exists for the PPM or private offering with the SEC, then the person raising the funds has possibly disregarded the law. As stated earlier, if someone is willing to disregard the law to get your money, what is stopping them from disregarding the law to not pay you back (it’s just the law)?
  6. Investigate Backgrounds of Persons You’re Entrusting Your Money to. Investigate the background of the person(s) with whom you are entrusting your money. When you are investing with others, you need to think like the bank and do what the bank does. What is this person’s credit worthiness? What is their employment or prior business experience? What is their business or investment plan? What are the terms of the investment? Is there a realistic rate of return that fairly recognizes the risk being taken?
  7. Don’t Be Hurried. If you’re pressured that this opportunity will pass if your self directed IRA doesn’t invest now, then let the opportunity pass. Most scams use this technique, and most legitimate investments never have this funding crisis.
  8. Engage a Lawyers to Look Out For Your Interests. Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents, it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting your self directed IRA. Sometimes, unfortunately, the devil is in the details, and many investments have clauses that can significantly impact your ability to get your money back or that give the company raising the money the ability to pay whatever compensation to themselves that they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
  9. Seek Opinion of Friend or Fellow Investor. Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else, he or she can help you find issues to consider and questions you should be asking.
  10. Get Comfortable Saying No. Be comfortable saying no and only invest what you are willing to lose. Non-traditional investments have made many millionaires over the years, but they have also caused some financial ruin. Just keep the risk in perspective and don’t “bet the farm” in one deal.

Don’t be scared about investing into non-traditional investments. Just remember though that you may need to get out of your comfort zone by asking lots of questions, by demanding additional documentation, or by simply saying no. Remember, you are the best person to protect yourself.  So do it.

This article is a modified except from The Self Directed IRA Handbook

By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.

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