NASAA President William Beatty.

State securities regulators warned investors participating in self-directed IRAs Monday to brush up on third-party custodians’ duties, as fraudsters can deceive them into thinking that a third-party custodian is a trusted intermediary gatekeeper.

“Fraud promoters can misrepresent the responsibilities of self-directed IRA custodians to deceive investors into believing that their investments are legitimate or protected against losses,” William Beatty, NASAA president and Washington securities director, said in a statement. “The third-party custodian’s sole responsibility is to report information to the IRS and from the issuer to the investor.”

NASAA’s recently released enforcement survey reflecting data for 2013, which tracked for the first time fraud related to third-party custodians of self-directed IRAs, found that securities regulators opened 92 investigations and initiated 13 formal enforcement actions involving third-party custodians of self-directed IRAs last year.

“While self-directed IRAs can be a safe way to invest retirement funds, investors should understand that third-party custodians have limited duties to investors,” Beatty said.

NASAA listed the following six facts about third-party custodians’ duties:

  • A third-party custodian does NOT research or perform due diligence reviews or recommend investments to clients.

  • A third-party custodian is a passive company that simply serves as an intermediary between the investor and the issuer of an investment. A third-party custodian does not have a fiduciary duty to clients.

  • Fraud promoters often state or suggest that self-directed IRA custodians investigate and validate any investment in a self-directed IRA. Self-directed IRA custodians are responsible only for holding and administering the assets in a self-directed IRA. They generally do not evaluate the quality or legitimacy of any investment in the self-directed IRA or its promoters. A third-party custodian only reports the information provided by the issuer and does NOT verify the accuracy of the information.  While an account statement provided by a third-party custodian may show an increase in the value of the investments in the account, this information has NOT been verified for accuracy by the third-party custodian. 

  • While the third-party custodian is a regulated trust company approved by the IRS, its sole obligation is to track and report to the IRS the contributions to and distributions from the account in order to maintain the tax-deferred status of the IRA or qualified plan. Again, the third-party custodian does NO diligence review regarding the investment; therefore, this does not mean the investment is safe or “legitimate.”

  • Fraud promoters can misrepresent the responsibilities of self-directed IRA custodians to deceive investors into believing that their investments are legitimate or protected against losses. The third-party custodian’s sole responsibility is to report information to the IRS and from the issuer to the investor.

  • The third-party custodian is merely the keeper of the deposits to and distributions from the account. The third-party custodian bills the investor for its record-keeping services. The custodian does NOT hold the investment funds or assets. The third-party custodian transfers the investment funds directly to the issuer when an investment is made.

— Check out Best Firms for Self-Directed Investors: J.D. Power—2014 on ThinkAdvisor.