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Self-Directed IRA Schemes, Digital Asset Fraud Among Top Investor Threats in 2022

March 16, 2022

In January 2022, The North American Securities Administrators Association (“NASAA”) released its annual list of top investor threats. NASAA prepared the list by identifying the most cited threats compiled through a survey of North American securities regulators. Three common investor threats from NASAA’s list include:

  • Financial schemes connected to Self-Directed Individual Retirement Accounts
  • Investments tied to cryptocurrencies and digital assets
  • Fraud offerings related to promissory notes

Self-Directed IRAs Financial Schemes

Financial schemes involving self-directed IRA accounts pose a unique threat to investors. Unfortunately, these schemes often target senior citizens and retirees.

How Does the Self-Directed IRA Scheme Work?

To open any kind of IRA account, one must use an IRS-approved institution firm that will serve as the account’s custodian. The custodian then acts as an intermediary between an investor and an investment.

In self-directed IRAs, investors have decision-making power over their investments in the IRA. Sometimes, a promoter approaches an investor and offers an investment opportunity that the company holding the investor’s IRA does not have. The promoter will then direct the investor to transfer money from their original IRA to a new, third-party custodian to facilitate the transaction. The third-party custodian, however, does not hold the received investment funds or assets. The third-party custodian transfers investment funds directly to the issuer when an investment is made.

Unfortunately, fraudsters exploit the mechanics of self-directed IRAs and third-party custodians to affect their schemes through misrepresentation and obfuscation. For more information on the risk of fraud in self-directed IRAs, read the Securities and Exchange Commission’s Investor Alert.

Digital Assets and Cryptocurrencies Pose Ponzi Scheme, Fraud Risks

Cryptocurrencies are digital assets created by companies or individuals that take the form of virtual coin or tokens. Cryptocurrencies are intangible, exist only on the internet, are not insured by banks or the government. There is the little regulatory framework for digital assets.

How Does the Digital Asset Scheme Work?

NASAA identified common fraudulent schemes involving digital assets, two of which are described below.

  1. Fake digital wallets. A digital wallet refers to types of software that can be installed on any Internet-connected device that store your public and private crypto keys. The digital wallet allows its owners to store, send and receive cryptocurrencies. Unfortunately, fraudsters use fake digital wallet to entice unsuspecting users into providing their private key or code that enables the wallet to open and the fraudster to steal the wallet’s funds.
  2. Pump-and-dumps. There are thousands of cryptocurrencies, many of which are thinly-traded. In this scheme, there are group, coordinated efforts to promote the cryptocurrency on social media to push up demand and the price, and then sell it in a coordinated sale. Next, the cryptocurrency’s price plummets and investors left with valueless cryptocurrency holdings.

Promissory Note Fraud

A promissory note is a written promise to pay or repay) a specified sum of money at a stated time in the future or upon demand. Promissory notes typically pay interest either periodically prior to the maturity of the note or in a lump sum at maturity.

How the Promissory Note Fraud Scheme Works

NASAA uses the following example to describe a fraudulent promissory note scheme:

Suppose a business person you meet through a community networking event introduces an intriguing investment opportunity – a company he or she is connected with is looking to expand its business and needs to raise money.

Instead of borrowing money from a bank, the company is offering the opportunity to purchase “promissory notes” with a maturity of 12 months and an annual interest rate of 8 percent paid in monthly installments. As a purchaser, you have the option to take your money out after one year or renew the note.

The promoter emphasizes that this investment is better than other investments because it is not subject to market volatility, the principal and rate of return are guaranteed, and the company has never missed a payment to an investor. You may be pressured to move money quickly from other investments into these notes or to borrow from your home equity to invest.

Promissory Note Red Flags

State securities regulators identify the following characteristics as red flags for promissory notes:

  1. Insured or guaranteed returns.
  2. A promise of above-market returns
  3. Risk-free notes
  4. Short-term offer

To protect against promissory note fraud, investors have several resources. Among them include reviewing SEC’s EDGAR Database or a state’s securities regulator to confirm that the notes are registered or legally exempt from registration, researching the company, asking a seller for information such as their commission, and involving a trusted, independent financial professional, lawyer or accountant.

About KlaymanToskes

KlaymanToskes is a leading national securities law firm that practices exclusively in the field of securities arbitration on behalf of retail and institutional investors throughout the world in large and complex securities matters. KlaymanToskes has recovered more than $230 million for investors in FINRA arbitrations. KlaymanToskes has office locations in California, Florida, New York, and Puerto Rico.

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