The U.S. House is going to debate the “Audit The Fed” bill. I don’t pay close attention to what’s being debated and passed on the floor of the Senate of House of Representatives because what’s usually written up, sponsored, and voted on isn’t even read by our Congressmen.

This Audit the Fed bill is a different story. It’s sponsored by a Congressman who some call the only honest politician left… Ron Paul. He’s often called “Dr. NO” because he is a medical doctor and he regularly votes against any bill for which the U.S. Constitution doesn’t give Congress the power to pass, no matter how seemingly good the benefits are. Suffice it to say that when Ron Paul votes “yes” on anything, it is a rare occasion.

So to see him sponsoring a bill that is getting attention is even rarer. His objective to audit the Fed is a just a stepping stone to ending it. One CNBC commentator agrees that the Fed would be shut down if audited.

In fact, that’s the reasoning behind the opposition to the bill: if we knew what the Fed was actually doing we would have no confidence in it. Wow. That’s not a very good argument to get us to stop wondering what they’re doing over at the Fed.

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• Banks need about $75 billion to reach “adequate capitalization”
• “Adequate capitalization” is when common equity equals 4%
• Common equity being at 4% means a debt-to-equity ratio of 25-to-1
• The current bank needs do not factor in the potential for bank assets to lose their value
• The current bank needs are based on a rosy worst case scenario of a 3.3% drop in GDP this year and unemployment of 8.9%
• The government’s latest understated unemployment data is already reporting unemployment at 8.9%, so the government is trying to convince us that the worst case scenario is unemployment stays the same

Additionally, here are what some of the larger banks needed according to the stress tests:

• Citigroup $5.5 billion
• Wells Fargo $15 billion
• Bank of America $34 billion

Keep in mind that these are the amounts of money that must be given to the banks now in order for the banks to get themselves UP to a 25-to-1 leverage ratio. Also, while Citigroup appears to be less incompetent than Wells and B of A, a recent article in Time magazine says that Citi “got credit for a capital conversion it has yet to complete. Strip that out, and the amount of capital Citi needs balloons to nearly $63 billion, more than any of the other banks tested.”

*** This is Part 3 of a series about the dangers of letting an administrator act as custodian. Make sure you read Part 1 and Part 2 first to make sense of this post. ***

The illegitimate custodian test

Ask “Who should the check be payable to for the rollover contribution or transfer?”

Ask “If my IRA buys real estate and rents it out, to whom should the tenant make the rent checks payable?”

Ask “If my IRA owns real estate that needs repairs, who issues and signs the check to the repairmen?”

These questions will tell you who is actually serving as custodian. For instance, if you live in TX and unregulated company Dotrust is marketing its self-directed IRA services to you, the answer to one or more of the questions above will probably be something like Dotrust of Texas, Inc. If this is the case, ask to see its bank or trust charter – if it is an illegitimate custodian it won’t have one, and it will insist that another bank is technically the custodian. It not only matters who’s the custodian on the paperwork is; but it also matters who is acting as custodian as uncovered by the answers to the 3 questions above.

Why would somebody operate an illegitimate custodian company?

First of all, if it’s a franchise operation, the franchisee might not even know that he or she is part of an illegitimate IRA custodian scheme. Secondly, there can be a lot of profit to be made in an illegitimate IRA custodian scheme. The company can earn interest off of your IRA funds, and it may pass only some (or even none) of that interest earned on to you. It may also be able to earn higher interest rates when it collectively has custody of hundreds of millions of dollars in funds.

Surprised?

You may be thinking “This sounds like a company I’ve run into. But it promotes and and advertises and has been in the business for decades… it can’t be illegitimate, can it????”

Many high-profile schemes have been shut down. The private annuity trust scheme was promoted for over a decade before the IRS shut it down. Additionally, being in business for decades doesn’t guarantee that business is legitimate. Look at Bernie Madoff.

Madoff may be a harsh comparison. Those involved in an illegitimate IRA custodian scheme may not be knowingly harming anyone. They may even be attorneys or CPAs. They may believe they’ve merely created a loophole for themselves with the “stepped transaction” arrangement. They may be good people. But the bottom line is that there are significant risks you take in using their services, and you will pay the consequences if uncovered by the authorities. In my opinion, it never makes sense to use an illegitimate custodian because there are dozens of regulated/legitimate self-directed IRA custodians out there. There should be a balance between risk and reward. There is significant risk of using an unregulated/illegitimate custodian, and it offers no unique reward that isn’t offered by other self-directed IRA custodians.

Confused? If you have a self-directed IRA or are thinking of opening one at a custodian company, perform the illegitimate custodian test as described above.

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*** This is Part 2 of a series about the dangers of letting an administrator act as custodian. Make sure you read Part 1 first to make sense of this post. ***

Signs that your custodian may not really be a custodian

1. They sometimes call themselves an administrator. “Administrator” is an accurate label for any company who provides record keeping services. Being an “administrator” doesn’t require any regulation. These types of companies may expand their services to include asset custody without actually registering as a bank or trust company.
2. Their name contains the word “trust” attached to other letters or words. A legitimate custodian usually has the word “bank” or “trust” as a separate word included in its name. In most states, the word “trust” is a restricted word for naming companies – just like the word “bank”. This means that you can’t start a company called “ABC Bank” unless it’s registered as a bank. You also can’t start a company called “XYZ Trust Company” without being a registered trust company. An illegitimate custodian might get around this by calling themselves Trustus rather than Trust Us, Dotrust rather than Do Trust, or Safetrust rather than Safe Trust. You see, if trust is attached to another word instead of used as a separate word, then it sneakily gets around the naming restrictions.
3. They have dozens of offices all around the country. Expanding to dozens of cities across the country can get expensive for a regulated custodian. The self-directed IRA custodian business isn’t nearly as profitable as the securities business, and most legitimate custodians must operate only one or two offices in order to be able offer their services for reasonable and competitive fees.
4. They sell franchises. Franchises can be a powerful and leveraged way to build a brand, but for the IRA custodian business it is nearly impossible to expand a legitimate custodian business through franchising. If a legitimate custodian had 40 offices across the country, its overhead would be so high that its fees would be much higher than the next most expensive competitor and its services would have nothing to offer to justify the higher fees. In reality, it appears that only illegitimate custodians are able to run franchise operations, and this is made possible by not having to deal with the regulatory costs of having dozens of audited and regulated offices.
5. They hire a real bank or trust company to be the custodian, but then they fulfill custodial duties themselves. In the legal world, there is a concept known as “stepped transactions” or the use of a “strawperson”. This is basically where a step is added to a transaction to include a person or company, and this inclusion is only involved to circumvent a law. For instance a self-directed IRA can’t buy or sell assets to or from its accountholder or its family members. So let’s imagine a guy named Joe wants to sell his personal residence to his IRA – which would normally be a prohibited transaction. In an attempt to get around this prohibition, he sells his home to his friend Randy, who then sells the house to Joe’s IRA. This would easily be deemed a “stepped transaction” because Randy did not really want to buy the house; he was just trying to disconnect the real parties from transacting (Joe and his IRA) directly so that it would appear to not break any laws. This same concept can be seen with IRA custodians. An administrator may want to serve as a custodian without being a bank or trust company. So it hires a bank to serve as custodian on the paperwork. Then it gets the bank to outsource custody-related tasks (holding and controlling assets) right back to it. In this scenario, the bank is a “strawperson” and the arrangement is similar to a “stepped transaction”. To understand the legal ramification of what’s really going on, you must remove the step/strawperson. In this scenario, what’s really happening is that a non-custodian is serving as the custodian, and it is illegitimate.
6. They are opposed to the “checkbook control” IRA LLC strategy. Illegitimate custodians primarily profit by earning interest on the funds of others (like a bank) without registering themselves as a bank or trust company. In an IRA LLC structure, most of the IRA funds are invested into an LLC where the IRA/LLC accountholder puts them at any bank of their choosing – where the LLC will earn the interest on the funds. This undermines the primary goal for the illegitimate custodian (earning interest on your funds) so it usually discourages (or even disallows) you to use the IRA LLC strategy.

Coming up in Part 3 of this series: How to tell if your custodian is compliant using the illegitimate custodian test.

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