It should come as no surprise to anyone that if purchasers of securities or a state’s securities commission bring an enforcement action for the unlawful sale or contract for sale of unregistered securities, then they will seek recourse against anyone involved in the transaction because the proceeds of such sales have often been spent by unscrupulous issuers in many of these circumstances. Self-directed IRA custodians are no exception.
Such was the case in Boyd v. Kingdom Trust Company, et al.,[1] where two Ohio residents opened self-directed IRA accounts to invest in promissory notes as alternative investments. As practice dictates, the promissory notes were purchased by the self-directed IRA custodians for the benefit of the Ohio residents and the physical promissory notes held by the custodians in the self-directed IRA accounts.
The residents argued that the self-directed IRA custodians and the issuer were jointly and severally liable pursuant to Ohio Securities Act provision that states:
“The person making such sale or contract for sale, and every person that has participated in or aided the seller in any way in making such sale or contract for sale, are jointly and severally liable to the purchaser … for the full amount paid by the purchaser and for all taxable costs.”[2]
The Ohio Supreme Court in this case took a narrow view of this enactment by distinguishing the self-directed IRA custodians’ role as purchasers of the promissory notes as opposed to either participating in the sale or aiding the issuer in the sale and vindicated them, finding that “a financial institution’s mere participation in a transaction, absent any aid or participation in the sale of illegal securities, does not give rise to liability under R.C. 1707.43(A).”[3]
But every self-directed IRA custodian should also note that this Court also stated that:
“Nothing in our holding today would insulate from liability a self-directed IRA custodian who colludes with the seller in an unlawful sale of securities or actively participates or aids in the sale of illegal securities. But the certified question before us is limited to the liability of a self-directed IRA custodian whose only alleged participatory conduct was the purchase of illegal securities on behalf and at the direction of the owner of a self-directed IRA.”[4]
Consequently, the self-directed IRA custodians escaped liability in this case merely because the two Ohio residents failed to allege any other participatory activity in the sale of the promissory notes, such as providing the templates for the promissory notes, drafting them, being included in the issuer’s pitch materials, etc.[5] And in a regulatory environment such as the present one in which plaintiffs and enforcement sections of state securities commissions seek restitution for defrauded investors by all means available to them, self-directed IRA custodians should be extremely mindful of their participation in these transactions.
Consequently, if faced with such potential liability, you may wish to consult with experienced securities enforcement counsel at Cosgrove Law Group, LLC.
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[1] 150 Ohio St. 3d 196, 2018-Ohio-3156, 113 N.E. 3d 470 (2018).
[2] R.C. 1707.43(A). Note this provision has been enacted by each state that has adopted the Model Securities Act.
[3] 150 Ohio St. 3d at 199, 113 N.E. 3d at 473.
[4] Id. Emphasis added.
[5] Situations where the custodian issues a finder’s fee or commission to the seller could also be “participatory activity.”