Questions for a Custodian After Scams Hit I.R.A.’s

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Questions for a Custodian After Scams Hit I.R.A.’s
Louis Lanzano/Associated Press, top: Joe Skipper/Reuters
A COMMON REFERRAL Bernard L. Madoff, top, and Daniel Heath, bottom left, with his father, John William Heath, preyed on an increasingly popular retirement account, the self-directed I.R.A. The men, all convicted in financial frauds, steered most of their victims to Fiserv, once a giant in the industry.

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LinkedinDiggFacebookMixxMySpaceYahoo! BuzzPermalinkBy DIANA B. HENRIQUES
Published: July 24, 2009
Three unrelated Ponzi schemes, including Bernard L. Madoff’s, erased more than $1 billion from hundreds of individual retirement accounts set up through a single financial company.

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Peter Moskowitz, a Madoff victim who was directed to a Fiserv unit called Retirement Accounts.
At a minimum, this coincidence would appear to be a mystery worthy of investigation by regulators. After all, that financial company is part of an important industry that is supposed to help keep America’s retirement savings safe from crooks like Mr. Madoff.

But so far, no one prosecuting those three giant frauds appears to be asking why Mr. Madoff and two other large-scale swindlers steered virtually all of their victims to a single company: Fiserv, a giant in the I.R.A. service industry until it sold the business last year and still a prominent provider of bank and credit technology services.

The company, which is still responsible for legal issues that arose during its ownership, said it bore no blame at all for the losses its customers incurred in these various Ponzi schemes.

But the relative silence on the matter from a variety of financial regulators suggests how little attention government watchdogs have paid to a business whose protections many Americans take for granted.

“If you had asked me, point-blank, whether there could be any I.R.A. money lost in these Ponzi schemes, I’d have said ‘no,’ ” said Mercer Bullard, a law professor at the University of Mississippi.

Given the protections he assumed would be in place, he said, tapping into I.R.A. accounts “would be almost like running your Ponzi scheme through the police department.”

Mr. Madoff was not the only criminal who ripped off I.R.A. accounts set up through various units of Fiserv. Fiserv customers were also victims of a Florida con artist, Louis J. Pearlman, a music impresario who ran the Backstreet Boys and N’Sync before being jailed last year for a huge fraud he ran largely through a company called Transcontinental Airlines.

And other Fiserv clients were swindled by Daniel Heath, a Bible-quoting promoter in Southern California, who was convicted early last year after defrauding hundreds of elderly churchgoers attracted to his seminars by offers of a free lunch.

All three con artists preyed on an increasingly popular kind of retirement account, the self-directed I.R.A. — a misnomer that usually refers to I.R.A.’s that are invested in a range of assets beyond traditional stocks, bonds and mutual funds.

A person who sets up a self-directed I.R.A. picks the investments — anything from real estate to hedge funds to commodities. The investor then typically relies on a support firm, called an I.R.A. custodian, to follow those directions, make the purchases and do the administrative work.

According to interviews and court records, Mr. Madoff, Mr. Heath and Mr. Pearlman all told their victims to use various units of Fiserv as their I.R.A. service firm.

“From the beginning, that was the only firm that Madoff recommended,” said Peter Moskowitz of Corona, Calif., one of dozens of Madoff victims who said they were directed to a Fiserv unit called Retirement Accounts.

“Once, when I wanted to change, they told me ‘absolutely not’ — they would only deal with Fiserv,” he added.

In the Madoff fraud, about $1 billion was lost from self-directed I.R.A.’s set up through Fiserv. The Heath and Pearlman scams took hundreds of millions more from other Fiserv customers.

To be sure, Fiserv’s past expansion may have made its presence in all three scandals more likely. “Over the years, we acquired several companies that act as custodians for individuals with self-directed I.R.A.’s,” said Judy Wicks, a spokeswoman for Fiserv.

Pending lawsuits that blame the company for investor losses in these frauds “have no merit whatsoever,” Ms. Wicks added. “Fiserv intends to vigorously defend against the assertions contained in the complaints.”

She continued: “We are not investment advisers and we do not consult or advise our account owners on which investments to choose for their I.R.A. Our contracts with the account owners make clear that we do not do these things.”

Clear answers to a simple question — what are firms like Fiserv required by law to do? — are surprisingly hard to come by.

“There really is just a black hole here,” said David Pratt, a veteran pension lawyer now on the faculty at the Albany School of Law. “There is very, very little law on the obligations of custodians.”

The firms might reasonably be expected to accurately maintain account records, to have custody of the paperwork proving ownership of a chosen asset, and to make sure an investor’s “self-directed” choices comply with the complex provisions of the tax code — for example, collectibles and life insurance are not allowed, but real estate probably is if neither you nor certain of your relatives are living in it.

But those expectations have not been consistently enforced by court rulings, based on cases cited by Fiserv — indeed, one state court absolved the company of liability after it let an investor put her I.R.A. into a life insurance product, despite an Internal Revenue Service prohibition on life insurance investments in I.R.A.’s.

When custodians do these basic chores — custody, record-keeping and compliance — it is difficult for crooks to steal their customers’ I.R.A. savings, said Professor Bullard. Similar arguments are being made against Fiserv in court. The company has paid $8.5 million to settle a class-action case filed by Mr. Heath’s victims in state court in California, where a second state lawsuit was forced into arbitration.

It is also facing two lawsuits by Mr. Pearlman’s victims in federal court in Florida, and two from Mr. Madoff’s victims in federal court in Colorado.

These cases acknowledge that Fiserv did not steer customers into these disastrous investments. Instead, they argue that Fiserv failed to perform its contractual and fiduciary duties as an I.R.A. custodian and, as a result, failed to protect the accounts from fraud.

For example, the Heath victims assert that Fiserv issued inaccurate account statements that concealed Mr. Heath’s repeated defaults on the promissory notes he sold them.

The vague securities pushed by Mr. Pearlman were so “completely mystifying,” one lawsuit claimed, that Fiserv described them variously as mutual funds, assets, shares, nonstandard assets and brokerage accounts — all within the same account statements.

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Louis J. Pearlman, top left, who ran the Backstreet Boys, told his fraud victims to use Fiserv.

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And, of course, Madoff victims want to know how a custodian could have failed to notice that no stocks were ever purchased for their I.R.A. accounts.

Ms. Wicks, the Fiserv spokeswoman, said these lawsuits all were improperly blaming the company for failing at tasks that it never agreed to perform — tasks that investors were supposed to do for themselves. Although the tax laws require that all I.R.A. accounts be set up through a trustee or custodian, the I.R.A. custodial business still occupies a regulatory limbo.

It is not squarely under the eye of securities regulators — the Securities and Exchange Commission gets involved only in cases of fraud, a spokesman said.

The Internal Revenue Service monitors only “nonbank” custodians, while most custodians — including the units that Fiserv owned — technically are banks or trust companies, an I.R.S. spokesman explained.

As for bank examiners, a spokesman for the Federal Deposit Insurance Corporation declined to comment, citing the existing litigation against Fiserv. But although the agency’s examination manual does specify some tests for I.R.A. custodians, that function has rarely been the target of enforcement action.

And the courts have made contradictory rulings, which were usually rooted in state contract law and were sometimes inconsistent with the F.D.I.C. manual.

“It’s more like a Wild West out there with many of these I.R.A. custodians,” said Jacob I. Friedman, a tax lawyer with the New York firm Proskauer Rose. “It is clear that I.R.A.’s need the protection of federal law rather than the current vagaries of the laws of 50 states.”

Mr. Pratt, the law professor, agreed. “There is a regulatory vacuum in this area and the federal government is the only entity that could fill it,” he said.

“There’s no question in my mind that there will be stricter supervision and monitoring of I.R.A. custodians as a result of the Madoff case,” Mr. Friedman added. Until that happens, he cautioned, investors should make sure their custodial contracts contain appropriate safeguards.

Meanwhile, yet another Ponzi scheme, shut down by regulators in April, has claimed additional millions in I.R.A. savings. On June 22, a fund manager named Edward T. Stein admitted stealing $30 million from his clients.

In the wake of that scandal, some of the fraud victims filed a lawsuit to place part of the blame for their losses on the I.R.A. custodian that handled their accounts with Mr. Stein — which, coincidentally, was Fiserv.