H&R Block IRA Fraud News

New York State's Attorney General, Eliot Spitzer, announced a $250 million lawsuit against H&R Block on March 15, 2006, in a claim alleging fraud and deceptive marketing practices. The firm had learnt of Spitzer's intent to sue about a month earlier through a notice sent from his office. It has become public through a company email obtained by a news source, that the Attorney General offered to settle the claim against the firm for an undisclosed amount prior to announcing the lawsuit.

According to Spitzer, the tax preparation firm marketed individual retirement accounts (IRAs) to low- and middle-income clients as having "great interest rates" when instead they contained hidden fees and low-interest rates. The combination resulted in investors standing little chance of making a profit. Spitzer alleges that on the contrary, hundreds of thousands of clients ended up losing money through these investments placing the company squarely in the aggressive AG's sights. His office stated that 85% of customers paid more in fees than they earned in interest eventually driving 150,000 of them to close down their accounts. This triggered additional undisclosed fees and $6 million worth of tax penalties. The investigation was initiated after clients complained and a tip-off from an H&R Block insider.

The legal complaint against H&R Block also charges that senior managers were aware that customers were losing money in their accounts. To substantiate this, Spitzer's office produced an email from the tax firm stating a district manager's concerns to Chief Executive Mark Ernst about this very issue. The aspect of the company's actions that makes the allegations particularly egregious is that the accounts were targeted at working families.

While Block is widely known as a tax preparation business, in the last few years it has diversified its business into mortgages and also financial planning services. The Express IRA was offered to customers whose taxes it prepared as an option for saving all or part of their tax refunds and is held by at least a half-million account holders. The federally-insured money market accounts required a minimum $300 initial deposit. IRAs more commonly offer a tax- deferred means of saving for retirement through a variety of potentially higher-interest investment vehicles such as stocks and mutual funds. Spitzer gave the example that in the last few years, an Express IRA with a balance of $323, the average invested in the accounts, has earned interest of $3 a year. In contrast, the fees levied included a $15 setup fee as well as a $10 annual maintenance fee. On closing the account, participants would incur another fee, one that was initially $75 but subsequently reduced to $25.

At a news conference in New York, the AG stated that the IRAs were used as "bait" to lure customers and generate loyalty to the tax preparer year after year. He believes that the company did not operate fairly when it failed to disclose to its customers that the fees they would incur would exceed any interest earned on the accounts. He also noted that if individuals have been forewarned about the fee deductions, it was his belief that they would have made difference choices about opening these accounts.

Spitzer has earned a reputation in recent years of being a committed advocate in protecting the public interest. In doing so, he has investigated companies in a range of industries from investment banking and mutual funds to insurance. The Attorney General's track record of standing up for the public has coincided with a national crackdown on corrupt public company executives and practices and also earned him a number of nicknames including "The Enforcer". Spitzer's efforts have extracted billions of dollars in landmark settlements, which have been used to partially compensate retail investors and other consumers for their significant losses. His zeal has also drawn criticism from some who point to his political aspirations and attribute Spitzer's actions to his run for the New York Governor's office in 2006.

Ernst, for his part, has expressed his intent to aggressively defend the firm's reputation and IRA product in court. In a company statement, the Chairman and CEO said "Make no mistake -- we believe in the Express IRA product and are proud of the opportunities it presents for our clients". He cited the tax and savings benefits of the accounts saying that participants had saved more than $360 million and accrued tax benefits of at least $50 billion. Ernst believes that in filing the lawsuit, Spitzer had overlooked these factors.

Block's CEO also pointed out the accounts required a lower minimum balance than those at most financial institutions which are often leery of small accounts because of the high administrative costs. Ernst further commented that the firm had incurred losses of $12 million in developing and marketing the program but did so with the objective of assisting its customers with saving for their retirement. Senior VP and General Counsel with the firm, Nick Spaeth, also stated that if clients chose to withdraw their funds early, they would incur IRS penalties as with any other IRA product. Spaeth defended the IRA as "an innovative and sound savings choice." The company has said that it is fully cooperating with the investigation and has handed over data and other supporting information to the Attorney General's office.

The suit comes at a difficult time for H&R Block after a string of legal and accounting issues faced by the firm and right at the peak of tax season when millions of Americans prepare to file their returns to meet the April 17 deadline. It follows another lawsuit filed by California's Attorney General, Bill Lockyer, on February 16 of this year in which he alleged that the company had misrepresented "high interest" refund-anticipation loans as "instant" tax refunds in violation of state and federal laws. The company also announced in February that its third quarter results fell dramatically by 68% due to the cost of settling class-action suits related to its refund- anticipation loans. Then on February 23, in another major embarrassment, the high-profile tax firm announced that it would have to restate its financial results for fiscal 2004 and 2005 as well as results already released for the previous two quarters of this year, primarily due to errors in calculating its state-effective income tax rate. The miscalculation resulted in it understating its income tax liability by $32 million last year.

Further contributing to the tax firm's troubles, a separate class action suit was filed on the same day of Spitzer's suit by the law firm of Lerach Coughlin in federal court in Kansas City, also citing problems with Block's retirement accounts. The complaint accuses the firm of breaching its fiduciary duties and engaging in unfair and deceptive trade practices. It also seeks an unspecified amount of actual and compensatory damages. If New York's Attorney General has developed a reputation as a formidable foe, then it is at least matched by trial lawyer, Bill Lerach, who is a well-known and tenacious securities litigator.

Since filing suit, Spitzer has lived up to his reputation as a tough adversary by saying that the company's ensuing actions lead him to believe that it is unlikely that a settlement will be reached. His comments were made in response to a press release from the firm and an op-ed piece by CEO Mark Ernst in the Wall Street Journal both of which defended the company's marketing of the IRAs. The Attorney General also pointed out that the resulting fines and penalties the lawsuit demands would negatively impact Block's shareholders. The company's share price fell by 6.2% on the day the complaint was filed, closing at $20.63. The stock has since rebounded with a closing price of $21.65 on March 30.