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New York charges H&R Block with fraud

New York state filed a $250 million fraud suit Wednesday against H&R Block Inc., the nation’s largest tax preparing service, charging the company fraudulently steered customers into a losing retirement account plan.
Chairman and CEO of H&R Block Mark Ernst speaks in New York
“Make no mistake — we believe in the Express IRA product and are proud of the opportunities it presents for our clients,” said H&R Block’s Chairman and CEO Mark A. Ernst, responding to a $250 million fraud suit filed by New York state against the tax preparer.Nicholas Roberts / Reuters file
/ Source: Reuters

H&R Block Inc. the largest U.S. tax preparer, fraudulently marketed retirement savings plans that caused hundreds of thousands of mostly low-income clients to lose money, New York State Attorney General Eliot Spitzer charged in a lawsuit filed on Wednesday.

The suit seeks $250 million in fines plus refunds after H&R Block steered roughly 500,000 tax return customers to invest in individual retirement accounts, but failed to disclose high hidden fees that actually outpaced interest earned on the accounts, the attorney general said.

As a result, about 85 percent of these customers lost money, Spitzer said.

The suit is the latest in a line of legal and accounting issues faced by H&R Block and comes at a crucial time for the tax preparer as millions of Americans get ready to file taxes before the April 17 deadline. Its shares fell more than 4 percent.

H&R Block used the retirement accounts, with an minimum initial deposit of $300, to try to make sure tax customers returned every year, the suit charges.

“This is the bait designed to keep consumers coming back,” Spitzer said at a news conference in New York. “They (H&R Block) did not have the decency or the sense of fairness to disclose to these low-income clients that the fees that they were imposing would mathematically outweigh the interest being paid on these accounts.”

Spitzer said an investigation was launched into the “Express IRA” product after complaints from customers and a tip from an H&R Block tax preparer.

He said one 32-year old Albany, New York, resident made a one-time deposit of $300 into an H&R Block Express IRA in 2002, but actually ended up with less money four years later. The customer received $10.29 in interest but paid out $45 in fees.

Kansas City-based H&R Block defended the Express IRA accounts and contended Spitzer ignored evidence that disproved his allegations. H&R Block said it was cooperating with the investigation.

“We believe in the Express IRA product and are proud of the opportunities it presents for our clients,” H&R Block Chief Executive Mark Ernst said in a release. He said the company would “vigorously defend” the product in court.

The civil complaint, filed in Manhattan state court, cites internal documents showing that senior H&R Block management knew that many of its customers were losing money on their Express IRAs. In a 2002 e-mail to Ernst, a district manager complained about the impact of these accounts on customers.

Fees included a $15 setup fee, a $15 recontribution fee, a low interest rate and a $10 annual maintenance fee. More than 150,000 H&R Block customers closed their Express IRA accounts, only to incur additional undisclosed fees, as well as nearly $6 million in tax penalties, Spitzer said.

H&R Block said it received Spitzer’s notice of intent to sue last month, followed by a settlement demand letter.   

“We have cooperated fully and provided volumes of data and detailed analyses to the Attorney General’s office, but it has ignored all of the positives and has chosen to launch this attack,” said H&R Block General Counsel Nick Spaeth.

H&R Block said that between 2001 and 2005, three-quarters of its Express IRA customers experienced “positive net tax savings benefits and interest earnings.” An attorney for H&R Block also said the company has lost money operating the program.

The suit is the latest in a line of high-profile cases for Spitzer, who made his name with multimillion-dollar settlements of charges against Wall Street investment banks, fund managers and insurance brokers.

Legal and financial run-ins
H&R Block, which has grown rapidly over the past six years and seen its stock price treble in that time, has had a series of legal and financial run-ins.

In December, the company agreed to pay $62.5 million to settle four class-action lawsuits over very high-interest loans for customers waiting for tax refunds. Last May, a federal judge in Chicago rejected a $360 million nationwide settlement over similar issues, calling the sum inadequate.

In 2003 the company paid $3.3 million to settle a previous suit from Spitzer and other state attorneys over over fees it charged customers for additional audit protection.

In 2004 brokerage regulator NASD charged H&R Block Financial Advisors, Inc. with fraud over the sale of millions of dollars worth of Enron Corp. bonds in the weeks before the energy trading company’s bankruptcy, even though Enron’s finances and bond ratings were collapsing. The case has yet to be settled.

NASD also fined H&R Block Financial Advisors, Inc. $500,000 in 2004 for enabling a hedge fund customer to engage in deceptive practices involving the timing of investments in mutual funds.

Only last month, the company said it had underestimated its own state income tax rate, meaning it owes another $32 million in back taxes. As a result, H&R Block said it would restate previously reported earnings going all the way back to 2004.

H&R Block’s troubles in New York are likely to further complicate the company’s effort to secure a bank charter from the Office of Thrift Supervision.

Last fall, the OTS deemed the company’s application for a charter complete. But opposition from groups like the California Reinvestment Coalition and the Chicago-based Woodstock Institute, which accuse the company of “gouging” poorer consumers with high-rate refund anticipation loans and other products, has delayed approval.