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H&R Block Accused of Misleading IRA Clients

The tax preparer touted a product that earned less interest than what customers paid in fees, New York's Eliot Spitzer alleges in a lawsuit.

Mar 17, 2006 | Los Angeles Times

New York Atty. Gen. Eliot Spitzer sued H&R Block Co. on Wednesday, accusing the nation's largest tax preparer of steering clients into individual retirement accounts that Spitzer said "were virtually guaranteed to lose money" because of hidden fees and low returns.

H&R Block has opened nearly 600,000 individual retirement accounts since 2001 for its tax customers. Spitzer's lawsuit alleged that the company assured its clients that they would earn "great rates," but 85% of them paid more in fees than they earned in interest.

More than 150,000 customers have closed these Express IRA accounts, incurring additional undisclosed fees and $6 million in tax penalties to boot, Spitzer said. The suit claims that the company violated state fraud laws and seeks $250 million in civil penalties and unspecified punitive damages.

In a statement, Kansas City, Mo.-based H&R Block said it would "vigorously defend" itself against the charges. It characterized its retirement accounts, which can be opened with as little as $300, as a "powerful first step toward ensuring a secure financial future" for people with modest incomes.

More than 40% of the account holders had never set aside any money before, said H&R Block Chairman and Chief Executive Mark A. Ernst, who called the IRAs "a helpful savings option."

Some H&R Block tax preparers disagreed with that assessment, refusing to open the accounts for clients and criticizing the products in internal memos, according to Spitzer's suit in state court in Manhattan.

"I really don't think maintenance fees should exceed the amount of interest that we are paying on these accounts," one district manager complained in an e-mail to Ernst that was cited in the lawsuit.

Instead of addressing these concerns, the company's management "continued to tout the Express IRA as a good way for lower- and moderate-income people to save," Spitzer alleged. The company's intent, according to the suit, was to encourage repeat customers for its tax-preparation services and to increase its stream of fees.

Last year, an H&R Block employee brought the issue to Spitzer, who opened an investigation.

"Many of those hardest hit were working families who struggle to save," Spitzer said in a statement. "Instead of providing these families with accurate information that would have allowed them to make informed choices, H&R Block steered them into retirement accounts that actually shrank over time."

The accounts were invested in money-market funds and typically earned just 1% to 2% a year, said Juanita Scarlett, a Spitzer spokeswoman. The average U.S. stock mutual fund gained 6.7% last year, according to Morningstar Inc.

In a lengthy written response, H&R Block said it had designed its IRAs by working with scholars, policymakers in the federal government, and nonprofit groups including the Brookings Institution and Aspen Institute. The idea, it said, was to provide low- and moderate-income people a way to benefit from the accounts, which offer tax breaks to encourage retirement savings.

The company is represented by former New York Atty. Gen. Robert Abrams, now with New York law firm Stroock & Stroock & Lavan. Abrams said that when tax benefits were taken into consideration, 78% of the Express IRA account holders came out ahead financially.

"This is a positive and powerful statement of achievement," Abrams said, adding that Block "has lost money operating this program."

The dispute arose in the middle of tax-preparation season, sending shares of H&R Block down $1.37, or 6.2%, to $20.63. Last year, H&R Block prepared nearly 16% of all individual income tax returns, according to a company regulatory filing.

Spitzer's action is the latest in a series of run-ins H&R Block has had with regulators and consumer advocates. The company has been attacked over its ties to check-cashing firms, its higher-priced mortgage-lending to borrowers with poor credit, and for making loans to tax clients that are repaid with their tax refunds.

These "refund-anticipation" loans have led to a series of lawsuits, including one last month by California Atty. Gen. Bill Lockyer, who accused the company of misleading customers about their costs. Saying the refund loans can carry interest rates of more than 500%, Lockyer alleged that Block inaccurately depicted them as "instant money" and didn't adequately warn recipients about the possible consequences if their refund was less than expected.

Lockyer is seeking to bar the company from offering the loans in California and wants H&R Block to pay at least $20 million in fines in addition to refunding customers for its alleged abuses.

Block has defended the loans as a popular program that adheres to all laws.

Lockyer spokesman Tom Dresslar said Spitzer's lawsuit "has all the earmarks we've learned to expect from H&R Block, including deceptive marketing and failure to disclose to consumers their true financial interest in the products they are pushing."

The lawsuit came one day after federal regulators, following lengthy protests by consumer groups, approved H&R Block's proposal to start a savings and loan. The U.S. Office of Thrift Supervision, which regulates S&Ls, will require that refund-anticipation lending be kept separate from the new thrift because of the concerns over its effect on consumers, said agency spokesman Kevin Petrasic.

Even so, regulators were surprised to learn of Spitzer's lawsuit, Petrasic said. He said H&R Block had notified the agency two or three weeks ago that the New York attorney general was investigating the company, "and we asked them whether there was going to be a lawsuit."

"And the answer we got back was it did not appear likely," Petrasic said.

H&R Block spokeswoman Linda McDougall said the company had told an Office of Thrift Supervision official Feb. 26 that it had received a letter from Spitzer saying that he intended to sue the company, and that H&R Block intended to contest the allegations.

One consumer advocate said that regulators should not have allowed H&R Block to start a savings institution, saying the company has a history of pushing questionable financial products on its customers.

"We think Block is a predatory institution, as evidenced by past litigation, and now by lawsuits from arguably the nation's two most influential [attorneys general]," said Kevin Stein of the California Reinvestment Coalition, a leader of the protests against the Block S&L.

Petrasic said his agency believed its oversight of the Block thrift would influence the company to improve its business practices.

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