H& R Block Accused of Defrauding Customers

New York Attorney General Eliot L. Spitzer announces a lawsuit against H& R Block Inc., accusing it of fraudulently marketing high-fee IRAs.
New York Attorney General Eliot L. Spitzer announces a lawsuit against H& R Block Inc., accusing it of fraudulently marketing high-fee IRAs. (By Mike Segar -- Reuters)
By Brooke A. Masters
Washington Post Staff Writer
Thursday, March 16, 2006

NEW YORK, March 15 -- H&R Block Inc., the nation's largest tax-preparation service, defrauded hundreds of thousands of customers by encouraging them to invest their tax refunds in individual retirement accounts without disclosing that high fees meant most small investors would lose money, New York Attorney General Eliot L. Spitzer alleged in a civil lawsuit Wednesday.

The 28-page complaint, which seeks $250 million in damages, said 85 percent of the more than 500,000 H&R Block customers who opened accounts through its Express IRA program paid more in fees than they received in interest. More than 150,000 of the customers closed their accounts within four years, incurring further fees and $6 million in tax penalties.

Spitzer alleged that H&R Block's top managers, including chief executive Mark A. Ernst, were aware that many customers were losing money but continued to market the Express IRA program as "a better way to save."

H&R Block fired back immediately, saying it had hired Robert Abrams, a former New York attorney general, to defend its product in court. "Make no mistake -- we believe in the Express IRA program," Ernst said in a statement released minutes after Spitzer announced his case. "We've helped 596,000 of our clients begin saving for their future, and more than 40 percent of them had never saved before."

The typical H&R Block IRA customer earned less than $30,000 a year and was saving for the first time, the suit said.

"H&R Block misled investors about the fees. This is a blatant violation of law," Spitzer said in an interview. "The outrageous nature of this misrepresentation is magnified by the fact that the most vulnerable members of our society were being ripped off."

The complaint alleges that more than half of the program's participants made only the minimum investment of $300 and that for 2002, 99 percent of those small investors lost money.

H&R Block said 78 percent of its customers ended up ahead, once the tax savings involved in opening an IRA are included along with the interest. But Spitzer's investigators dispute that figure, saying it includes savings on deferred taxes that will eventually have to be paid and the waiving of an H&R Block fee.

Abrams said in the statement that the company was simply trying to encourage its lower-income customers to save and that it had actually lost money running the program.

Spitzer's complaint noted that Ernst had touted the IRAs in a November 2001 call with stock analysts for their "retention impact" on tax clients. "Clients who leave some of their money behind with us at H&R Block are far more likely to come back."

The share price of Kansas City, Mo.-based H&R Block dropped quickly and closed at $20.63, down more than 6 percent.

According to the lawsuit, the central problem with the H&R Block program is that it offers customers only one investment option -- a money-market account that pays interest -- without disclosing to customers that it assesses maintenance fees that outstrip the interest income for small investments. IRAs offered by brokers generally include a wider range of investment options, which have higher risk but, over the long term, have higher returns.

Some of H&R Block's employees were uncomfortable with the program, and one of them sparked the inquiry by complaining to Spitzer's office.

Offering an investment product with high fees and low returns is not illegal. But Spitzer argued that H&R Block violated New York law and committed fraud by promoting the Express IRA as having "great rates" and failing to disclose all the fees.

H&R Block spokesman Nick Iammartino said the IRA "paid very competitive interest rates for at least the last three years." He said, "Right from the start, we disclosed all of our fees properly and fully."

The firm also argued that without the program, many of its customers wouldn't save their tax refunds at all.

Peter R. Orszag, a Brookings Institution senior fellow, used the program to test whether low- and moderate-income people would save if they were offered a match for their tax refunds. H&R Block provided the matching money but did not pay for the research. Orszag said he could not comment on the litigation but noted that "making it easy to save can have very large effects on participation."

But Elizabeth Maresca, who runs Fordham University Law School's tax-litigation clinic, said H&R Block's customers are particularly vulnerable to improper sales pitches. "You have this high level of trust with your tax preparer. You've just given them all your information, and then they recommend this financial product."

In December, H&R Block agreed to settle several lawsuits by paying $62.5 million to 8 million customers in the District, Maryland and 25 other states who exchanged expected tax refunds for instant payments. The suits claimed that the company failed to tell customers that the payments -- formerly called "rapid refunds" -- were actually high-interest, short-term loans.

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