An executive whistleblower has filed suit against payroll giant ADP, Automatic Data Processing ($ADP), accusing senior management of long-running state and federal tax crimes and pension fraud.
The case was filed by David Schwartz, a top-performing national salesman, who was fired after questioning the legality of ADP's policies, then reporting the company to the SEC and FINRA.
ADP sued him to return "proprietary information" about how they do business, plus all his clients files; Schwartz responded he would only give up the documents to a judge for discovery in his counter-claim.
The accusations threaten to knock ADP off its stock market pedestal, where its shares are at an all time high, valuing the company at $71 billion, as investors treat the stock as a bellwether for a growing employment market. Despite the bullish macro-economic sentiment, the internal corruption revealed here for the first time by this whistleblower could bolster years of civil and class action suits, bringing ADP to its knees.
Long from installing punch card readers and only processing payroll transactions, in the days when future Senator Frank Launteberg led the Roseland, NJ, company, the whistleblower's filing describes a culture of greed and lawlessness, institutional hazing and ethics failures from the relentless pressure to win new business.
Instead of enabling its 60,000 employees to do the actual work of helping 600,000 small business clients with book keeping services, Schwartz discloses how ADP’s business is now being run to maximize cash flow from customers so it can invest their balances, totaling billions of dollars each year.
ADP is the largest company in the payroll outsourcing sector, processing 1-in-6 pay stubs in the country. It's also investing all those employee withholding taxes for its own profit until it hands the funds over to the government at the end of each quarter.
In 2018, ADP had annual sales of $13.3 billion, with net profit of $1.6 billion, but about a third of that ($466 million) was earned from trading the $27 billion in client balances.
The pressure to feed that beast with new client cash has led management, who are paid 90% on commission, to advise ADP sales reps to cut corners and break the law.
The three big examples detailed in the case are around social security tax fraud, illegal pension sales, along with forging signatures of business owners on state unemployment forms.
The last is the most obvious crime -- in the interest of expediency, ADP reps fill out and forge business owner names for all their state Department of Revenue documentation -- the DR1–(RT6) form used to determine how much State Unemployment Tax (SUI) companies owe on their employees.
Forgery is obviously wrong, but the worst part is that business owners rarely understand all that ADP has agreed on that form for them to do. Because ADP puts down its corporate address as the contact, if those customers leave ADP, giant fines for business owners can build up because the notices never get to their intended destination. And they can't technically be held responsible, though they are, because they didn't actually acknowledge or agree to the state's terms.
The IRS fraud is a much worse example, and shows the lawlessness and laziness that pervades ADP's culture today. The impact is felt by potentially tens of thousands of unlucky and innocent people with nothing to do with ADP at all but ensnared as victims in this federal crime.
According to the details of Schwartz's filing, before ADP can start collecting client cash -- "to run payrolls" -- sales reps need to gather the year's payroll and tax records, including information for every current and former employee, including their social security numbers. The last four digits are often missing or masked by the previous payroll company that no longer has access to those records or are uncooperative in helping out ADP to get the data.
A restaurant with ten employees could have upwards of a hundred who worked there over the course of a year. ADP can't run payrolls until every employee form is complete, so what to do when running out of time to do the leg work at the quarter end? When reps ask management, they say: make up the numbers. Unfortunately, those "fake" social security numbers are real, and actually belong to someone else.
The outcome is victims around the country are forced to pay tens of thousands of dollars in back taxes to the IRS from money they were never paid, by companies they've never worked for, in states they've never even been.
According to Schwartz's filing, where ADP's management also breaks the law is in its pension business.
Created as a cutout in the 1993 ERISA legislation, with the rationale that assisting clients in signing up for a savings product was more important than its reps being licensed to provide investment advice to clients, ADP sells two "self directed" pension products but can't recommend either.
What Schwartz reported to FINRA was that its sales incentives are precisely geared towards selling one over the other, all they do is recommend it, exclusively, even though that one is more expensive and less advantageous for most clients — but more advantageous for increasing ADP's cash flow. Basically, reps are not licensed to sell pensions, but they are sort of allowed to, they can't recommend one over the other, but they certainly do, and, what's worse, the one they recommend is usually the worst for their client.
The SIMPLE IRA is the "favored son" by a factor of 10-to-1. Why ADP likes it is that it includes an automated monthly withdrawal from employee pay and cash up front bonus to the salesmen. That deal compares to the somehow "more complex" SEP IRA has a bigger tax deduction, allows business owners to make a one-time pension payment at the end of the year -- but no monthly inflows for ADP and deferred sales commissions. The SEP IRA is almost always the right choice for small business, and always for those under four employees — in other words, most of ADP's clients who are pushed into the SIMPLE IRA.
As for sales rep commissions, according to other employees who have also left or been terminated by the firm, the incentive structure is $600 for selling a SEP vs. $1,200 for selling a SIMPLE.
Schwartz, who was ADP's top-selling SIMPLE IRA salesman nationally, describes the delicate dance designed by management to designed to skirt the pension regulations, while fully breaking the spirit of all those laws.
To set the tone, the primary role of management is to goad sales reps via social media accounts, with motivation-by-greed, offering of cash bonuses to "sell SIMPLE."
How it works, in theory, is that after describing the two products, the client is supposed to use an "algorithm" in an online app to determine which, SIMPLE or SEP, would be the better choice. That information is sent directly to the pension desk inside ADP that completes their enrollment.
How it really works is reps, working for the cash bonus, tell the clients that SIMPLE is the way to go, they do the calculator questionnaire for them, asking the client questions, but helping it recommend the SIMPLE.
And it actually doesn't matter if the algorithm outputs SEP, because when the rep call headquarters with their client to finish the deal with someone who's licensed, the phone number on the end is the SIMPLE IRA desk, where the operator starts with, I was told by the rep that you're ready to enroll in SIMPLE, any questions before we continue with the paperwork?
ADP's pension business, with 70,000 clients, has come under regulatory scrutiny before: in a 2005 class action suit, Huffman vs. ADP, and in separate action by a financial advisor and whistleblower who reported ADP and competitor PAYCHEX to the Department of Labor, the SEC and FINRA for the structural harm created by the ERISA legislation.
In the latter, Royce Charney, President of Trust Administrators, Inc., has described all the ways in which allowing unlicensed sales reps to sell pension investments has both hurt traditional financial advisors, because of the competition, but also hurt customers because the fees are just as high but they're not getting any advice out of it.
Charney petitioned the Department of Labor in 2017 and the SEC in 2018. His complaints have yet to be heard, owing to the resistance put up by these two giant adversaries, although politicians have begun to come around to supporting his calls to review the current ERISA status quo.
The 2005 class action suit, Huffman vs. ADP, was more successful, though much more limited in scope. That case claimed that ADP pension clients were being told that the SIMPLE IRA would cost them only $39 per year, until Huffman learned from an insider that Fidelity, who managed the money, was actually paying ADP a rebate equal to a 3.5% commission, plus kicking back a 0.5% management fee.
The "Fidelity" branded mutual funds they were invested in, were actually lower-performing versions of the real products, because all the added fees were eating up client net returns. Huffman vs. ADP sparked more action against other "pay-for-play" schemes in the pension industry.
The case ended in a settlement, but the details were very awkward. Rather than going to trial, which they had planned, the plaintiff and her lawyer said they came under direct pressure from white shoe firms that represented ADP and Fidelity who imposed cruel retribution on them for standing up to that cabal.
The whistleblower lawyer, Bret Landrith, who had won important cases before, was suddenly disbarred. (Landrith had raised the ire of General Electric and its lawyers by suing them for antitrust and Medicaid fraud in the medical device industry among his many other powerful enemies.)
Huffman had to accept the settlement on her own, without a lawyer, and the duo were forced to abandon the 300,000 people originally identified as victims unable to join the class action they had been putting together.
Huffman went to law school, but was blocked from taking her bar exam for three years -- she blamed the legal community for making her life miserable; meanwhile, her brilliant lawyer, was forced into obscurity and poverty.
For ADP, the case ended its deal with Fidelity, moving the pension funds to American Century Investments, then then the business became about really pushing SIMPLE.
The ADP representative and ultimate culprit named in the case -- in the filings but excluded from the press reports at the time -- ADP Vice President for Pensions, James Blake remains at the company to this day.
The current case against ADP is based on retaliation against Schwartz, who lives in Ft. Meyers Beach, under Florida's Whistle-Blower's Protection Act, § 448.102(1) and (3), Florida Statutes, once they fired him for speaking up.
"Rather than attempt to cure the illegality of these activities, practices and policies, ADP simple ignored Schwartz's objections and turned the proverbial blind eye to the above-described illegal and fraudulent conduct," the filing concludes.
In the original complaint against Schwartz, ADP claimed the reason he was fired -- not for demanding a response from management about his ethic concerns, or filing against the company with SEC and FINRA -- but for breaking his contract by emailing company files from his personal account.
Schwartz's lawyer, Daniel Levine, responded, out of the gate, that the company broke Florida's Whistle-Blower Law by firing him once he filed with SEC and FINRA. And as for the single email they found, Schwartz, on a day when the company email was on the fritz, sent himself on-boarding documents to sign a new client.
ADP also claimed Schwartz set up a competing firm -- United Consulting Group -- but that was actually a wholesaling operation formed to service big accounting firms, and that he created under direction from his managers. The whole point of it was to keep the money flowing to the bosses.
Shares of ADP are at record highs, as the stock's dominant position in the sector has made it a proxy for economic growth, and new jobs. With employment figures now showing there are more new jobs than there are available workers, a tight labor market should translate to ADP's bottom line, according to analysts cover the company.
Dueling activist investors Robert Chapman and Bill Ackman, who also faced off in Herbalife in 2013 -- Chapman long, Ackman short -- had big positions in ADP in 2017 -- Chapman short, Ackman long -- when Ackman harangued management to improve its efficiency by cutting the workforce. (The counterpoint being ADP needs its aggressive, hard-charging sales reps to actually push new clients into signing up, and then into its cash cows.)
None of the valuation models or questions factor in the reputational cost of their unethical business model or alleged fraud therein, as described by Schwartz in what is now a public filing.
ADP's 91% retention rate could drop of national sentiment shifts on its brand. The stickiness of having to re-do all the forms with a new company -- which could be just as bad -- generally makes clients loathe to switch. But judging by the harsh criticism of the company on its page at the Better Business Bureau (despite an unfathomable A+ rating) and after reviewing all the angry responses from customers on its Twitter feed, many customers are furious and publicity around this case could catalyze a movement to dump ADP.
Meanwhile, the cash management side hustle of investing $26 billion in withholding cash -- if it were taken directly by the government -- would cost ADP a third of its net profit.
Salad days for investors enjoying ADP's high earnings per share, generous dividends and large share buybacks could be over because of this whistleblower.
At 8:30AM on Wednesday, ADP will release its third quarter results, with CEO Carlos Rodriguez facing analyst questions on a live webinar. The revelations brought forth by this whistleblower lawsuit will be heard.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: article published by whistlebl0wer.com
Additional disclosure: whistlebl0wer.com is an investigative news site, reporting on the unreported news from brave whistleblowers who stand up to corporate thieves, bad politicians and corruption, in general.