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H&R Tastes Credit Crunch

The tax giant gets shut out of the commercial paper market.

A storm is brewing at

H&R Block

(HRB) - Get H&R Block, Inc. (HRB) Report

.

Shares fell 4% after the Kansas City, Mo.-based tax services provider became the latest financial company to face problems raising money in the market for short-term loans known as commercial paper.

Block said it had to draw down some bank credit lines when its Block Financial unit was locked out of the commercial paper market. Other big financial companies, including mortgage giant

Countrywide

(CFC)

, have been forced to tap their bank lines after other market-based funding sources dried up.

Block's bank drawdown came as a big proxy adviser sided with dissident shareholders mounting a proxy campaign. Institutional Shareholder Services recommended investors side with activist investor Breeden Partners.

Breeden, a hedge fund and investment firm founded by former

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SEC

chairman Richard Breeden, is attempting to gain three seats on H&R Block's board to improve shareholder returns. The Greenwich, Conn.-based firm intends to nominate three individuals, including Mr. Breeden, at H&R Block's annual meeting slated for Sept. 6.

ISS, a Rockville, Md.-based proxy-voting firm, said that new board members will help H&R Block overcome the challenges it is experiencing as a result of diversifying too far away from its core business.

"The company's long-term underperformance can be traced to either a failed diversification strategy or poor execution," ISS said in a report. "While the company already is trying to divest its troubled mortgage unit (some would argue a day late and a dollar short), we believe that the company will continue to face other challenges, including what to do about the poorly performing brokerage unit, whether the benefits of the bank outweigh the drawbacks and the continued competitive pressure in the core tax prep business. A new shareholder perspective on the board should help to meet these challenges."

Last week one of H&R Block's largest shareholders, Harris Associates, made known in an SEC filing that it intends to vote in favor of the Breeden Partners nominees at the annual meeting. The Chicago-based money manager owns 6.76% on behalf of its clients.

Breeden is looking for the company to consider several strategic options including "stopping the bleeding" at its subprime mortgage business, Option One.

The subprime lending outfit has suffered stiff losses as a result of the mortgage meltdown. H&R Block is trying to sell Option One to Cerberus Capital Management, but it said two weeks ago that the deal, which was supposed to close in October, now might not close until December.

H&R Block should also consider selling its securities brokerage business and banking arm, among other changes, Breeden said in a recent SEC filing.

H&R Block said in a statement that it was disappointed at ISS' recommendation.

Richard Breeden has embarked on a "self-serving campaign to win election for himself and the other Breeden Partner nominees to the H&R Block Board

that has been characterized by a troubling pattern of inadequate disclosure and misleading statements. The company is concerned that many of Mr. Breeden's so-called 'new ideas' could be harmful to shareholder value," H&R Block said.

Shares of H&R Block fell 81 cents to $18.98.