Pre-Paid Suffers Legal Setback

Exposure

Although Pre-Paid has estimated its maximum exposure at more than $300 million, the company has reserved only about 1% of that amount for potential legal setbacks. Instead, the company has been using all of its free cash -- and even borrowing more -- to fund a share buyback program that some believe provides critical support for the thinly traded stock.

After slipping 28 cents to $22.36 on Thursday, Pre-Paid shares are sitting smack in the middle of their 52-week trading range.

"It should surprise nobody who has followed Pre-Paid management that they have been aware of this potentially huge legal setback but have failed to disclose it to investors," said one short-seller.

Cohan, who has been researching Pre-Paid extensively, said both Stonecipher and Martin Belsky -- a Pre-Paid director who serves as a law school dean in Tulsa -- dodged his specific questions about the company's legal exposure. He said Stonecipher also shifted gears when asked how Pre-Paid's multilevel marketing system really worked.

"Maybe these are topics they know would get them into big trouble if the truth ever came out," Cohan speculated.

Robert FitzPatrick, founder of the consumer watchdog organization Pyramid Scheme Alert, has declared virtually all MLM companies -- including Pre-Paid -- illegal scams. Even Len Clements, an industry watchdog who actually embraces MLM, says he believes that Pre-Paid has violated illegal pyramid laws and could face serious legal exposure as a result.

Both men have served as expert witnesses in other pyramid scheme trials. Clements testified in several cases against Equinox, a company that was eventually shut down by the federal government in one of the industry's biggest cases.

Clements has since predicted that, should Pre-Paid fail in its defense of pyramid-related lawsuits, the company may someday end as a multilevel marketing opportunity and return to its roots as a direct sales company, peddling legal policies much like regular insurance companies do. But he has also questioned the value of Pre-Paid's product. And Pre-Paid itself continually struggled to survive before adopting the MLM strategy -- heavily focused on recruiting -- that led to its explosive growth.

Cohan, for one, says the company may be doomed altogether.

"If it's a pyramid scheme, then it needs to be shut down," he said. "It seems to me that, if the government really wants to clean up business, then it has to start taking this sort of thing seriously."