Pre-Paid Legal Services
knows how it feels to be on trial.
The legal services company, which promotes "equal justice for all," has spent much of the past week defending itself against fraud charges in a state known for its runaway jury awards. The company could hear the jury's verdict -- and any ruling on punitive damages -- as early as today, says plaintiffs attorney Cliff Johnson.
The case is the first in a string involving hundreds of Mississippi customers who claim that Pre-Paid exaggerates the services provided under the company's legal policies. Using network marketing -- the sales strategy made famous by Amway -- Pre-Paid peddles legal plans that exclude full coverage for common legal problems such as bankruptcy and divorce. As a result, some customers find themselves facing the expensive retainers they had hoped to avoid by paying a monthly fee to Pre-Paid.
Johnson says his clients hope to secure damages from both Pre-Paid and CEO Harland Stonecipher, whom he describes as the "architect of the company's marketing scheme."
"If we win ... we are going to argue for an award that's sufficient to punish the company and Stonecipher for their conduct," says Johnson, who counts former U.S. Attorney Brad Pigott among his law partners. "It will be based on their net worth."
For its part, Pre-Paid doesn't comment for stories by
because it believes the coverage is negatively biased. To be fair, however, the company has won some legal victories in the past. Most notably, it has managed to block the class-action status of lawsuits filed by members of its own sales force. And it continues to defend itself in its regulatory filings.
"The company believes it has meritorious defenses in all pending cases," Pre-Paid states in its latest quarterly report, "and will vigorously defend against the plaintiffs' claims."
Early Tuesday, Pre-Paid slipped a nickel to $25.70.
Regardless of how the trial progresses, Massachusetts investment strategist Peter Cohan says the ongoing standoff between Pre-Paid insiders and short sellers -- who have sold 65% of available shares -- could keep the stock in limbo. But he doubts that even loyal insiders can protect the stock forever.
"I think Pre-Paid's survival depends on winning in Mississippi," said Cohan, who has no position in the stock. "If they lose there, that just opens the floodgate for more lawsuits. ... You pull out the foundation stone of the business, and the whole thing crumbles."
Indeed, critics point to the company's dwindling net worth. At the end of the second quarter, Pre-Paid posted shareholder equity of $41.9 million. But the company has since spent $25.5 million -- $19 million of it borrowed -- on a stock buyback that could slice its net worth in half.
Meanwhile, Stonecipher may have ended the quarter worth more than the company itself. At recent prices, his 1.47 million shares of Pre-Paid stock are valued at $37.9 million alone.
The plaintiffs are pursuing charges of fraud, civil conspiracy and violation of the Mississippi unfair practices law, Johnson says. In total, Pre-Paid's regulatory filings show, more than 400 people have filed 18 lawsuits against the company in Mississippi. At least four of those cases are already scheduled for trial next year, Johnson said.
Another 18 lawsuits, involving dozens of additional plaintiffs, are pending in nearby Alabama as well. But Cohan views the current case against the company -- apparently the first ever to actually go to trial -- as particularly significant. He says it has attracted the most attention and could set the tone for future legal developments.
Even so, Cohan doubts that a guilty verdict would immediately hurt the company's business.
"The bad news about this company has been reported and reported over and over again," Cohan said. "But Pre-Paid has a remarkable ability to mesmerize potential recruits
who sell the company's product and policyholders. ... There are definitely a bunch of people out there who appear to be immune to reason."
Still, Pre-Paid could take a financial hit. Some believe the Mississippi trials could trigger enough damages to at least trip certain bank covenants. For example, they note that Pre-Paid must post a net worth of $25 million at the end of next year. The company also faces restrictions on its debt coverage ratios.
In the meantime, Pre-Paid apparently has already fallen out of compliance with the listing requirements set forth by the
New York Stock Exchange
. Earlier this month, the company disclosed that the departure of its newest independent director -- insurance veteran Steve Hague -- has left its audit committee one member shy of NYSE requirements. The company said that Hague, who joined the board just last year, resigned on Sept. 30 "due to job relocation and increased demands on his time at his new location."
Meanwhile, based on Pre-Paid's past two proxy statements, the company's compensation committee has now dwindled to just one member.
Pre-Paid, itself a legal services provider, has no so-called directors-and-officers insurance to protect either the company or its board. Moreover, the company has set aside just $3 million to cover any damages that might result from all of the pending lawsuits.
Given Pre-Paid's potential exposure, Cohan suspects that "only somebody with a masochist streak" would want to serve on the company's board. And he doubts that even a courtroom win this week would be enough to remedy the situation.
"It would be a major psychological victory for the company," he conceded. "But this is a multigame series. It is not just one game."