After cracking down for years on people tied to
Pre-Paid Legal Services
, government officials are now taking aim at the company itself.
Last week, federal prosecutors began a formal probe into Pre-Paid's activities during a December surge -- followed by a January crash -- in the company's stock. The
Securities and Exchange Commission
has launched an informal inquiry into the same matter.
The stock's wild ride began after a glowing recommendation from Gotham Partners, a prominent New York hedge fund, in late November. It took a sharp turn south just six weeks later -- following sales of the stock by both Gotham and Pre-Paid insiders -- when the company reported an end to its 10-year growth streak.
Those with a close eye on Pre-Paid, including a crowd of short-sellers, believe the company will pay dearly for the Gotham endorsement it once embraced. Meanwhile, even some longtime Pre-Paid fans are re-evaluating their support of the company.
"Did the short-sellers just put out adverse information, or was Pre-Paid actually doing all this stuff?" questioned Bob Rader, a senior partner at Capital West Securities in Oklahoma City, which has no position in the stock. "If they were doing it ... this crap has got to stop."
In light of the current controversy, some observers are taking a harder look at Pre-Paid bulls in general.
Behind the Bulls
Over the years, a number of investment firms have recommended Pre-Paid as an undervalued and misunderstood stock. Several of those firms have since gone out of business, tarnished by their involvement in other stocks. Pre-Paid, which broke through $40 twice, actually proved to be one of their better picks. Still, the stock has brought no lasting rewards to traditional "buy-and-hold" investors. At $18 a share, Pre-Paid fetches 45% less than it did five years ago despite massive company buybacks and bullish touts from professional investors.
As a matter of policy, Pre-Paid declines to comment on stories published by
, saying it believes the coverage is biased against the company.
Gotham Partners, led by Harvard Business School graduates William Ackman and David Berkowitz, was perhaps the most prestigious firm to ever endorse Pre-Paid's stock. But the former Wall Street powerhouse now bears a queasy resemblance to some lesser firms that have touted Pre-Paid in the past. Like those firms, Gotham is now under investigation for possible securities violations. And it, too, is headed for demise; Gotham has said it plans to liquidate.
"These guys were supposed to be smart guys," said one hedge fund manager with a large short position in Pre-Paid's stock. "What in the world were they doing mucking around with Pre-Paid?"
In previous reports,
exposed a number of questionable characters -- some with criminal backgrounds -- who have ranked high within Pre-Paid's massive sales organization. But Pre-Paid's colorful cast extends beyond those who peddle the company's legal policies and its Amway-like business opportunity. It also includes some rather dubious firms that have pushed Pre-Paid's stock.
To date, Pre-Paid has been promoted by what prosecutors said was a mob-controlled investment house known to manipulate securities, an Internet talk show host who was punished for paid touts, a New York analyst who doubles as a Pre-Paid sales agent and -- with the addition of Gotham -- a fallen financial giant that has triggered an investigation into the secretive hedge fund world.
The stock has remained largely ignored by mainstream Wall Street.
"If a firm is covering Pre-Paid, you have to ask yourself how they're getting paid for that," said Peter Cohan, a Massachusetts author and investment strategist with no position in the stock. "And my guess is that it's going to be shady."
'Mob on Wall Street'
In early 1997 -- while under scrutiny for possible ties to the Mafia -- Sovereign Equity Management took the time to publish a glowing report on an "undervalued and under-followed" stock.
For the second time in just over a year, Sovereign was issuing a strong buy recommendation for Pre-Paid. That recommendation would become Sovereign's last on record.
Investigators were closing in on the firm, sniffing for stock manipulation and ties to organized crime. They found both. Sovereign soon went out of business, accused of profiting from illegal "pump-and-dump" schemes involving a handful of small-cap stocks. And Philip Abramo -- once described as the most powerful mobster on Wall Street -- wound up in jail even before he admitted that he was behind the plan.
Pre-Paid was never singled out as a stock manipulated by Sovereign. However, it shares two critical traits with the stocks Sovereign targeted. It is both relatively obscure and thinly traded -- making it, even today, vulnerable to huge price swings.
By the time Sovereign dissolved in scandal, Pre-Paid was gaining notice elsewhere. Pre-Paid's charismatic CEO, Harland Stonecipher, had become a popular featured guest on a stock radio show called JohnyDot.com.
A veteran at pitching the Pre-Paid story, Stonecipher would talk easily about the company's explosive growth and -- citing a huge untapped market -- its even brighter future. John Westergaard, the former Wall Street analyst hosting the show, would toss out a few softball questions and then wait his piece before coming back with some favorable observation about Pre-Paid's strong performance.
The pair came across as old friends carrying out a genuine, if familiar, discussion. But Westergaard, as it turns out, was pocketing up to $48,000 for his side of those conversations.
The SEC later cracked down on Westergaard for accepting undisclosed payments for his "independent research" of other stocks. Westergaard's Internet-based companies, including Johnny.Dot.com, soon went out of business and settled charges with the SEC. Last year, Westergaard personally settled similar charges.
Of all the promoters of Pre-Paid's stock, New York analyst Alan Weber stands out as perhaps the most enthusiastic.
Weber has tracked Pre-Paid's stock for years, both at Prescott Investors -- whose managing partner ranks as Pre-Paid's largest shareholder -- and currently at Robotti & Co. Regardless of market or even company-specific conditions, Weber has consistently rated Pre-Paid a buy. He downplayed the significance of a 2000 SEC investigation into Pre-Paid's accounting -- which triggered a massive restatement -- and continues to dismiss the potential liability associated with a slew of lawsuits filed against the company.
Instead, Weber focuses on Pre-Paid's steady growth, predictable cash flow and aggressive stock buybacks. But in the end, he talks less about these metrics -- typical analyst fodder -- than about the wonders of Pre-Paid's product.
Weber will argue, at length, about the value embedded in Pre-Paid's $26-a-month legal coverage. If his discussions border on sales pitches, there's a reason. Questioned about possible compensation for his endorsements, Weber revealed that he's "technically" a Pre-Paid sales associate.
To be fair, Weber counts himself among the huge crowd of "inactive" Pre-Paid associates who've made little or no money off the business. He instead relies on income from his day job at Robotti -- which picks up trading commissions for executing Pre-Paid's busy buyback program.
Weber isn't the only Pre-Paid sales associate with ties to the securities industry. A couple of highly successful Pre-Paid associates have played their hands in the investment world as well.
John Brinker scored headlines in recent years for his leadership of an offshore operation called Wellington Bank & Trust. Federal investigators called the obscure Caribbean bank a Ponzi scheme, alleging that it sucked in millions of dollars from unsuspecting investors. A Web site published by Wellington's receivers says Brinker was one of several Pre-Paid associates involved. Today, Brinker continues to be ranked as one of the top performers in a huge sales organization led by Pre-Paid front man Dave Savula.
Michael Roy Fugler, who launched Pre-Paid in Louisiana, also has a history. Fugler's firm, Millennium Financial, helped take a company called GenesisIntermedia public in 1999. Less than two years later, the company voluntarily delisted itself amid allegations that it had paid for misleading touts that pushed its stock to $25 a share. Fugler served as a GenesisIntermedia director throughout the ordeal, finally resigning last May with the company's stock fetching less than a penny on the pink sheets.
The Big Fall
Until now, Pre-Paid has escaped any major fallout from the alleged misdeeds of those who have promoted the company. But that could be changing.
Federal agencies are now looking squarely at Pre-Paid and, more specifically, its top executives. At least three Pre-Paid insiders disposed of company stock during the six-week period federal agencies are now examining. Pre-Paid Chief Operating Officer Randy Harp sold 55,000 shares -- collecting enough to repay a large insider loan -- during the December rally. Stonecipher also benefited, gifting stock at high prices during the year-end tax-planning season. Pre-Paid director Martin Belsky, dean of a Tulsa law school, unloaded shares as well.
All three of those insider sales came at a time when Pre-Paid was wrapping up a quarter that, based on the company's own comments, was likely to disappoint.
Ironically, Pre-Paid recently took the offensive and invited an investigation by the SEC. The company called upon Oklahoma Attorney General Drew Edmondson -- a politician handsomely backed by Pre-Paid leaders -- to request an SEC probe into short-sellers accused by the company of manipulating its stock.
Pre-Paid sought out a similar investigation more than 15 years ago. No findings were ever reported.
At least one shareholder advocate suspects that Pre-Paid bulls -- not the bears -- are who investors should fear most.
"You have to wonder why they're recommending Pre-Paid to begin with," said Floyd Schneider, the publisher of a former consumer watchdog site called thetruthseeker.com. "This company reminds me of a lot of over-the-counter Bulletin Board stocks.
"The promotion has just been amazing."