Pre-Paid Legal Services ( PPD) has been spending an awful lot of time in the courtroom lately. The Oklahoma-based legal services provider -- itself a magnet for massive litigation -- last week saw a state supreme court reverse an earlier ruling in favor of the company. The case, which accuses Pre-Paid of fraud and breach of contract, is headed for trial after a swift, three-week decision by the high court in West Virginia. "We feel this is a good case for punitive damages," said Jane Peak, the attorney for the plaintiffs. "Pre-Paid needs to learn that it has to live up to the representations made by its sales
force." As a policy, Pre-Paid does not comment in stories by TheStreet.com because it believes the coverage is biased. Ironically, Pre-Paid's latest setback came at a time when a prominent New York hedge fund was downplaying the risks associated with lawsuits targeting the company. Gotham Partners, which owns 1 million shares of Pre-Paid, instead touted Pre-Paid as extremely undervalued, offering a ringing endorsement that lit a fire beneath the heavily shorted stock. But Pre-Paid critics -- including RealMoney columnist David Rocker, who is short the stock -- were quick to pounce on the Gotham report as flawed. They saw particular weaknesses in Gotham's evaluation of the litigation and regulatory risks surrounding the company. Short-sellers blame the company, at least in part, for such favorable analysis. They accuse Pre-Paid of practicing "selective disclosure," releasing information only when things go the company's way. They point to last week's ruling in West Virginia as the latest evidence of this practice. "When Pre-Paid issues press releases only about its victories, it's misrepresenting the state of its liabilities," one short-seller said. To illustrate their case, short-sellers pointed out that Pre-Paid officially alerted investors when the company defeated the class action aspects of a lawsuit filed by customers in Alabama. But the company said nothing when a judge last month ruled against striking down the class action aspects of an even bigger $315 million lawsuit filed by members of its own sales force.
Pre-Paid has also made only the barest disclosures, buried deep in regulatory filings, about $810 million worth of potential liability in plaintiff-friendly Mississippi. Compared to these multiple-party lawsuits, the case in West Virginia seems rather immaterial -- at least on the surface. The West Virginia plaintiffs, a mother and two daughters injured in an automobile accident, have accused Pre-Paid of fraud and breach of contract for the company's alleged mishandling of their case against a negligent driver. The plaintiffs said Pre-Paid misled them with promises -- still touted today -- that Pre-Paid customers enjoy the finest legal representation available. But in this instance at least, Pre-Paid's lawyer failed to even serve the errant driver with a lawsuit, causing the case to automatically be dismissed. The plaintiffs say they learned of the dismissal only a year later, after their Pre-Paid attorney had already lost his license to practice law. "She knew attorneys in her own town that she could have hired," Peak said of her primary plaintiff. "But she relied on representations made to her -- what Pre-Paid said she was paying for -- when she chose to use their service." The court ruled that a jury -- rather than a judge -- must decide whether Pre-Paid is bound by vocal promises, issued by its sales force, that are omitted from the boilerplate contracts Pre-Paid customers receive only after they begin paying for the service. Much larger cases, set for trial next quarter in Alabama and Mississippi, will also attempt to nail Pre-Paid for allegedly touting better coverage than its contracts officially provide. Short-sellers see significance in the West Virginia case for another reason as well. The case shows that Pre-Paid is vulnerable to courtroom reversals. Pre-Paid's biggest legal victory so far is the dismissal of a shareholder lawsuit, now on appeal, that critics of the company have long insisted could easily be overturned. Some observers were, in fact, stunned when an initial ruling cleared Pre-Paid of misleading investors even after the Securities and Exchange Commission ordered an accounting change that erased more than half of the company's reported earnings.
Some believe the SEC still has its eyes on the company. A recent SEC letter, issued in response to a request for information, seems to support that stance. The SEC declined to supply certain information "compiled for law enforcement purposes, the release of which could reasonably be expected to interfere with enforcement proceedings." Despite the possible risks, investors have recently pushed Pre-Paid's stock toward a new 52-week high. That rally, which briefly shoved Pre-Paid shares above $30, came just before the company disclosed that one of its top executives -- Chief Operating Officer Randy Harp -- plans to sell Pre-Paid stock in order to repay a loan. The loan now totals $1.3 million, nearly three times its size when Pre-Paid last disclosed it.