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On the Defense at Pre-Paid Legal Services

The story is company legend. In 1969, Harland C. Stonecipher, founder of Pre-Paid Legal Services, was involved in a car accident. The driver of the other car survived the crash. But, as Stonecipher later wrote in a corporate memoir, "I faced thousands of dollars in legal costs stemming from an accident in which I was blameless."

The experience gave him the idea to start a business charging customers a monthly fee to cover future legal expenses. Today, Pre-Paid (PPD) has more than 1.2 million customers paying an average of $21 a month to access its network of lawyers. Revenues of the New York Stock Exchange-traded company topped $300 million last year, and at a recent price of $29, its stock is trading at a healthy 19 times the last 12 months' earnings.

Stonecipher's account of his accident leaves out a few details, however. According to his attorney at the time and copies of the suits obtained by BusinessWeek Online, he was the first to sue in court for injuries. He later settled. Meanwhile, the driver of the other car sued Stonecipher the following year for just a fraction of what Stonecipher had sought for injuries incurred in the accident. A spokesperson for Pre-Paid says only that Stonecipher's recollection of the events are 33 years old.

NUMEROUS CHARGES. A growing number of Pre-Paid's customers and salespeople say they think its sale's pitch is also missing a few details. Pre-Paid laid out $1.5 million in 2001 to settle a series of suits from customers in Alabama who claimed that it overstated the amount of legal coverage it offered. Since then, at least 20 new cases involving 113 former customers and salespeople have been filed in that state.

In March, four former salespeople filed a fraud and breach-of-contract suit in Oklahoma, this time accusing Pre-Paid of operating an "illegal pyramid scheme." On Apr. 19, two other former customers filed suit in Pre-Paid's home state of Oklahoma, alleging breach of contract, negligent hiring, training, and supervision, and other violations of the state's consumer protection act.

Pre-Paid says the suits are without merit and were initiated by attorneys who advertised for plaintiffs. The suits are proof, says one company executive, of the "need for a legal service like ours in this litigious society."

JUST ONE WORD. But the escalating number of cases could become a burden for Pre-Paid, whose stock has more than doubled in the last year. "Members are not given sufficient information to know what they are buying," says Edward E. Angwin, a Birmingham (Ala.) attorney behind many of the suits. "We want them to stop selling the product as it is."

The recurring theme in the litigation is that Pre-Paid's salespeople overstate what its membership contracts cover. In the suits, former salespeople and customers claim that they're told Pre-Paid will cover all of a person's legal needs. Indeed, in a copy of its in-house magazine distributed to salespeople last year, Pre-Paid board member David A. Savula wrote: "All you have to know is the word: Yes. Does our product cover everything? Yes. So if somebody asks does it cover this or does it cover that, we're going to say, 'Yes.'"

However, Savula's article goes on to recommend that salespeople walk prospective customers through the company's brochures, which detail benefits more specifically.

NOT COVERED. A review of sample Pre-Paid contracts shows many limitations. Cases involving bankruptcy, alcohol, drugs, pre-existing conditions, wage garnishment, divorce, annulment, child custody, class actions, hit and runs, driving without a license, civil or criminal charges associated with a business, and commercial vehicles over two axles aren't covered. Nor are any "claim, defense, or legal position which, in the opinion of the Provider Attorney, will not prevail in court." Pre-Paid provides for 60 hours of trial time per year, but pretrial work -- the bulk of most cases -- is limited to 2.5 hours per year in a basic policy.

Pre-Paid provides its service through a network of designated law firms, typically one per state. Customers whose legal work falls in uncovered areas are offered the ability to contract with Pre-Paid's attorneys at a discount of 25% off the hourly rates. Those fees can be high, says Robert Schweikert, a 61-year-old food vendor in Charlotte, N.C. He became a Pre-Paid salesman and customer in March, 2000.

Schweikert says he twice tried to use Pre-Paid's attorneys for services he thought were covered under his membership, once to add a new beneficiary to his will and a second time to incorporate a new business. In each case, Schweikert says, Pre-Paid's representative wanted additional compensation to do the work. In the case of the business document, the fee was twice what Schweikert's regular attorney charged.

RESTATED FINANCIALS. "Everything you do with them costs money," says Schweikert, who is one of the plaintiffs in the first suit seeking class action status in Oklahoma. "The services were not what they were advertised." Pre-Paid says it won't comment on the specifics of any ongoing cases, but it asserts that it more than adequately discloses what it covers and that Schweikert has never complained directly to Pre-Paid about his coverage.

Pre-Paid is no stranger to controversy. It has publicly battled short-sellers -- investors who bet that the stock will fall -- for years. In 1987, Pre-Paid asked the American Stock Exchange to investigate possible manipulation of the stock by short-sellers. In 2001, it changed its accounting methods and restated its financials at the request of the Securities & Exchange Commission. Pre-Paid had been booking commissions advanced to salespeople as an asset rather than expensing them in its earnings.

Pre-Paid ultimately restated three years worth of results, cutting earnings in half and reducing assets by two-thirds for that period. In a letter to shareholders announcing the change, PrePaid's chairman wrote: "We are now required to expense commission advances when paid. Doing so does not change our ultimate profitability; it only changes the timing of reported profits. Even after restating reported results, we were quite profitable in 2001, and we grew."

NO PAIN? Pre-Paid has had some good news in the courtroom. In March, a suit from shareholders regarding the accounting changes was dismissed, in part, because the judge found that "reasonably diligent investors" could have investigated the allegations using public SEC filings.

On Apr. 22, Pre-Paid announced that a record 200,000 new members had signed up for its services in its most recent quarter. Revenues increased 17%, to $82 million, and earnings were up an equal percentage, to $8.8 million. Allen H. Lee, an analyst at Allen Financial Advisors doesn't think the lawsuits will hurt Pre-Paid's finances. "So far, there hasn't been any impact," Lee says. "It has had them before. It's a 30-year-old company."

Pre-Paid may yet triumph over its latest suits, but for a company that aims to solve people's legal troubles, it certainly has attracted a large share of its own. By Christopher Palmeri in Los Angeles

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