Pre-Paid Faces Day in Court

TheStreet.com/May 10, 2004
By Melissa Davis

Rich folks tend to wind up in dirt-poor Holmes County, Miss., for the same basic reason.

They have to appear in court. Maybe they work for some deep-pocketed company facing ugly lawsuits and potentially monstrous damages, or maybe they happen to be a lawyer or expert witness.

This fall, Harland Stonecipher -- the CEO of a company that boasts one of the most heavily shorted stocks on the New York Stock Exchange -- could take the stage. His company, Pre-Paid Legal Services, is accused of bilking customers with overpriced legal insurance instead of delivering on its promise of "equal justice for all." The company's policies, sold by network marketers like those engaged by Amway, exclude coverage for most common legal problems and can still require expensive retainer fees when a customer is sued.

"To the best of our knowledge, this is the first time a jury will ever be considering the legality or possible harmfulness" of Pre-Paid's practices, said Doug Minor, a lawyer at a prominent Mississippi law firm that boasts former U.S. Attorney Brad Pigott as a senior partner, who is leading the case against Pre-Paid and its founder. "We're definitely going to trial ... [and] plan to seek punitive damages based on the fraudulent conduct that harmed our clients."

Minor had expected his case against Pre-Paid to go to trial this week. But on Monday, the court stayed the proceedings. But Minor still believes the company could wind up in court by this fall.

The Holmes County trial is just one of 18 that Pre-Paid could ultimately face in Mississippi state courts known for their runaway jury awards. All told, some 432 Mississippi residents have filed claims against the company in multiparty lawsuits that, in some cases, seek a whopping $90 million in damages.

On the basis of its market value, Pre-Paid itself is worth less than five times that amount. And the company has just $47 million -- most of it restricted at the subsidiary level -- of cash and saleable investments listed on its balance sheet.

To be fair, Pre-Paid generates considerable cash flow from its business operations. But the company has been spending most of it -- and even borrowing more -- to buy its own stock and finance a fancy new $30 million headquarters in the small town of Ada, Okla.

As a matter of policy, Pre-Paid refuses to comment for stories by TheStreet.com because it believes the coverage is negatively biased. At this point, however, some short-sellers estimate that just a $15 million legal hit could be enough to bankrupt the company.

Pre-Paid's stock fell 47 cents Friday to end at $24.53 ahead of this week's trial. More than 70% of the float is sold short by investors betting against the company.

Poverty Row

For its part, Pre-Paid has portrayed the Mississippi cases as baseless and -- just as important -- called the estimated damages outlandish. In its regulatory filings, the company has repeated pointed out that plaintiffs in the Mississippi cases have spent only "$500,000 or less" on their legal policies despite their huge damage claims.

But half a million bucks, even divvied up, is a whole lot of cash in a place like Holmes County. Pre-Paid likes to tout its flagship $26 legal policy as cheaper than a daily cup of coffee. But most people in Holmes County -- the poorest county in the poorest state in America -- can't afford much.

Numbers tell the story. All told, 41% of the county's residents live in poverty. Blacks, who make up nearly 80% of the population, are even poorer than most. Per capita, they earn just $8,165 annually -- less than half their white counterparts. Local residents own houses that are worth about one-third of the national average. Those who rent pay about $150 a month.

So a $26 legal policy -- costing as much as two months' rent a year -- looks a whole lot more expensive in Holmes County than in just about any place else. And it seems even costlier when customers wind up with limited services instead of the full legal coverage some of them had expected.

"What is the real value of Pre-Paid's policy for people in Holmes County?" one short-seller questioned. "For them, this is an inappropriate -- almost worthless -- product."

Mississippi Jackpot

Two years ago, a Mississippi jury in Hinds County -- where Pre-Paid also faces trial -- actually issued a $30 million judgment against a company for selling a couple an unsuitable insurance product. Holmes County has made even larger awards. Most notably, a jury there three years ago awarded $150 million to six plaintiffs who were simply exposed to asbestos but never really fell sick.

Both Hinds and Holmes are among five Mississippi counties listed as "judicial hellholes" by a business-friendly group seeking tort reform. The entire state of West Virginia -- where Pre-Paid recently settled a case instead of risking a trial -- also made the list.

Pre-Paid has settled at least one big case in Mississippi as well. The company paid $1.5 million to settle a $745 million class-action lawsuit -- previously never disclosed to shareholders -- just before the trial was set to start in early 2001. Since then, however, the company has seen other plaintiffs rush to get settlements, too, and has vowed to battle them in court instead.

The U.S. Chamber of Commerce, where Stonecipher fills a board seat, has lent some assistance. Indeed, Forbes reported last year that the national organization is largely bankrolling a crusade to oust plaintiff-friendly judges in states like Mississippi.

The chamber claimed a particularly sweet victory last year. It managed to unseat a popular Mississippi judge who, according to Forbes, built a career on "defending the have-nots against the haves."

For now, Pre-Paid's fate rests with a jury instead. And if the company loses, it will find itself coughing up cash even as it pursues a more favorable decision on appeal. The company must post a bond equal to 125% of any award and will be responsible for 10% of the bond amount itself. So a $90 million jury award -- while admittedly unlikely -- could leave Pre-Paid with just a few million dollars in the bank as it approaches a slew of similar trials.

"Investors in Pre-Paid should not only worry in the short term about the 10% to 15% of any awards made in Mississippi," one short-seller said. "They should also worry about the 10% to 15% of other awards that might follow on copycat lawsuits filed all around the country."

Heat Index

For the time being, the spotlight remains trained on Mississippi.

Facing down will be nine Mississippi residents and a multimillion-dollar corporation run by a well-paid executive who used to be poor. To date, Stonecipher has celebrated his rise to power in two separate books.

"Where else but in America could the son of poor sharecroppers have an idea that the whole establishment opposed and, without money or connections, watch that idea take root and grow into a prosperous company?" his more recent book marvels.

Stonecipher grew up in a "shotgun" shack located in a rural Oklahoma county that's nearly as poor as the one in which he now stands trial. But the charismatic executive -- who likes to portray himself as the founder of the legal services industry -- has plenty of money and connections now. In fact, he could nearly double the per capita income by moving to Holmes County. Instead, he has been pocketing seven-figure bonuses for years and using at least some of that cash to help finance the campaigns of the politicians who regulate his company.

Over time, Stonecipher's company has regularly been accused by its customers -- and even its own sales associates -- of engaging in deceptive practices that unfairly fatten corporate profits at their expense. So far, however, the company has escaped serious punishment.

But short-sellers, who've been researching the company for years, believe that Pre-Paid is finally going to pay.

"Maybe I shouldn't just assume they'll lose," one short-seller conceded. "But based on what I know about this company's practices -- and the former U.S. attorney who's trying the case -- I'd bet heavily that it goes that way."