A Pyramid Scheme Alert, July 18, 2001
In January and February of this year, a number of stockholder class actions lawsuits were filed against Pre-Paid Legal Services, a company based in Oklahoma which sells legal “insurance” through a multi-level marketing system. The company trades on the New York Stock Exchange (NYSE) as PPD.
At issue is Pre-Paid’s accounting practice regarding commission advances to associates. According to the Wall Street Journal of January 17, 2001:
“[An] associate sells a policy that costs about $25 a month. Even though the customer can cancel the policy at any time, Pre-Paid pays three years’ worth of annual commissions upfront, a total of about $225. As a multilevel marketing company, Pre-Paid spreads the money among the associate who sold the policy and those sales associates above him in the company’s pecking order.
“That is a big recruiting tool for Pre-Paid, whose growth is tied chiefly to its ability to expand its sales force.”
PPD then classifies the commission payments as “assets,” which it expenses over three years. However, the average customer holds a policy for only 2 years, and most sales associates never sell enough for PPD to recoup the advances. According to the company, only 26% of associates actually sold any policies in the first nine months of 2000.
Here is a partial list of class action suits filed against PPD in the early part of this year:
January 22, Berger & Montague, PC, class period April 19, 1999 through January 16, 2001.
January 25, Berman DeValerio & Pease LLP, class period April 19, 1999 through January 16, 2001.
February 13, Barrack, Rodos & Bacine, class period April 19, 1999 through January 16, 2001.
February 15, Spector, Roseman & Kodroff, P.C., class period April 19, 1999 through January 16, 2001.
February 16, Milberg Weiss Bershad Hynes & Lerach LLP, class period April 19, 1999 through January 16, 2001.
February 18, Holzer & Holzer, class period February 7, 2000 and January 16, 2001.
The complaints all revolve around the issue of securities fraud, accusing PPD of inflating stock prices by the use of inappropriate accounting methods.
The Securities and Exchange Commission launched an investigation of PPD’s accounting practices. They rejected an appeal from the company, because PPD’s accounting practices do not conform to generally accepted accounting principles.
Sales Associates Initiate Class Action, Charge Company with Deception, Breached Contracts, and Other Violations
Then, in June, a group of Pre-Paid Legal “Associates” filed a class action suit against the company. The suit claims that PPD breached contracts, and violated both the Consumer Protection Act and the Oklahoma Uniform Credit Code. The suit also charges the company with inflating customer retention figures in order to attract sales associates. Individuals are enticed to join as sales associates when presented with figures that lead them to believe most policies will remain on the books long enough for the associates to generate future income. The complaint alleges that most policies are cancelled before this happens, leaving the associates having to repay advances — with interest.
Oklahoma City Attorney John Dexter is handling the lawsuit. According to Dexter:
“It appears to me that Pre-Paid Legal has been deceiving hundreds of thousands of ordinary people who wanted – and earnestly tried – to sell their program, but were never able to do it as successfully as Pre-Paid represented they could.”
The class includes any Pre-Paid Legal Services Associates who was active between September, 1997 and June 29, 2001. According to a spokesman for the class action, the company has represented a 76% renewal rate over three years. According to numbers that PPD released to the SEC, however, the “persistency” rate is only 28%.
Pre-Paid Legal Services apparently has no legal insurance to fall back on. (Source: Pyramid Scheme Alert – http://www.pyramidschemealert.org)