Pre-Paid Legal Faces Legal Problems

The News & Observer, Raleigh, S.C.

July 17, 2001
Author: Vicki Lee Parker ; STAFF WRITER
Edition: Final Section: Business Page: D1

In 1997, Richard Pucciarelli thought he was on the path to becoming a millionaire by selling legal services to consumers for a nominal monthly fee.

After all, that’s what he said he was led to believe by the testimonials of sales associates at Pre-Paid Legal Services. But instead of making millions, Pucciarelli said he wound up paying Pre-Paid. In March, he filed a complaint with state Attorney General’s Office accusing the company of fraud.

The Attorney General’s Office has received seven complaints against the 29-year-old Ada, Okla.-based company, which has been recruiting sales associates and members in North Carolina since 1995. On the national front, the company is facing multiple lawsuits and appealing a recent ruling by the U.S. Securities and Exchange Commission that it overstated its earnings.

Pre-Paid describes itself as a multilevel marketing company, which means that members pay a fee to join and then have an opportunity to make money two ways – by selling a product, and by bringing on board more fee-paying sellers. Multilevel marketing, also known as network marketing, is not illegal – Amway, a manufacturer and distributor of cleaning products, is one well-known company that uses such a structure.

Pre-Paid markets itself as an HMO for legal services. Consumers pay between $16 and $32.95 a month (the rate varies by state and by the type of plan chosen) for access to a lawyer in Pre-Paid’s legal network. If they ever need the services of that lawyer, they will get a 25 percent discount on his or her fees, as well as certain free services, such as one phone call or letter a year.

Those services are sold by sales associates who are recruited at meetings held almost weekly at hotels throughout the Triangle.

The new recruits, who have heard about the company through friends, co-workers and fellow churchgoers, listen to testimonials from Pre-Paid associates and then are given an opportunity to pay $249 to become sales associates in Pre-Paid’s network. Associates earn commissions on the memberships they sell and on the memberships their recruits sell. The more people an associate recruits, the more money he or she can make.

Richard Pucciarelli, who lives near Charlotte, went to such a meeting three years ago when he was living in Colorado and was hooked.

“When you are in the [meetings] long enough and people are telling you that they are making $10,000 a month in 10 months … you start to think you have the same opportunity to make that money,” Pucciarelli said.

Four weeks after attending his first meeting, Pucciarelli, a former chiropractor, became a Pre-Paid sales associate. Shortly afterward he moved to North Carolina, where he built a network of nearly 1,000 sales people. By the third year he was averaging $7,000 to $8,000 income per month from Pre-Paid.

But by his third year, something disturbing began happening: His commissions were decreasing. He said he learned that his sales income was being reduced by chargebacks resulting from membership cancelations.

The news disturbed Pucciarelli, who said he was told by Pre-Paid executives that he would start earning additional income from membership renewals after his third year. In fact, that was the main reason, Pucciarelli said, that he joined the company. Pucciarelli said he was told that Pre-Paid had an average annual membership “persistency rate” of 76 percent since 1981. The persistency rate does not reflect the company’s actual membership retention rate, because it measures the number of members at the end of the year as a percentage of the total at the beginning of the year plus any new members who joined during the year. In other words, members who did not renew were offset by new memberships.

But a recent SEC filing by the company reported a much lower retention rate. After the first year only 53 percent of its customers remained. That dropped to 37 percent after the second year and to 29 percent after the third year. For Pucciarelli, this meant that instead of earning renewal income from 76 percent of his original members – as he believed would happen – he only earned renewals for about 30 percent. In addition, Pucciarelli had to repay the advance commissions – plus interest – he received on memberships that later were canceled.

“I accrued a debit balance at 9 percent interest,” Pucciarelli said.

Pucciarelli and other sales people recently learned the true retention rate from an 8-K filing that Pre-Paid made to the SEC in January. An 8-K is a filing that companies make to disclose some material event or information.

“When I found this 8-K filling I was devastated,” said Pucciarelli.

“We changed the disclosure this year somewhat,” said Kathy Pinson, vice president and controller of Pre-Paid Legal. “After a lot of questions and comments and accusations came up this year, we gave a year-by-year membership persistency rate.”

Pinson maintains, however, that Pre-Paid has always provided enough information in its earlier financial filings with the SEC for people to determine the retention rate on their own.

“You could calculate the number because all the information needed was there,” she said.

Pinson said that under the old disclosure method, Pre-Paid “blended the new members and active members” – a practice that has led to one of the recent lawsuits against the company.

“Pre-Paid enlisted tens of thousands of salespersons or associates by deceptively stating that 76 percent of the memberships would remain in force,” according to a lawsuit filed on behalf of all Pre-Paid’s U.S. sales associates last month in state court in El Reno, Okla.

Two lawsuits also were filed earlier this year in U.S. District Court for the Western District of Oklahoma in Oklahoma City. One, on behalf of shareholders, accused the company of inflating its earnings and stock price. The other was filed on behalf of consumers who have bought Pre-Paid’s legal services. Both seek class-action status. According to Ann Baskin, a secretary for the clerk of court in U.S. District Court for the Western District of Oklahoma, about 19 lawsuits have been filed against the company in federal court there. Those lawsuits have been consolidated into one and are still pending, Baskin said.

Pre-Paid officials contend that the suits have no merit. In a letter to shareholders, Harland C. Stonecipher, Pre-Paid’s founder and chief executive, wrote that “there is not merit to the lawsuits” and “we do not believe that our accounting is in any way inaccurate, misleading or inappropriate.”

Last month, however, the SEC found that Pre-Paid’s accounting practices did not comply with generally accepted accounting principles.

According to the SEC, the company had overstated its earnings by counting advance commissions paid to salesmen such as Pucciarelli as assets rather than expenses. The SEC ordered the company to restate its 2000 earnings from $1.92 per share to 81 cents per share. Pre-Paid has refused to make do so while it seeks a meeting with SEC Chief Accountant Lynn Turner. Pre-Paid’s stock dropped 26 percent to $14.10 after the SEC’s restatement order. It has since climbed to close Monday at $17.56.

Pre-Paid is also facing questions at the state level in North Carolina.

“We are working to resolve the seven complaints we have received here at the Attorney General’s Office regarding Pre-Paid Legal Services,” said spokeswoman Julia White. White said she could not comment further about the complaints.

Among the complaints on file at the AG’s office are those from members who complained of not receiving the legal representation that was guaranteed under their contract with Pre-Paid.

Belinda Brittain, owner of Brittain Academy, a private school in High Point, said in her filed complaint that after paying approximately $24 monthly for three years, Pre-Paid refused to write a letter on her behalf – a service she thought was covered by her premiums.

Brittain said Pre-Paid referred her to several lawyers – including one who requested an approximate $5,000 retainer – but all required a fee to write the letter. Brittain eventually sought legal help elsewhere. She said she paid a lawyer in High Point $500 to to write the letter. She asked Pre-Paid to refund the nearly $900 in premiums she had paid over the three-year period. “That should have been enough to cover one letter,” Brittain said.

In its written response to Brittain’s complaint, also on file in the AG’s office, Pre-Paid stated that Brittain repeatedly declined to hire its attorney “at a reduced hourly rate,” and that “We do not believe a refund is due.”

Pre-Paid also wrote: “We felt that a letter would be damaging to her position if she failed to follow through and retain the attorney and pursue the issue.”

“Generally, we are absolutely hands-on in addressing any complaints that members bring to our attention,” said Martin Horn, partner with Browne, Flebotte, Wilson & Horn of Durham, the firm hired by Pre-Paid to administer legal services to members in the state. “We take those complaints seriously and do whatever we can to make sure these people are satisfied and are getting the service they desire.”

The controversy surrounding the company has had little effect on its recruitment meetings.

George Tabb Jr., a high-level sales associate in Raleigh, was unaware of the SEC rulings or the company’s change in its retention rate numbers. Even after learning of the charges and lawsuits, he remains an ardent supporter. He joined Pre-Paid 10 months ago after a former co-worker convinced him that he could more than double the $75,000 he made annually selling ads for the Yellow Pages. Tabb said he now earns an average of $10,000 a month selling individual memberships and recruiting people into his network marketing group.

“Look at Amway in the 1980s; they went through the same thing,” Tabb said. “Today they are a company that offers a wonderful product. I think [controversy] comes along with growing pains.” (Copyright 2001 by The News & Observer Pub. Co.)