SEC criticizes Pre-Paid Legal Services' accounting

Journal Record, The (Oklahoma City), Jul 26, 2001 by Ray Carter

The Securities and Exchange Commission's chief accountant has decided Pre-Paid Legal Services' accounting policies for commission advance receivables do not conform to generally accepted accounting principles, Ada-based Pre-Paid said Wednesday.

That opinion, conveyed in a July 24 letter to company officials, concurred with the prior staff opinions of the Division of Corporation Finance and Office of the Chief Accountant, and may impact a host of lawsuits filed against the company.

Pre-Paid officials said they are exploring what - if any - actions will be taken in response.

Randy Harp, Pre-Paid's chief operating officer, disagreed with the SEC opinion.

We continue to believe our current accounting policy is in accordance with generally accepted accounting principles, he said. Pre-Paid said its accounting policy reflects the economic reality of our business and clearly illustrates to our shareholders the progress of our business in a given reporting period.

How we eventually report our financial results does not change the cash economics of our business, it merely changes the timing of reported earnings, Harp continued. As noted in our May 16, 2001, and June 28, 2001, press releases, the SEC's proposed accounting would have a material adverse effect on the company's balance sheet and results of operations.

Based on preliminary estimates, Harp pointed out the firm's pro- forma earnings per share for the first quarter of 2001 would fall to 27 cents per share from 60 cents per share under Pre-Paid's policy. Fiscal 2000 results would drop to 81 cents from $1.92, and fiscal 1999 results would plunge to 57 cents per share from $1.67.

The SEC inquiry of Pre-Paid, the developer and marketer of legal expense plans, was initiated after numerous lawsuits were filed against the company and industry analysts criticized the company in a Wall Street Journal article.

That criticism centers on how the company classifies at least some of its sales commission payments as assets. The issue was highlighted in a Jan. 17 article published in the Journal, which quoted two analysts who questioned Pre-Paid's results. Company officials have argued that the practice is correct because the payments are associated with a stream of future monthly premium revenue.

In January, the Philadelphia-based law firm of Berger & Montague filed a class-action lawsuit against Pre-Paid in the Oklahoma City federal court on behalf of all persons or entities who purchased Pre- Paid securities from April 19, 1999, through Jan. 16, 2001. The lawsuit alleged that Pre-Paid used misleading accounting information to artificially inflate the company's stock prices.

Pre-Paid officials said they believed the suit was completely without merit and vowed a vigorous defense.

Similar lawsuits quickly followed. The complaints all centered on alleged violations of the Securities Exchange Act of 1934.

In late February, Pre-Paid Legal Services' board of directors authorized the repurchase of 500,000 shares. However, no time limit was set for completion of the additional share repurchases.

Before publication of the Wall Street Journal article and initiation of the lawsuits, the 52-week high for Pre-Paid's stock was $48.75, and the company's 52-week low was $19.87. By mid-March, Pre-Paid's stock had closed as low as $14.18. Prices have rebounded somewhat since then.

In trading Wednesday, Pre-Paid's stock fell 58 cents to close at $18.38 per share.

Pre-Paid is the only publicly traded company in the nation that markets legal insurance policies.

Despite the controversy, the company sold a record 188,120 new memberships during the second quarter, up 11 percent from the prior year. New sales associates recruited during the second quarter increased 6 percent to 26,905 from 25,354 a year earlier. The company's membership base grew 22 percent in the last 12 months.