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And it has happened before - In 2001, the SEC forced Pre-Paid to start treating commissions paid to its sales associates as expenses rather than assets. The change cut the company's reported earnings by more than half. Moreover, it marked the second time the company found itself adjusting its treatment of commissions and slashing its reported profits as a result.
For now, however, the company has escaped a so-called qualified opinion from its auditor and the need for additional restatements. Instead, Thornton has simply offered no opinion at all until the company addresses problems with its internal controls.
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Guilty Verdict
News of the reporting problems came just days after Pre-Paid weathered a legal setback. A Mississippi jury last week found both the company and its founding CEO, Harland Stonecipher, guilty of fraud and deceptive advertising, according to plaintiffs' attorney Doug Minor.
Still, the company did escape without paying any punitive damages in a state known for its runaway jury awards.
"I think Pre-Paid was lucky," Russell said. "But a finding of fraud is not exactly the greatest news as far as goodwill and reputation are concerned."
Pre-Paid has been accused of overstating the coverage provided by its legal policies. In an earlier trial, the company prevailed. Pre-Paid expects that pattern to continue.
"We are very pleased with the jury's verdict and the impact this verdict may have on other pending litigation," Stonecipher said after the favorable ruling in October. "We hope this verdict, our first jury verdict in Mississippi, sets the tone for future legal developments in Mississippi."
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Pre-Paid has been accused of overstating the coverage provided by its legal policies. In an earlier trial, the company prevailed. Pre-Paid expects that pattern to continue.
"We are very pleased with the jury's verdict and the impact this verdict may have on other pending litigation," Stonecipher said after the favorable ruling in October. "We hope this verdict, our first jury verdict in Mississippi, sets the tone for future legal developments in Mississippi."
Instead, a second jury has saddled the company with a guilty verdict and ordered that some -- albeit small -- damages be paid to four individual plaintiffs. For its part, the company has insisted that the damages, totaling $45,000, "were not based on the evidence" and has vowed to "seek post-trial relief, as necessary."
"We still have more litigation in front of us," Pre-Paid Chief Operating Officer Randy Harp acknowledged during a conference call in October. "It has been very expensive for us to defend ourselves, but we continue to believe that we have very meritorious defenses."
Still, Pre-Paid has limited resources. Minor said that the company's net worth dropped from $41.5 million last summer to $22.5 million when the first trial started in October. In contrast, he said, Stonecipher saw his own net worth jump -- to nearly twice the company's own -- during that period.
Moreover, the company could still face big damage awards in the future. Minor said that his firm will continue to fight for punitive damages in a number of pending cases involving hundreds of Mississippi plaintiffs "because we believe the conduct the jury found fraudulent is also conduct that should be punished." The company will next defend itself three months from now in Holmes County, a Mississippi region notorious for its "jackpot justice."
Pre-Paid has set aside $3 million to cover any major damages that may result from the lawsuits. The company -- which markets its product as essential -- carries no legal insurance itself.
From the PPD 2002 annual report:
Beginning in the second quarter of 2001 and through December 31, 2002, multiple lawsuits were filed
against the Company, certain officers, employees, sales associates and other defendants in various Alabama and
Mississippi state courts by current or former members seeking actual and punitive damages for alleged breach of
contract, fraud and various other claims in connection with the sale of memberships. As of December 31, 2002, the
Company was aware of 28 separate lawsuits involving approximately 298 plaintiffs that have been filed in multiple
counties in Alabama. One suit involving two plaintiffs which was filed as a class action has been dismissed with
prejudice as to the class allegations and without prejudice as to the individual claims. As of December 31, 2002, the
Company was aware of 14 separate lawsuits involving approximately 428 plaintiffs in multiple counties in
Mississippi. Certain of the Mississippi lawsuits also name the Company's provider attorney in Mississippi as a
defendant. Proceedings in the eleven cases which name the Company's provider attorney as a defendant have been
stayed for at least 90 days as to the provider attorney due to the rehabilitation proceeding involving the provider law
firm's insurer. At least two complaints have been filed on behalf of certain of the Mississippi plaintiffs and others
with the Attorney General of Mississippi in March 2002 and December 2002. The Company has responded to the
Attorney General's requests for information with respect to both complaints, and as of February 28, 2003, the
Company was not aware of any further actions being taken by the Attorney General. In Mississippi, the Company
has filed lawsuits in the United States District Court for the Southern and Northern Districts of Mississippi in which
the Company seeks to compel arbitration of the various Mississippi claims under the Federal Arbitration Act and the
terms of the Company's membership agreements, and has appealed the state court rulings in favor of certain of the
plaintiffs on the arbitration issue to the Mississippi Supreme Court. These cases are all in various stages of
litigation, including trial settings beginning in Alabama in May, 2003, and seek varying amounts of actual and
punitive damages. While the amount of membership fees paid by the plaintiffs in the Mississippi cases is $500,000
or less, certain of the cases seek damages of $90 million. Additional suits of a similar nature have been threatened.
The ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits also filed a similar suit against
the Company and certain of its officers in the District Court of Creek County, Oklahoma on behalf of Jeff and Jana
Weller individually and doing business as Hi-Tech Auto making similar allegations relating to the Company's
memberships and seeking unspecified damages on behalf of a "nationwide" class. The Company's preliminary
motions in this case have been denied, and, as of February 28, 2003, the Company's appeal of the denial of its
motion to compel arbitration is pending before the Oklahoma Supreme Court. The ultimate outcome of this case is
not determinable.
On June 29, 2001, an action was filed against the Company in the District Court of Canadian County,
Oklahoma. In 2002, the petition was amended to add five additional named plaintiffs and to add and drop certain
claims. This action is a putative class action brought by Gina Kotwitz, George Kotwitz, Rick Coker, Richard
Starke, Jeff Turnipseed and Aaron Bouren on behalf of all sales associates of the Company. The amended petition
seeks injunctive and declaratory relief, with such other damages as the court deems appropriate, for alleged
violations of the Oklahoma Uniform Consumer Credit Code in connection with the Company's commission
advances, and seeks injunctive and declaratory relief regarding the enforcement of certain contract provisions with
sales associates. The impact of the claims alleged under the Consumer Credit Code and the assertion of entitlement
to injunctive relief could exceed $315 million if plaintiffs are successful both in their request for class certification
and on the merits. The plaintiffs' request for class certification is set for hearing on July 22, 2003. The ultimate
outcome of this case is not determinable.
On March 1, 2002, an action was filed in the United States District Court for the Western District of
Oklahoma by Caroline Sandler, Robert Schweikert, Sal Corrente, Richard Jarvis and Vincent Jefferson against the
Company and certain executive officers. This action is a putative class action seeking unspecified damages filed on
behalf of all sales associates of the Company and alleges that the marketing plan offered by the Company
constitutes a security under the Securities Act of 1933 and seeks remedies for failure to register the marketing plan
as a security and for violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities
Exchange Act of 1934 in connection with representations alleged to have been made in connection with the
marketing plan. The complaint also alleges violations of the Oklahoma Securities Act, the Oklahoma Business
Opportunities Sales Act, breach of contract, breach of duty of good faith and fair dealing and unjust enrichment and
violation of the Oklahoma Consumer Protection Act and negligent supervision. This case is subject to the Private
Litigation Securities Reform Act. Pursuant to the Act, the Court has approved the named plaintiffs and counsel and
an amended complaint was filed in August 2002. The Company filed motions to dismiss the complaint and to strike
the class action allegations on September 19, 2002. All discovery in the action is stayed pending a ruling on the
motion to dismiss. As of February 28, 2003, all briefs had been filed by the parties on the motion to dismiss and a
decision on the motion will be made by the Court. The Company is unable to predict when a decision will be made.
The ultimate outcome of this case is not determinable.
In December 2002, the West Virginia Supreme Court reversed a summary judgment which had been
granted by the Circuit Court of Monangalia County, West Virginia in favor of the Company in connection with the
claims of a former member, Georgia Poling and her daughters against the Company and a referral lawyer with
respect to a 1995 referral. That action was originally filed in March 2000, and alleges breach of contract and fraud
against the Company in connection with the referral. The case is now scheduled for trial in August 2003, and
plaintiffs seek actual and punitive damages in unspecified amounts. The ultimate outcome of this case is not
determinable.
On January 30, 2003, the Company announced that it had received a subpoena from the office of the
United States Attorney for the Southern District of New York requesting information relating to trading activities in
the Company's stock in advance of the January 2003 announcement of recruiting and membership production results
for the fourth quarter of 2002. The Company also received notice from the Securities and Exchange Commission
that it is conducting an informal inquiry into the same subject. The Company is cooperating fully in responding to
these requests. The ultimate outcome of these matters is not determinable.
