(v. 3, i. 14 7/20/01)
By Kathryn M. Welling
| “Fool Me Once” Pre-Paid Legal Services’ Bookkeeping Dispute With SEC Goes Way Back |
||
| At 18, with a market cap just shy of $400 million, and sporting a P/E on this year’s estimates of only about 8, Ada, OK-based Pre-Paid Legal Services (PPD) scarcely looks like the most outrageously valued stock in the universe. Indeed, as recently as last November, the shares changed hands north of 48. So why did short interest in the peddler of legal services plans, at last report, stand at over 7 million shares, amounting to almost 19 days of average trading volume—and nearly half its public float? The answer, in a nutshell, is contained in an old saw you most likely learned at your mother’s knee: “Fool me once, shame on you. Fool me twice, shame on me.” On recent evidence neither the shorts nor the Securities and Exchange Commission is inclined to accept any blame for being fooled again by the activities of Big Board-listed PPD, a 30-year-old multi-level marketing organization, whose ostensible business, as its name implies, is selling pre-paid legal services plans. But whose modus operandi, like that of other pyramid-style marketing organizations, going back to notorious stock tout Glenn Turner’s Dare To Be Great Inc., in the 1960s, is simplicity itself: Prey on the gullibility, greed and laziness of investors by convincing them they can get rich by piggybacking on the efforts of others—by selling memberships which include the rights to overrides on subsequent sales by anyone they bring into the charmed circle. It’s not a business, in other words, for the chuzpah-challenged. But Pre-Paid founder and CEO Harlan Stonecipher seems well-equipped. He frequently recounts a touching tale of being inspired to start the company as a young man when he found himself the target of an expensive lawsuit over an auto accident. The thing is, the legal plans PPD sells don’t cover members who find themselves in a similar fix. Yet that’s not the half of Pre-Paid’s hubris. What has caught the eyes of the shorts and the SEC is the company’s accounting. The Off Wall Street Consulting Group in Cambridge, MA, stirred the pot last November, with a report questioning the average life of PPD’s plans and, hence, the way it was capitalizing commission expenses. The Wall Street Journal reported the controversy in January, and it was evidently shortly thereafter that the SEC started making inquiries into PPD’s accounting practices. On May 11, the agency’s accounting staff sent PPD a letter saying the company’s accounting for commission advances receivables doesn’t meet the requirements of GAAP. Most companies would have folded tent right there. Instead, Pre-Paid issued a defiant press release and filed an appeal. A little more than a month later, the SEC staff again rejected PPD’s arguments and told it to restate its financials to expense all commission advances when made. But PPD has yet to comply, demanding a personal meeting with the SEC’s chief accountant and continuing to issue press releases asserting the virtues of its accounting. Just a couple of numbers from PPD’s March 10Q go a long way toward explaining its intransigence: The “asset” it calls “membership commission advance receivables” (essentially, the hefty unearned commission payouts it advances to ensnare sales-types), at $166 million, account for all its shareholders equity of $147 million, and then some. But a little historical perspective— neatly provided by a story I wrote in Barron’s June 8, 1987 issue—is also telling. The burden of that piece was that PPD’s head-turning growth, which owed more to the commission expense-deferring activities of its accountants than to the exertions of its sales people, was running out of steam. (Which it soon did; the stock cracked, before the crash). The SEC belatedly agreed and in 1994 ruled that Pre-Paid had to expense deferred acquisition costs as incurred. Which evidently is why PPD recently has heard not only from the SEC’s accounting staff, but its Enforcement Division. For even a brief perusal of its financials indicates that while PPD modified its accounting and commission structure in 1995, it also found auditors willing to bless an apparent loophole. One it has been using to again report eye-popping growth in revenues and earnings, while effectively deferring its commission expenses as an “asset” with a different name. Why? Well, PPD’s preliminary estimates of the hit to reported earnings the SEC is demanding roughly slash them in half. So its motives seem obvious. But end runs are not the way to curry favor with regulators. In the meantime, Pre-Paid is under increasing legal assault from unhappy plan buyers, sales associates and the state attorneys general. Not good news for a company whose every sale, its own SEC filings admit, results in “significant negative cashflow” (because it pays about 2.5 years of commissions up front, but collects payments only monthly). That cash drain can only be turned positive over time, and then only if generous (and increasingly unlikely) assumptions are made about happy plan buyers continuing to make monthly payments—and enticing others to do likewise. If the SEC has wised up, can the fools be far behind?
|
 |
|