Top Ten Red Flags for Fraud at Pre-Paid Legal Services Inc. (NYSE:PPD). The company is clearly on a decline, with recruitment numbers suffering and overall memberships.

Here are some of the more interesting points in the report:

• The company admits that recruiting is the lifeblood of Pre-Paid Legal, with COO Randy Harp saying: “And as goes recruiting, so goes membership sales.” Well recruiting is down 25% in the first 6 months of 2008, and down 31% in the second quarter alone.
• In spite of a huge drop in cash generated from operations in 2008, management went on a stock buyback spree. They even borrowed $10 million to do it! The company spent $27.7 million to repurchase shares in the first half of 2008.
• Memberships are down 8% compared to one year ago, yet the company is trumpeting increased revenues, due solely to higher average membership fees.
• Associates were paid $3 million less in the second quarter of 2008 than the same quarter last year, another testament to the decline of the Pre-Paid Legal business.
• Pre-Paid Legal advertises “one of a kind” services which give “access to valuable benefits that cover the most common legal needs that you will encounter” and “level the playing field” in the legal system. Yet the product  is materially flawed, as demonstrated by the terrible retention rates. About 50% of new customers cancel their legal plans within the first year. Before the end of the third year, more than 75% of customers have canceled their plans.
• Pre-Paid Legal ripped off a Washington Times columnist.
• The associates aren’t selling many memberships! Only about 20% of the Pre-Paid Legal associates sell one or more memberships to outside customers.
• Similarities to YourTravelBiz.com (YTB), a company recently sued by the California Attorney General, could mean trouble for Pre-Paid Legal. Multi-level marketing companies that purport to sell products to retail customers have long carried on a charade that included pretending that their distributors were actually selling products to third-party customers. Since no one could prove otherwise, the charade was plausible. With a service-based business like YTB or Pre-Paid Legal, however, it’s much harder to pretend that sales are being made. The numbers are in black and white, and the numbers proved that YTB agents did very little selling of services, in favor of massive recruiting that led to the Attorney General calling it a “gigantic pyramid scheme.”