St. Paul Travelers Sued Over Reserve Decision

Specifically, the language in the offering statement being pointed to by company lawyers and accountants says: "The combined company may incur income statement charges if the claims and claim adjustment expense reserves are insufficient. Such income statement charges could be material, individually or in the aggregate, to the combined company's operating results and financial condition in future periods and could result in rating agency actions and/or the need to raise capital."

Responding to initial questions about the lawsuits from National Underwriter, Joan Palm, a representative at St. Paul Travelers, said: "We are still digesting the complaints, but our initial reaction is that we believe they have no merit, and we intend to defend ourselves vigorously."

The lawsuits filed in Minnesota U.S. District Court allege the registration statement was false and misleading because the statement didn't indicate that the accounting practices of the two firms were incompatible before the merger, and now the combined firm is taking the huge charge to blend them.

Top officials of the company said at the time the charge was taken that they were going to talk to officials at the Securities and Exchange Commission as to the correct accounting treatment for the increase in reserves, and that an income statement charge could prompt a $275-to-$300 million bottom-line loss. On Aug. 2, St. Paul Travelers announced that the SEC staff had provided general guidance, and that based on this guidance, the company would reflect the reserve adjustments in its income statement.

Three days later, St. Paul Travelers officially reported its second-quarter financial results, indicating that the charge would result in an operating loss of $310 million, or 47 cents per share, and an overall net loss of $275 million.

Robert C. Finkel, the lawyer at New York-based Wolf Popper LLP who filed one of the lawsuits, said he would not be surprised if the SEC launched an inquiry into the reserving decision.

"It wouldn't be surprising if the SEC investigated this," Mr. Finkel said. "The companies represented in the offering statement and other merger documents that their accounting was compatible, and now this [charge]. The SEC normally investigates when there is such a big discrepancy."

An SEC official would not comment on what the agency was doing, if anything, about the St. Paul Travelers matter as this edition went to press.

At press time, two additional announcements of class-action filings were released by other law firms. The second announcement came from the law firm of Lasky & Rifkind in New York, and a third was filed by Schiffrin & Barroway, LLP, based in Bala Cynwyd, Pa.

Mr. Finkel said he has as yet not computed how much he would seek in damages against the company, but he estimated that the charge was worth $5 a share for every Travelers shareholder in the merged company, and $2 to every St. Paul shareholder.

Ms. Palm made clear there is no SEC probe of the charge underway. She said the company decided to take the charge against earnings after discussions with the federal agency. "We just wanted to do the right thing, and consulted with the SEC before deciding on the appropriate treatment of the addition to reserves. There is no SEC investigation," she said.

One justification for the additional reserves is that Travelers had reserves set up for surety losses, while The St. Paul did not. But one analyst who asked not to be named cautioned that the risk disclaimer in the offering statement for the merger does not make the firm "bulletproof" from securities fraud allegations.

"Surely, they must have been able to determine while doing due diligence the difference in accounting for surety losses," the analyst contends. "If they knew at the time they prepared the offering statement that they would have to take such a big charge, they would be vulnerable to allegations of fraud."

Reproduced from National Underwriter Edition, August 19, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.