Steven Silber, spokesperson for PricewaterhouseCoopers, declined to comment on Kingsway's allegation, noting that his accounting firm doesn't comment on matters that are in litigation.

Mike Miller, a principal at Bloomington, Ill.-based EPIC Actuaries and the former president of Miller, Herbers, Lehmann & Associates, also declined to comment on the lawsuit, as did Steven Lehmann, a principal at Pinnacle Actuarial Resources, also in Bloomington, Ill., who was vice president at Miller, Herbers, Lehmann.

Kingsway's Chief Financial Officer Shaun Jackson said that since the matter is before the court, his company is also not at liberty to comment. But in a short press release announcing its legal action, Kingsway noted that the suit relates to the “understatement of the reserves of American Country's insurance subsidiary for the years 1998 through 2001 and associated costs and damages thereon.” These reserve deficiencies, the company also pointed out, took place before Kingsway acquired American Country in April 2002.

Kingsway also assured that its own bookkeeping is in order, by noting these reserve deficiencies have all been recorded in the company's 2002 audited financial statements. And the company so far did not experience any “material adverse development” from American Country's reserves this year.

Michael Goldberg, a vice president and financial services analyst at Montreal-based Desjardins Securities who tracks Kingsway, explained that Kingsway relied on these audited statements from American Country when it was doing its due diligence before the acquisition last year.

“And don't forget, this was a hostile takeover by Kingsway. When you are involved in a hostile transaction, you don't have the ability to go in and do the verification of the financials you would be able to do otherwise,” Mr. Goldberg told National Underwriter.

“Kingsway was very careful when it was doing its due diligence. But it still had to rely on audited financial statements, which are supposed to fairly reflect the financial position of the business,” he added.

The lawsuit also involves former directors at American Country, Mr. Goldberg explained, “because it's my understanding that one of the roles of directors is to approve financial statements. And, in addition, there would be an audit committee from the board. So Kingsway is alleging that these former directors didn't actually fulfill their responsibilities.”

But the most serious aspect in this case, according to Mr. Goldberg, is the possibility that American Country's management and directors, as well as its auditors, were involved in intentionally misleading its buyer.

“If they wanted Kingsway to pay more, they clearly would want the financial statements to look better,” he argued. “During the acquisition, Kingsway had originally submitted one bid, but it was initially declined by American Country. So Kingsway increased it to get a more favorable reaction.”

Although he declined to speculate on how much the alleged reserve shortfall might be, Mr. Goldberg counted two ways that the situation has already affected Kingsway.

“First of all, if the allegation is true, it means that when Kingsway closed on the transaction and had final adjustments for the closing, they recorded a higher goodwill, which affects the amount of capital they have and would have an adverse impact on the amount of business they could now write,” he explained.

The second effect, he said, was that by having American Country's financials re-audited, it caused significant delays in filing their recent F-3 prospectus with the Securities and Exchange Commission for issuing trust securities.

It may also be worth noting that Kingsway had already gone through a similar situation from another past acquisition.

“In some respects, this is very similar to the situation that took place some years back, when Kingsway acquired a privately owned insurer called Jevco Insurance Company. There is still an ongoing legal action involving Jevco's financial statements that Kingsway relied on as well.”

Mr. Goldberg recalled that there were alleged misstatements in Jevco's audited financial statements. “This legal action, also against one of the major accounting firms, has been underway for some years now.”

He added that litigation involving American Country, as well as Jevco, would probably still take considerable time until they get resolved.

“I would suspect some types of settlements for these, and they will likely come out of the blue,” he predicted.

Kingsway, which writes insurance through nine subsidiaries in Canada and the United States, is primarily involved in the nonstandard auto insurance business. American Country, located in Chicago, specializes in insurance for taxicab fleets and restaurants.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 11, 2003. Copyright 2003 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.