Owners of Providian will vote on the proposed deal on Aug. 31. Under its terms, they will receive just under $19 a share in cash and Washington Mutual stock. That price represents a modest premium of 4.2 percent over the price of Providian just before the merger announcement.
David L. King, a portfolio manager at Putnam Investments, has said he will vote against the merger. The funds own 7.5 percent of Providian's shares. Officials at Providian have said that the deal is fair.
Last week, three proxy advisory services published reports advising institutional investors on how they should vote on the deal. Two recommended that shareholders reject it, mostly because the price was inadequate.
Those encouraging a no vote are Glass, Lewis & Company of San Francisco and Egan-Jones of Wynnewood, Pa. Both are independent firms that make money solely from institutional investors who buy their advisory or research reports. Neither accepts fees from issuers of shares or bonds, which keeps them out of the morass of serving two masters.
Enter I.S.S. of Rockville, Md. Unfortunately for the shareholders who rely on it, I.S.S. is very much in that two-master morass.
It provides corporate services to issuers of securities and therefore receives fees from the companies it analyzes. For example, it advises companies on how to structure their stock option plans so as to be acceptable to the shareholders who will be asked to vote on them.
The firm discloses its dueling services on the cover of its reports. The disclosure, however, is less than revealing.
"This issuer may have purchased self-assessment tools and publications from I.S.S.' Corporate Services division or the Corporate Services division may have provided advisory or analytical services to the issuer in connection with the proxies described in this report," the disclaimer says. It provides an e-mail address for those who want to ask about any issuer's use of I.S.S. products.
If this kind of nondisclosure seems familiar, just think back to those made famous by Wall Street analysts prior to the regulatory investigations into the conflicts in those shops.
When asked in an e-mail message whether any of the players in the Providian deal were I.S.S.'s paying customers, and if so, what they paid the firm for other services, Cheryl Gustitis, I.S.S.'s spokeswoman, declined to comment. She said the firm managed the conflicts appropriately and added that I.S.S. provided such details to its clients. Ms. Gustitis said that in order to protect the privacy of clients, I.S.S. did not disclose the details of its relationships to reporters.
"From all the feedback we receive from our institutional clients, it appears they are quite happy with our transparency and fulfillment of their information needs," she said.
BUT the potential for conflicts remains troubling, as is I.S.S.'s refusal to disclose publicly what it has received in pay from the issuers it writes about. The news media regularly report the firm's recommendations on mergers, option plans and other proxy matters, yet news organizations cannot judge whether the reports are colored by the firm's lucrative relationships with the companies being discussed. By contrast, news articles in which research analysts are quoted now routinely disclose those analysts' conflicts, if there are any.
The I.S.S. report on the Providian deal is lukewarm. It noted that the offer "may be at the low end of a reasonable value range" for the company. I.S.S. pointed out another concern for shareholders - that Providian was not shopped aggressively to other potential buyers. The report also said that in the firm's meeting with Joseph W. Saunders, Providian's chief executive, his comments seemed to raise a question regarding his motivation "to achieve the maximum price for shareholders."
Sound like red flags to you?
Not to I.S.S., which concludes that there is "insufficient consensus surrounding Providian's long-term earnings potential that would warrant a higher valuation and voting against this transaction."
"With such a low premium of 4 percent to the prior day's close and the fact that there is a significant breakup fee of $225 million, it doesn't give us much comfort that investors are being protected," said Sean Egan, managing director of Egan-Jones Ratings. "There has been a huge turnaround among the credit card issuers over the past three years, and with MBNA being acquired, there's some scarcity value for Providian. But their shareholders are not getting it."
In its report, Glass Lewis said it believed that Providian was worth $21 to $24 a share. It said the company's business was performing well and could easily remain independent.
"Clearly, the Street felt this was a business that was turning around and growing substantially," said Greg Taxin, chief executive of Glass Lewis. "To sell that business without bothering to ask whether anyone else would pay more seems to us a failed process. We believe that shareholders ought to empower this management team to go negotiate a better deal."
Perhaps most disturbing about the I.S.S. recommendation is that it advises Providian shareholders to give up their rights to have their company appraised at a possibly higher value.
Providian is incorporated in Delaware, where state law gives shareholders rejecting a merger or withholding their votes on it the right to secure an independent appraisal. That process is overseen by a Delaware court.
There is almost no downside to a shareholder asserting his appraisal rights. If the independent appraisal finds the proposed deal to be fair, holders can still vote for the merger. The appraisal would also carry no cost to Providian shareholders; Washington Mutual would have to pay for it.
But only those shareholders who do not vote for a merger can assert their appraisal rights. So by advising its institutional investor customers to vote for the deal, I.S.S. is recommending that they give up a virtually free option to secure a possibly higher price.
Ms. Gustitis said I.S.S. chose that route because it reckoned the deal was in the best interests of Providian shareholders.
Sophisticated investors know to exercise their appraisal rights in deals that they think were struck at too low a price. As has been widely reported, the investor Carl C. Icahn has asked for an independent appraisal of a deal involving two drug companies, Transkaryotic Therapies and Shire Pharmaceuticals.
I.S.S. does not always advise shareholders to vote yes on mergers, of course. Ms. Gustitis said that while the firm could not quickly compile a comprehensive assessment of how often it had supported mergers in the past, I.S.S. had recommended against eight mergers so far this year. She also noted that I.S.S. had recommended that holders side with dissident shareholders on four proxy contests this year.
But I.S.S.'s merger recommendations have often been the difference between acceptance or rejection by shareholders. Without its favorable recommendation on the Hewlett-Packard and Compaq merger, for example, that marriage probably would not have been consummated, according to many commentators at the time.
THERE is no doubt that shareholders have rubber-stamped mergers for far too long. And in so many past cases, executives have gained immense wealth in deals that have destroyed shareholder value.
Free-thinking Providian shareholders don't have to take I.S.S.'s advice and forgo the chance of a better deal. Those who do will have only themselves to blame.