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Hedge fund activist Joseph Stilwell has been so busy trying to block the acquisition of SCPIE Holdings (SKP) by privately held The Doctors Company that he lost sight of the forest amid the trees. Investors don’t get an answer to the obvious question of why no higher bid has been made, even though Stilwell insists that a higher bid was available. The reason: the potential buyers all signed standstill agreements that prevent them from making acquisition proposals without the board’s approval.

Not that you could tell from either of the proxies. The company obviously does not want to make it clear in its proxy. And Stilwell seems to have forgotten to write about it in his proxy. We had to make a few phone calls to people familiar with the deal to figure it out (under proxy rules, Stilwell himself cannot talk to us).

Stilwell joined the board in late 2006 and agreed not to nominate candidates to the board. He has extensive experience in the insurance industry and sits on the boards of several of SCPIE’s competitors, including American Physicians Capital (ACAP). It so happens that ACAP was also bidding to acquire SCPIE and offered $28 in stock, whereas The Doctors Company, as a private firm, offered $28 in cash. Much of the public disagreement between Stilwell and the SCPIE’s board concerns the question whether ACAP’s bid was better or not. The board points to the certain value of cash. Stilwell did not give any argument that would have convinced us to support him - but then we found out about the standstill agreements.

Now we believe that there is a good chance that a higher bid will materialize if shareholders reject the merger with The Doctors Company. Once shareholders vote against this transaction, other bidders can enter the scene.

Stilwell will spend $100,000 on this proxy solicitation, so we hope he will spend a few dollars extra and send out another proxy that clarifies the standstill agreements. He has an excellent record as an activist investor, so there is a good chance he will succeed again if he can improve the effectiveness of his communications. After all, there are five weeks left until the March 26 shareholder meeting, a period during which Stilwell and SCPIE have plenty of opportunity to attack each other.

In addition to the Stilwell fight, there is another unusual incident in this merger. The Doctors Company is a competitor of SCPIE that attempted to break into SCPIE’s computer systems just days before entering the bidding process. SCPIE notified authorities and a government investigation is pending. A SCPIE spokesman did not know any further details. We do not recall any precedent where a buyer hacked a target’s computers.

SCPIE’s stock trades at a discount to the $28 merger consideration. For a transaction that has a good chance of getting a higher hostile bid, this is very unusual. It is as much a testimony of the current state of risk aversion in the market as a reflection of Stilwell’s weak campaign. When we get closer to the March 28th meeting and the campaigning heats up, it is likely that the discount will turn into a premium. In the end, a higher bid can materialize only if shareholders reject the current deal.

Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which holds shares of SCPIE.