CHICAGO - Consultant J.H. Ellwood & Associates is caught in a flap over millions of dollars in investment losses incurred by the Lutheran Church of the Missouri Synod Foundation, St. Louis.
In 1998 and 1999, the foundation lost upward of $40 million on internally managed derivative investments called interest-only strips and inverse floaters. As a result of the losses, two lawsuits have been filed: one by the LCMS Foundation against Vining-Sparks Inc., Memphis, Tenn., the foundation's former bond dealer, and one by church foundation donors and former church employees against the LCMS Foundation and Vining-Sparks.
Although Chicago-based Ellwood & Associates has been left out of the legal finger pointing, the consultant has lost the church's business. Ellwood no longer works for either the $677 million foundation or $3 billion LCMS workers' benefit, or pension, plan.
Some, including Robert Doggett, a Cincinnati attorney representing 20 church donors and former employees in a lawsuit against the LCMS Foundation, have suggested Ellwood's failure to oversee the investments contributed to the losses and led the foundation and the benefit plan to fire the consultant. In a written statement, Ellwood officials dispute that, saying they were the ones who first discovered the losses and told the LCMS Foundation.
Either way, Ellwood no longer has contracts with the LCMS Foundation or the workers' benefit plan.
Officials for the foundation and the benefit plan on Dec. 4 interviewed three consultant finalists: Ennis Knupp & Associates and Watson Wyatt Investment Consulting Inc., both of Chicago; and Wilshire Associates Inc., Santa Monica, Calif.
Both will choose from among the same three finalists, but likely will choose different consultants, said a source familiar with both the foundation and the benefit plan.
The foundation plans to name a new consultant in the next two weeks, said Wayne Price, the foundation's vice president for finance.
Nobody saying who or why
Nobody at the LCMS or Ellwood will say who decided to end Ellwood's 14-year consulting relationships with the LCMS or why.
Mr. Doggett, the Cincinnati attorney, suggested it may have been Ellwood's failure to monitor the investments and prevent losses that led the foundation and the pension plan to seek new consultants.
"Ellwood was supposed to be employed to monitor the investments and protect them," he said. "In this case, these investments slipped by a lot of people."
But in a statement, Ellwood officials said important information about the foundation's investments was kept from the consultant by Fred C. Sticht, a former foundation worker who oversaw its bond investments - the same investments that eventually lost $40 million. Nevertheless, in late 1998, Ellwood officials said the firm discovered large losses in the bond portfolio, and quickly told foundation officials.
What Ellwood found was that the bond portfolio returns Mr. Sticht was reporting were inconsistent with the market.
Beginning in 1994, the foundation had told Ellwood to start using bond pricing data provided by Mr. Sticht, who was following Vining-Sparks' investment advice. That advice was to put money into interest-only strips and inverse floaters. Both are considered complicated and risky derivative instruments.
In its lawsuit against Vining-Sparks, filed in June in U.S. District Court in St. Louis, the LCMS Foundation said that such investments went against the church's conservative investment policy, which was well-known to Vining-Sparks. It called the strips and inverse floaters "risky" and "speculative" and said their use constituted an "unauthorized and reckless investment scheme" by Vining-Sparks. The suit seeks compensation in excess of $40 million plus punitive damages.
Returns on interest-only strips and the inverse floaters are subject to exaggerated swings in response to even small changes in the market. There are opportunities for big returns, but also for big losses. That's what makes them so risky. Market conditions suggested the strategies were losing money, but that was not represented in Mr. Sticht's reports, according to Ellwood's statement.
"Key data provided by (Mr.) Sticht was incorrect, masking the problems in his bond portfolio," according to the Ellwood statement. "JHEA discovered these problems when preparing the September 1998 quarterly report."
Ellwood said it recommended that the foundation shift its bond portfolio to an external money manager. It is unclear when or if the foundation followed that advice. Neither Mr. Sticht nor his attorney responded to questions by press time.
The LCMS Foundation did not name Ellwood in its lawsuit against Vining-Sparks, but a source familiar with the case said the foundation might be negotiating a settlement with Ellwood out of court.
Ellwood not in suit
Similarly, LCMS donors and former employees have left Ellwood out of their lawsuit, for now, said another plaintiff attorney, William K. Flynn of the Cincinnati law firm Strauss & Troy. That lawsuit, filed in St. Louis County circuit court, names the LCMS Foundation, Mr. Sticht, Mr. Price, retired LCMS Foundation President Norman Sell and Vining-Sparks as defendants.
Many of the hundreds of donors who are suing the foundation and Vining-Sparks donated their farms to the church, which then sold the land and invested the money. In return, the LCMS promised to pay the donors a percentage of the investment return that their money generated, an arrangement known as a charitable remainder unitrust or annuity trust. As a result of the losses, some donors have seen no money.
Former church employees claim their pensions were cut due to the losses, although the workers' benefit plan says it never lost any money.