The Clarence T.C. Ching Foundation, a major contributor to Catholic organizations in Hawai'i, lost thousands of dollars by investing in a poorly performing Morgan Stanley junk bond fund, according to the nonprofit's tax filings.

The investment was overseen by the son of former Ching Foundation trustee Paul Loo, who heads Morgan Stanley Dean Witter's Honolulu office. Loo's son, Rodney Loo, works for Morgan Stanley's San Francisco office.

The state attorney general's office looked into Morgan Stanley's relationship with the Ching trust last summer and found insufficient evidence of a conflict. But that was before the losses from the junk bond fund were disclosed in a November tax filing.

The attorney general's office is now requesting a broad range of financial and accounting records from the foundation in response to recent complaints by a former Ching Foundation trustee, Wallace Ching, who alleged the trust is mismanaging its assets.

Experts on laws governing nonprofits questioned the way the investment was handled.

"It smells like a conflict of interest," said Robert Schriebman, a Rolling Hills, Calif.-based tax attorney and former accounting professor at the University of Southern California. "Why would a tax-exempt organization even care about an investment like this?"

Founded in 1967, the Clarence T.C. Ching Foundation is a charity that has provided millions of dollars in funding to Saint Louis School, Chaminade University and St. Francis Medical Center.

The foundation, which has $4.2 million in assets, stands to receive most of the proceeds from the $131 million sale of the Kukui Gardens affordable rental complex downtown, which was developed in 1970 by the foundation's namesake, Clarence Ching.

The foundation's latest tax filings show that it lost $630,698 or about 69 percent of its capital investment in the Morgan Stanley High Yield Securities Fund A, a mutual fund that invests in junk bonds and other fixed-income securities.

The foundation paid $904,095 for the shares, which it acquired over several years dating back to at least 1998. It sold the shares on May 16, 2005, for $273,397. The loss reflects the decline in the fund's share price and does not include accumulation of dividends, which mitigated the loss to some degree.

The foundation's holdings in the Morgan Stanley fund represents more than one-fifth of all of its assets. The loss from the investment brought down the foundation's overall annual performance.

According to its tax filing, the Ching Foundation said it lost a net $434,829 from its stock, bond and mutual fund investments in 2005.

The losses have tarnished the foundation's long-term investment record, which has generally kept pace with the market over the years.

Between 1998 and 2005, the portfolio's return on assets was 48.9 percent. During the same period, the total return for the Dow Jones Industrial Average was 58.2 percent while the broader S&P 500 index's total return was 45.8 percent.

Paul Loo, who resigned from the Ching Foundation's board last year due to time constraints, denied any conflict of interest. Loo said the allegations of a conflict of interest were raised last summer by a Kukui Gardens' tenants group. He said the complaint was dismissed recently by the attorney general's office.

ACCOUNT MANAGEMENT

According to Loo, Morgan Stanley and its predecessor firm have handled the foundation's investments for 16 years, but he said the firm's San Francisco office and not the local office handles the account.

He said his son Rodney Loo serves as the foundation's account executive and that the foundation pays all of its fees to the firm's San Francisco office to avoid any appearance of conflict. He said he didn't have details on the fees paid to Morgan Stanley but said that the fee is fixed and is lower than what banks or other custodial agents typically charge for such services.

Rodney Loo, an employee of Morgan Stanley and its predecessor firms since 1985, did not return calls.

Paul Loo said he didn't have the particulars for the fund's performance and didn't know when the foundation acquired the shares in the junk bond fund. But he said the Morgan Stanley fund once paid an annual yield of about 13 percent.

Paul Loo estimated that over a five-year period at that yield, the foundation would have earned back 60 percent of its investment in income, giving the investment a positive total return, he said.

"It could well be that it was a pretty good investment," Paul Loo said.

Morningstar Inc., a leading mutual fund rating service, said the fund's total return was negative during the time that Ching Foundation owned the shares.

Including dividends and the share price, the Morgan Stanley fund lost an average of 3 percent a year between 1998 and 2005, said Dan Lefkovitz, senior mutual fund analysts at Morningstar.

During that eight-year period, the total return on the fund was a negative 35 percent, he said. By comparison, the bellwether CS First Boston High Yield Index rose by about 70 percent during the same period, Lefkovitz said.

Lefkovitz said Morningstar gave the Morgan Stanley fund a one-star rating, which is the lowest rating that Morningstar gives to mutual funds.

"If you invested $10,000 in this fund in 1998, you would have had $6,467 on the date it was sold," Lefkovitz said.

Morningstar has been critical of the fund's performance for years.

One of Lefkovitz's predecessors, Morningstar analyst Alan Papier, put out a report on May 15, 2002, saying the fund "has shown no ability whatsoever to preserve shareholder assets, making its high level of income a moot point."

"Spring is the metaphorical season of optimism. Unfortunately, Morgan Stanley's High Yield Securities Fund remains firmly planted in a nutrient-void soil of its own making," Papier wrote.

Morningstar analyst Jeffrey Ptak gave a more blunt assessment in September 2002: "Hold your nose when you pass this stinker."

Lawrence Ching, trustee of the Ching Foundation, said recently he couldn't recall particulars surrounding the foundation's investment in the Morgan Stanley fund. He agreed to look into it and get back to The Advertiser. However, Ching called back a few days later, saying he could not provide the details on the investment due to an unspecified confidentiality agreement.

Ching said he didn't believe Paul Loo had a conflict since the foundation's investments were being handled by Morgan Stanley's San Francisco office. He said the fees are much lower than what most advisers charge for similar services but did not provide details.

GUIDELINES

Losing money in a junk bond fund in and of itself doesn't violate governance guidelines for nonprofits as long as the investment decisions are guided by the so-called prudent investors rule.

Under that rule, investment managers or trustees of charitable foundations, universities, pension funds or private trusts are required to exercise good judgment to preserve the principal of their investment, earn income and avoid speculative or risky investments.

But in the case of the Ching Foundation, the investment represented a large chunk of the trust's overall portfolio and the losses were so large that it jeopardized the assets of the trust, said New York attorney Daniel Kurtz, who teaches courses on nonprofits at Yale Law School.

Kurtz, who headed the charities bureau of the attorney general's office in New York during the 1980s, said the Ching Foundation's board members exposed themselves to hefty fines by the Internal Revenue Service for placing the trust in such unsuitable investments and for self-dealing.

Kurtz added that Loo's actions remain in conflict even if the foundation doesn't pay its fees to Morgan Stanley's Honolulu office because "the money goes into the same (Morgan Stanley) pot at the end of the day."

"It's difficult for me to see how that's a suitable investment for such a small foundation," said Kurtz. "When a fifth of their assets are in a junk bond fund and they lose two-thirds of their investment, it's not because they had an astute management philosophy."

The management of Ching Foundation's assets has been a source of friction within its boardroom.

Lawrence Ching's younger brother, Wallace Ching, was removed as a trustee of the Ching Foundation last month by a majority vote of its five-member board. The removal came after Wallace Ching raised questions about the management of the foundation's assets and called for an accounting.

The attorney general's office is reviewing the trust dispute and recently requested a wide range of financial and accounting information from the trust. The attorney general's office also has recommended the appointment of a special master.

Wallace Ching is the only Ching Foundation trustee who opposed the controversial sale of the Kukui Gardens apartments. Tenants said the sale of the 857-unit project near Chinatown will lead to the displacement of hundreds of senior citizens and low-income residents.

The Ching Foundation trustees also are board members of the apartment's owner, Kukui Gardens Corp.

Drew Astolfi, lead organizer for Faith Action for Community Equity which represents Kukui Gardens' tenants, initiated the conflict of interest complaint with the attorney general's office in July.

While the attorney general's office took no action, Astolfi said neither he nor the attorney general's office were aware of the bond fund losses, which were disclosed by the Ching Foundation in a tax filing in November.

"If they do this when they have $4 million to play with, what are they going to do when they have $131 million to play with?" Astolfi said.

Reach Rick Daysog at rdaysog@honoluluadvertiser.com.