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BEHIND THE NEWS: Few signs of endowment's diversification yet

April 16, 2007

It's a rite of spring. The annual arrival of Lilly Endowment Inc.'s annual report provides a rare glimpse into the operations of the secretive-butsuper-powerful Indianapolis-based foundation.

This year, there's more anticipation than usual. Beyond the listings of who received the hundreds of millions of dollars in grants the endowment passed out last year, the report-due to be released by the end of this month-also will show where the endowment invests its $7 billion in assets.

Until now, that part of the annual report was a snoozer. From its founding in 1937 by members of the Lilly family, the endowment held nearly all its assets in stock of the pharmaceutical company.

So it was a historic moment, indeed, when the endowment last July announced it would begin diversifying away from Eli Lilly and Co. shares. The focus on Lilly long has been controversial, serving the endowment well during Lilly's boom years but hurting it badly as the stock swooned over the past seven years. Since 2000, the value of the endowment has fallen by more than half.

An endowment spokeswoman wouldn't preview the contents of the annual report. But other public documents make clear that whatever the endowment has done with its investments since announcing the diversification plan has been far from radical.

As of this February, the endowment held 140.4 million Lilly shares, which represents a 12.4-percent stake in the company. That's only slightly below the 147.6 million shares the endowment held a year earlier. Much of the reduction may stem from stock sales used to fund grants.

That's not to say the endowment hasn't begun to get into the diversification game, investment professionals say. Holders of huge blocks of stock don't diversify by dumping them on the market, a move that would have the effect of depressing a company's share price.

Rather, they use sophisticated tools like "zero-cost collars," which rely on options to mitigate the risks of being concentrated in a single stock. Under such arrangements, the endowment would have to sell Lilly shares if the stock rose to a certain level. Conversely, if the stock fell to a certain level, another investor would be required to buy endowment holdings.

To be sure, the longtime leadership of the endowment isn't suddenly cool to Lilly shares. It's worth noting that the eight-person board includes Carmel's Eli "Ted" Lilly II, a great-great grandson of the pharmaceutical firm's founder. And when the endowment announced the diversification, board Chairman Thomas Lofton made clear that Lilly stock would continue to represent the bulk of the endowment's holdings.

He noted that diversification would not be complete until 2010. And at that point, the plan would be to have only $2 billion of the endowment's assets diversified.

"Lilly Endowment has for many years enjoyed substantial benefits from its holding of Eli Lilly and Co. stock and believes that Lilly stock will continue to be a rewarding investment," Lofton said in a written statement last July. "Nonetheless, there is wisdom in embarking upon some level of diversification. This transition will take time, and our thinking is fluid."

Even the modest diversification effort is a huge step for the 70-year-old foundation-a huge step forward, many investment professionals believe. Many spend their days advising clients that it's reckless to tether their fortunes to a single stock.

"I'm of the mind, they should have been diversified years ago," said Paul Coan, managing partner of locally based Wealth Planning & Management.

Ice Miller ousted

A federal judge has disqualified Ice Miller from representing Emmis Communications Corp. in its lawsuit against CBS Radio-the New York-based broadcasting powerhouse that hired away Emmis Chief Financial Officer Walter Berger last year.

In the suit, Emmis is accusing CBS of tortious interference with Berger's contract, which wasn't set to expire until 2009.

Here's the rub: To lead its legal assault, Emmis late last year enlisted Ice Miller-the same firm that represented Berger when he negotiated the pact.

Berger had howled in protest. In a letter to Ice Miller three days after Christmas, he wrote: "It is inconceivable to me that your firm now has chosen to represent Emmis in litigation involving this very contract. Your representation constitutes a conflict of interest, and I am concerned that my rights may well have been violated."

Ice Miller had argued there was no conflict, in part because the suit is against CBS Radio, not Berger himself, and the narrow issues raised in the suit make who drafted the contract irrelevant. Even so, the firm said it had "gone the extra mile and done the unnecessary," creating "a screen" around the attorney who'd worked with Berger on crafting the contract.

Unmoved by such arguments, Judge Larry McKinney ruled March 30 that "disqualification in this case is absolutely necessary."

Emmis has not yet appointed replacement counsel.
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