Hi Steve
this is what I did for my rotary encoder designs.

http://www.simviation.com/cgi-bin/yabb2/YaBB.pl?num=1093185023

I don't have the part number of the encoder but they have a spst switch function on them as well and are 24 detent. I think they are made by Bourn but any standard 2 bit grey code encoder should work fine.

The problem you describe sounds like a faulty encoder switch to me. 

cheers
chuck

Weak on the interace side, but a good description of the devices themselves: http://www.xilinx.com/products/boards/s3estarter/files/s3esk_rotary_encoder_inte...

You could always go with a more complex switch and less complex cicuitry... http://www.knitter-switch.com/p_rotary.asp

Check out the Rotary Pulse switches... they close one set of contacts when turned one way and a different set when turned the other.