The International Journal
of Not-for-Profit Law
Volume 1, Issue 2, December 1998
Margery S. Bronster, Hawaii’s Attorney General, has asked the state’s probate court to remove the five trustees of the Bernice Pauahi Bishop Estate, the wealthiest charity in the state. Bronster cites various breaches of fiduciary duties as the reason for her action.
Kamehameha Schools/Bishop Estate (KS/BE) was established 114 years ago by the will of Princess Bernice Pauahi Bishop, the great-granddaughter and last descendant of King Kamehameha the Great. Initial funding of this charitable trust consisted of roughly 10% of the Kingdom of Hawaii’s land mass, including all of Waikiki. The KS/BE corpus today is estimated to be worth approximately $10 billion, including a 10% interest in Goldman Sachs.
TERMS OF THE WILL. The will directs five trustees “to erect and maintain in the Hawaiian Islands two schools, each for boarding and day scholars, one for boys and one for girls, to be known as, and called the Kamehameha Schools.” Up to one-half of the corpus is for “the purchase of suitable premises, the erection of school buildings, and in furnishing the same with the necessary and appropriate fixtures, furniture and apparatus.” Annual income generated by the remaining corpus must be expended “in the maintenance of said schools; meaning thereby the salaries of teachers, the repairing [of] buildings and other incidental expenses; and to devote a portion of each years income to the support and education of orphans, and others in indigent circumstances, giving the preference to Hawaiians of pure or part aboriginal blood; the proportion in which said annual income is to be divided among the various objects above mentioned to be determined solely by my said trustees ….”
The two schools were established relatively soon after Pauahi’s death and then combined many years later. Except as noted above, the will does not require or even mention special treatment for native Hawaiians. The trustees’ longstanding practice of limiting enrollment to children with at least some quantum of aboriginal blood, though widely supported, is one of many issues currently being scrutinized by the IRS in an audit that began three years ago.
Despite the governing instrument requirement that income be expended each year, the most money ever actually spent in one year on the school and other charitable activities has been about $70 million, less than 1% of the estimated value of trust corpus. Competition for admissionto Kamehameha Schools is intense, with about ten applications for each slot.
The will directs that trustees be chosen by justices of the “Supreme Court,” which at the time of the princess’ death meant the Supreme Court of the Kingdom of Hawaii. But Supreme Court justices continued to make the selections when Hawaii was a republic, territory and state … until late last year. It was then that four of the five justices, bowing to public pressure, agreed not to participate in future trustee selections. The one dissenter has suggested privately that he has authority to make future selections “as a majority of one.” In past years, the justices did not hesitate to decide cases involving the trustees they selected. But earlier this year, the justices agreed to recuse themselves in such matters.
HIGHLY COMPENSATED TRUSTEES. KS/BE trustees have paid themselves annual fees averaging about $900,000 each. They argue that this has been within the compensation cap set by mechanical application of Hawaii’s statutory fee provision. But the nation’s preeminent authority on trust law has called this formula “practically incomprehensible … an awful statute.” Among other problems, it does not define “revenue,” “income” and “general profits.” As a result, it is not clear in what circumstances net income as opposed to gross income is to be used, or to what extent capital losses are to be offset against capital gains.
These ambiguities take on greater meaning when you consider a few numbers. During the three-year period currently under review by a court-appointed master, the trustees experienced losses and loss reserves totaling $241 million. This exceeded investment income from all sources, including Goldman Sachs. Plus, annual management and general expenses rose from $42 million to $52 million to $61 million. According to the master, the total return for this three-year period was minus 1.0% .
Due to a dramatic, last-minute floor vote on the floor of the state House of Representatives, the 1998 Legislature replaced the statutory fee formula with a simple requirement that trustee compensation always be “reasonable under the circumstances.” The bill had been bottled up in the House Judiciary Committee (whose chair has for years received a $4,000 monthly retainer from KS/BE), and was actively fought by the Speaker of the House (who recently received a $132,000 consulting fee on a KS/BE land transaction).
POLITICAL CONNECTIONS. One of the current trustees was Speaker of the state House of Representatives at the time of his appointment in 1984 and for several years thereafter. Another had been President of the state Senate just prior to being appointed a trustee. A third had just been chairman of the state Judicial Selection Commission, and a fourth was a physical education teacher turned state Department of Education administrator who recently had served as chairperson of the sitting Governor’s re-election committee on the island of Maui. The fifth trustee, Oswald Stender, is sometimes called the accidental trustee. Unlike the other four, he is not politically active and was not the first choice of any justice. Stender emerged as a compromise candidate only when the justices reached a stalemate over other candidates, one of whom was generally regarded at that time as a political “king maker.” Stender is the only trustee with CEO-like credentials.
Cynics sometimes point out that members of the Judicial Selection Commission are selected by the Speaker of the House, President of the Senate and Chief Justice of the Supreme Court … and that KS/BE trustees in recent years have included a Speaker of the House, President of the Senate and Chief Justice of the Supreme Court. The Governor also selects Commission members, and the most recent trustee is the best friend and political confidant of the Governor.
The law firm of another recent Judicial Selection Commission chairman has received $15 million in fees from KS/BE since his tenure on the Commission, and the law firm of a former Governor received millions in fees soon after he left office in 1995.
Unsuccessful candidates for justice of the state Supreme Court have described being quizzed by members of the Judicial Selection Commission about who they might be inclined to name as a KS/BE trustee. These candidates concluded that no one gets appointed to the high court in Hawaii unless they answer this question “correctly.”
On August 9, 1997, the Honolulu Star Bulletin published Broken Trust, a newspaper article written by four prominent members of the native Hawaiian community (a senior federal district court judge, retired state appellate court judge, former principal of Kamehameha Schools, and head trustee of the Queen Liliuokalani Trust) and a University of Hawaii law professor. This 6,400 word essay triggered a public outcry for reform and prompted an investigation by the state Attorney General. The resulting media coverage rivaled what might have been given to the declaration of World War III.
GOVERNANCE OF KAMEHAMEHA SCHOOLS. Four months later, a court-appointed fact finder submitted a scathing report on the trustees’ management of the Kamehameha Schools. Focused primarily on the so-called Lead Trustee for Education, the report painted a picture of insensitivity, favoritism, incompetence and vindictiveness. According to the fact finder, this trustee frequently would countermand decisions of the school’s president and principals, and tell teachers and staff that they were incompetent and uncaring. At one point in time, she commanded that nothing in writing leave the campus until it had been approved by her, causing months-long delays in simple communications.
She had the student body president pulled out of class and ushered by a principal to her downtown office for a closed door meeting after hearing that this student was planning to write a letter supportive of the school’s president. Among other thinly disguised threats was “reassurance” that she wouldn’t dream of calling administrators at Princeton (where he had been offered a scholarship) to tell them that he was a “rabble-rouser.” As he left the two-hour session, his stomach was “wrenched with pain.” Later this student leader wrote that the session was intimidating and terrifying, and that he felt trapped: “[I] could not get up, at any time, and leave her office that day, though I wished I could have.”
When one of this trustee’s confidants wanted a particular child admitted to Kamehameha Schools, a red dot would appear on that applicant’s file. Staff had been instructed to admit red- dot applicants, regardless of qualifications. On at least one such occasion, the party asking for special treatment reportedly was the Supreme Court justice who had pushed hard for her appointment as a trustee, and who now contends that he can select future KS/BE trustees “as a majority of one.”
According to the fact finder, these and other ways in which the lead trustee for education and the people around her “usurped,” “undermined” and “subverted” the powers of the president and his staff left the school in “turmoil” and “disarray.”
Other trustees pleaded ignorance, but the fact finder would have none of that: “The Fact Finder finds that … the other four trustees … knew or should have known that the Lead Trustee was engaged in actions that were detrimental to the Kamehameha School …. It is inconceivable to the Fact Finder that her fellow Trustees acting in concert could not find out what the Lead Trustee was doing on campus. Though the alarms were being sounded by the actions of one of the Trustees, the others either ignored it, or failed to grasp the consequences of it.”
A few months later, a Western Association of Schools and Colleges (WASC) accreditation team was harsh in its assessment of the trustees, calling the governance of the school “dysfunctional.”
A master appointed by the probate court to review the trustees’ accounts also has been critical of the trustees’ conduct: “Currently, there is no policy to guide the Trustees on expending its resources …. Such a policy is fundamental to the development of a strategic plan for investments and educational expenditures.”
One of many “flawed” actions identified by the master related to the trustees’ termination of long-standing outreach programs in order to build new campuses on neighbor islands. Their premise was that all planned programs, both old and new, had to fit within that year’s direct educational expenditure budget of $55 million. But the trust at that time had an accumulated income balance of $316 million, and even taking into account the cost of running new campuses, unspent accumulated income was projected to reach $1.5 billion in just ten years.
The trustees announced the plan to build new campuses just three days after publication of Broken Trust. This timing troubled the master: “Your master is unable to determine the reasons why GoForward [the expansion plan] was announced in such a hurried manner with limited involvement of key personnel and educational expertise …. your master is not satisfied that critical and fundamental planning considerations have been adequately analyzed …. both professional staff and key management employees at the Kamehameha School (sic), as well as key management personnel at the trust estate, were unaware of the many key details of the GoForward initiative until it was publicly announced by the Trustees. This understandably resulted in misunderstanding, confusion, loss of confidence, and a decline in morale.”
“Curiously” (the master’s word), the financial model for estimating the operating and capital costs of the proposed neighbor island campuses was not developed until one year after critical decisions had been made.
The master addressed many other aspects of the trustees’ management of estate assets. In a report filed with the probate court three months ago, he noted numerous serious and repeated breaches of trust. A sampling follows.
TRANSFER OF INCOME TO CORPUS. Despite will language directing the trustees to expend income each year, and a Hawaii Supreme Court opinion and probate court order indicating that all income be spent in the year earned or in accordance with an approved plan, the trustees surreptitiously moved $350 million on the books from the income account to the corpus account. The funds themselves were invested in highly illiquid growth-oriented investments rather than spent on the school as required by the will.
This diversion of funds was not noted in minutes of trustee meetings or disclosed in notes to the financial statements. The master was concerned by what appeared to be an element of deceit and attempt to blame others: “The contention in the Trustees’ Response that the reclassification of accumulated income to corpus was not deceptive because the information necessary to figure out how much income had been accumulated was always available for past masters to uncover is outrageous. To blame past masters for failing to discern the Trustees’ concealment … is … a diversionary attempt …. [R]esponsibility for their malfeasance should not be laid at the doorstep of past masters ….The fact that the trustees cloaked their decision to reclassify income to corpus as being ‘confidential and privileged’ speaks volumes regarding the forthrightness of their action.”
Trustee efforts to minimize the issue’s significance by pointing out that the amounts easily can be transferred back to the income account, have not satisfied the master: “The inability of the Trustees to comprehend the gravity of their failure to properly account for and expend accumulated income betrays a lack of sensitivity to one of their most fundamental duties as trustees.”
INVESTMENT PRACTICES. According to the master, investment decisions have been ad hoc, based more on “relationships” than financial analysis; due diligence work often has not been done … or done but ignored; and completed investments have not been properly monitored and measured against appropriate benchmarks. In numerous ways, the estate’s financial statements have been misleading.
As recently as earlier this year, the trustees were reporting the fair market value of trust assets at about $2 billion even though the assessed value of estate land on the island of Oahu alone totals nearly $5 billion and the estate’s stake in Goldman Sachs is generally believed to be worth up to $3 billion. Critics have suggested that attempts to minimize the size of the trust estate are related to trustee contentions that $70 million is not an inappropriately small amount to expend on the school each year.
Several months ago, a court-ordered study by Arthur Andersen confirmed the master’s findings: “In virtually all areas of investment and management decision-making by the trustees, the Andersen Report notes a lack of appropriate investment planning. Even more problematic, the Andersen Report observes that even to the extent that there may be a semblance of an investment plan, there is a weak commitment to abide by the plan.”
LEAD TRUSTEES AND ACCOUNTABILITY. The master was especially critical of the trustees’ insistence upon a so-called lead trustee management system in which each trustee acts as a CEO. According to the master, “efforts to identify a comparable management structure within any major business organization of note turned up nothing.” The master noted that the trustees effectively hired themselves to manage this unusually complex organization without first developing job descriptions, minimum qualifications or procedures for reviewing job performance.
Compensation studies commissioned by the trustees were then cited by them as proof of the reasonableness of their fees. But each compensation consultant basically was asked little more than how much CEOs of billion-dollar businesses usually get paid. None of these reports even considered the qualifications or performance of these particular individuals.
FAILURE TO PROPERLY ACCOUNT. In addition to normal disclosure requirements, the will directs that the trustees annually file with the court “an inventory of the property in their hands and how invested.” Interestingly, the will also directs the trustees to publish this information in a newspaper for public review. This has simply been ignored. According to the Attorney General, “The trustees have not only failed to account as required by the Will and by law, but have intentionally concealed the accounts and the true condition of the Estate from the Court and the beneficiaries.”
The quality and quantity of available financial information about KS/BE is amazingly limited. Even the court-appointed master compared his attempts to get information from these trustees to trying to get it from the CIA. The usually mild mannered master was “outraged” by the trustees’ “specious rationale” for not properly disclosing vital information. He called their excuses “so pathetic as to border on the ludicrous.”
When the trustees described the master’s preliminary report as “a product of flawed analysis, largely attributable to a failure of communication between the Estate staff and the Master’s accountant,” the master stood by his reference to “the CIA” and called the trustees’ explanation “a gross mis-characterization:” “[T]he trustees are inclined to disclose financial information only when and to the extent that it serves their own purposes.”
CONFLICTS OF INTEREST AND PRIVATE INUREMENT. According to the Attorney General, “the trustees have at all times failed even to comprehend the concept, meaning, or existence of a conflict of interest between themselves and the beneficiaries.”
The master’s report details instances of co-investing and other troubling situations, such as the time one trustee “recused” himself as a trustee just long enough to negotiate a large land purchase from KS/BE, and the trustees’ use of trust funds to lobby against enactment of federal intermediate sanctions law. The master felt that this last matter would have been a serious breach even if the trustees had used their own money since it definitely worked against the best interests of the trust: “Your master finds that [these efforts were] predominantly directed at preserving the historical procedure for determining compensation of the trustees under state statutory law and minimizing the potentially adverse impact that the intermediate sanctions law would have on their continued ability to receive compensation in accordance with and at the levels permitted under state law.”
The $1 million or so that went into fighting enactment of this salutary legislation, and millions more, went to the law firm of the former Governor who had appointed all five of the current Supreme Court justices and key members of the Judicial Selection Commission.
The trustees (except for Stender) accepted free golf club memberships worth up to $40,000 from KS/BE leaseholders around the time leases were being renegotiated, and one of the trustees is alleged to have pocketed substantial director fees from a company in which the estate held a large block of stock. Another trustee used estate personnel to perform valuable personal services and accepted trips in private jets to events such as the Super Bowl and Olympics from vendors around the time of major purchases by KS/BE. Yet another trustee is alleged to have engaged in a kickback scheme with his brother-in-law and the estate. One of the trustees instructed KS/BE personnel to surreptitiously and illegally pay off the campaign debts of several state senators.
When the Attorney General accidentally discovered that one of these senators had used a KS/BE credit card in strip bars and Las Vegas casinos, the trustees response was to offset the $21,000 debt against a “retroactive bonus” so the senator would not have to personally repay the estate for his unauthorized use of the card. (Though lacking a clear job description, this particular senator had for many years been on the KS/BE payroll.)
INVESTIGATIONS AND PETITIONS FOR REMOVAL. The KS/BE trustees are currently being investigated by the Internal Revenue Service and state Attorney General. They also are the subjects of two grand jury criminal investigations, one conducted by the U.S. Attorney in Hawaii, the other by the state Attorney General, plus an inquiry by the state Campaign Spending Commission. The probate court has not yet approved trustee accounts for any year since fiscal 1993 and so the court-appointed master also is actively involved in KS/BE affairs. Two of the trustees have asked a state circuit court to remove a third (the one who had been lead trustee for the school). That trial started on the 9th of November and is projected to last four to six months.
The Attorney General’s petition to permanently remove all five trustees has been set for trial in late 1999, is not expected to start until sometime in the year 2000. Her petition for temporary removal was taken under advisement by the probate judge on October 2, 1998. The probate court’s failure to act on this petition is not easily explained since the court has had scathing reports from fact finders for many months and the applicable law is quite clear.
The Master has documented numerous profound breaches of trust that violate the fundamental purpose of the trust, the law, and numerous court orders. When the Master sets forth a prima facie case of breach, the trustees have the burden of proving that there is no breach. Monting v. Leong Kau, 7 Haw. 486 (1888); Nawahi v. Trust Co., 31 Haw. 958, 973 (1931); and Estate of Baker, 34 Haw. 263, 267-268 (1937). Attorney General’s Response to Master’s Consolidated Report.
There also is clear precedent in Hawaii and elsewhere for the removal of trustees on an expedited basis. In Estate of Holt [33 Haw. 352, 362 (1935)], for example, the court did not even wait for a formal petition since it was evident from the master’s report that the trustee “was not sufficiently careful and diligent in the performance of his duties to meet the requirements of good stewardship.” The probate court is supposed to do what is in the best interests of the beneficiaries, even if the removed trustees have done their best. In Holt, for example, the court affirmed the expedited, pre-petition removal even though nothing in the record reflected adversely on the ousted trustee’s honesty or integrity.
WILL THEY BE REMOVED? In response to highly critical reports of fact finders and outside consultants, the trustees have promised much in the way of reform, but have yet to produced anything of significance. Their words express a desire to cooperate with the various investigations, but their actions seem designed to stall for as long as possible.
Among other on-going questionable expenditures, the trustees reportedly are paying nearly $100,000 of trust funds each month to a law firm that the Attorney General believes is working for “the protection and benefit of the individual trustees and not the Estate or its beneficiaries.” Total cost of the many investigations, inquiries and related court battles, is estimated to have exceeded $5 million … and an end is not yet in sight.
For many years whenever the subject was KS/BE, Hawaii’s judges and justices opted not to make waves … choosing simply to “look the other way.” Some people think this has not changed and is the reason for the probate court’s inaction. Many of them are convinced that these trustees will never be removed.
Others think it is perfectly understandable that a probate judge would approach this matter with caution or even trepidation. After all, she has been asked to fire politically powerful people who were appointed by justices of the Supreme Court. Plus, the job of naming a person or persons to run this historic and emotionally charged institution would fall squarely into her lap. Just imagine if that person or those persons were to perform poorly.
EVERYONE IS WATCHING. The judiciary’s handling of this matter arguably will establish the direction of justice in Hawaii for years to come. A concerned public is watching closely, as are scores of concerned political insiders.
To locate key documents go to https://starbulletin.com/specials/bishop.html and scroll down to “milestones.
About the Author: Randall W. Roth is professor of law at the University of Hawaii and can be reached at email@example.com.