Wednesday, May 5, 1999

Peters says suit
against IRS
not ruled out

'I'd like to be able to subpoena
the IRS if I could,' the Bishop
Estate trustee says

By Rick Daysog


Bishop Estate trustee Henry Peters says the estate has not ruled out legal action against the Internal Revenue Service, which has threatened to revoke the multibillion-dollar trust's tax-exempt status if all five of the estate's board members do not step down.

Peters, in an interview yesterday, said he was concerned by what he considered to be improper contacts between the IRS, outgoing state Attorney General Margery Bronster and the estate's court-appointed master Colbert Matsumoto.

Although the estate's board has made no decision to contest the IRS' findings and individuals trustees are barred by court order from responding to the audit, Peters said he personally has not ruled out taking the federal agency to court.

"I'd like to be able to subpoena the IRS if I could," Peters said. "They will have to show us that they have not tampered with us."

Some legal experts see a legal fight with the IRS as a desperate and foolhardy move for the Bishop Estate, which has a mission to educate children of native Hawaiian ancestry. Critics believe that a courtroom battle would be expensive, could further jeopardize the trust's tax-exempt status and would largely serve the personal interests of trustees rather than the interests of 114-year-old trust.

Peters and fellow trustees -- who each were paid over $1 million in 1998 -- are the subject of the IRS investigation

into excessive compensation and private inurement.

He also is a key target of Bronster's 18-month investigation into allegations that trustees breached their fiduciary duties and mismanaged the estate, which operates the Kamehameha Schools. Separately, a 16-member Oahu grand jury - convened by Bronster - indicted Peters for theft in connection to an alleged kickback scheme involving Bishop Estate land.

But Peters said the issue with the IRS is one of due process. He said he believes Bronster played a role in the IRS ultimatum, noting that she had been in contact with the federal agency.

Over the weekend, estate attorney William McCorriston issued a subpoena for Bronster's testimony for hearing on Friday before Probate Judge Kevin Chang. Chang last Thursday ordered the trustees to demonstrate why they should not voluntarily step down or be removed temporarily in wake of the IRS's threat.

Peters also said Denver-based IRS agent Janet Hughes, a specialist in tax-exempt organizations, made improper contact with Matsumoto.

Both Bronster and Matsumoto have denied the charges that they influenced the IRS investigation. Bronster said she met informally with IRS officials at a national conference in Portland, Ore., last October where she and the head of IRS's tax-exempt division, Marcus Owens, were guest speakers.

Bronster said she saw nothing wrong with communicating with with the IRS as long as the talks did not violate any confidentiality laws. In her conversation with the IRS, Bronster said, she stressed the importance of maintaining the estate's tax-exempt status.

Peters said he is not aware of many of the details surrounding the IRS audit since he and fellow trustees are barred from responding to the examination under a ruling by Judge Chang, who said trustees had a conflict of interest.

A five-member panel of special purpose trustees appointed by Chang to take over the trust's negotiations with the IRS were reportedly informed by IRS agents in an April 19 meeting in Los Angeles that they would discontinue negotiations and begin the process of revoking the estate's nonprofit status if they did not receive "a clear signal" that the trustees would resign or be permanently removed.

Peters said he believes the ultimatum may be coming from the IRS Western region office and not from the agency's national office, which has the final say.

He said that he thinks that once the trustees are able to present their side of the story to the IRS, they will be able to answer many of the federal government's concerns.

IRS verifies
demand that Bishop
trustees step down

By Rick Daysog


Internal Revenue Service officials have confirmed that they are considering revoking the Bishop Estate's tax-exempt status if all five trustees of the Bishop Estate do not step down, according to documents filed with the state Probate Court.

But lawyers for the majority trustees argued such a removal would violate board members' due-process rights and questioned whether the IRS is truly requiring the trustees' ouster.

In a letter to a five-member special panel appointed by Probate Judge Kevin Chang to negotiate with the IRS, Terry Franklin, an agent in the IRS' Western region division, stated the Bishop Estate's five trustees would have to step down in order to resolve issues raised by the service's audit of the multibillion-dollar charitable organization.

Franklin and Marcus Owens, the Washington, D.C.-based director of the IRS' exempt-organizations division, recently reiterated the IRS' position in a follow-up letter to the special panel, which was filed under seal with the state Probate Court yesterday.

"You have asked for clarification of one of the conditions that must be addressed, specifically the status of the board of trustees," Franklin wrote.

"As we made clear, in addition to the other issues we discussed, the current five incumbents of the board of trustees must resign or be removed, to resolve the IRS' concerns."

Excerpts of Franklin's initial letter were included as an exhibit-to-court document filed yesterday by William McCorriston, an attorney for majority trustees Richard "Dickie" Wong, Henry Peters and Lokelani Lindsey.

The letter described discussions between IRS officials and the special panel at an April 19 meeting in Los Angeles. The special panel is comprised of Hawaiian Electric Industries Inc. Treasurer Constance Lau, retired Adm. Robert Kihune, former Iolani School headmaster David Coon, retired Honolulu Police Chief Francis Keala and local attorney Ronald Libkuman.

The panel has argued in sealed court documents that the IRS is threatening to revoke the 114-year-old trust's nonprofit status if trustees aren't removed and if the trust doesn't implement a process for selecting successor trustees.

The IRS also is demanding that the estate establish a policy for reasonable trustee compensation and hire an internal auditor to police the trust's finances, according to the panel.

Revocation of the nonprofit status could cost the estate tens of millions of dollars each year, prompting the estate's court-appointed master Colbert Matsumoto to petition Judge Chang to order the resignation or temporary removal of all five trustees.

A hearing on Matsumoto's recommendation, which was filed under seal last Thursday, is scheduled for Friday.

Experts in the IRS' auditing process say that such ultimatums are extremely rare but may indicate that the IRS wants to see drastic reforms at the Bishop Estate.

Daniel Kurtz, author of a book on how nonprofit organizations are run and a former top regulator for charities in New York, said the threat of revocation of the estate's tax-exempt status shows that the trust's operations may be so flawed that the federal agency believes it can't be rehabilitated under current management.

Kurtz noted that recent federal legislation known as the intermediate sanctions law allows the IRS to surcharge trustees as an alternative to yanking nonprofit status. But that law is more geared toward small trusts that require surgical remedies, and may not be appropriate for the massive Bishop Estate, he said.

"I think they're deadly serious, and if they don't get these things, they'll yank the exemption," said Kurtz.

William Lehrfeld, a Washington D.C., tax attorney and former IRS lawyer, said that these days the IRS rarely threatens a trust's tax-exempt status, although there have been some exceptions in audits involving ministries.

Lehrfeld, who has represented nonprofit organizations audited by the IRS, said he was surprised that the IRS may be attempting to leverage the trustees' removal with the revocation issue. He believes that the IRS ultimately does not have the legal authority to oust trustees.

But Lehrfeld said that once the IRS has determined that trustees should step aside, temporary resignation might be the proper move in order to spare the trust further exposure from the IRS.

"If they chose not to resign and in doing so brought the power of the Internal Revenue Service on the organization, then the question is whether they have faithfully executed the fiduciary duties," Lehrfeld said. "First and foremost, fiduciaries should have an undivided loyalty to the trusts they serve."

N. Jerold Cohen, an Atlanta tax attorney and former IRS chief counsel, believes that it would be highly improper and unlikely that the IRS would call for the removal of trustees by threatening revocation.

Cohen, who is advising the three majority trustees, said that to remove the trustees would violate the most elemental rules of due process and would leave the estate's management "in shambles."

Cohen noted that recent congressional reforms of the IRS were meant to address alleged abuses of the auditing process.

"It would not only be highly unusual, but it would be close to improper," Cohen said. "It just doesn't sound like the service -- certainly not the new service."

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