Conversion to nonprofit corporation would help Kamehameha Schools

Editor's note: Nearly nine years have passed since the Star-Bulletin published an essay by five citizens who questioned the operation of the Bishop Estate. Its trustees have been replaced, the method of choosing them has changed and it has been renamed Kamehameha Schools, but disagreement about its operation continues.

Yesterday » Part One: Better governance can take KS forward About the author Robert R. Midkiff is president of the Atherton Family Foundation and former president of American Financial Services of Hawaii. He is the great-great-grandson of Amos Star Cooke, one of the founders of Castle & Cooke, and son of Frank E. Midkiff, president of Kamehameha Schools from 1923 to1934 and a Bishop Estate trustee from 1939 until his death in 1983.

» Second of two parts

Operating the schools in the form of a trust has brought management problems. Perhaps to justify their exorbitant trustee commissions, the former trustees hired compensation consultants. The consultants told them that corporate CEOs earned compensation similar to their commissions. They appointed themselves to be CEOs and hired themselves to run all trust operations. This allowed trustee Lokelani Lindsey, for example, to single-handedly decide to close down KEEP, the nationally recognized Kamehameha early education outreach program, fire 175 well-trained teachers and cut out 25,000 part-Hawaiian children from a good beginning in life.

The traditional trust accounting form calls for separating principal and income. Leasehold condemnation receipts go into principal. Rental income was used to support the school. For many years the estate was land-rich with inadequate rental income to support the schools properly. A closing agreement with the Internal Revenue Service that was approved by the probate court in 2000 permits trustees to combine income and principal and set a target of paying out 4.5 percent of the endowment annually for charitable operations.

Today, almost all large operating endowments have adopted "total return" accounting and merged income with principal. This allows universities like Yale and Harvard to diversify their investments and seek out capital appreciation as a defense against inflation while distributing a conservative percentage of the market value of the endowment for the needs of the school. These institutions expect to sell assets and capture capital appreciation as well as bond income and rents for current expenses.

The marketable assets of the Kamehameha Schools are now valued at $6.7 billion. A 4.5 percent payout based on market value could provide more than $300 million annually for salaries and continuing education for teachers, scholarships for students, money for building construction and maintenance, and proper compensation for investment and administrative staff.

There are hundreds of years of trust law and precedent. One of the primary goals of a trustee is to conserve assets and earn a fair return. Trustees are responsible for prudent investing. The trustees today are retaining more than 350,000 acres of unproductive agricultural and conservation land, which might be ecologically sound but is not sanctioned as a charitable endeavor under the trust agreement.

Trustees have unlimited personal liability for wrongdoing, although they may purchase (expensive) liability insurance. Corporate directors have greater protection from personal liability.

Operating as trustees is cumbersome. At least three trustees must sign off on every major decision and most documents. Although somewhat protected by the new CEO manager, they still retain individual personal responsibility for all transactions. All five must participate in the discussions leading up to a decision, and this takes a great deal of staff preparation and briefing. Tenants have complained about the time it takes to negotiate with the trustees and reach agreement. There is a history of micromanagement and trustee favoritism for leases and admissions.

Building the endowment

Operating as a trust with compensated trustees inhibits traditional endowment building through alumni and other contributions. A nonprofit school with volunteer community-leader directors, like Punahou or Iolani, is able to raise millions of donated dollars for new buildings and endowment.

The Yale Endowment Report for 2005 makes the following statement: "Without the benefit of endowment gifts to Yale in the last 55 years, the 1950 Endowment of $132 million would have grown to about $3.2 billion by 2005 rather than the actual $15.2 billion. The difference -- a staggering $11.5 billion -- comes from gifts and investment performance on those gifts. Yale's current academic distinction would be unthinkable without these financial contributions. Looking forward, Yale's endowment will fail to maintain its level of importance to the university over the long term unless donors continue to provide Endowment support."

Benefits of converting

Operating as a trust rather than converting to a nonprofit corporation similar to all the other major educational institutions in America will continue to hobble the potential of the Kamehameha Schools. For example, Harvard, Yale, Stanford, Punahou and Iolani all operate as nonprofit corporations with honorary, uncompensated boards of directors and world-class chief executive officers.

Converting to a nonprofit corporation would not be difficult. The Bishop Museum, formerly operated by the trustees of the Bernice P. Bishop Museum Trust, is an excellent precedent. The five trustees of the Bishop Museum Trust, who also served as trustees of the Bishop Estate, resigned in favor of an outstanding group of community and business leaders with the sanction of the probate court.

The Bishop Museum Trust had no record of fundraising for capital. Since the trustees resigned and a corporation was formed, the museum has raised millions of dollars from federal, state and private sources.

As long as Kamehameha Schools remains a trust, the trustees are likely to insist upon substantial fees and will tend to micromanage the trust's operations. There also will be troubling legal questions about the trustees' authority to hold indefinitely more than 350,000 acres of non-income-producing land. If the trust were converted to a nonprofit corporation, however, directors would be expected to serve without pay, confine themselves to setting policy and providing oversight to professional managers and find it relatively easy to legally justify not selling or developing the 350,000 acres of non-income-producing land. It also would be easy, under corporate law, to require that directors be Protestants.

Precedents for converting

The Bishop Museum provides us with a successful local model. Harvard and Yale are two other examples of educational trusts that converted to nonprofit corporations. Studying their differing corporate structures shows us that there are many routes to successful operation of a large school.

Harvard's endowment is held in a separate corporation known as the Harvard Management Co., which is managed by a board of directors appointed by the corporation.

The Yale University Corp. has 19 members: the school's president, the governor and lieutenant governor of Connecticut, six alumni elected by alumni for six-year staggered terms, and 10 members of a self-perpetuating board.

The self-perpetuating board serves as the successors to the original seven ministers who were the first trustees of Yale. These persons are nominated for six-year terms and can be renominated for second terms. The mandatory retirement age is 70. There is a careful search process to provide Yale with outstanding men and women who will provide wisdom and wealth to the university.

At both schools the alumni vote for candidates chosen by a nominating committee or added to the ballot by petition.

There is no magic formula for a successful board of a nonprofit corporation. The Bishop Museum, Harvard and Yale provide useful lessons to be studied in the future by a select committee of trustees, alumni and community leaders. The process of collaborative study and thinking will lead to a happy and expanding Kamehameha Schools.

Make the change

We will soon learn of the decision by Probate Court Judge Hirai as to who will be the replacement for Connie Lau as trustee. There is no guarantee at this time that future Hawaii Supreme Court justices will not resume their appointment responsibilities under the will and appoint some leading local politicians to replace the present trustees as their staggered terms expire.

Politicians have succeeded in the art of deal making and are not trained in the skills necessary to manage a great school and a $6.7 billion educational endowment. The best safeguard to protect the integrity of the school and preserve the CEO manager system for governance of the school is to convert to a nonprofit educational corporation with a strong board of directors.

Kamehameha Schools should be the guiding beacon for the renaissance of Hawaiian culture and values. Reaching out to Hawaiian families and their young children on all the islands, partnering with the Department of Education in districts heavily populated with Hawaiians, and preparing students to build on their Hawaiian heritage while succeeding in the world of the 21st century, the new board of directors of the Kamehameha Schools nonprofit corporation would better the lives of Hawaiians and, therefore, of all Hawaii.