calls for trustee
Bishop Estate has incurredBy Rick Daysog
serious losses, a master appointed
by the court concludes
Critics of Kamehameha Schools/Bishop Estate renewed calls for the removal of several trustees after a report concluded that the estate posted $264.1 million in losses and loss reserves in its fiscal year ended June 30, 1994.
In a scathing, 120-page critique of the estate's investment strategies, the court-appointed master for the estate, attorney Colbert Matsumoto, said the trust's for-profit subsidiary Pauahi Holdings Inc. suffered losses and write-offs that amount to more than 21/2 times the $100 million annual operating budget of Kamehameha Schools.
Matsumoto, appointed by the state Probate Court to review the operations of the estate for its 1993-1994 fiscal year, said the trust faces additional "unreported loss exposure" of about $1.9 billion from investments and loan guarantees to third parties.
"I think this is going to make it easier for the attorney general to convince the court that major changes are in order," said Randall Roth, University of Hawaii law professor and one of five authors of the "Broken Trust" article. "Broken Trust," which ran in the Star-Bulletin in August, alleged mismanagement and conflicts of interest by trustees and called for their dismissal.
"I would be surprised if several trustees aren't removed from office," Roth said.
The 113-year-old Bishop Estate, the state's largest private landowner, was founded by the will of Princess Bernice Pauahi Bishop and finances the operations of Kamehameha Schools.
In his report, Matsumoto said trustees have failed to implement a strategic investment plan that matches the long-term educational goals of Kamehameha Schools, despite calls by past court-appointed masters to do so.
Matsumoto -- who charged that the estate withheld information from him -- also said that the trust may be using inflated income figures that boost trustees' commissions and that the trust may be relying on nonstandard accounting practices that overstate its investment returns.
Minus the accounting irregularities, some holdings may have underperformed. For instance, rent income from the estate's property holdings would have produced a mere 1.7 percent return under generally accepted accounting principles, he said.
Estate defends statusThe estate, meanwhile, said that it is in good fiscal shape and that the master's report is limited to the trust's 1994's investment results and do not reflect improvements in its finances since then.
Elisa Yadao, Bishop Estate's spokeswoman, said that losses detailed in the master's report don't take into consideration corresponding gains during the same period, which outpaced losses by a margin of three-to-one.
The estate's overall holdings have averaged a compound rate of return of 15 percent a year for nearly two decades, Yadao said. She specifically cited the estate's $500 million investment in Wall Street investment banker Goldman Sachs & Co., which netted the estate a $200 million windfall last year and has offset losses in other investments.
"You need to look at the complete portfolio to get a full financial picture of this organization," Yadao said.
"You can't just look at losses. You also have to look at gains."
One trustee, Gerard Jervis, said through his attorney that Matsumoto's recommendations should be regarded seriously and appropriate actions need to be taken, given its "frankly negative" charges.
"This report covers a period in which I was not yet a trustee. But that does not relieve the current trustees, myself included, from making needed corrections," he said.
Facing intense scrutinyThe master's report comes as the estate is facing intense scrutiny from federal and state investigators. The Internal Revenue Service is conducting an audit of the estate's finances and state Attorney General Margery Bronster has opened an investigation into allegations of trustees' mismanagement.
Bronster, through a spokeswoman, said her agency currently is reviewing the report, which only covers a limited period of the trust's activity. But she said she found it "appalling" that the estate was holding back information to Matsumoto.
Matsumoto, for one, complained that the trust withheld from him information about some real estate deals such as the lease terms of the Kahala Mandarin Hotel.
He said he was only able to discover the terms after reviewing a Supreme Court decision on a tax appeal filed by WKH Corp., the former owner of the posh hotel. WKH, headed by William Weinberg, was forced to sell the hotel about four years ago to local developer Bill Mills and Tokyo General Corp. after an arbitration panel increased WKH's annual lease rent in 1992 from about $96,000 to $5.6 million.
(With the sale to Mills and Tokyo General, the hotel's lease was restructured so that the current hotel owners now pay a base rent of $1.2 million, plus a percentage of gross income that could yield an additional $4.4 million a year, Matsumoto said.)
Critics feel confirmedCritics of the Bishop Estate said the master's report confirms what they have been saying all along: that trustees have mismanaged the estate's assets and that they need to be accountable for their investment decisions.
Beadie Dawson, attorney for students and alumni who have criticized the management of Kamehameha Schools, renewed calls for the removal of all trustees, with the exception of Oswald Stender.
Since trustees commissions -- which amounted to about $843,109 for each trustee in the fiscal year 1996 -- are based on investment income, trustees have become overly aggressive in their investments and put school assets at risk to boost their income, Dawson said.
She pointed to the trust's $85 million investment in McKenzie Methane Inc., a Houston oil and gas venture, in which trustees and staffers also invested about $3 million of their own money during the early 1990s.
Dawson said the investment was inappropriate for a nonprofit, charitable trust and the estate initially lost nearly all of its investment. The estate has since recouped some of that investment.
Matsumoto said the McKenzie deal underscores the need for more stringent conflict-of-interest guidelines at the estate.
Exposed to further lossesIn his report, Matsumoto cited other investments that he said exposed the trust to potential losses, such as its $30 million investment in an insolvent Beverly Hills, Calif.-thrift called Southern California Savings and Loan Association in 1992.
To meet compliance standards, the estate in 1995 had to inject $42.5 million in the savings and loan, which has been renamed the People's Bank of California, Matsumoto said.
The thrift reported losses of $17.2 million in 1993, $57.4 million in 1994 and $11.5 million in 1995, before rebounding recently.
The estate income from the thrift reached $60 million in fiscal year 1995 and doubled to $120 million in the following year, according to the estate's tax filings.
"Your master shares a certain level of discomfort with the aggressive nature of many of the trust estate's investments," Matsumoto said.
"Such investments don't provide stable sources of income and have a high degree of volatility. . . . Such characteristics are troubling when viewed in the context of the future income necessary for the trust estate to meet and expand its educational mission."
for dividing duties
The court master says havingBy Mary Adamski
each trustee in charge of an area
is potentially problematic
The Bishop Estate trustees have divided their areas of responsibility in a way that may violate the will of Princess Bernice Pauahi Bishop, the court master found.
The informal division of territory so that each member is "lead trustee" for specific subject matters is "at worst, an unauthorized division of the trusteeship and, at best, a sweeping delegation of authority without appropriate safeguards," Colbert Matsumoto wrote in his report to the court. He recommended that it be dismantled.
This system has made Henry Peters overseer of asset management and put Lokelani Lindsay in charge of educational programs. It has Richard S.H. Wong in charge of government affairs and Gerard Jervis, of legal affairs. "Trustee Oswald Stender, apparently, did not have a portfolio of responsibility," Matsumoto wrote of the 1994 status of the informal system.
He said the trustees assured him the practice was not intended to result in delegation of the board's authority to one individual, and that decision-making authority is reserved for the board as a whole.
However, he said, there are "inevitable dynamics of a five-member board of trustees."
Matsumoto wrote that one of the pitfalls may be that a lead trustee may filter matters which ought to be presented to the whole board.
He said he "believes that decisions not to produce certain records in connection with the annual account review were made by a single trustee directing the trust estate staff, rather than by decision of the board of trustees."
Other potential pitfalls of the "lead trustee" system:
It fosters the likelihood that other board members will defer to the judgment of the one member in matters concerning that one's area of responsibility.
It may result in "horse-trading" between trustees if they want special consideration for a matter in another's area, which Matsumoto says violates the discretion entrusted to board members.
It puts employees within each area of responsibility in a difficult position of perhaps having to cater to the lead trustee in their area, even to the extent of supporting something that the board as a whole has not voted on.
Elisa Yadao, spokeswoman for the trustees, responded that, "Responsibility for the management and operations of KS/BE rests squarely with the board of trustees. This authority is held collectively by the members of the board and no single member has ultimate responsibility for any specific area or operating group . . . .
"In (KS/BE's) efforts to operate as efficiently as possible, the board of trustees has organized itself in a manner that is intended to utilize the talents and skills of each of its members," Yadao said in a written statement.
Matsumoto said the state law permits board members of trusts to delegate authority to an "agent" who is subject to direction and dismissal by the trustees. The lead trustee system doesn't appear to fall within that guideline.
He said the way delegation of fiduciary responsibility is intended to work is demonstrated by the employment of the Kamehameha Schools president, who is screened and selected for his ability and has defined duties within an administrative hierarchy.
Matsumoto said delegation of authority over the asset management group to a principal executive is also permitted since similar policies for employment screening, accountability, monitoring and oversight by the board have been established.
However, he noted, Peters has carried out much of the responsibilities of the principal executive of asset management since the position became vacant in 1995 by the death of Anthony Sereno.
Matsumoto said he believes Princess Pauahi Bishop "specified that five trustees administer her Trust Estate because she saw a particular value and wisdom in having five capable people meet, jointly discuss administration of the Trust Estate, and collectively collaborate upon decisions affecting the trust estate. Any system of administration which detracts from that direction would be inconsistent with the will."
of trustees actions
They made him feel as if heBy Mary Adamski
were reviewing CIA finances
In his report to the court, Colbert Matsumoto said the Bishop Estate's board of trustees put his court-mandated review under such controls and scrutiny that "your master could not help but feel as though he was reviewing the CIA's finances rather than those of a charitable educational organization."
Matsumoto, charged with reviewing the estate's 1993-94 operations, complained that trustees and employees did not provide all information required by 1995 court guidelines for trusts.
He said that written statements are required from trustees under the "Restated Guidelines" -- but that certain, unidentified, trustees did not submit them.
Matsumoto also said public controversy and media attention surrounding the estate this year focused his attention to some areas. "Your master has attempted to keep abreast of numerous recent and past media reports which raised issues relating to matters within the period of review."
"Your master was also taken aback by the level of secrecy and monitoring of the master's review demanded by the trustees," he reported.
He said, unlike previous court masters, he was prohibited from removing any documents from Bishop Estate offices resulting in "an extremely cumbersome, inefficient and costly review process."
Although the Bishop Estate accounting firm Coopers & Lybrand initially agreed to make their work papers available for review, "the trustees denied access to those work papers."
Some current and former employees responded to his request for interviews but others declined. "Upon request of your master, the Trust Estate agreed to give such individuals assurances that they would not be subject to liability." The reluctant employees still declined to talk to him, Matsumoto said.
"Based on the restrictive manner in which information was provided, your master was left with the impression that the trustees view the annual review process as an undesirable intrusion into their affairs," Matsumoto said.
"That is, of course, not the case. The annual review ... is done at the direction of Princess Pauahi in accordance with the terms of her will."
Court master's proposalBy Star-Bulletin staff
to improve estate record
The master's report on the Kamehameha Schools/Bishop Estate outlines these recommendations:
1. Court should require the trustees to consolidate the financial statements of the estate and its subsidiaries to comply with generally accepted accounting procedures, as of the annual account for fiscal year ended June 30, 1997.
2. Court should require trustees to prepare a schedule of contingent loss exposure to be made available annually to the court master.
3. Court should require trustees to prepare a current fair-market value listing of estate assets to be filed with the annual account.
4. Court should require trustees to prepare an annual evaluation of estate's income yield and total return on its investment, individually and by category.
Investment expenses and income should be segregated between those involving direct management by Bishop Estate or Pauahi Holdings Inc., and those involving passive investments.
5. Court should require trustees to maintain the asset-pricing information upon which an investment was acquired, to be made available to the master annually.
6. Court should require trustees to prepare a supplemental report to the court verifying the extent of investment losses sustained by the estate and its subsidiaries during fiscal year 1995 and the preceding four years.
"The trustees should provide the court with an explanation of the investment strategy which led to the losses, how that strategy has been impacted by the losses and how that strategy has performed overall."
7. The trustees should complete their strategic plan, which is "a road map for the Trust Estate's future," for review by the court master at the end of fiscal 1997. Hire the best-qualified independent counselors in education, investment and financial planning to assist trust staff in the task.
8. The trustees should update guidelines for investment policy and asset allocation to coordinate with the objectives of the estate's strategic plan.
9. The trustees should compile a comprehensive listing of investments by the estate and its subsidiaries. Information available to court master should include nature of investment and acquisition price, additional capital investment in it, and profit or loss history of the investment.
10. The trustees must explain to the court why details of the 1994 renegotiation of the Kahala Hilton lease was not reflected in board meeting minutes or disclosed to the master. Explain how the economic terms yield a fair-market rental. Identify any other 1994 transaction not disclosed in meeting minutes, and any real estate transaction not disclosed in response to restated guidelines.
11. The trustees should cease the informal practice of designating a "lead trustee" in each area of interest, such as asset management, government relations, legal affairs and educational programs.
12. Trustees should be required to make a report to the court about co-investment in McKenzie Methane Gas by the trust, individual trustees and employees. It should address actual or potential breach of fiduciary duties by trustees, employees and agents.
13. The court should counsel trustees on their affirmative duty to prevent or redress a breach of trust.
14. The trustees should be required to provide a written description of the methodology or formula used to calculate commissions, and a description of any waiver of commissions.
15. The trustees should be required to adopt procedures to ensure that subsequent adjustments to estate's income are taken into account and corresponding adjustments made to trustees' compensation.
16. Court should determine whether interest payments from subsidiaries is considered revenue or income in calculating commissions, and trustees should be instructed to conform accordingly.
17. Court should instruct trustees that commissions are not to be paid upon return of invested capital, which must be distinguished from capital gains on an investment.
18. Court should require trustees to develop procedures making the estate in full compliance with the Intermediate Sanctions Law. It would be a conflict of interests for trustees to adopt a compensation review procedure so the compliance plan should be presented to probate court for approval.
19. Approval of this annual master's account should be subject to the outcome of the Internal Revenue Service's audit into the estate.
20. Court should instruct trustees to ensure that submission of the 111th annual account complies with the Restated Guidelines.
21. These recommendations should be incorporated in the Restated Guidelines.
Trustees' educationalBy Mary Adamski
changes are faulted
The Bishop Estate trustees put the cart before the horse when they began implementing changes in Kamehameha Schools programs in 1994, shifting the focus of the trust's educational programs for the future.
"The timing . . . was unfortunate since it preceded the development of the educational strategic plan," said Probate Court-appointed Master Colbert M. Matsumoto in his report on the trust's 1993-94 fiscal year.
The trustees implemented cuts in 1995 that dismantled outreach programs such as preschool Head Start programs and cut 170 teaching jobs.
Later that year, the board approved opening neighbor island elementary schools as part of its "Go Forward" plan.
But no strategic plan for education was adopted until August 1997, a 16-page document based on organizational goals set by trustees in 1994.
Even now "there is no indication that the 'educational strategic plan' was coordinated with an investment strategy," Matsumoto said. "Both must be developed hand-in-hand. The educational plan must take into account the future potential financial resources available. The investment plan must be fashioned around the projected educational program needs."
Matsumoto reported that school operations accounted for 41.2 percent of the total expenses of the Bishop Estate in 1993-94, with an additional 8.7 percent going into financial aid to students.
In the 1995 fiscal year, educational expenditures declined to 37 percent of the total. The 1994 expenditures were broken down to 16.2 percent on administrative expenses, 26.2 percent for real estate management and 7.7 percent on professional services.
"Your master believes that the reports of previous masters contemplated that a strategic plan prepared by the trustees would plan for expanding the Trust Estate's expenditures on educational services -- to provide benefits to an increasing number of Hawaiian beneficiaries.
"In other words, the trend should be to a greater percentage of the Trust Estate's resources being devoted to its educational mission as opposed to investment and administrative activities."
The Kamehameha Schools' 1994 annual report showed 2,937 full-time students at the Kapalama campus. In addition, 32,024 other students were served through the Community Education Division in alternative education programs, part-time summer programs, adult community school, several projects including reading, Hawaiian culture, post-high school scholarship and counseling, native Hawaiian Higher Education Program and Native Hawaiian Health School.
There were 10,606 students in programs offered by the trust's Early Education Division.
The schools' president Michael J. Chun wrote in the annual report 1994 was a "pivotal year" as it was the start of a two-year effort to develop a plan to take the schools into the 21st century. "By July 1995, with help from KS/BE staff at all levels, we should have goals and objectives for the strategic plan that will guide delivery of KS/BE educational services over the next decade."
Matsumoto said that despite Chun's statement, a strategic plan was not forthcoming in 1995.