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Challenged on all fronts, trustees finally fall

HAWAII'S Supreme Court justices insisted for years that there was nothing wrong with selecting (Bishop Estate) trustees while acting as private citizens and then putting on their robes and deciding cases involving the very same trustees. ... However, because the justices claimed to be acting unofficially, they could be sued personally (arguably without the benefit of judicial immunity) if trustees they negligently selected went on to harm the trust. Such exposure gave the justices a personal stake in any legal controversy involving Bishop Estate trustees. It was a classic conflict of interest.

EXCERPTS FROM THE BOOK Sunday: Trustees of Bishop Estate held power without accountability, a recipe for disaster. Monday: The selection of Bishop Estate trustees by Supreme Court justices showed signs of manipulation. Tuesday: Kamehameha Schools alumni, staff and students rose up against trustee Lokelani Lindsey. Wednesday: Investigating Bishop Estate was like probing the CIA, said a court-appointed master. Thursday: Attorney General Margery Bronster went head to head with Supreme Court justices over trustee selection. Friday: Instead of housecleaning, the interim trustees of Bishop Estate "handed the keys to the old guard." Want to comment on excerpts? Letters received by tomorrow evening will be published in Sunday's Insight section. For instructions, see "How to write us" on the letters page. Tonight on KITV Island Television News at 6 ... Is the broken trust now fixed? Former trustees and "Broken Trust" authors talk about what changes need to take place. starbulletin.com/specials/bishop.html This link takes you to the original "Broken Trust" essay of Aug. 9, 1997, and other Star-Bulletin stories about Kamehameha Schools.

Over the years, bar association leaders never said anything about this, at least not publicly. One former bar president said it was a simple oversight: "I had lost sight of the obvious -- the Supreme Court was ruling on all these cases involving the trustees they appointed. That was a real problem." Another former president admitted he had recognized the issue but did not want to be the one to point out that the justices were violating their code of judicial ethics.

WHEN CAYETANO instructed (Attorney General Margery) Bronster to investigate allegations made by the "Broken Trust" authors, he specifically said he wanted her to look into the way trustees were being selected. But when she met with the justices to discuss how best to proceed with this inquiry, they said that they would meet with lawyers from the attorney general's office only as a group. Otherwise, said the justices, the questioners might try to "trick us" into telling different stories.

Bronster said she was prepared to subpoena the justices, if necessary, to hear their individual accounts. Justice (Steven) Levinson took particular offense at this. He argued ardently that although the justices had acted unofficially in selecting trustees, they were still justices; it would not be proper to force them to cooperate in an investigation; the integrity of the judiciary was at stake -- case law said so. By the time he finished, he had gone red in the face.

According to Bronster, the justices' message to her was clear: "We'll just see whether your subpoena power goes so far. If we're the ones to decide it (which we probably will be), we don't think so."

After weighing all the pros and cons, including the possible impact this fight would have on other important cases her office had pending before the Supreme Court, Bronster decided not to subpoena the justices.

The justices had won the standoff. It left them above the fray, which was where they wanted to be. But in the process of getting their way, the justices had engaged in a private, ex parte (without the other side present) discussion with the attorney general about her subpoena power in the Bishop Estate investigation. Judicial ethics are very clear in this situation: Any justice who participates in such an ex parte discussion has no choice but to step aside and let substitute justices decide cases related to that issue. But these five Supreme Court justices appeared to have every intention of continuing to preside over Bishop Estate cases, including the many appeals that were already stacking up from Bronster's investigation. Bronster described the situation delicately, from her point of view:

"I thought perhaps they would realize that they didn't want to rule on something related to a discussion they had already had with one of the participants, so I wrote them a letter suggesting that they might want to recuse themselves from hearing that particular issue. They answered, 'You want us to recuse ourselves, you make a motion.' They probably thought I'd wise up and go away, but I did make that motion. They sat on it for a couple of months, and finally they sent it off to the judicial conduct commission with a suggestion that the 'appearance of impropriety' justified or necessitated recusal. The commission agreed; but nobody seemed to mention the fact that these conversations had occurred."

Sure enough, when the justices announced that they would not personally decide cases arising out of the Bishop Estate investigation, they said nothing about the ex parte communication that had forced them to step aside. Instead, they cited "overheated circumstances." The justices also said nothing about their refusal to cooperate with the state's top law enforcement officer in an official investigation of a matter in which they had participated -- as they had earlier insisted, over and over, they had done -- as private citizens. ...

STATE REP. Ed Case, whose attempt to rein in trustee compensation failed miserably in 1995, was ready to try again when the 1998 legislative session opened. Because of the May 15, 1997, march and everything that followed it, the political winds had clearly shifted. There was now widespread support for a revision of the statutory formula. Among the many voices, Cayetano said trustees should not be making more than the state's governor, whose salary was less than one-tenth of what Bishop Estate trustees were paying themselves. ... (I)ndependent experts favored a bill that required fees to be "reasonable under the circumstances," an approach that could be found in a number of federal and state statutes. ...

Henry Peters strongly favored leaving the old formulas in place. He said they provided an appropriate incentive: "People who raise the question want us to apologize for the success of our portfolio. If we had zero returns, guess what our compensation would be."

Experts testified differently. One pointed out that under the current formulas, $10 billion invested in a simple savings account, with no additional effort from the trustees, would still result in annual compensation of $2 million per trustee. Another expert noted that according to the trustees' interpretation of the current formulas, they could have paid themselves $11 million in 1994, a year in which they experienced net investment losses in excess of a $250 million. ...

MEANWHILE, the question at the Legislature was: Could any reform get passed into law, or would the trustees' friends stop it? A potential roadblock was the House Judiciary Committee, chaired by Terrance Tom ... (who) had received $4,000 each month from Bishop Estate to provide legal services. ... Critics of the trustees in the Senate managed to keep alive a reasonable-compensation bill in that chamber, which made it possible for Ed Case to force a floor vote in the House. ...

Coming up to the day of the vote, there was a lot of head-counting: It would be close. The difference between approval and rejection could be a matter of one or two votes -- the votes, for example, of Tom and (House Speaker Joe) Souki (who also had received fees from Bishop Estate), and of Rep. Robert Herkes, who was on the full-time payroll at Bishop Estate. Was it a conflict of interest ... to vote on this measure? Souki could have said it was, preventing himself, Tom and Herkes from voting, but he did not. They all voted, and the bill failed to pass by one vote: 26 to 25.

Speaking on behalf of Na Pua (a group of Kamehameha parents, alumni, teachers and students), Jan Dill expressed "dismay and disgust that so many legislators failed to vote their consciences." ("Broken Trust" co-author) Gladys Brandt urged members of the House "to revive this issue before the close of the Legislature." She also suggested that representatives "carefully consider how they vote, because voters of this state will not forget who in the Legislature was brave enough to take a stand, and who was not." Both daily newspapers listed the phone numbers of the representatives who had voted no, and these individuals were deluged with calls from their districts. Sensing an opportunity, Case forced a second vote several days later in a seldom-used procedure that bypassed leadership. Souki called it anarchy.

This time the vote was 50 to 1 in favor of the bill. The public had spoken so loudly, even Souki voted for the bill. The lone dissenter, Calvin Say, would go on to replace Souki as speaker. ...

ON THE LAST day of 1998, something big happened. Like a guillotine blade released in slow motion, the Internal Revenue Service issued notices of proposed adjustment, known as Form 5701. These documents could not have been more sharply worded. Essentially, the IRS officials had concluded that the level of abuse at Bishop Estate was unprecedented, leaving them no real choice but to revoke the trust's tax-exempt status.

Normally the IRS would be willing to discuss the 5701s with the trustees, but this time was different. The trustees had irreconcilable conflicts of interest and could not be trusted to adhere to any agreement that might be reached: They had "a history of ignoring probate court orders, master report recommendations, probate court stipulations and the advice of independent experts." The IRS flatly refused to communicate with the trustees or their agents.

The trustees' personal interests directly conflicted with the trust's interests because the IRS was demanding that each trustee reimburse the trust for millions in excessive compensation. The IRS was also troubled by the trustees' use of trust funds to defend their jobs, level of compensation and other personal interests.

Judge (Kevin) Chang agreed with the IRS. In early February 1999 he ruled that the trustees had "actual, adverse and material conflicts of interest in matters involving the IRS audit." Chang then appointed five "special purpose" trustees to deal with the IRS on behalf of the trust estate. ...

The IRS was proposing tax deficiencies, based on "creative" transactions between the trust and its wholly owned subsidiaries, totaling hundreds of millions of dollars. And that was not the worst of it. The real shocker was the IRS' decision to revoke the trust's tax-exempt status retroactive to July 1, 1989. An Arthur Andersen tax accountant estimated that this would cost the trust nearly $1 billion up front, and much more over time.

SOON, HOWEVER, there was reason for hope. The IRS extended a highly unusual offer: Officials from the national, regional and district offices were willing to gather in Los Angeles with the special-purpose trustees and their advisers to discuss a way of resolving the matter without hurting Kamehameha Schools. When that meeting began on April 19, 1999, there were no pleasantries. One of the special-purpose trustees later described it as "something out of a movie" -- 10 to 12 very serious people on one side of a long table, facing a similar number of equally serious people on the other side. Marcus Owens, who headed the IRS' Exempt Organization Division at the time, began the meeting by saying he would be doing the talking; the special-purpose trustees were there to listen.

Owens said nobody liked the idea of revoking Bishop Estate's exemption, but the scope and magnitude of abuse were unparalleled. The IRS was willing to negotiate anyway, but only if it was assured of fundamental change at Bishop Estate. He had a list of specific steps that needed to be taken, and the first item on his list was that all five current trustees must resign or be removed. These conditions, Owens said, were absolutely "non-negotiable."

THE SPECIAL-PURPOSE trustees reported all this to Judge Chang, who gave Oswald Stender, Dickie Wong, Henry Peters, Lokelani Lindsey and Gerard Jervis one week to resign or "show cause" why he should not remove them. Chang also ordered the trustees to stop paying compensation to themselves. ...

In the 5701s, the IRS stated that Bishop Estate had ceased to function primarily as a charity. To the IRS it looked more like "a personal investment club," one that paid grossly excessive fees, gave preferential treatment to insiders, engaged in excessive lobbying, and involved itself, illegally, in state and federal political campaigns. ... In addition to accumulating income in violation of Pauahi's will, the trustees had made improper payments to friends, relatives, business associates and elected officials, and had failed to collect millions of dollars of debts owed to the trust "without any apparent justification."... The IRS also took aim at the Supreme Court justices who had selected these trustees: "The process of selection of trustees apparently has not been conducted in any kind of systematic manner designed to discover and evaluate the most qualified individuals."

LEGACY BETRAYED WHAT WENT WRONG AND WHY This week the Honolulu Star-Bulletin is excerpting chapters of a new book about the Kamehameha Schools/Bishop Estate scandal that erupted in 1997 and forced the removal of trustees and changes in the estate's management. "Broken Trust: Greed, Mismanagement & Political Manipulation at America's Largest Charitable Trust" was written by two people at the heart of the event, Judge Samuel King and law professor Randall Roth. The book was published by the University of Hawaii Press (uhpress.hawaii.edu).