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COLBERT M. MATSUMOTO 2276-0
of MATSUMOTO LaFOUNTAINE & CHOW
Suite 2000, Amfac Tower
700 Bishop Street
Honolulu, Hawaii 96813
Telephone No. 523-2999
Master
When Princess Bernice Pauahi Bishop died on October 16, 1884, she left a Will1 in which she provided for the establishment of the charitable trust estate now known and referred to as Kamehameha Schools Bernice Pauahi Bishop Estate (the "Trust Estate"). Her Will was admitted to probate in the Supreme Court of the Hawaiian Islands2 on December 2, 1884.
In appointing trustees of the Trust Estate, Princess Pauahi charged them with two fundamental responsibilities. The first is to manage the assets of the Trust Estate so as to protect the corpus and derive income from which to carry out the charitable purposes of the Trust Estate. The second is to fulfill the educational mission of the Trust Estate as expressed in the Will.
Princess Pauahi prescribed a procedure for accountability by her Trustees by directing in her Will that:
[M]y said trustees shall annually make a full and complete report of all receipts and expenditures, and of the condition of said schools to the chief justice of the Supreme Court, or other highest judicial officer in this country; and shall also file before him annually an inventory of the property in their hands and how invested, and to publish the same in some Newspaper published in said Honolulu;
It is in accordance with this express direction of Princess Pauahi and the jurisdiction conferred by Hawaii Revised Statutes ("HRS") 
560:7-201(a) and the Hawaii Probate Court Rules that the Trustees of the Trust Estate have submitted their Petition on January 18, 1996, for approval of their One Hundred Ninth Annual Account for the period from July 1, 1993, to and including June 30, 1994 ("FY 1994").3
Pursuant to Rule 28 of the Hawaii Probate Court Rules, by Order of Reference filed on January 18, 1996, the Probate Court appointed the undersigned as the Court's Master to review the Petition and to report the recommendations of the Master to the Probate Court.
Rule 29 of the Hawaii Probate Court Rules describes the role of the Court's Master as follows:
Unless otherwise ordered by the court, the master shall review the operations of the fiduciary in light of the terms of the controlling document, as well as the financial transactions of the trust or estate. The fiduciary shall supply to the master a copy of the accountings and any master's reports for the prior three accounting periods and shall make available for the master's inspection all accounting records for the current accounting period. The master shall have unlimited access to the books and records of the fiduciary with respect to the trust or estate that are not protected by privilege, including minutes of all meetings, and may interview any employee of the fiduciary regarding the trust or estate as the master deems appropriate. The master shall submit a written report of the master's findings to the court and serve a copy on all interested persons.
It is pursuant to this direction that your Master has undertaken to review the annual account and hereby reports his findings and recommendations.
In undertaking this assignment, your Master was overwhelmed by the size and complexity of the Trust Estate and its financial dealings. Consequently, your Master retained the services of Steven Sakamaki, CPA of the firm of Shigemura & Sakamaki, CPA, Inc. to assist in reviewing, analyzing, and interpreting the financial records of the Trust Estate and in interviewing Trust Estate personnel connected with the preparation of those financial records to obtain additional information. Sakamaki's expertise and assistance was essential to an informed review of the Trust Estate's account by your Master.
Your Master also sought out the assistance of Edward Halbach, professor emeritus and former dean of the University of California at Berkeley School of Law (Boalt Hall), to provide advice and guidance regarding the principles of trust law which are applicable to the Trust Estate. As one of the foremost experts on trust law in the country and as the Reporter for the Restatement (Third) of Trusts (1992), he is eminently qualified to provide such guidance. Professor Halbach was extremely helpful to your Master in explicating the principles of law described herein which provide the standards whereby the conduct and performance of the Trustees are to be measured.
This report is comprised of four general sections. The first section deals with financial matters relating to the management of the assets of the Trust Estate. The second section describes the work of the Trustees in fulfilling the educational mission of the Trust Estate.
Because the Trustees are charged with the highest level of trust and responsibility expected of a person in managing the property of another, the third section of this report reviews the conduct of the Trustees in fulfilling their legal obligations as fiduciaries of the Trust Estate.
The final section of this report concerns the annual account review process for the Trust Estate. In conducting this review, various elements of that process which are in need of improvement were noted. Accordingly, your Master makes various recommendations to the Court to strengthen that process and make it more efficient.
1 Princess Pauahi left a Will dated October 31, 1883; a Codicil No. 1 dated October 4, 1884; and a Codicil No. 2 dated October 9, 1884, all of which contains language relating to the establishment of her Trust Estate.II. SCOPE OF REVIEW2 At that time, the Supreme Court of the Kingdom had jurisdiction over probate matters. However, that jurisdiction was subsequently transferred to the Circuit Court under the Territory of Hawii and the State of Hawaii. See HRS
3HRS
The basic scope of your Master's review of the Trustees' Petition was limited to the 109th Annual Account filed by the Trustees covering the fiscal year period from July 1, 1993 through June 30, 1994.
The Trustees provided your Master with most, but not all, of the information required by the Minimum Guidelines Concerning the Annual Accounts of the Trustees of the Kamehameha Schools Bernice Pauahi Bishop Estate and the Reports of Future Masters as amended and restated as of September 30, 1995 (the "Restated Guidelines").4 Your Master has accepted and relied upon the information furnished pursuant to those Restated Guidelines as true and correct in preparing this Report.
Such information included the reports of the independent auditors5, written and oral information obtained from Trustees, employees, and agents of the Trust Estate and its subsidiaries. While most of the materials required by Part C of the Restated Guidelines were produced, it should be noted that no materials responsive to paragraphs C.13., C.14, and C.20. of the Restated Guidelines were provided except in response to specific requests from your Master or his CPA.
In addition to the information produced pursuant to the Restated Guidelines, your Master or his accountant reviewed additional financial records specifically requested from the Trust Estate pertaining to investments and other matters within the scope of the Master's review. Such records continue to be produced by the Trustees to your Master and his accountant. Consequently, the review of such information by your Master remains ongoing.
All of the individuals who served as Trustees during FY 1994 were interviewed by your Master. The Restated Guidelines also require the Trustees to each make certain written statements and representations concerning the accounting period. As of the date of this Report your Master has not received those statements and representations from each of the Trustees.
Your Master also sought to interview several current and former employees of the Trust Estate who were involved with administration of the Trust Estate, asset management, and the Kamehameha Schools. While some personnel were interviewed by your Master or his accountant, others declined to be interviewed because of concerns that they may be subject to liability for violating confidentiality conditions of employment agreements with the Trust Estate. Upon request of your Master, the Trust Estate agreed to give such individuals assurances that they would not be subject to liability. However, your Master has not been able to interview any of the reluctant former employees as of the date of this Report.
Your Master notes that the nature of the Master's review of the annual account submitted by the Trustees is not for the purpose of conducting a general audit of the financial affairs of the Trust Estate or engaging in an unfocused inquiry in the nature of a "fishing expedition". However, your Master has approached his assignment with the recognition that various financial and operational matters require specific inquiry to ensure a sound and credible review.
Furthermore, to the extent that specific concerns have been raised or allegations articulated and called to your Master's attention, he has attempted to make inquiry into such matters and report to the Court on any material findings of substance. In this connection, your Master notes that he has communicated with several individuals who have provided information of varying nature and subject matter relating to the Trustees and the Trust Estate.
Because the Trust Estate and its Trustees have been the subject of considerable public controversy and intense media scrutiny in recent months, your Master has undertaken his review of the annual account with many of the issues raised in the public controversy in mind. 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. To the degree feasible, your Master has attempted to review the issues raised which are within the purview of his assignment.
Based upon the foregoing, your Master makes the following report.
4It should be noted that your Master’s review of such information was largely restricted by the Trustees to physically reviewing the information at the Trust Estate’s offices. Despite being subject to restrictions set forth in the Minimum Guidelines and a separate confidentiality agreement entered into with the Trust Estate, your Master was barred from removing any of the information from the Trust Estate’s offices for review and examination. Furthermore, severe limitations were placed on your Master obtaining copies of the information produced. This resulted in an extremely cumbersome, inefficient, and costly review process. In consultation with previous court Masters who reviewed the Trust Estate, your Master was informed that such a restrictive and burdensome procedure was not previously required of them.III. ASSET MANAGEMENT5 The CPA retained by your Master attempted to obtain access to the work papers of the Trust Estate’s independent auditors. While Coopers & Lybrand initially indicated their willingness to make their work papers available for review, the Trustees denied access to those work papers to your Master’s CPA. The denial of such access necessitated a more lengthy and burdensome process of reviewing financial information.
A. Management Of The Assets Is Entrusted To The Trustees.
In establishing the Trust Estate, Princess Pauahi bequeathed all of her residual estate to her designated Trustees to hold in trust, to erect the Kamehameha Schools, and to invest:
[I]n such manner they think best, and to expend the annual income in the maintenance of said schools . . . 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;
In Codicil 1 to her Will, Princess Pauahi authorized her Trustees as follows:
I give unto the trustees named in my will the most ample power to sell and dispose of any lands or other portion of my estate, and to exchange lands and otherwise dispose of the same; and to purchase land, and to take leases of land whenever they think it expedient, and generally to make such investments as they consider best . . . and I further direct that my said trustees shall not sell any real estate, cattle ranches, or other property, but to continue and manage the same, unless in their opinion a sale may be necessary for the establishment or maintenance of said schools, or for the best interest of my estate.
Pursuant to the authority granted to them by the Will and by law, the Trustees have undertaken to hold, administer, and invest the assets of the Trust Estate and expend the income derived from those assets to accomplish the trust purposes specified by the Will. B. The Trustees Must Provide Meaningful Financial Information In Connection With The Annual Review.
Princess Pauahi, no doubt, had great confidence and trust in the business abilities of the people she named as Trustees in her Will. However, she recognized that because her Trustees would be managing property they did not personally own, she specified in her Will that they be accountable to the court regarding the financial condition of the Trust Estate and their management of its assets. It is therefore incumbent upon the Trustees, in submitting their annual account, to provide relevant and meaningful financial information to facilitate the Court's review.
C. Audited Financial Statements for FY 1994.
The financial statements for FY 1994 were audited by the CPA firm of Coopers & Lybrand who have served as the Trust Estate's auditors for several years. The balance sheet of audited financial statements for FY 1994 reports that as of June 30, 1994, the Trust Estate had total assets of $1,808,390,261. This represents a 16.5% increase in total assets as compared to June 30, 1993.
Liabilities were reported as totaling $251,038,307, having increased from $215,339,138 at the end of the previous fiscal year.
The equity of the Trust Estate increased to $1,546,558,182 as of June 30, 1994. This represents a 16.8% increase from an equity position of $1,324,002,279 on June 30, 1993.
In FY 1994, the Trust Estate reported net income of $46,687,471. Because of a one time change in method for accounting for income taxes, this amount was adjusted by $35,606,8976 to result in total net revenue of $82,294,368 for FY 1994. This compares with net income of $17,072,621 in FY 1993.
The Trust Estate's financial statements are not prepared according to Generally Accepted Accounting Principles ("GAAP"). Instead, the Trust Estate employs a hybrid of GAAP and non-GAAP accounting methodology.
In 1995, Benjamin M. Matsubara, Esq., Master for the 107th and 108th Annual Account, recommended a review of whether the financial statements of the Trust Estate should conform to GAAP. Master's Report on the One Hundred Seventh Annual Report of the Trustees, filed herein on September 15, 1995, at 11 ("Matsubara Report").
The Trustees responded to this recommendation as follows:
KSBE follows established internal procedures of trust accounting which conform in almost all respects to GAAP. . . . Under normal circumstances, where the Will is silent as to accounting matters and there are no conflicting Court orders, it is anticipated that GAAP will be followed.
At the present time, KSBE's only significant departures from GAAP derive from previous court orders of this Court. GAAP would have the trust's assets valued at their cost; this Court previously directed the Trustees to adopt values based upon taxable valuations as of January 1, 1965. Similarly, during the period July 1, 1970 to June 30, 1977, this Court ordered KSBE not to provide for depreciation. Since July 1, 1977, KSBE has been providing for depreciation in accordance with GAAP. The results of this court-ordered departure from GAAP are not significant to the current accounts and will continue to diminish over time.
KSBE retains the services of a major national accounting firm and the Trustees are satisfied that the accounting system used by that firm for KSBE is appropriate to KSBE and that it presents an accurate, meaningful and consistent picture of KSBE's financial situation.
Trustees' Response to Master's Report on the One Hundred Seventh Annual Report of the Trustees, filed herein on October 5, 1995.
Your Master concurs with the concern expressed in the Matsubara Report regarding the deviation from GAAP. Your Master further disagrees with the Trustees' Response to the Matsubara Report. The Trustees' Response fails to note that a more significant departure from GAAP is the failure of the Trust Estate's financial statements to consolidate the results of the Trust Estate's operations with all the subsidiaries in which it holds a controlling interest.7
Consolidated financial statements present the results of the operations, financial position, and cash flows of two or more related entities as if they were a single entity. They are prepared by combining all parent and subsidiary accounts and eliminating inter-company balances and transactions. In accordance with GAAP, consolidation is required in order to show a more complete and accurate picture of the financial position and results of operations of the organization as a whole.
Currently, the Trust Estate and its subsidiaries prepare separate financial statements. This practice makes it difficult to obtain an overall view of the financial status of the Trust Estate.
The manner in which the failure to consolidate gives an incomplete financial picture are illustrated by the following examples:
1. Pauahi Holdings, Inc. is the Trust Estate's principal for-profit subsidiary. Pauahi Holdings, Inc. in turn owns several other subsidiaries, including Royal Hawaiian Shopping Center, Inc. ("RHSCI"), Kukui, Inc., and Kamehameha Investment Corporation. Its diverse investment holdings also include the limited partnership interest in Goldman Sachs & Company and a large stock ownership interest in Columbia/HCA. Despite the Trust Estate's 100% ownership of the entity, the financial statements of Pauahi Holdings, Inc. are not consolidated with the Trust Estate's financial statements.
Consolidation of the financial statements of Pauahi Holdings, Inc. would have had the following effect on the Trust Estate's financial statements for FY 1994, except for the required inter-company eliminations: assets would increase by $1 billion; liabilities would increase by $250 million; net revenues would increase by $82.4 million; and total expenses would increase by $79.1 million.
2. Another example is the Trust Estate's investments in four CONAM partnerships (collectively referred to as "CONAM"). The Trust Estate's stake in these partnerships range from 64% to 99.95%. GAAP would require consolidation of the financial results of CONAM. However, because the Trust Estate does not follow GAAP, the investment in CONAM is carried on the Trust Estate's balance sheet for FY 1994 at its cost basis of $41 million.
If the Trust Estate had followed GAAP in consolidating its financial statements for FY 1994, the addition of CONAM alone would have resulted in the following approximate adjustments, except for required inter-company eliminations: increase assets by $210 million; increase liabilities by $167 million; increase total revenues by $35.8 million; and increase total expenses by $33.3 million.
The impact of consolidation and the addition of these amounts would be significant when one considers that the Trust Estate's unconsolidated financial statement for FY 1994 shows total assets of $1.8 billion; liabilities of $251 million; and an excess of revenues over expenses of $82 million.
By not consolidating the financial statements, the Trust Estate's balance sheet gives an incomplete and potentially misleading view of the holdings of the Trust Estate as well as its income position. This in turn could lead to an inaccurate picture of the financial performance by skewing the return on assets and disguising the true amount of leverage.
8
The balance sheet of the Trust Estate's financial statements probably exaggerates the rate of increase in equity of the Trust Estate. Rather than reflect the current fair market value of all the assets of the Trust Estate, the balance sheet reports many major assets comprising the Trust Estate's portfolio at historical values. For example, real property holdings which were owned by the Trust Estate as of January 1, 1965, are reported based upon their tax assessed value on that date.9 This is in accordance with a prior order of this Court. Real property assets acquired after that date are reported on the balance sheet at acquisition cost.
Without information to determine current values of assets or information to identify the underlying reasons for certain changes in the reported asset values, the Trust Estate's balance sheet gives an incomplete picture of the growth in equity.
For example, the balance sheet for FY 1994 indicates that the net equity of the Trust Estate grew by $222,555,903 or 16.8% more than the prior fiscal year. However, during FY 1994, the Trust Estate realized $204,126,980 from real property sales. This income was derived primarily from sales of residential and condominium fee interests which were previously carried on the balance sheet at a low historical value. Accordingly, the increase in net equity must be viewed in the context of this accounting quirk. Most of the FY 1994 increase in the reported net worth of the Trust Estate might therefore be attributed to previously unrecognized land values which were converted into cash or an alternate form of investment.10
Another item typically not reported in the financial statements is the potential exposure to losses facing the Trust Estate. The balance sheet discloses outstanding debts of the Trust Estate in the amount of $251,038,307. This reflects loans and other debt instruments which the Trust Estate has undertaken.
The Trust Estate and its Pauahi Holdings, Inc. subsidiary, however, face unreported contingent loss exposure for a number of potential obligations. For example, the Trust Estate has guaranteed loans by subsidiaries and by others to third-parties. The Trust Estate has also insured a personal investment portfolio of Robert Rubin. More significantly, the Trust Estate has entered into various investments where it has and is probably expected to provide additional capital as the investment entity's future capital requirements dictate. This may be the result of contractual obligations, e.g. as in a loan agreement or partnership agreement. It may also be due to the size of the equity stake acquired by the Trust Estate. That stake may be so large that if the investment encounters financial difficulty, rather than allow their stake to be lost, the Trustees may be called upon to infuse more capital. Alternatively, the Trustees may feel compelled to acquire the stakes of other investors in order to assume control of the troubled investment.
The Trust Estate's investment in SoCal Holdings, Inc. might be viewed as one example of such an unreported contingent exposure to loss which triggers additional capital infusion by the Trust Estate.
In 1985, Southern California Savings and Loan Association ("SoCal S&L") was declared insolvent and taken over by the federal government. In April 1987, SoCal S&L was acquired by SoCal Holdings, Inc. Subsequently, the Office of Thrift Supervision ("OTS") took the position that under the Financial Institutions Reform Recovery and Enforcement Act of 1989 ("FIRREA"), the value attributed to goodwill by SoCal S&L would not qualify to satisfy its capital requirements. This determination by OTS and a slow real estate market in California caused SoCal S&L to be unable to meet its capital requirements as of December 31, 1991. In August 1992, the Trust Estate then loaned $30 million to SoCal Holdings, Inc. for which it received senior promissory notes and stock representing 62.5% of the class A common stock of SoCal Holdings, Inc. For the years ending December 31, 1993, 1994, and 1995, SoCal Holdings, Inc. reported net losses of $17.24 million, $57.43 million, and $11.48 million, respectively. In May 1995, SoCal Holdings, Inc. adopted a plan of reorganization under which in June 1995, the Trust Estate exchanged its $30 million loan and unpaid interest of $2.6 million for additional equity in SoCal Holdings, Inc. The Trust Estate also then infused SoCal Holdings, Inc. with an additional $42.5 million for preferred stock and senior debt. SoCal Holdings, Inc., in turn, infused SoCal S&L with $60.4 million obtained through its reorganization plan. This enabled SoCal S&L to come into compliance with regulatory requirements for capitalization.
It is difficult to quantify such contingent exposure. However, the analysis conducted by your Master's CPA suggests that the Trust Estate faces an aggregate exposure to losses comprised of contingent loss exposure and at-risk investments of at least $1.9 billion. This figure does not include any potential liability exposure arising as a result of any pending litigation and is based only upon the investments for which information has been provided to date.
6 This accounting adjustment represents a potential income tax credit arising from significant loss experiences. It does not reflect any earnings by the Trust Estate for the year.7 According to GAAP, a company has a controlling financial interest in another company if it owns more than fifty percent of the outstanding shares of the other company. It should be noted that while currently GAAP calls for consolidation of all majority-owned subsidiaries, the Financial Accounting Standards Board is considering extending this rule to certain minority-owned interests as well.
8 It may be desirable to have the Trustees prepare consolidated financial statements for earlier to provide a historical perspective for the Court when reviewing future accounts of the Trust Estate. The cost of consolidating the earlier financial statements would probably be minor in comparison to the value to be derived from a more complete financial picture.
9 The Trust Estate’s balance sheet reports real property holdings comprised of land, buildings, and equipment at a combined value of $471,155,205 although the real property tax assessed value of the real property holdings exceeded $5 billion.
10 Examination of the financial statements for the previous two years suggests that much of the "growth" in the Trust Estate’s equity during that period could also be attributed to sales of fee interests which were previously carried on the balance sheet at low historical values. In FY 1993, equity increased by $125,483,087 but the Trust Estate also realized real estate sales of $174,147,051. In FY 1992, equity increased by $60,149,320 but the Trust Estate also enjoyed $126,333,343 in real estate sales.
Princess Pauahi did not only require that her Trustees account for all receipts and expenditures. She specifically required annual review of their investments. Thus, her Will requires that they annually file with the Court "an inventory of the property in their hands and how invested." Moreover, she directed that the inventory of investments be published in a newspaper for public review. The language of the Will reveals Princess Pauahi's belief that maintaining the integrity of her Trust Estate's holdings and operations required annual judicial scrutiny and public review.
A trustee is under a general duty to hold, manage, and invest trust property so that the trust estate can produce a reasonable return appropriate to the particular trust purposes, requirements, and circumstances. See Ahuna v. Dept. of Hawaiian Home Lands, 64 Haw. 327, 640 P.2d 1161 (1982) (trustee is obligated to use reasonable skill and care to make trust property productive).
The Restatement (Second) of Trusts (1959) describes that duty as follows:
The trustee is under a duty to the beneficiaries to use reasonable care and skill to make the trust property productive in a manner that is consistent with the fiduciary duties of caution and impartiality.
Accordingly, the investment performance of the Trustees must be viewed in light of this legal duty.
Despite the fact that the Trustees are subject to the duty to make the trust property productive, the information currently required to be furnished by the Trust Estate to the Court's Master under the Restated Guidelines does not enable an analysis to be made of whether that duty has been properly discharged by the Trustees, either with regard to income yield or total return (income plus changes in capital value). Moreover, the financial sophistication and complexity of the Trust Estate's financial holdings add to the difficulty of evaluation. Nevertheless, an informed annual judicial review of the condition of the corpus of the Trust Estate and the investment performance of the investment portfolio is essential to maintaining the integrity of the Trust Estate.
Performance of the Trust Estate' investment portfolio should be evaluated based upon the overall return (income yield and total return). However, the current manner in which the Trustees' annual account is presented for review does not allow such an analysis.
Currently, there is no reasonably reliable or even proximate indication of the current fair market value of the assets of the Trust Estate. Thus, neither a year-to-year comparison of changes in the value of the Trust Estate11 holdings nor the rate of income productivity can be determined and evaluated.
Without a fair market valuation of the assets of the Trust Estate, one cannot determine the level of growth or decline in the Trust Estate's total endowment or the specific asset classes of which it is comprised. A relevant overall return analysis also cannot be made since the balance sheet largely reflects historical values. Measuring current income against such historical values would not produce an accurate or complete picture of the income yield enjoyed by the Trust Estate.
The Restated Guidelines presently require the Trustees to file with their annual account a list and current fair market value of all assets of the Trust Estate. See Paragraph B.3.j. of the Restated Guidelines. Such a list was neither filed with the annual account nor provided to your Master.
The information provided to the Master pursuant to the Restated Guidelines do not allow for a fair evaluation of the income yield of the investment portfolio after expenses.
Trustees are required to "incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship." Restatement (Third) of Trusts 227(c)(3)(1992); See also, Restatement (Second) of Trusts 188 (1959). In particular, it should be noted that recently enacted HRS 554C-7 (effective April 14, 1997) requires:
In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.
Analysis of whether the costs of administering the Trust Estate's assets are reasonable is essential to ensuring the proper administration by the Trustees. Certainly, one of the best measures of the reasonableness of such expense will be examining the net return produced by incurring such expense. This is critically important because alternative investments are available to the Trust Estate which require substantially less expense and risk but could produce comparable or better rates of return.
The income yield to the Trust Estate must therefore be measured by the net income derived from the investment portfolio. Expenses connected with managing the investment portfolio should be deducted from investment income before determining the income yield.
For example, rental income for the Trust Estate is reported on its income tax return and financial statement net of rental expenses. Thus, in FY 1994, it is known that the Trust Estate enjoyed $131,011,638 in gross rents for which it incurred $45,783,448 in rental expenses to yield net rental income of $85,228,190. Because the fair market value of the real estate holdings from which the rental income was derived is not known, evaluation of whether the net rental income enjoyed was at an appropriate rate of return cannot be determined.12
Attempting a similar analysis of the income derived from the Trust Estate's non-real estate investments indicates that those investments performed poorly.13
Exhibits "A" and "B" attached hereto depict analyses by your Master's CPA of the net income performance of the Trust Estate's non-real estate investments in FY 1994 and FY 1995. Those analyses allocate and deduct operating expenses from income derived from the investments of the Trust Estate other than in real estate and its passive investment in Goldman Sachs & Company.14 It suggests that in FY 1994, the Trust Estate suffered an operating loss of $31,394,599 from its "other investments" before taxes and accounting changes.
In 1996, this Court adopted the recommendation of the Matsubara Report that the Trustees formalize their due diligence procedures. Findings of Fact, Conclusions of Law and Order Approving the 107th Annual Report and the 108th Annual Report, filed herein on February 9, 1996, at 6.
The Matsubara Report had recommended that:
Due diligence practices should be carried to the point of formalization so that a check list of required steps, depending on the type of investments undertaken, can serve as a guidepost to decision making as well as a checkpoint for after the fact monitoring and review.Consideration should be given not only to financial, legal and tax considerations regarding entering into an investment, but also to monitoring and reporting procedures and exit strategies if the investment does not meet performance expectations. Formalizing and updating existing practices would be of assistance to both the Trustees and staff. Due diligence materials should be segregated and organized to reflect the data reviewed for the investment decision.
Matsubara Report, at 41.
As part of the due diligence policy, it is essential that the Trustees identify the basis upon which an acquisition price for an investment is decided. Asset pricing should be based upon the projected future return which is comprised of both income and change in market price. It should also take into account the level of risk involved which may warrant a premium return in cases where an increased risk is assumed. Subsequent monitoring of the investment and its performance should be specifically measured against the projected return upon which the investment was priced and acquired.
Basic asset pricing information for investments acquired by the Trustees should be made readily available to future Masters. This will enable them to readily evaluate the investment's performance in light of the original goals when acquired. Discrepancies will highlight any need to further examine whether appropriate procedures were employed in making investment decisions.
11 An internal report is currently prepared by the staff of the Trust Estate which estimates the value of its portfolio based upon tax assessed values for real estate and book value for non-real estate investments.E. The Investment Portfolio Suffered Substantial Losses In FY 1994.12 Based upon an estimated $5 billion dollar valuation for the Trust Estate’s real property holdings, the net rental income of $85,228,190 would yield only a 1.7% rate of return. The Trust Estate’s investment guidelines establish a goal for its real estate portfolio of achieving a "real long-term (rolling 5-year period) rate of return of six percent above the rate of inflation."
13 Measuring the return on investments after segregating rental income from other non-real estate investment income may give a more meaningful picture of the investment results since most of the rental income is derived from trust lands which form the original corpus of the Trust Estate rather than other investments later acquired by the Trustees.
14 Although the investment in Goldman Sachs is substantial, it is a passive investment which does not require any active management on the part of the Trust Estate or Pauahi Holdings, Inc. Any operating expenses specifically related to that investment should therefore be negligible. Consequently, the foregoing analysis segregates the income from the Goldman Sachs investment and does not attribute any operating expense to it.
The Trust Estate's overall investment portfolio reflects recognition of substantial losses and loss reserves in FY 1994. Unfortunately, the Trustees do not furnish as part of their annual account a report on the status of their various investments.15 As a result, it was only based upon the inquiry of your Master's CPA and his review of requested financial records that the losses were identified.
Based upon your Master's review of the records relating to the various investments held by the Trust Estate and its Pauahi Holdings, Inc. subsidiary, combined losses and loss reserves of $264,090,257 were recognized in FY 1994.
These totals are made up, in part, of the following losses and loss reserves recognized in FY 1994:
15 Paragraph C.13. of the Restated Guidelines requires the Trustees to provide the Master with a "schedule showing all transactions in which the Estate and any of its Affiliates were involved during the Accounting Period and any related gain or loss". Such a schedule was not provided to your Master in connection with the 109th Annual Account.F. The Trustees Are Governed By A Standard Of Prudent Investment.16 The Trust Estate reportedly experienced $44 million in write-offs and loss reserves during FY 1993 according to the Master’s Report on the One Hundred Eighth Annual Report of the Trustees filed herein on September 15, 1995, at 22.
17 Represents aggregate losses attributable to various investments among a group of 27 different investments. Loss amounts for individual investments range from $20,575 to $11,500,000. There were also gains among various investments in the group totaling $20,464,381 which have not been offset against the losses.
A trustee is expected to invest the trust corpus in a manner which would produce income from which to carry out the trust objectives. In fulfilling that investment function, a trustee is required to deal with the trust assets in accordance with the "prudent investor" standard. See Ahuna v. Dept. of Hawaiian Home Lands, 64 Haw. 327, 640 P.2d 1161 (1982); Steiner v. Hawaiian Trust Co., 47 Haw. 548, 393 P.2d 96 (1964).
During the period under review, the Uniform Probate Code at HRS 560:7-302 imposed the following standard of care and performance upon a trustee:
Except as otherwise provided by the terms of the trust, the trustee shall observe the standards in dealing with the trust assets that would be observed by a prudent person dealing with the property of another, and if the trustee has special skills or is named trustee on the basis of representations of special skills or expertise, the trustee is under a duty to use those skills.
Cf., Brown v. Brown, 22 Haw. 715 (1915) (the trustee must act with honesty, prudence, and faithfulness, and exercise such sound discretion as prudent business men exercise in the investment of their own moneys, having regard not only to the income, but to the security of the principal and to the permanency of the investment); Bishop v. Kemp, 35 Haw. 1 (1939) (every investment of trust funds must be made with honesty, prudence, and fidelity); Restatement (Second) of Trusts 174 (1959) ("The trustee is under a duty to to exercise such care and skill as a man of ordinary prudence would exercise in dealing with his own property;").
While the Uniform Probate Code does not define the term "prudent person", the Uniform Trustees' Powers Act (HRS Chapter 554A) contains the following definition applicable to that chapter:
As used in this chapter:
"Prudent person" means a trustee whose exercise of trust powers is reasonable and equitable in view of the interests of income or principal beneficiaries, or both, and in view of the manner in which persons of ordinary prudence, diligence, discretion, and judgment would act in the management of their own affairs.
Section 227 of the Restatement (Third) of Trusts (1992) articulates the prudent investor standard as follows:
The trustee is under a duty to the beneficiaries to invest and manage the funds of the trust as a prudent investor would, in light of the purposes, terms, distribution requirements, and other circumstances of the trust.
(a) This standard requires the exercise of reasonable care, skill, and caution, and is to be applied to investments not in isolation but in the context of the trust portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the trust.
(b) In making and implementing investment decisions, the trustee has a duty to diversify the investments of the trust unless, under the circumstances, it is prudent not to do so.
(c) In addition, the trustee must:
(2) act with prudence in deciding whether and how to delegate authority and in the selection and supervision of agents ( 171); and
(3) incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship ( 188).
(d) The trustee's duties under this Section are subject to the rule of 228, dealing primarily with contrary investment provisions of a trust or statute.It is pursuant to this prudent investor standard that the Trustees' management of the Trust Estate's assets must be measured.18
18 The 1997 Hawaii State Legislature adopted the Hawaii Uniform Prudent Investor Act (HRS Chapter 554C) which became effective on April 14, 1997. That Act applies to trusts existing on and created after its effective date. However, as applied to trusts, such as the Trust Estate, existing on its effective date, the Act only governs decisions or actions occurring after that date. HRSG. Prudent Investment Requires A Strategic Plan.
Evaluation of the investment performance of the Trust Estate cannot be fairly achieved by only examining one year's investment result since it only represents a snapshot view of an investment continuum. Investment results must be evaluated from a broader perspective. To do so requires that the investment experience be measured against the overall strategy of the Trust Estate - both as to investments and the achievement of the trust objectives.
Section 227(a) of the Restatement (Third) of Trusts (1992) specifies that prudence requires that investment be done as part of an overall investment strategy:
[The prudent investor standard] requires the exercise of reasonable care, skill, and caution, and is to be applied to investments not in isolation but in the context of the trust portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the trust.19 [emphasis added]
Such a requirement for a trustee is understandable since in administering the assets of another person, a prudent investor should be able to articulate his or her plan for implementing the goals of the trust. The absence of a well conceived strategic plan not only hinders the proper evaluation of the investment performance of the Trust Estate, it also suggests that there is a lack of proper focus and planning devoted to attainment of the trust objectives. It is because of such reasons, the need for an appropriate strategic plan for the Trust Estate has been a subject of concern of several previous Masters.
In 1990, William H. Dodd, Esq., the Master for the 103rd Annual Account, recognized such a need and recommended the following:
The current and projected cash balances clearly show that more will be received than will be required to meet the needs of the Kamehameha Schools, the sole beneficiary of this Estate. While it is recognized that the beneficiary is expected to continue in perpetuity and that the income generating base must ever increase in order to meet inflationary factors, the present course of the business end of KS/BE will continue to produce, save some extraordinary circumstance, a great deal more cash flow than is needed to meet the currently projected operations of Kamehameha Schools. Planning is ongoing to handle this dilemma; however, the Estate does not have a comprehensive strategic and financial plan and existing financial planning does not appear to achieve a point of equilibrium between income and outflow. In your Master's view, and as recognized by KS/BE, such a plan is critical and the time is now. [emphasis added]
Master's Report on the One Hundred Third Annual Report of the Trustees, filed herein on May 30, 1990, at 19 ("Dodd Report").
In response to this recommendation this Court ordered that:
The Trustees shall make available to future masters (beginning with the Master for the 105th Annual Report) a copy of their then-current long-range comprehensive strategic and financial plan, together with reasonable supporting detail. The plan shall be prepared, reviewed, and updated from time to time as necessary. In view of the sensitive nature of a strategic plan, future masters shall not copy or publish the contents of the plan except where it is reasonably necessary to do so in connection with the masters' review of the Trustees' accounts, and then only to the extent necessary. The masters shall afford the Trustees, the Attorney General and the Court adequate opportunity to determine the reasonable necessity of such publication and the decisions ultimately shall lie with the Court.Findings of Fact, Conclusions of Law and Order Approving the 103rd Annual Report, filed herein on October 16, 1990, at 10.
Despite the foregoing Court order, in a subsequent report, James E. Duffy, Jr., the Master for the 105th and 106th Annual Accounts, reiterated the need for a strategic plan and expressed a concern similar to the Dodd Report. Duffy made the following recommendation regarding a strategic plan to coordinate "revenue generation" with "educational spending":
Considering these cash resources, the mission of KS/BE, and the demonstrated need for expansion of educational opportunities for the Hawaiian people, what is needed is a Strategic Plan (both short-term and long-term) to expand the educational opportunities in a manner consistent with the growth in revenues that KS/BE can reasonably anticipate. It is anticipated that such a Strategic Plan would include (among other things) articulated goals, guidelines and criteria for both investment income and income generation on the one hand, and for the nature and type of educational opportunities to be provided on the other hand. The Strategic Plan would thus directly coordinate the "revenue generating" role and the "educational spending" roles of KS/BE, and allow the Trustees to more effectively meet the mission, purpose and goal of KS/BE as stated in the Will. Indirectly, adoption of such a Strategic Plan would also provide the KS/BE Management and staff with clearly articulated goals, guidelines and criteria, which would enhance their opportunities for development as professionals, and would also provide the Trustees with a measuring stick for accountability. [emphases added]Master's Report on the One Hundred Fifth Annual Report of the Trustees, filed herein on April 21, 1992, at 36 ("Duffy Report"). See also, Master's Report on the One Hundred Sixth Annual Report of the Trustees, filed herein on September 8, 1993 ("Duffy Report 2") (recommending that the Trustees follow-up as soon as possible on the strategic plan described in the Duffy Report).
In response to the Duffy Report, the Court made a determination as follows:
Concerning the matter of a strategic plan, the Court notes that the Trustees concur with the Master and that an effort is in progress to prepare such a plan. The Court will await the preparation of that plan.
Findings of Fact, Conclusions of Law and Order Approving the 105th Annual Report, filed herein on June 8, 1992, at 6. See also Findings of Fact, Conclusions of Law and Order Approving the 106th Annual Report, filed herein on December 27, 1993 (noting that the Trustees had represented to the Court that the recommended strategic planning effort was ongoing).
Benjamin M. Matsubara, Esq., the Master for the 107th and 108th Annual Accounts also reiterated Duffy's recommendation and added the following comments:
In the Findings of Fact, Conclusions of Law and Order Approving the 107th Annual Report and the 108th Annual Report, filed herein on February 9, 1996, this Court ordered:
Strategic Plan. That the Trustees continue to balance desire to expand the scope of educational services with the realities of the cost of expanded services and facilities, bearing in mind the realistic long term projected revenue generating capacity of the Trust Estate; and that the Trustees' Strategic Plan clearly establish responsibility and accountability for performance.
Your Master notes that as late as June 30, 1997, the strategic plan contemplated by the Dodd Report, the Duffy Report, the Duffy Report 2, the Matsubara Report, and addressed by this Court in connection with its orders approving the 103rd, 105th, 106th, 107th, and 108th Annual Accounts, had not yet been prepared and adopted by the Trustees.
The Duffy Report identified the need for the Trustees to adopt a strategic plan which would focus the Trust Estate on its educational mission and accordingly guide its investment strategy. What the Duffy Report contemplated was a strategic plan which identifies specific goals for expansion of the educational mission, supported by a financial plan geared toward financing those goals within the bounds of prudent investment. Such a strategic plan is essential to help ensure that the Trustees maintain their focus and not orient their investment strategy towards becoming a financial conglomerate whose educational mission is obscured by the investment activities and goals of the Trustees.
The Trustees are required to produce to the Master their current long-range comprehensive strategic and financial plan, together with supporting detail. See Paragraph C.21. of the Restated Guidelines.
Initially, such a plan was not produced to your Master. Instead, he was referred to the Trust Estate's 10-year Projection Plan produced in response to paragraph C.9. of the Restated Guidelines. In August 1997, your Master then was given access to what the Trustees describe as its overall "strategic plan" responsive to the prior Masters' recommendations and orders of this Court. After studying that "strategic plan," your Master is not satisfied that it achieves the goals for a strategic plan as contemplated by the prior Masters' reports and orders of this Court.
For example, there is no investment strategy which is specifically tied to the educational goals of the Trust Estate. The plan developed in 1997 contains an Investment Policy adopted in 1992 and modified in 1993. That Investment Policy incorporates asset allocation guidelines which were apparently developed with no specific educational expansion goals in mind.
The 1997 plan incorporates an "educational strategic plan" adopted in August 1997 by the Trustees. However, there is no indication that the "educational strategic plan" was coordinated with an investment strategy.
While your Master is aware that a planning process was engaged in by the Trustees and various Trust Estate personnel between March 1997 and August 1997 to develop the educational strategic plan, a similar process was not employed to develop an investment plan.
A more meaningful strategic plan as contemplated by the Duffy Report should involve development of an educational plan in conjunction with an investment plan. 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. The selection and mix of future investments by the Trustees should be accordingly guided. The development of a strategic plan in that manner will best ensure that the focal point of the Trust Estate's planning process will be its educational mission.
When such a strategic plan is developed, hopefully it will show a greater proportion of the Trust Estate's assets and income being allocated to educational programs rather than administrative and other expenses.
The balance sheet of the Trust Estate shows that in FY 1994, school assets comprised only three percent (3%) of the assets of the Trust Estate. This percentage was the same in FY 1993 and remained the same in FY 1995. See Exhibit "C".
In addition, the percentage of expenditures of the Trust Estate on school operations comprised only 41.2% of the total expenses of the Trust Estate while financial aid accounted for an additional 8.7%. Meanwhile, administrative expenses comprised 16.2%, professional service expenses made up 7.7%, and real estate management expenses made up 26.2% of the total expenses. Analysis of the FY 1995 financial records reveals a further deterioration in the percentages of total expenditures attributable to school operations and financial aid. Although total dollars expended increased, the percentage of the total expenses of the Trust Estate devoted to school expenses declined to 37.0%; financial aid dropped to 8.0%; administrative expense rose to 19.2%; professional services increased to 9.5%; and real estate management expense remained at 26.3%. See Exhibit "D".
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 beneficiaries20. 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.21
Had such a strategic plan been adopted by the Trustees it would have established goals against which the investment performance of the Trust Estate could be measured from year to year.
19 HRSH. The Trustees Are Subject To A Duty To Diversify Investments.20 The Duffy Report cautioned that the Trustees must:
[K]eep in mind that the sole reason for the creation and continued existence of KS/BE is to provide educational opportunities to the Hawaiian people. Moreover, KS/BE presently has the cash resources to significantly expand educational opportunities, as a result of the Land Reform Act sales of land, the renegotiation of commercial and industrial leased fee interests as leases terminate, and the astute investments of the Trustees.
Duffy Report, at 35.21 A similar concern was expressed by George S. W. Hong, the Master for the 99th Annual Account as to the failure of the Trustees to expend a greater amount of accumulated income to achieve the educational objectives of the Trust Estate. As with the masters who followed him, Hong also identified the need for long range plans which coordinate expansion of educational activities with the growth in income. Report of the Master on the Petition of the Trustees of the 99th Annual Report, filed herein on August 2, 1985, at 10-24.
One of the basic elements of prudent investment by a trustee is the duty to diversify the investment portfolio. See Steiner v. Hawaiian Trust Co., 47 Haw. 548, 393 P.2d 96 (1964) (it is the specific investment duty of a trustee to diversify trust investments unless absolved from so doing by express direction in the trust instrument).
Section 227(b) of the Restatement (Third) of Trusts (1992) prescribes the following:
In making and implementing investment decisions, the trustee has a duty to diversify the investments of the trust unless, under the circumstances, it is prudent not to do so.22This principle acknowledges the maxim "Don't put all your eggs in one basket" and recognizes that the proven way to avoid unrewarded high-risk investment is through diversification.
Asset allocation is the basic tool of diversification. Its aim is to produce an optimal mix of investments that has the potential to produce a desired return with the least amount of fluctuation in the overall value of the investment portfolio. It accomplishes this by reducing a portfolio's exposure to losses caused by a decline in one or more of the portfolio's investment class. By spreading funds among several investment types, it increases the probability that if one investment class falters, another will increase in value.
Asset allocation guidelines are the road map which chart the course toward a diversified investment portfolio. They help ensure that the Trust Estate's investments are balanced and in accordance with the Trust Estate's objectives. Such guidelines, however, are a means to an end. They can play a critical role in the implementation of a strategic plan for the Trust Estate if they have been developed with the strategic goals in mind.
Factors such as safety, liquidity, diversity, risk tolerance, and return objectives all need to be incorporated in developing the guidelines.23 Because the income requirements of the Trust Estate need to be identified to shape the guidelines, it is critical that the long range plan for achieving the Trust Estate's objectives be identified and serve as a guidepost for allocating between capital growth versus income investments.
In April 1992, the Trustees adopted an Investment Policy which sets forth investment goals and asset allocation guidelines. When that policy was adopted, however, no strategic plan for the Trust Estate was in place. There is nothing to indicate that the allocation plan was tied in with achieving any particular income requirements or for meeting future growth in educational programs. Curiously, the text of the policy seems to give little consideration to the educational program goals of the Trust Estate.
Even with the adoption of asset allocation guidelines, doubt exists as to whether the Trustees have conformed their investment practices to achieve the goals set out in the guidelines.
In 1987, Arthur S. K. Fong, Esq., Master for the 101st Annual Account reported that the total endowment of the Trust Estate was apportioned 92% real estate and 8% non-real estate investments. Fong then indicated that the Trust Estate's financial advisor, Cambridge Associates, had recommended that the targeted allocation for 1992 be 81.8% real estate and 18.2% non-real estate investments. Master's Report on the One Hundred First Annual Report of the Trustees, filed herein on October 23, 1987, at 6-7.
The asset allocation guidelines adopted in 1992, target a 70% allocation to real estate and 30% allocation to non-real estate investments. The target date, however, is not specified. An internal allocation analysis performed by staff of the Trust Estate indicates that as of FY 1994, the allocation of the Trust Estate's assets were 83% in real estate and 17% in non-real estate investments.24 While that analysis suggests that the Trustees may have substantially met the initial allocation targets reported in the Fong Report, they have a long way to go to attain the current targeted allocation.
Your Master is concerned regarding the allocation monitoring process. There appears to be an internal monitoring process whereby staff of the Trust Estate makes an attempt to annually determine the actual allocation of assets. However, your Master notes that the basis upon which values are attributed to various investments is unclear and may not reflect current fair market values.
The monitoring process itself also appears to lack the necessary discipline. In classifying investments among various allocation categories, the Trustees have deviated from recommendations from Cambridge Associates, their investment advisor. Assets appear to have also been miscategorized. For example, Pauahi Holdings, Inc. is the principal for-profit subsidiary of the Trust Estate whose own portfolio of investments is quite diverse. However, rather than reflect this diversity, the entire investment in Pauahi Holdings, Inc. is categorized as an "equity" investment. In addition, while the Trust Estate has various oil and gas investments, none are reflected in an oil and gas asset category although such a category is specified in the asset allocation guidelines. Instead, oil and gas investments such as McKenzie Methane Gas, Invexco Inc., and Smith Offshore Exploration Co. are categorized as "special situation" investments. Moreover, although certain investments were originally classified as "special situation" investments when entered into, some are now financially troubled and should probably be reclassified.
Enforcement of asset allocation guidelines requires appropriate data and self-discipline. The lack of accurate data regarding current asset allocation could lead to erroneous decisions in making new investments. While the temptation may arise from time-to-time to deviate from a pre-determined asset allocation strategy, investment in accordance with a long term strategy offers the most prudent course of conduct for the Trustees.
In reviewing the investments comprising the Trust Estate's portfolio, your Master made various observations which are noted below.
(a) Substantial Investments Continue To Be Made In Real Estate.
Because of the nature of Princess Pauahi's bequest and the restrictions in her Will,25 the asset portfolio of the Trust Estate is heavily weighted with Hawaii real estate.26 However, rather than attempt to further reduce the disproportionate amount of real estate holdings in its portfolio, the Trust Estate continues to reinvest in real estate ventures in Hawaii and on the mainland with varying levels of success. The Trust Estate is also committing substantial resources to the development of its land holdings in the Kakaako district of Honolulu where it is one of the largest single landowners.
(b) Excessive Amounts Of Cash Are Regularly Kept In Demand Deposit Accounts.
Your Master notes that the Trustees need to better manage the Trust Estate's cash assets. At any given time, it seems that the Trustees hold an enormous amount of funds in a single money market account and various minor amounts in several bank demand deposit accounts. Their own asset allocation guidelines establishes a target allocation for cash at approximately $16 million or 0.3% of the total assets of the Trust Estate. Despite this guideline, the financial statements indicate that Trust Estate held $56,466,599 in cash as of June 30, 1993, and $155,020,819 in cash as of June 30, 1994.27
(c) Investments In Stocks And Bonds Are Very Limited.
The asset allocation guidelines target a 3.8% allocation in marketable fixed income investments such as bonds and a 6.7% allocation in marketable equities such as stocks. As of June 30, 1994, the internal asset allocation report indicates that only about 1.0% of the total portfolio of the Trust Estate was made up of such investments. The Trust Estate actually had more invested in the oil and gas investment assets than in marketable stocks and bonds combined.28 The stock portfolio itself is made up of diverse classes of stock, including special situation and venture capital type holdings.
(d) The Goldman Sachs Investment Represents A Major Allocation of Investment Funds.
During FY 1994, the Trust Estate owned, through RHSCI, a 5.25% equity interest in the Goldman Sachs & Company investment banking firm. The ownership interest is held in the form of a limited partnership interest in Goldman Sachs LP I and was acquired in 1992 at a cost of $250 million. For the fiscal year ending June 30, 1994, RHSCI recognized $79,692,452 in investment income from Goldman Sachs LP I. In addition, the value of RHSCI's equity interest in Goldman Sachs LP I increased by $34,229,000 during FY 1994.
The Trust Estate's investment in Goldman Sachs represents the single largest non-real estate investment of the Trust Estate. That stake became even greater when RHSCI paid another $250 million in November 1994 for a 4.25% limited partnership interest in Goldman Sachs LP II. As depicted in Exhibit "E", the investment comprised as much as 17.2% of the non-school assets of the Trust Estate in FY 1994, and 26.2% of the non-school assets in FY 1995 based upon balance sheet values. It is unclear how such a substantial investment in a single entity figures in the overall asset allocation strategy of the Trust Estate.
Assuming that the acquisition cost was reasonable,29 the investment represents a unique opportunity for the Trust Estate since Goldman Sachs, as one of the premier investment banking firms in the world continues to be a leader in the global financial market. It is hoped, however, that the partnership interest of the Trust Estate will not foreclose opportunities for the Trust Estate to deal with competitors of Goldman Sachs.
(e) Investments Appear To Be Grouped Based Upon Relationships.
Your Master noted that relationships with particular investors seemed to be a consideration for the Trustees' decision to enter into particular investments. As a result, many of the real estate, special situation, and venture capital investments of the Trust Estate seem to be "grouped" investments. In other words, the investments share a common denominator in the form of the same principal investment promoters.
While a relationship based upon historical business experience may have a certain utility in evaluating an investment opportunity, it is not a basis for dispensing with a disciplined due diligence analysis and a dispassionate price evaluation of any potential investment. Relationship based investing may serve as the reason for investing one's own money, but it should not be a basis for risking someone else's money.
Their duty of loyalty prohibits the Trustees from making any investment or expending Trust Estate funds unless it is for the sole purpose of advancing the interests of the beneficiary. See Steiner v. Hawaiian Trust Co., 47 Haw. 548, 393 P.2d 96 (1964).
Comment q. to Section 170 of the Restatement (Third) of Trusts (1992) states:
q. Action serving the interest of a third person or a non-trust objective. In administering the trust the trustee is under a duty to the beneficiaries not to be influenced by the interest of any third person or by motives other than the accomplishment of the purposes of the trust. Thus, it is improper for the trustee to purchase property for the trust or to sell trust property for the purpose of benefitting a third person rather than the trust estate or for the purpose of advancing an objective other than the purposes of the trust.
No doubt the Trustees may develop close working relationships with some of the investment promoters who do business with the Trust Estate. They may even have personal business ties with such promoters. If so, then the Trustees must be even more careful not to allow emotional considerations such as friendship to cloud their objective judgment as fiduciaries.
(f) The Trust Estate's Investments Reflect An Increased Level Of Risk.
In the Matsubara Report, it was noted that funds derived from leased fee conversion sales were being reinvested by the Trustees into various other sophisticated and complex investments. That report suggested that consideration should be given to segregating the proceeds from leased fee sales from revenue derived from operating and investment activities and limiting their reinvestment into more conservative investments. See Matsubara Report, at 38.
Your Master shares a certain level of discomfort with the aggressive nature of many of the Trust Estate's investments. Many of the major investments of the Trust Estate appear to be entrepreneurial in nature. Such investments do not provide stable sources of income and have a high degree of volatility with regard to principal value. 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.
Your Master notes, however, that the Modern Portfolio Theory based upon asset allocation does sanction a certain amount of higher risk investments depending upon the risk tolerance of the investor. It is your Master's hope that the supplemental report of the Trustees proposed by Recommendation No. 5 regarding the Trust Estate's investment loss experience and the Trustees' prognosis for the future will provide the Court with a satisfactory level of comfort regarding their investment strategy.
The CPA retained by your Master is currently compiling a listing of the investments of the Trust Estate and its subsidiaries along with a summary description of each investment. Unfortunately, because of the difficulties in obtaining access to certain financial records, the investment summary is not ready. The investment summary will be filed with the Court when completed. Your Master believes that such a compilation is an essential tool to assist future Masters in their review and analysis of the financial condition of the Trust Estate. In the future, the Trustees should be required to prepare a similar investment summary for review by the Master as part of the annual account review.
22 See also HRS23 HRS
24 This may have been largely the result of a cyclical decline in the value of the Trust Estate’s real property assets from the prior year since in FY 1993, the allocation report indicated that the Trust Estate’s assets were apportioned 87.58% in real estate and 12.4% non-real estate.
25 In paragraph 17 of Codicil No. 1 to her Will, Princess Pauahi imposed the following restriction:
I give unto the trustees named in my will the most ample power to sell and dispose of any lands or other portion of my estate, and to exchange lands and otherwise dispose of the same; and to purchase land, and to take leases of land whenever they think it expedient, and generally to make such investments as they consider best . . . . I further direct that my said trustees shall not sell any real estate, cattle ranches, or other property, but to continue to manage the same, unless in their opinion a sale may be necessary for the establishment or maintenance of said schools, or for the best interest of my estate.26 In FY 1994, the Trust Estate held fee title to 367,509 acres of land in the State of Hawaii. Conservation lands comprised 189,336 acres and agricultural lands constituted 172,614 acres. The conservation lands produced no revenue. Agricultural land leases generated about 3% of the total revenue from the Hawaii lands. Residential land holdings comprised 4,726 acres and generated 9% of the Trust Estate’s total income from Hawaii lands. Although commercially zoned lands comprised only 833 acres or 0.25% of the Trust Estate’s total land holdings in Hawaii, its rental income generated 88% of the total income from real estate in Hawaii. 1994 Annual Report of the Kamehameha Schools Bernice Pauahi Bishop Estate, p 26-28.
27 Curiously, the internal asset allocation report prepared for the Trustees reports cash on hand of $50.5 million as of June 30, 1993, and $230.1 million as of June 30, 1994. Meanwhile the Minutes of the Board of Trustees Meetings report a cash balance of $128,203,754 as of June 30, 1993, and $279,773,609 as of July 1, 1994. The reason for these apparent discrepancies from the figures in the audited financial statements is unknown to your Master.
28 The Trust Estate’s cash investment in oil and gas exceeded $100 million as of FY 1994.
29 Your Master could not obtain access to the due diligence documents for the Trust Estate’s acquisition of its interest in Goldman Sachs - ostensibly because of a confidentiality agreement with Goldman Sachs.
The Trust Estate is the fee owner and ground lessor of the 6.485 acres of land on which the former Kahala Hilton Hotel is located. The ground lease was issued by the Trust Estate to to WKH Corporation. Pursuant to the ground lease terms, the annual lease rent for the ten-year period beginning on November 1, 1990, was subject to renegotiation and if no agreement could be reached, then by appraisal and arbitration. WKH Corporation and the Trust Estate had widely divergent positions on the value of the unencumbered fee interest. WKH Corporation had offered the Trust Estate $1,200,000 in annual rent based upon a land value of $20,000,000. The Trust Estate sought an annual rent of $18,000,000 based upon a $300,000,000 valuation. The dispute over the ground lease rent was submitted to arbitration in accordance with the ground lease. After five days of hearing, an arbitration panel comprised of three real estate appraisers rendered their award on August 13, 1992. The arbitration award established a value of $93,500,000 for the Trust Estate's fee interest as of November 1, 1990. This yielded a annual rent of $5,601,000 (six percent of $93,500,000).
After the arbitration award was rendered, the Trust Estate petitioned the Circuit Court to confirm the arbitration award. Over WKH Corporation's objections the award was confirmed by the Circuit Court and WKH Corporation appealed from that ruling.
While the appeal was pending, WKH Corporation threatened to file for bankruptcy protection and attempted to negotiate a lower rent with the Trust Estate. The outcome of those negotiations was a letter agreement between the Trust Estate, WKH Corporation, and a proposed purchaser of the Kahala Hilton Hotel - Bill Mills Development Company and Tokyo General Corporation (together referred to as "Mills Development/Tokyo General"). Under that agreement, WKH Corporation agreed to sell its interest in the Kahala Hilton to Mills Development/Tokyo General. The Trust Estate in turn agreed to enter into a new ground lease with Mills Development/Tokyo General. The terms of that new ground lease, among other things, lowered the annual lease rent from $5,601,000 to a minimum rental of $1,200,000 plus a percentage of the annual gross income; extended the lease term from ten to forty years; and required capital improvements of not less than $30 million to the hotel. Trust Estate personnel reportedly stated that the objective of the new lease terms was to yield the "economic equivalent" of $5,601,000 in annual rent. The new ground lease was dated October 23, 1993.
WKH Corporation later filed a challenge to its real property tax assessment for the Kahala Hilton for the 1992 and 1993 fiscal years ending June 30. The City and County of Honolulu had established a valuation for the land portion of the property of $72,303,000. WKH Corporation challenged the valuation as being excessive and sought to have it reduced to $20,000,000. The Tax Appeal Court upheld the real property tax assessment and WKH Corporation appealed to the Hawaii Supreme Court. The Hawaii Supreme Court also affirmed the real property tax assessment of $72,303,000 for the land portion of the Kahala Hilton property. Weinberg v. City and County of Honolulu, 82 Haw. 317, 922 P.2d 371 (1996).
Your Master recently learned about this lease transaction with Mills Development/Tokyo General by reviewing the opinion in Weinberg after having been informed of its existence by an independent source. The foregoing factual summary is based upon that reported Hawaii Supreme Court opinion.
Despite the size of the ground lease transaction with Mills Development/Tokyo General, it is unreported in any of the minutes of the meetings of the Board of Trustees. There is no mention of the transaction in the schedule of real estate transactions for FY 1994 which was appended to the Trust Estate's annual account filed with the Court. There was also no mention of this transaction in the information provided to your Master pursuant to the Restated Guidelines.
Your Master has made inquiry about this transaction to the Trust Estate. However, there has been an insufficient opportunity in which to obtain sufficient information and to conduct an informed analysis.
In paragraph Thirteen of her Will, Princess Pauahi provided for the establishment of her trust:
The Kapalama Heights campus of Kamehameha Schools represents the "flagship" of the educational programs undertaken by the Trust Estate. It is on this sprawling campus overlooking Honolulu that the Trust Estate carries out the basic mission defined by Princess Pauahi in her Will.
From an initial enrollment of 37 students in the 1887-88 school year, enrollment on the Kapalama Campus grew to 2,937 full-time students in the 1993-94 school year. Annual Report of the Kamehameha Schools for 1993-94, at 7-9. These students are provided with a college preparatory education with facilities and equipment that would be the envy of any comparable institution.
During the 1993-94 school year, the Trust Estate also reportedly serviced 32,024 other students in various community outreach programs through the Community Education Division. Id. at 10. These programs include a range of student participation from full-time students enrolled in alternative education programs; part-time students enrolled in the summer programs, adult community school, elementary guidance and intermediate reading programs; and various participants in drug education programs, Hawaiian culture lectures, Hawaiian Studies Institute, post-high school scholarship and counseling program, Native Hawaiian Higher Education Program, and Native Hawaiian Health Scholarship Program. Many of these programs involve government grants which enable the Trust Estate to leverage its resources to reach a greater number of members of the Hawaiian community.
In addition, 10,606 students were participants in the programs offered by the Early Education Division. Id. at 11. These students participated in the Kamehameha Elementary Education Program ("KEEP"); Preservice Education for Teachers of Minorities ("PETOM"); and the Kamehameha Prekindergarten Education Program ("PREP").
President Michael J. Chun noted in his message contained in the Annual Report of the Kamehameha Schools for 1993-94, that the school year was a "pivotal year" because it marked the first year of a two-year effort to develop a strategic plan which would take Kamehameha Schools into the 21st century. He predicted that:
By July 1995, with help from KSBE staff at all levels, we should have goals and objectives for the strategic plan that will guide delivery of KSBE educational services over the next decade.Id. at 1.
Despite President Chun's statements, as your Master will discuss in more detail in his report on the 110th Annual Account, a strategic plan was not developed by July 1995. That year indeed proved to be a pivotal year since the Trustees first announced and began the implementation of the "Go Forward" Plan which will redefine and shift the focus of the Trust Estate's educational programs for years to come. The timing of that shift, however, was unfortunate since it preceded the development of the educational strategic plan.
A. The Board Of Trustees.
Trustees hold a unique status in our legal system. As the very name indicates, they are the recipients of another person's trust and confidence. As a result, the law expects the highest degree of integrity in their conduct and administration of the affairs of the trust. They are also expected to conform their conduct to standards which might not be the norm for someone acting on his or her own account.
In her Will, Princess Pauahi appointed her husband and four other prominent citizens of the Hawaiian Islands as the initial trustees of her trust. In her words she stated:
Fourteenth. I appoint my husband Charles R. Bishop, Samuel M. Damon, Charles M. Hyde, Charles M. Cooke, and William O. Smith, all of Honolulu, to be my trustees and to carry into effect the trusts above specified. I direct that a majority of my said trustees may act in all cases and may convey real estate and perform all of the duties and powers hereby conferred; but three of them at least must join in all acts. I further direct that the number of my said trustees shall be kept at five; and that vacancies shall be filled by the choice of a majority of the Justices of the Supreme Court, the selection to be made from persons of the Protestant religion.
During the fiscal year ending on June 30, 1994, the Board of Trustees was comprised of the following members, all of whom had been appointed in accordance with the Will:
Chair: Myron Thompson1st Vice Chair: Oswald K. Stender2nd Vice Chair: Richard S. H. WongTreasurer: Henry PetersSecretary: Lokelani Lindsay
The term of Trustee Myron Thompson later ended on November 30, 1994. He was succeeded on December 1, 1994, by Trustee Gerard Aulama Jervis who was appointed by the members of the Hawaii Supreme Court.B. The Trustees Operate An Informal Management System.
Your Master notes that in meetings with the individual Trustees and staff he learned that the Trustees have operated under an informal system where individual trustees are designated as "lead trustees" with responsibility for certain subject matter areas.30 Trustee Henry Peters is the "lead Trustee" for asset management; Trustee Lokelani Lindsay is the "lead Trustee" for educational programs; Trustee Richard S. H. Wong is the "lead Trustee" for governmental relations; and Trustee Gerard Jervis later became the the "lead Trustee" for legal affairs after joining the Board of Trustees. Trustee Oswald Stender, apparently, did not have a portfolio of responsibility.
The Trustees indicated that the status of "lead Trustee" was intended to divide responsibilities among them for various subject matter areas. However, several Trustees assured your Master that this practice is not intended to result in a delegation of the authority of the Board of Trustees to an individual "lead Trustee". Thus, any decision-making authority is still reserved for the Board of Trustees as a whole.
Despite the assurances that decision-making authority is reserved to the five Trustees as a group, various Trustees described the Board of Trustees as constituting "five CEOs" or being comprised of "five fingers - acting as one hand". In discussions with the Trustees and staff, it was apparent to your Master that a "lead Trustee" wields substantial influence, if not actual managerial control and authority, over their respective areas of assignment and the Trust Estate personnel employed within those areas.
Your Master finds this practice of a "lead Trustee" being assigned with responsibilities relating to particular subject matter areas as potentially problematic under the terms of the Will31 and in light of the inevitable dynamics of a five member Board of Trustees.
The Trustees are subject to restriction on their authority to delegate their responsibilities to others.
Recently enacted Section 554C-9 of the Hawaii Uniform Prudent Investor Act which applies to conduct of the Trustees after April 14, 1997, articulates standards for delegation of the investment and management functions of trustees. That statute (which apparently contemplates delegation to agents and employees - not among co-trustees) provides as follows:
(a) A trustee may delegate investment and management functions that a prudent trustee of comparable skills could properly delegate under the circumstances. The trustee shall exercise reasonable care, skill, and caution in:
(2) Establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust; and
(3) Periodically reviewing the agent's actions in order to monitor the agent's performance and compliance with the terms of the delegation.
(c) A trustee who complies with the requirements of subsection (a) is not liable to the beneficiaries or to the trust for the decisions or actions of the agent to whom the function was delegated.
(d) By accepting the delegation of a trust function from the trustee of a trust that is subject to the law of this State, an agent submits to the jurisdiction of the courts of this State.
554A-3(c)(23)(specifying the power of a trustee to act as a prudent person would in appointing agents).
The statute clarifies the general standard set forth in the Restatement (Third) of Trusts (1992) which specifies the restriction on delegation as follows:
A trustee has a duty personally to perform the responsibilities of the trusteeship except as a prudent person might delegate those responsibilities to others. In deciding whether, to whom and in what manner to delegate fiduciary authority in the administration of a trust, and thereafter in supervising agents, the trustee is under a duty to the beneficiaries to exercise fiduciary discretion and to act as a prudent person would act in similar circumstances.32
The delegation by the Trustees of management authority over the Kamehameha Schools and the Education Group of the Trust Estate to the President of Kamehameha Schools might be viewed as a delegation of fiduciary authority consistent with HRS 554C-9. This is because the Trustees undertake to screen and select a candidate who is fully qualified and best able to carry out the duties and responsibilities of the President. The duties and responsibilities of the Office of the President are defined and fit within an overall hierarchical scheme for administration of Kamehameha Schools and the Education Group. There is a procedure for accountability by the President to the Board of Trustees. There is also a system of performance monitoring and oversight by the Board of Trustees.
Likewise, the delegation of responsibility and authority over the Asset Management Group33 to a "principal executive" is also permissible since similar policies for employment screening, accountability, monitoring, and oversight by the Board of Trustees have been established for the principal executive of that group.34
However, the informal practice of designating a "lead Trustee" for different subject matter areas of administration of the Trust Estate would appear to constitute, at worst, an unauthorized division of the trusteeship and, at best, a sweeping delegation of authority without appropriate safeguards.
Since the practice is an "informal" one, there are no governing policies or guidelines established by the Trustees. In your Master's view, such a system presents serious practical obstacles to ensuring accountability and oversight.
The "lead Trustee" system fosters the likelihood that the other Trustees will defer to the judgment of lead Trustee with respect to matters falling within that Trustee's subject matter area. Similarly, Trust Estate employees who work within a lead Trustee's area are hard pressed not to cater to the directions or preferences of the lead Trustee even in matters upon which the full Board of Trustees has not deliberated or acted.
Although the Trustees assured your Master that a lead Trustee never usurps the authority of the entire Board of Trustees to act upon a matter, the very nature of a "lead Trustee" system poses the risk that a lead Trustee may filter (even unintentionally) matters which ought to be presented to the full Board of Trustees for their consideration. In fact, your Master 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.
The "lead Trustee" system poses further risks as it may result in "horse trading" between Trustees who want special consideration for matters outside their subject matter area but within another lead Trustee's area of responsibility. While "horse trading" may be a fact of life in many organizations, it is prohibited in the trust setting since it would constitute an abdication of the discretion entrusted to the Trustee who trades his or her vote on one issue to gain support or advantage on an unrelated issue. Cf. Restatement (Second) of Trusts 187, Comment "h" (1959)(court intervention appropriate where trustee fails to exercise judgment).
Even more problematic is that in order for the Trustees to delegate even limited authority to another Trustee, they must ensure that the lead Trustee is qualified to undertake the delegated authority. This presents a practical problem since it would require the Trustees to stand in judgment of their fellow Trustee.
It is even more troublesome when after-the-fact, the Trustees must evaluate whether the lead Trustee has properly carried out his or her delegated responsibility. With a Board of Trustees comprised of only five members, it may result in difficult inter-personal dealings among the Trustees and hamper their ability to work as "one hand". This would appear to be the very reason why the authority to delegate as specified in HRS 554C-9 and Section 171 of the Restatement (Third) of Trusts (1992) refers to selecting an "agent" (other than a trustee) who would be subject to direction and dismissal by the Trustees.
Although Princess Pauahi could have designated a smaller number of trustees, she was very specific in requiring that there always be five trustees administering the Trust Estate. Your Master believes she 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.
35
It is an undisputed tenet of trust law that the most fundamental duty owed by a trustee is the duty of loyalty, which requires the trustee to administer the trust solely in the interest of the beneficiary. This duty is imposed on the trustee not because of any provisions in the trust instrument but because of the fiduciary nature of the relationship that arises from the creation of the trust. 7 Scott, The Law of Trusts 170 at 311 (4th ed. 1987).
Subsection (1) of Section 170 of the Restatement (Third) of Trusts (1992) succinctly describes that duty as follows:
170. Duty of Loyalty.
(1) The trustee is under a duty to administer the trust solely in the interest of the beneficiaries.
170 of the Restatement (Second) of Trusts); Steiner v. Hawaiian Trust Co., 47 Haw. 548, 393 P.2d 96 (1964) (approvingly citing former 170 of the Restatement (Second) of Trusts); In re Estate of Campbell, 36 Haw. 631, 653 (1944) (approvingly citing former 170 of the Restatement of Trusts).
This rule in the Restatement (Third) of Trusts (1992), which has since been codified as HRS 554C-2(b), recognizes the fiduciary relationship between the trustee and the beneficiary and the special duties that relationship imposes upon the trustee. As a result of the duty of loyalty, a trustee is prohibited from engaging in certain acts which might otherwise be lawful.
In March 1995, the Honolulu Advertiser reported on the McKenzie Methane investments of the Trust Estate. In that newspaper story, it was reported that several Trustees as well as other employees of the Trust Estate had also personally invested in the McKenzie Methane investments. The news article went on to raise a question regarding the conflict of interests which the personal investments of the Trustees and the employees created with the Trust Estate.
Comment (j) to Section 170 of the Restatement (Third) of Trusts (1992) indicates that a trustee may be prohibited from purchasing individually an interest in the subject matter of the trust if the effect of doing so would be to subject him to a temptation not to act solely in the interest of the beneficiary in the administration of the trust.
Your Master has inquiry regarding the subject matter of the newspaper article but has not received full responses to the questions raised by him. Based upon limited amount of information obtained by your Master, he has identified a number of issues which require further investigation. While the full and specific facts are not yet known to your Master, it may be that:
Your Master is of the opinion that based upon the circumstances currently known to him, there are issues regarding a potential breach of duty by some of the Trustees in connection with their co-investment in the McKenzie Methane Gas investment which require further scrutiny.
Your Master is concerned about the apparent failure of the Trustees who did not co-invest in the McKenzie Methane Gas investment to raise any concern regarding the potential conflict of interests by the investor Trustees. There is no indication that any attempt was made to conduct any kind of internal inquiry or to seek instructions from the Court. Trustees are under an affirmative duty to act to prevent a co-trustee from engaging in a breach of trust.
Section 184 of the Restatement (Third) of Trusts (1992) describes the co-trustee's duty:
If there are several trustees, each is under a duty to the beneficiaries to participate in the administration of the trust and to use reasonable care to prevent a co-trustee from committing a breach of trust, and if necessary to compel a co-trustee to redress a breach of trust.
The Hawaii Supreme Court has recognized this duty owed by a trustee in Richards v. Midkiff, 48 Haw. 32, 396 P.2d 49 (1964) (approvingly citing Restatement (Second) of Trusts 184). The Court in Richards also acknowledged that if a co-trustee fails to act to prevent a fellow trustee from committing a breach of trust, the co-trustee himself would also be guilty of a breach of trust. Id. at 42.
This duty of a co-trustee to act to prevent a breach of trust is also statutorily specified in HRS 554A-6 where the relevant provisions state:
(a) Any power vested in three or more trustees may be exercised by a majority, but a trustee who has not joined in exercising a power is not liable to the beneficiaries or to others for the consequences of the exercise; and a dissenting trustee is not liable for the consequences of an act in which the trustee joins at the direction of the majority of the trustees, if the trustee expressed a dissent in writing to any of the cotrustees at or before the time of the joinder.
***
(c) This section does not excuse a cotrustee from liability for failure either to participate in the administration of the trust or to attempt to prevent a breach of trust. [emphasis added]
Clearly, a Trustee who is aware of a potential breach of trust by any other Trustee has an affirmative duty to act to protect the Trust Estate. In instances where bona fide issues are raised regarding a breach of trust by one or more Trustees, it is incumbent upon any of the other Trustees to take steps to verify the facts and circumstances involved, identify any legal standards that have been violated, determine if the Trust Estate had been injured or prejudiced by the acts or omissions, and take appropriate steps to seek redress for the Trust Estate.
Although serious allegations were raised regarding the McKenzie Methane Gas investment, there is nothing to indicate that the Trustees attempted to take steps to verify whether the allegations were of substance or not. In your Master's opinion, this does not satisfy the Trustees' duty to prevent a breach of trust or redress such a breach.
This is not to suggest that the Trustees are duty bound to react to any charge of a breach of trust even if unsupported by any facts. Certainly a degree of judgment must be exercised. However, where such allegations are given such wide public dissemination and are based upon sufficient facts as to raise a bona fide question of the merit of such charges, they should not be ignored. For a charitable trust it is even more important to deal with such widely disseminated allegations to maintain public confidence in the integrity of the Trust Estate.
The Will of Princess Pauahi did not specify the manner in which her Trustees were to be compensated.36 Because her Will is silent, statutory provisions govern the schedule of fees payable to the Trustees. The two statutes which the Trustees cite as the basis for determining the fees to be paid to them are Section 607-18(b) and Section 607-20 of the Hawaii Revised Statutes.37
HRS 607-20 sets forth a percentage schedule which prescribes the maximum commissions payable to Trustees based upon varying percentages of revenue or income during a calculation period of not less than one year.
607-20. Charitable trusts, special provisions.
Notwithstanding any other provisions, in the case of an estate of a charitable trust, the commissions of the trustees shall be limited to the following schedule of percentages on all moneys received in the nature of revenue or income of the estate, such as rents, interests, and general profits: ten per cent on the first $1,000; seven per cent on the next $4,000; five per cent on the next $100,000; three per cent on the next $100,000; and two per cent on all over $205,000. This schedule of percentages shall be applied not oftener than once a year.
The trustees shall also be entitled to just and reasonable allowances for bookkeeping, clerical, and special services and expenses incidental thereto.
This section shall apply as well to future accounting in existing estates as to new estates.
HRS 607-18(b) provides for the payment of commissions based upon a percentage of the "cash principal received after the inception of the trust" and "final payments" of cash principal.
***
(b) Upon the principal of the estate, trustees shall be allowed as commissions . . . two and one-half per cent upon all cash principal received after the inception of the trust and neither being nor representing principal upon which the two and one-half per cent has previously at any time been charged, payable at the receipt out of the principal, and two and one-half per cent upon the final payment of any cash principal prior to the termination of the trust, payable at the final payment out of the principal . . . .
See generally Smith v. Lymer, 29 Haw. 169 (1926) (expenditures for construction of school facilities are "final payments" for purpose of calculating trustee commissions).
It is pursuant to the foregoing statutory authority that the Trustees determine the commissions payable to themselves. Based upon the statutory formula, the Trustees calculated commissions for FY 1994 as follows:
Based upon a sliding scale of percentages against revenue receipts of $182,690,974 = $3,658,100 in commissions;
B. Capital receipts:
2.5% of capital receipts ["cash principal received after inception of the trust"] of $218,913,833 = $5,472,846 in commissions; and
C. Final disbursements of capital:
2.5% of final disbursements of capital ["final payment of any cash principal prior to termination of the trust"] of $89,861,535 = $2,246,538 in commissions.
Applying the statutory schedule of percentages to those amounts, the Trustees were entitled to a maximum amount of $11,377,484 in commissions. However, because the Trustees waived a portion of their commissions on various receipts, the net commissions paid to the Trustees totaled $4,576,192 in FY 1994.38
Your Master learned that there is no written description of the methodology or formula by which the commissions payable to the Trustees is calculated. A written description would be useful for verifying whether or not the calculation of commissions was in accordance with a proper statutory interpretation.
For example, HRS 607-20 does not define the terms "revenue or income of the estate" or "general profits". As a result, it is not clear in what circumstances "net income" as opposed to "gross income" is used as the measure for calculating commissions. It is also unclear to what extent "capital losses" are offset against "capital gains" for purposes of calculating commissions. Moreover since the waiver policy of the Trustees has changed from time to time, it is important to articulate the specific waiver policy and the dates during which it is applicable.
Your Master notes that there is no procedure in place to make adjustments for commissions paid to the Trustees when there is a subsequent adjustment to the revenues or income upon which those commissions were paid.
For example, during October 1990, the Trustees transferred a group of investments known as "Rock Cap" to RHSCI at the Trust Estate's book value for the investments. The Rock Cap transfer was effected after two Rock Cap subsidiaries had already been deemed worthless. Despite this, it was only after the Rock Cap investments were transferred to RHSCI, that the losses were recorded by RHSCI.
Several years later, the Internal Revenue Service disallowed the deduction of the losses on Rock Cap by RHSCI.39 The IRS asserted that the losses did not belong in RHSCI and should have been recorded by the Trust Estate prior to the transfer. Had the Rock Cap losses been recorded by the Trust Estate prior to transfer to RHSCI, it would have resulted in a reduction in that year of the total revenues upon which commissions were calculated. Despite the IRS determination, the Trustees did not make a subsequent adjustment to recapture the commissions previously paid.
It is not known to your Master what adjustment amount might be warranted because of the disallowance of the deduction of the losses on Rockcap by RHSCI. However, your Master notes that the amounts involved where the Trustees transfer non-performing assets to subsidiaries of the Trust Estate are not insignificant and could have a material effect on commissions payable to Trustees. For example, the notes to the Trust Estate's financial statements for FY 1994 reflect that in FY 1993 the Estate transferred a $34,586,042 investment to a wholly-owned subsidiary.
The Trust Estate has made substantial loans to its for- profit subsidiaries such as Pauahi Holdings, Inc. Although Pauahi Holdings, Inc. is a 100% owned subsidiary, nevertheless its interest payments to the Trust Estate on loans made by the Trust Estate are treated as income to the Trust Estate for purposes of calculating commissions payable to the Trustees. It is not clear to your Master whether such a practice is permitted under HRS 607-20. Particularly when viewed as a whole, the Trust Estate is not gaining from the transaction since the income to the Trust Estate is merely an interest expense of its wholly owned affiliate.
Under GAAP the loans to the affiliates and the related interest income would be eliminated. As a result, none of the interest income to the Trust Estate would be included in the computation of commissions to the Trustees.
It is not clear to your Master that the Trustees are properly characterizing certain investment distributions for purposes of calculating commissions. For example, some distributions from partnerships comprise return of capital as opposed to partnership income. The Trustees should not be entitled to any commission on a return of capital since it is not an infusion of new cash principal. Rather it is only a return of the original equity investment. Simply put, the Trustees would be paying themselves commissions based upon the original capital invested in the partnership rather than limiting the commissions to the income or gain generated from that investment. Cf. In re Estate of Foster, 33 Haw. 666 (1936)(a trustee may not receive commissions twice upon cash principal received after the inception of the trust).
On June 30, 1996, President Clinton signed into law legislation referred to as the Taxpayer Bill of Rights 2, Pub. L. No. 104-168, 110 Stat. 1452, (1996). A key component of that legislation was the enactment of Internal Revenue Code section 4958 ("Intermediate Sanctions Law") which provided for the imposition of intermediate sanctions in the form of excise taxes on "excess benefit transactions" between a "disqualified person" and a tax-exempt organization such as the Trust Estate.
This salutary legislation is aimed at making tax-exempts more accountable, improving compliance with the law, and providing the public with more information about such organizations through disclosure requirements. It also incorporated the effort by Congress to mitigate the extreme penalty of the loss of tax-exempt status which a non-profit organization might face because of misconduct by its principals. The legislation provides for intermediate sanctions which would penalize the principals but save the tax-exempt organization itself from loss of its tax-exempt status.40
One of the essential factors for an organization to maintain its tax-exempt status is it must not allow any of its earnings to "inure" to the benefit of a private shareholder or individual. Inurement is the improper diversion of an organization's net earnings by persons with substantial influence over the organization for their private benefit or that of related parties (such as family members). This would include excessive salaries, interest-free loans, use of resources of the tax-exempt for a private benefit, and other instances of self-dealing.
A recent article in the Journal of Accountancy summarized the impact of the new Intermediate Sanctions Law:
Excess benefit transactions also include those in which a tax-exempt makes payments wholly or partially based on its revenues, as defined by regulations to be written by the Treasury. The penalty taxes will be levied on any disqualified persons who benefit from the transactions and on organization managers who participate in the transactions knowing they are improper.
Who are disqualified persons? Individuals who are officers, directors or trustees typically are disqualified persons unless they are not able to exercise substantial influence over the organization. The legislative history says an individual may be disqualified even if he or she is not employed by the organization in question as long as that person is able to exercise substantial influence. Family members of disqualified persons also are considered disqualified, as are entities in which a disqualified person has a 35% ownership interest. An individual's classification as disqualified continues for five years after he or she severs ties with the tax-exempt organization.
Compensation of "disqualified persons" is an area of potential private inurement which is subject to close scrutiny. Whether compensation results in private inurement depends on its reasonableness. The standards for evaluating reasonableness are still being crafted in regulations yet to be issued by the Treasury Department. However, according to the House Ways and Means Committee Report on H.R. 2337, a compensation arrangement is presumed to be reasonable if it meets three requirements:
Intermediate sanctions may be imposed on excess benefit transactions which occurred on or after September 14, 1995. As for benefits paid under a written contract in effect on September 13, 1995, that has not materially changed, if the contract was formed after that date but before January 1, 1997, the contracting parties may rely on the rebuttable presumption of reasonableness described earlier by meeting the foregoing threefold criteria within a reasonable period after entering into the compensation package. As for contracts entered into from 1997 and later, the rebuttable presumption of reasonableness will be allowed only if the threefold criteria are satisfied prior to payment of compensation.41
The Intermediate Sanctions Law requires a new perspective by the Court regarding compensation for the Trustees and other "disqualified persons" with respect to the Trust Estate. Currently, the Trustees determine their own level of compensation within the parameters set by statute. However, in light of the Intermediate Sanctions Law, that procedure may no longer be appropriate.
Your Master is informed that the Internal Revenue Service is currently conducting an audit of the Trust Estate. The information sought pursuant to the audit is quite extensive and overlaps a number of areas of inquiry in connection with the annual account. Despite the potential significance of that inquiry, your Master has not had an opportunity to obtain adequate information regarding its nature and scope.
30 It is unclear when this informal practice was initiated and how long it has been followed by the Trustees. Your Master found no written documentation establishing this practice or references to it in the minutes of the meetings of the Board of Trustees. Such a management model was one of various alternative models considered by Ernst & Young in an undated report titled: "Alternative Organizational Structures" which was prepared in 1994.VI. ANNUAL ACCOUNT REVIEW PROCESS31 In an earlier case involving an individual trustee’s effort to file suit on behalf of the Trust Estate, the Hawaii Supreme Court noted:
Richards v. Midkiff, 48 Haw. 32, 40-41, 396 P.2d 49, 55 (1964).
32 The standard of prudent investment in Section 227(c)(2) of the Restatement (Third) of Trusts (1992) requires that Trustees "act with prudence in deciding whether and how to delegate authority and in the selection and supervision of agents" who are involved with the investments of the Trust Estate.
33 The formal organizational hierarchy of the Trust Estate is headed by the Board of Trustees who oversees two principal divisions: the Education Group and the Asset Management Group. These two divisions are in turn supported by the Administration Group and the Legal Group. See 1994 Annual Report of the Kamehameha Schools Bernice Pauahi Bishop Estate, at 26. The organizational structure has since been revised with the addition of a Budget and Review Group.
34 Your Master notes that the position of Principal Executive for the Asset Management Group became vacant in 1995 with the death of Anthony Sereno. The position remains vacant with Trustee Peters carrying out much of the responsibilities previously performed by Sereno.
35 This Court has previously addressed a recommendation by Michael D. Hong, Esq., Master for the 100th Annual Account, that the Trustees appoint a Chief Executive Officer to manage the Trust Estate and report to the Trustees. In the order approving the 102nd Annual Report, the Court concluded that:
[T]he Court will not interfere in the administration of the Trust by the Trustees absent an abuse of discretion or breach of fiduciary duties. Staffing is a matter of trust administration. Therefore, possible creation and appointment of a chief executive officer for the Estate is not an appropriate matter for judicial action at this time.
Findings of Fact, Conclusions of Law and Order Approving 102nd Annual Report, filed herein on October 16, 1990, at 9. There is no indication that the Probate Court reviewing the 102nd Annual Account considered any circumstances involving an informal management system comprised of "lead Trustees" as described herein.
36 At the time the Will was prepared, there was no statutory provision for the payment of fees to trustees. It was not until 1928 that legislation was enacted which specified a schedule for trustee fees. See generally In re Estate of Bishop, 37 Haw. 111 (1945) (discussing the history of trustee compensation).
37 Because the language of HRS
38 For several years the Trustees have waived all commissions on educational revenue receipts (e.g., tuition), capital receipts (principally gains realized from sales related to the Trust Estate’s condominium and single-family residential land sales program) and final disbursements of capital (payments for fixed assets such as a classroom building). However, in FY 1994, the Trustees modified this historical waiver practice and paid themselves commissions on certain final disbursements of capital. Had they continued their historical practice, the net commissions payable would have been $4,084,380 for FY 1994.
39 The full extent to which the deduction was disallowed is not known since the Trustees did not provide the information requested as of the date of this Report.
40 This legislation was beneficial for the Trust Estate since it insulates its tax-exempt status from the consequences of any improper actions by its Trustees.
41 This assumes that the Treasury regulations will follow the House Committee on Ways and Means rebuttable presumption criteria.
Princess Pauahi explicitly required her Trustees to annually account to the Court by providing in her Will that:
While she entrusted a high level of discretion, she also expected that they be accountable. The annual review by this Court of the Trustees' account is therefore integral to maintaining the integrity of the Trust Estate.A. General Comments Regarding The Review Process For The 109th Annual Account.
Your Master notes that because of the size and complexity of the Trust Estate, the annual account review process has become an increasingly challenging undertaking. The Trust Estate is a massive and complex educational and financial organization. Even with the information required by the Restated Guidelines, the current review process does not lend itself to ready evaluation of the operations of the Trust Estate. The problem facing any Master reviewing the account is whether he or she can undertake and complete the review process in a meaningful yet expeditious manner which would give confidence to all interested parties that the Court has properly fulfilled its review function.
Unfortunately, this task is not facilitated by the Trustees. While the Trustees are careful to comply with the strict requirements of the Restated Guidelines, your Master found that they did not volunteer information or highlight any issues or decisions of significance which may have arisen during the fiscal year being reviewed. Rather, the Master is left to sift through a room full of documents and identify any issues which require further inquiry and pursue the necessary information regarding such matters.
Your Master was also taken aback by the level of secrecy and monitoring of the Master's review demanded by the Trustees. Of all the information provided to your Master, he was allowed to remove from the Trust Estate's premises only a minuscule amount. The Trustees also insisted on knowing of each interview of current employees and former employees conducted by your Master (although not necessarily the content of such interviews). Subjected to such scrutiny, your Master could not help but feel as though he was reviewing the CIA's finances rather than those of a charitable educational organization.
Based upon 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. That is, of course, not the case. The annual review of the Trust Estate's account is done at the direction of Princess Pauahi in accordance with the terms of her Will. It is not only a statutory requirement.
Accordingly, the Trustees should approach the annual review with a good faith desire to comply with the settlor's intent and provide meaningful information to the Court through its Master regarding the affairs of the Trust Estate.
Information should neither be dribbled out nor provided in such a voluminous manner so as to make any meaningful analysis burdensome. Presumably, the Trustees are regularly furnished with monthly financial reports, investment summaries, informational briefings, and reports regarding issues affecting the Trust Estate in a readable and comprehensible format. The availability of such information should be volunteered by the Trustees to the Master. It should not be incumbent upon the Master to have to figure out what exists and then ask for the information. Obviously, the same sort of information the Trustees require to properly administer the Trust Estate would probably be helpful for the Court's annual review.
The annual review by the Court is to ensure the integrity of the Trust Estate. The Trustees should be committed to rendering a full and meaningful disclosure of the condition of the Trust Estate to the Court. The Trustees should therefore view the annual review process as an opportunity to report their good work and promote public confidence in their stewardship of the Trust Estate.
As previously discussed, the information currently presented to pursuant to Parts B, C, D, and E of the Restated Guidelines are inadequate for a proper evaluation of the investment performance of the Trust Estate's financial portfolio. Your Master recommends that the Restated Guidelines be amended to incorporate the following recommendations:
Your Master notes that Princess Pauahi contemplated that the investments of her Trustees be made public when she specified in her Will that the Trustees annually publish in a newspaper an "inventory of the property in their hands and how invested". That publication was accomplished on October 27, 1997 in the Honolulu Advertiser. See Affidavit of Publication of Annual Statement of Personal, Real and Other Property Held at June 30, 1994, of Kamehameha Schools Bernice Pauahi Bishop Estate filed herein on November 10, 1997 (attached hereto as Exhibit "G".
The Trustees should modify the format and content of their publication of the list of the Trust Estate's investments. Your Master is of the opinion that the current published notice does not satisfy the direction and intent of the Will.
The Restated Guidelines require the Trustees to provide a schedule of all real estate transactions for the fiscal year under review. While the Trustees append a comprehensive list of transactions involving fee sales and acquisitions of Hawaii real estate, there is no mention made of any leasehold transactions or any real estate transactions involving real property outside of Hawaii. Your Master believes that such omissions are inconsistent with the requirement of the Restated Guidelines.
The Restated Guidelines require the Trustees to provide a schedule of all receipts and disbursements of the Trust Estate during the annual review period. This schedule is typically a voluminous computer print-out of names and dollar amounts. While your Master believes that the detailed schedule should continue to be furnished, the information should also be presented in a format which is more comprehensible and useful.
To ensure compliance with the terms of the Will and applicable laws, at the very least, the information should be provided in a format which delineates gross receipts by income categories; summarizes disbursements according to groupings corresponding to income categories; reconciles net trust income; delineates gross receipts and disbursements for corpus; reconciles net changes to corpus; and be reconciled with the financial statements and the trustees' commission computation.
The Restated Guidelines requires that the Trustees file:
Despite this explicit requirement of the Restated Guidelines, such a list was not appended to or filed in connection with the Petition for Approval Of The One Hundred Ninth Annual Account.
Your Master reviewed the Minutes of the Meetings of the Trustees which were held during FY 1994. The Trustees hold regular meetings on Tuesday and Thursday morning of each week. Your Master found that while minutes were prepared for each meeting, the minutes lack any significant detail or specificity. There is nothing in the minutes to indicate the nature of any discussion or debate among the Trustees regarding any issues. A review of the minutes alone would furnish little guidance as to the basis for the exercise of the discretion entrusted to the Trustees in their decision making.
As mentioned earlier, certain decisions (as in the case of the Kahala Hilton lease) are not reflected on the minutes. Such material omissions are unacceptable. Greater care needs to be exercised to ensure that the minutes reflect all material matters discussed and decided at meetings of the Board of Trustees to ensure that a credible and complete record is maintained.
Your Master also believes that the Trustees may occasionally hold special meetings for which minutes are not available or were not furnished to your Master. For example, your Master was informed that the Trustees held "retreats" at which various planning decisions were made. Your Master was not provided with any minutes of such meetings if they were held.
The Restated Guidelines require the Trustees to provide a list of current litigation. In the connection with the approval of the 103rd Annual Report, the Court defined the term "current litigation" and ordered that:
The term "current litigation" as used in item 7 of Part A of the Amended Order of July 12, 1989, shall mean and refer to litigation pending at the time of a Master's appointment even if such litigation concerns matters outside the period under review, and the Trustees shall identify to future Masters any "current litigation" which concerns the Will of Bernice Pauahi Bishop; construction of the Will or the Trust; the administration of the Estate; the mission, goal or objective of the Kamehameha Schools/Bernice Pauahi Bishop Estate; the powers duties, and responsibilities of the Trustees; or which in the reasonable opinion of the Trustees likely will materially affect the Estate or its operations.
In response to paragraph C.8. of the Restated Guidelines, your Master was provided with computer print-outs listing the various pending litigation matters in which the Trustees, the Trust Estate, and its affiliates were parties, along with a status of each case (pending, settled or closed). There was no summary or other description of the nature of each case provided.
As presented to your Master, the materials comprising the Trustees' response to paragraph C.8. are not helpful to the annual review. In the future, the listing such be supplemented to include a case summary which identifies whether any case listed involves a matter which concerns the Will; construction of the Will or the Trust; the administration of the Trust Estate; the mission, goal or objectives of the Trust Estate; the powers duties, and responsibilities of the Trustees; or a matter which in the reasonable opinion of the Trustees was likely to materially affect the Trust Estate or its operations.
The Trust Estate is required to provide the Master with a statement of the complaints received by the Trust Estate and the Attorney General as parens patriae. That requirement should be modified to require that the Trustees furnish the Master with any complaints received at any time which relate to any matter within the period of the annual account. This should include any newspaper accounts and other media reports which may raise various allegations concerning the operations of the Trust Estate.
Your Master noted that during 1995 there were several newspaper accounts which appeared in various publications which raised questions relating to the investment practices of the Trust Estate, allegations of conflicts of interest by Trustees and employees of the Trust Estate, and other financial and fiduciary issues which involved the period under review. Yet none of these media accounts were included in the materials provided in response to paragraph C.15. of the Restated Guidelines.
The Trustees are required by the Guidelines to prepare an annual report. The history behind that requirement can be traced back to the Dodd Report which observed:
The Dodd Report went on to recommend that:
The Court then ordered:
Your Master notes that the annual report as now prepared is of little utility to the annual account review process. While it is a slick and attractive brochure which has the appearance of an annual report of a Fortune 500 company, its content is of very little substance and would certainly not satisfy a shareholder of such a company.
The annual report should be prepared in a manner that facilitates the annual account review process as was intended in the Dodd Report. This means that its content should include meaningful data concerning the experiences of the Trust Estate in the fiscal year reported. Among the information it should contain are the following:
(b) A listing of the investments of the Trust Estate and the estimated current fair market value of the investments.
(c) An analysis of the current asset allocation of the Trust Estate's investments and an explanation of any variance from established asset allocation goals.
(d) An analysis of the return (income yield and total return) on the Trust Estate's overall portfolio investments as well as specific asset classes.
(e) An analysis of the Trust Estate's contingent loss exposure.
(f) A discussion summarizing the major investment and operational decisions made by the Trustees during the fiscal year.
(g) A discussion summarizing new investments acquired or entered into and the disposition of previously acquired investments during the fiscal year.
(h) A discussion summarizing material developments affecting key investments of the Trust Estate and its subsidiaries.
(i) A discussion summarizing external events which materially affect or are anticipated to affect the Trust Estate, such as legislation, government regulations, tax laws, regulations and rulings, judicial decisions, and economic developments.
(j) A discussion of any noteworthy fiduciary issues currently involving the Trustees or other fiduciaries of the Trust Estate as well as any which arose during the fiscal year.
Prepared in that manner, the annual report required by the Guidelines would furnish the Court and its Master with a meaningful foundation and outline from which to start his or her review of the annual account.
The Trust Estate's overall strategic plan is a critical component of the review process and should be provided to the Master for review along with a progress report on the Trust Estate's attainment of the objectives set forth in the strategic plan. Such a strategic plan should not be confused with a 10-year budget projection.
Employees of the Trust Estate are bound by confidentiality clauses in their employment contracts. Such confidentiality provisions operate as a deterrent to free and open provision of information from employees to the Court's Master. During your Master's review of the annual account, he was required to arrange all contact with employees of the Trust Estate through the General Counsel's Office. This proved to be cumbersome and it may have had a chilling effect on the interview process since employees would be contacted by the General Counsel's Office prior to being interviewed by your Master.42 Your Master suggests that the Guidelines should make clear that such confidentiality provisions are inapplicable and may not be enforced with respect to any communications between any employee of the Trust Estate and its subsidiaries and the Court's Master. The Trustees should also be required to modify the confidentiality clauses in any future contracts with its employees so as not to inhibit communications with the Court's Master.
Currently, the Restated Guidelines require the Trustees to make written "statements and representations" concerning the Accounting Period upon which the Master may rely. In connection with the approval of the 103rd Annual Account, the Court previously ordered that the Trustees issue a certified statement. Findings of Fact, Conclusions of Law and Order Approving the 103rd Annual Report, filed herein on October 16, 1990, at 8. As such the Restated Guidelines should be amended accordingly.
The form and content of the certification by the Trustees should also be modified. The current statement is too limited and somewhat ambiguous. Instead, it should certify that all facts and circumstances that are within the control and knowledge of the Trustees have been fairly presented to the Court.
The statement should also certify that none of the Trustees has committed any intentional or knowing breach of his or her fiduciary obligations. It should also certify that each Trustee has no knowledge of a breach of fiduciary duty or other misconduct by any other Trustee or employee of the Trust Estate. In addition, certain key employees and independent agents who are in a fiduciary relationship with the Trust Estate should also be required to provide similar certifications.
The Master should be able to examine the legal advice and standards by which the Trustees are being guided in their administration of the Trust Estate. The Trustees should be required to make available to the Master all legal opinions prepared by or paid for by the Trust Estate which provide advice regarding fiduciary duties. This would not include any legal opinion protected by the attorney-client privilege provided to an individual Trustee not paid for by the Trust Estate.
The Trustees should be required to provide information to the Master regarding internal investigations regarding trust issues of a fiduciary nature concerning any Trustee or employee of the Trust Estate.
42 In fact, several present and former employees did express hesitation and requested assurances that they would not be violating the confidentiality clauses of their employment contracts or otherwise subject to liability by speaking with your Master.
Based upon the foregoing Report and recommendations, your Master respectfully requests the following:
DATED at Honolulu, Hawaii, November 17, 1997.
[Signed]
COLBERT M. MATSUMOTO
Master