May 20, 1999 | Read Time: 12 minutes
Move by court seeks to avert threat to Bishop Estate’s tax exemption
A long struggle to wrest control of one of America’s wealthiest and most powerful charities
ALSO SEE:
Old and New Trustees of the Bishop Estate
FROM THE ARCHIVES:
1/15/98: Trustees of Hawaii’s Wealthiest Charity Make Changes to Quell Criticism
10/8/98: In Unusual Move, Hawaii Seeks to Remove Trustees of Embattled Bishop Estate
04/22/99: Top Trustee Indicted at Big Hawaii Charity
from its trustees reached a major milestone this month with their removal from office and the installation of a panel of court-appointed trustees.
At the urging of the Internal Revenue Service, a Hawaiian probate judge ousted — at least temporarily — four incumbent trustees and accepted the resignation of the fifth, saying their continued tenure in office would jeopardize the tax-exempt status of the multibillion-dollar Bernice Pauahi Bishop Estate, in Honolulu. The trustees, each of whom last year received more than $1-million in compensation, have faced increasing criticism during the past two years for a long list of alleged abuses involving mismanagement, conflicts of interest, and enrichment of themselves and their cronies at the charity’s expense.
Probate Judge Kevin Chang said he took the extraordinary action to avert an I.R.S. threat to revoke the trust’s tax exemption. The Bishop Estate’s sole beneficiary is the Kamehameha Schools (now a single institution), which educates more than 3,000 children of native Hawaiian descent. Loss of tax-exempt status could cost the estate tens of millions of dollars a year in federal taxes — and could force it to pay state and county taxes as well.
On the school campus and throughout much of Hawaii, Judge Chang’s decision was hailed as a welcome, if overdue, development. But some critics of the ruling saw it as a blow to native Hawaiians — or even as a chilling example of how the I.R.S. can use its muscle to impose on a charity a wholesale change in leadership.
Judge Chang said he found that the “inaction and indifference” of the four trustees he removed constituted “a breach of duty” that warranted their temporary dismissal. The probate court reserved for later consideration the question of whether the removals should be made permanent.
The estate’s chairman, Richard S. H. Wong, has been quoted as saying he would appeal the decision and fight to regain his position with the estate, which is Hawaii’s largest landowner and controls a far-flung financial empire with assets estimated variously to be worth between $5-billion and $10-billion. The other sacked trustees are said to be considering their legal options.
But many observers consider their reinstatement unlikely. “The old trustees, as a practical matter, are gone for good,” said Randy Roth, a University of Hawaii law professor who has been a persistent critic of the former trustees.
In a separate ruling issued the day before Judge Chang’s decision, Judge Bambi Weil ordered the permanent removal of Lokelani Lindsey from the board. Two of Ms. Lindsey’s fellow trustees — Gerard A. Jervis and Oswald K. Stender — had sought her dismissal on grounds of mismanagement and repeated breaches of her fiduciary duties.
Two other trustees — Mr. Wong and Henry H. Peters — also have been indicted on charges of receiving kickbacks on their condominium purchases in exchange for arranging a “sweetheart deal” for a Hawaii developer when he acquired part of the estate’s interest in another condominium complex. Both men have denied the allegations.
The I.R.S. has been conducting an extensive audit of the Bishop Estate for nearly a decade. It has expressed concern that the trustees have:
* Received excessive compensation.
* Used estate funds for their personal expenses.
* Focused on expanding the estate’s lucrative commercial activities at the expense of its charitable purpose of running an educational institution.
* Improperly lobbied against federal legislation enacted in 1996 that penalizes excessive compensation or perks among non-profit officials and board members.
The federal tax agency presented its initial findings to the estate in January. Judge Chang ruled that the interests of the incumbent trustees in dealing with I.R.S. concerns conflicted with those of the estate. He therefore named five prominent Hawaiians to be “special-purpose trustees” who would negotiate with the agency on the charity’s behalf.
Talks came to a head last month when the I.R.S. set forth several conditions for negotiating a settlement of the issues that the agency turned up in its audit. The service restated those conditions in a letter to the special-purpose trustees. They included:
* Permanent removal of the incumbent trustees. “As long as the five incumbent trustees are in a position to direct the Estate’s operations,” the letter states, “the Service believes that the assets are at risk.”
* The devising of a system for selecting qualified trustees. The 1884 will of Princess Bernice Pauahi Bishop, the last descendant of King Kamehameha I, stipulates that trustees be appointed by justices of Hawaii’s Supreme Court, acting in their private capacities. But in the past couple of decades — as annual trustee compensation jumped from $50,000 to more than 10 times that figure — the position became a political plum, awarded by the justices mostly to people with strong ties to the state’s Democratic Party. Last year, responding to widespread criticism, four of the five justices recused themselves from making future appointments.
* Several other changes, including a revision of the way trustees and other officials are compensated, and the imposition of stricter internal and external audit procedures.
The letter, which was signed by Marc Owens, who directs the service’s Exempt Organizations Division, and Terry Franklin, chief charity regulator in the I.R.S.’s Western district, warned that the service would end the negotiations and revoke the estate’s charity status if it detected any apparent attempt to remove trust assets from I.R.S. jurisdiction.
“The Estate,” it said, “lacks internal controls and the requisite fiduciary oversight to ensure that only activities appropriate for a tax-exempt charity occur.” The letter added: “Interim removal of the incumbent trustees will ensure a stable environment for closing agreement discussions and clearly demonstrate the bona fide nature of negotiations on behalf of the Estate.”
In a highly unusual step, the service also offered to expedite what is normally a lengthy process for resolving audit disputes, which involves passing sequentially through successive layers of bureaucracy. Instead, it proposed using a “special consolidated procedure” in which representatives from the relevant local, regional, and national I.R.S. offices would simultaneously try to hammer out a “closing agreement” with the special-purpose trustees to resolve all matters raised in the audit.
That combination of carrot and stick prompted Judge Chang to remove four of the incumbent trustees and to accept the resignation of Mr. Stender — who has waged an unsuccessful battle to persuade his fellow trustees to institute several structural and procedural changes.
“Simply put,” wrote Judge Chang, “with the exception of Trustee Stender, the other Incumbent Trustees are not acting in the interests of the welfare, protection and preservation of the Trust Estate.”
The judge then named the five special-purpose trustees to fill the resulting vacancies on an interim basis, until the former trustees are reinstated or a new system for selecting permanent trustees is in place.
The five interim trustees, whose compensation has not yet been determined, are vested with “full and complete discretion, power, and authority” to run the estate’s affairs, Judge Chang declared.
Many Hawaiians hope that the judge’s action will help heal deep divisions between students, teachers, alumni, and administrators of the Kamehameha Schools. The 600-acre campus has been in turmoil since the spring of 1997, when students and faculty members staged a virtual revolt against what they saw as the arrogant, high-handed, and intimidating management style of the trustees.
But praise for Judge Chang’s decision was not universal.
“There was a complete lack of due process that I found astonishing,” noted N. Jerold Cohen, an Atlanta tax lawyer who once served as chief counsel for the I.R.S. and more recently was hired to advise the Bishop Estate trustees. Judge Chang gave the trustees less than a week to respond to issues raised in the audit, he said, and ordered their removal prematurely, in his view.
“They should have been given 30 days to review [the documents], and the opportunity to discuss them with the I.R.S.,” he said. “Whether the trustees should be removed or should be left in charge of the trust is a decision that ought to have been reached after the I.R.S. made its final determination, not before.”
Mr. Cohen said the federal agency’s action to secure the trustees’ ouster should sound a tocsin for other non-profit groups. “The entire charitable world ought to be alarmed if indeed the I.R.S. is going to say to a charity, We’re not going to negotiate with you unless you remove the trustees,” he said.
Not everyone agrees. “This is not anything that the charitable sector should be concerned about,” said Bruce R. Hopkins, a Kansas City lawyer who specializes in non-profit law. “In fact, they probably should applaud it,” since the process shows that the I.R.S. is committed to curbing abuses. Mr. Hopkins has had no involvement with the Bishop Estate, he said, although “from reading the media reports, this is an egregious case.”
The new trustees named the Bishop Estate’s in-house lawyer, Nathan Aipa, as its chief operating officer — a new position. The charity’s other principal executives will report to Mr. Aipa, who has served as the trust’s general counsel since 1986.
The old trustees had been acting more like chief executive officers than traditional trustees — getting involved in day-to-day management rather than simply setting policy and leaving the administration to others. Critics charged that such a practice created severe management problems — and served principally to help the trustees to justify receiving such high compensation.
The trustees, under state law, have been entitled to draw collectively up to 2 per cent of estate revenues in commissions. Even forgoing a portion of the full amount, they each took home $844,600 in the fiscal year ending June 30, 1997, and more than $1-million last fiscal year. Despite passage last year of a state law limiting pay for trustees of charitable trusts to an amount that is “reasonable under the circumstances,” the trustees each received $862,000 in the first 10 months of the current fiscal year — until Judge Chang ordered a hold on any further compensation.
The trustees agreed in October to name a chief executive officer and to convert to a more typical style of management, in which they would relinquish their administrative roles.
But they failed to make that conversion by a court-ordered deadline of March 29.
Judge Chang noted in his ruling that, with the exception of Mr. Stender, the trustees’ failure to follow the court order “was not thoughtless or inadvertent” and that legal sanctions were warranted, though he did not specify the type.
In addition to being forced to give up their jobs, at least four of the five former trustees are widely expected to face hefty fines imposed by the I.R.S. under a 1996 law that allows the agency to penalize charity officials who receive overly generous financial benefits. Those excise taxes are often called “intermediate sanctions” because they allow the service to punish abuses at charities without revoking their tax-exempt status — which previously had been its only recourse.
The law permits the I.R.S. to impose fines equal to 25 per cent of the benefits found to be excessive on the official who received them; if that person fails to pay the penalty promptly, he or she faces fines of up to 200 per cent of the amount in dispute.
Although the law was passed in 1996 and applies to transactions that occurred after September 13, 1995, the service has yet to issue final regulations that describe how it will enforce the law. Some observers think that, for that reason, the service may hesitate to invoke the law in the case of the Bishop Estate.
But others say the law is clear, even if some details have yet to be filled in. “It’s a natural test case for intermediate sanctions,” said Mr. Hopkins. “If they can’t win this one, they should give up.”
Mr. Roth notes a certain irony in the fact that the former trustees spent hundreds of thousands of dollars lobbying against passage of the legislation.
“Had they been successful in their attempts to prevent the enactment of the intermediate-sanctions law, the I.R.S. today would have no option but to revoke the charity’s tax-exempt status.”
The service might still take that step, if only to require the Bishop Estate to file a new application for charity status that spells out additional conditions imposed by the agency to prevent future abuses. But Mr. Roth said that “because the court acted so quickly and decisively, and because the replacement trustees are so competent, I’m quite optimistic that the I.R.S. will simply require a number of changes and impose a lot of intermediate sanctions, but will leave the tax-exempt status alone.”
Some defenders of the former trustees see the I.R.S. action as an opportunistic attempt to use mounting criticism of the trustees as an excuse to replace a group of knowledgeable and successful trustees with a more pliable panel of successors. “When you bring in five trustees who are not familiar with the estate, how can they reasonably protect the estate’s interest with that kind of background?” said Renee Yuen, a lawyer representing Mr. Peters, one of the trustees removed by Judge Chang. “You don’t have in place the kind of people with historical involvement in the estate that are going to be standing tall in front of the Internal Revenue Service when it’s called for.”
Said Ms. Yuen: “I find it sad that you have a Hawaiian institution run by Hawaiian trustees that has been very successful, but is now being torn apart by critics from the outside.”
Others take a different view.
“Hawaii’s a small state, and the Bishop Estate is one of the major economic powers on the island,” said Daniel L. Kurtz, a former New York charity regulator who has written about board liability. “The people running it had more or less unchecked power. Unless you have saints or philosophers occupying seats of power, people are corrupted by it. I think that’s what happened here.”
