The Harmon Chronicles

THE HARMON CHRONICLES - 1988 - 1996

~ ~ ~

11/??/88 BH hired by KSBE. He was hired by Gil Tam, who was at the time Dir. of Personnel [Ltr]

??/??/89 The responsibility for KSBE’s safety program was added to BH’s functions.

??/??/89 Trustees approve the McKenzie Methane deal, with trustees, managers, family members, contractors, etc., co-investing their own money.

Various BH re: The Kona Enterprises, Wayne Rogers et al claim. When the first lawsuit in this case was filed in North Carolina, it was apparently so "sensitive" that Aipa did not report the claim to United Educators, the E&O carrier. Consequently, the insurance company did not pay any defense costs in the North Carolina case. As these costs were paid out of the OGC account, and not the insurance account, I do not know how much this omission on the part of Aipa cost the estate in lost recoveries from the insurance carriers.

I did get word of a second lawsuit filed in Utah and gave notice of the claim to UE. Aipa assigned Lyn Anzai to handle the claim directly with the carrier.

In a letter to Anzai dated 08/13/93, UE's claims adjuster, Joseph McCullough, points out:

"As we discussed, the plaintiff has made allegations and seeks certain remedies which fall outside the coverage of the insurance policy..."

"Several of the trustees of the Bishop Estate also made individual investments and became shareholders in Kona. While your investigation indicates that they did not act outside of the scope of their duties to the Estate, should it be determined that they did act outside this scope, the United Educators policy would not be able to indemnify for that liability."

“The policy also excludes any loss arising out of any insured gaining a profit or advantage to which they were not entitled."

"It is further alleged that the Bishop Estate violated Rule 10b-5 of the Securities Exchange Act of 1934. The policy excludes damages arising from a willful violation of a statute or governmental regulation and the policy will not apply to any damages arising out of this allegation."

"The policy will respond to the defense of the lawsuit and any damages arising out of covered allegations, in excess of the retention. The retention applies to both defense costs and damages combined."

"Under the terms of your policy, you have the right to select defense counsel subject to our approval. Our approval is predicated on defense counsel agreeing to work within the parameters of the enclosed Defense Counsel Guidelines..."

"We will not be able to credit the retention or pay any amounts which are incurred without our prior approval. Until we receive a legal budget we can only authorize up to $25,000 for counsel to protect your interests..."

A 3rd lawsuit was filed in Hawaii. Despite UE’s warnings, Aipa retained attorneys Michael Hare of Cades Schutte Fleming & Wright, as well as William Raper of Womble Carlyle Sandridge & Rice in North Carolina, without the required prior consent of the insurance company..

With Aipa's knowledge, the Cades firm continued to disregard UE's Guidelines. This resulted in fees and expenses that UE questioned and would not approve. Consequently, Aipa began paying the Cades firm from his General Counsel's account rather than from my insurance account.

A memo from McCullough dated 03/21/96 said that many of the Cades fees were disallowed due to noncompliance with the policy terms. The Hawaii case was settled in KSBE's favor, but was appealed to the 9th Circuit.

I don’t know the total defense costs in this case, or how much UE has paid. But if the original lawsuit had been reported, and if UE's Guidelines and policy conditions had been followed, the total defense costs to KSBE should have been limited to the self-insured retention of $250,000. I know that the Cades firm alone had billed approx $760,000 as of 09/30/96. (Note: Cades also billed approx. $13,000 for a review of the Master's inquiries into this litigation.)

Various BH re: Politics and political favors. Even before I accepted my position with KSBE, I was advised by Gil Tam that KSBE was "a very political organization." At the time, I had no idea what this really meant. I began to get an inkling when I was "invited" by Tam to attend a political fund-raiser for Milton Holt, a KSBE employee. The fund-raiser was held at Bishop Museum, a non-profit, tax-exempt organization founded by Charles R. Bishop. The trustees for the C.R. Bishop Estate are the same trustees as for Bishop Estate. On another occasion I was "invited" to attend a fund-raiser for Bob Herkes, an employee of KIC. This was also held at Bishop Museum.

On one occasion I was invited by Mr. Tam to "waive signs" for Henry Peters who was running for re-election to the State House of Representatives. Although I was not even a resident of Peters' district, I "volunteered". Luckily, for me, the demonstration was called off on account of rain.

Rocco Sansone personally met with Peters, to ask his assistance in getting "wrap-up" insurance legislation passed in the 1996 session. This legislation is expected to greatly benefit the large brokers who are experienced and equipped to handle these large multi-insured programs - at the expense of the small agents who are not so equipped...

Various - BH re: The Environmental Protection Act Intentional Violations. Staff members in the Asset Management Group expressed concern in some of our meetings that, given all of Bishop Estate's property holdings, it would cost too much to comply with the regulations. If the properties were undeveloped, suggestions were made that KSBE should wait until there were plans for development; then the developer could pay to remedy the environmental hazards. The advice of in-house attorneys at these meetings was that we should not try to identify problem locations because "if we knew about them we would have to correct them." The advice of the Legal Group prevailed. Consequently, for several years little was done in the way of identifying, remedying or insuring potential environmental hazards. The responsibility for managing environmental risks was assigned by Aipa to Alan Yee. As with many of these "sensitive" matters, one purpose of this assignment was to maintain the attorney-client privilege. As a result I often was not given information about environmental issues until I learned of them through other sources or an actual problem arose.

An example is the Nationwide Industries’ acquisition. Colleen Wong and Alan Yee were responsible for performing due diligence for mergers and acquisitions. Nationwide had a chemical manufacturing plant in Pandora, Ohio, which had known problems with chemical leaks or spills. Ms. Wong and Mr. Yee either failed to determine this in their due diligence, or else did not disclose it to me as risk manager. I learned about it after the acquisition through discussions with management at Nationwide. During the years when RHSCI owned Nationwide, no remediation of the site was done. Even after Nationwide/SNAP Products was sold, RHSCI retained the liability for clean-up of the site. I do not know if clean-up was ever performed.

Another example is the Waterpark Tower site. I learned of this through an article in the June 12, 1995 issue of the Pacific Business News, which reported: “We are just about to start our environmental clean of our site, said Neil Hannahs, manager of Bishop Estate's Kakaako development.” It was only after contacting Neil that I learned that the environmental remediation contracts had already been signed (and incidently back-dated) and work was already under way. Stay & Sons, Inc. was awarded the contract for clean-up. As KSBE's liability insurance policy does not afford protection for environmental claims involving remediation work, I advised Neil that in order to protect KSBE we should make sure that either the contractor(s) or KSBE obtain this coverage. As Neil had only recently taken over this project from John Peterson, he expressed surprise that I had not been apprized of the situation earlier by Alan Yee, who been given the responsibility for handling the contracts. After reviewing the so-called “contract” with Stay & Sons, Inc. and other information I wrote memos on July 19, August 1, August 22 and September 5, 1995 to Neil Hannahs. No action was taken, so the final result was that KSBE had no environmental liability insurance protection for the project, potentially exposing the estate to millions of dollars in environmental liability claims. I attempted to obtain the Bid Specs for the project, and found there were none. I searched the yellow pages for Stay & Sons, Inc., and could find no listing. I called the Contractors' Licensing department of the State, and was told they did not have a listing under Stay & Sons, Inc. or Robert Stay. I called Stay & Sons' insurance agent and learned that they were unaware that their insured was doing this type of work (they were told he was doing composting work). I called other bidders for the job to inquire if their Miscellaneous Charges had included environmental liability insurance, and was advised that they did. However, I was advised by one contractor that the bid was basically, "done over the phone." When trying to get a copy of Ed Tabangay's independent consultant" contract with our Legal Group, I found there was none. I also learned that Trustee Lindsey's stepson worked for Stay.

??/??/89 - BH re: Non-bid Insurance Contracts and Conflicts of Interest. At the time I joined KSBE, the insurance agent was the wife of KSBE’s Financial Asset Mgr. The person responsible for the purchase of ins. at that time was Doyal Davis who can verify the pressures placed upon him to keep the ins. program with this agent. Obtaining competitive bids for the ins. program on a periodic basis is considered to be a good risk management practice in order to "keep the broker honest." I requested proposals from a number of reputable local general agencies. MMI submitted, and I recommended, a competitive proposal which improved coverages and reduced the costs of insurance to KSBE. For this I was commended by Gil Tam and received an "Outstanding" performance rating with a corresponding increase in pay. This was the only time the insurance program was put out to competitive bid until Hobbs Group presented its proposal for the Property ins. in mid-1996.

11/02/89 - M&M Ins Mgt Services, Inc. sent info entitled “Outline of Mgt Resources for a Hawaii Captive.”

12/22/89 - Memo from Rocco Sansone M&M re Captive Mgt Fee Structure - Gives hourly rates for captive mgt contract & estimated hrs required for services. No mention of a flat fee that was later charged.

10/16/90 - KSBE signed a business agreement with AutoFuel Co. (AFCO), and the Bank of Hawaii and the Bank of New York signed a revolving credit agreement and loan agreement with AutoFuel.

Various - BH re: Americans with Disabilities Act (ADA). The ADA became effective 01/26/92. The issue of compliance with the ADA impacted on discussions regarding the high costs of compliance. On 11/14/91, for example, Colleen Wong sent Allen Young a letter re Americans with Disabilities Act - Public Accommodation. Wong stated that re your inquiry whether KSBE is exempt from Title III (Public Accommodations) requirements because of Judge Alan Kay's ruling that Kamehameha Schools is a religious institution. We answer in the affirmative. There is an exemption for `religious organizations or entities controlled by religious organizations, including places of worship.' We believe, based on the Federal decision concerning Kamehameha Schools as a religious educational institution, that it should fall into this exemption. This advice was given to KSBE’s engineering dept despite an earlier opinion given to Stan Hioki by Chas. Ching of the law firm of Perkin & Shimizu. In his letter of 12/11/90, Ching stated that the ADA has a sweeping application and extends to both the KS campus as well as commercial properties owned by KS/BE. In describing the scope of coverage of ADA Title III, a Senate report specifically stated that "private schools, including elementary and secondary schools, are covered by this title." On 01/07/92, Rosemary Fazio of the law firm of Ashford & Wriston sent a letter to Aipa providing information about the Act, and stated that one of the reasons they had prepared this letter was their concern about the impact of the rather strong remedies and penalties provided for in the Act. On March 3, 1992, Allen Young arranged a meeting re ADA for Kamehameha Schools, with guest speakers, Colleen Wong, Cindy Winegar of Watanabe, Ing & Kawashima, and Peter Fritz, Esq. Attendees included Sam Hata, Ed Tabangay, Jim Holt, Mike Lum, Bob Stender, Lena Young, Charlee Kowalski, Clifford Kobashigawa and myself. These attorneys again stated their opinions that KSBE, as a religious institution, was exempted from the act. On 10/06/92, I sent a memorandum to Aipa, Colleen Wong, Gil Tam, Sandie Wicklein, Tony Sereno, Richard Wong (RHSC), and Wally Tirrell (KIC) enclosing two articles from the CPCU Journal: 1) Risk Management Implications of the ADA; 2) The ADA and Workers Compensation. I advised that KSBE's Educators Legal Liability insurance policy provided certain coverages for discrimination; however, the willful violation of a statute or government regulation or ordinance committed by or with the knowledge or consent of an Individual Insured is excluded. Also, I advised that payment of any governmental fines or penalties was not covered. On 07/15/93, Ed Tabangay sent a memo to Tony Sereno, Nathan Aipa, Mike Chun and Gil Tam regarding an "Organizational Wide KS/BE ADA Action Plan". In the memo he stated that there had been several meetings within the past weeks regarding the ADA and that an ADA Action Plan was essential. Tabangay noted that KSBE's exposure to civil lawsuits for noncompliance was a major concern. He recommended that KSBE establish compliance goals, which would serve as evidence of a good faith effort to comply. This would help safeguard KSBE from legal and risk management concerns. On 02/14/95, an ADA Action Plan was presented to all KS supervisors by Bob Ramsey and Bruce Clark for information and action. Engineering was given responsibility for implementing the plan. However, as late as 10/02/96, Sam Hata stated that he was concerned about the lack of compliance with the ADA. I remarked that I thought a master plan had been submitted a long ago and that we had taken action. Sam replied that, yes, the plan was drafted, but Trustees never approved the funds for implementation.

Various - BH re: Failure to act in good faith with KSBE's insurance and bonding companies; fraud; deceptive practices in financial and regulatory reporting; discrimination; conflicts of interest; breach of fiduciary responsibilities; non-bid contracts; political favors; improper actions for personal gain or profit; and other wrongful acts. Aipa's philosphy was that "sensitive" issues, financial information, etc. should not go outside the company, or even outside the Legal Group, if possible. Consequently, when it came to completing insurance apps that requested "sensitive" information such as financial statements, knowledge of any pending claims or future potential claims, this information was often not disclosed, or was provided only after repeated requests.

It is apparent that Aipa found my philosophy of dealing in good faith with the insurance carriers too "open" in contrast to his philosophy of keeping everything "confidential". It is also apparent that he found someone that was willing to go along with his method of operation: Marsh & McLennan, Inc. Aipa went to great lengths to control information. Central Files and Documentary are under his supervision. All staff reports are reviewed by the Legal Group. Information provided to the Master is provided by Aipa. The Tax Dept is under Aipa.

12/??/91 - AutoFuel signed a stock pledge and security agreement with KSBE.

03/??/93 - B.M. McKenzie and McKenzie Methane Corporation filed a lawsuit in Texas for $2,300,000,000 against the Trustees under the Will & Estate of B.P. Bishop and Kamehameha Schools/Bishop Estate. Additional defendants were: HAK Partnership I, II, III, IV and V; Smith-Gordy Methane Co.; SG Methane Co., Inc.; Gordy Oil Co.; L.H. Smith; R.D. Gordy; D.A. Barras; Lee H. Henkel, III; Mitch Gilbert; Royal Hawaiian Shopping Center, Inc.; Maralex, Inc.; M. O'Hare; Kukui, Inc.; JGI Resources, Inc.; and Northwestern Mutual Life Insurance Co.

BH: Aipa does not file a D&O Liability insurance claim although Trustees and other employees apparently have coverage. BH is not advised of the lawsuit, and it goes unreported to the insurance carrier, United Educators, for approximately five months. Apparently the lawsuit is also glossed over by the auditors, Coopers & Lybrand, and the co-investments by KSBE trustees, employees, friends and relatives are not reported to the Master, the Probate Court or the AG’s office.

07/22/92 - BH letter to Gil Tam re William Rosehill’s potential wrongful discharge claim. This was 1^st claim under United Educators’ D&O policy. Legal Group refused to follow U. E.’s guidelines — kept BH and Mullen out of the loop in dealing with attorneys. Nathan Aipa and/or Colleen Wong engaged Watanabe, Ing and Kawashima to handle lawsuit, w/o obtain required approval from the insurance company. Neal Seamon at John Mullen set up appt to meet with James Kawashima. C. Wong canceled meeting, saying reason was “political”. KSBE contact at the law firm was Douglas Ing. Wong said that Ing might be the next Trustee.

05/??/93 - BH was transferred from the Administration Group to the Legal Group. The staff report recommended that the trustees approve a joint request by the Admin and Legal group heads to transfer the risk/insurance and safety management dept function and staff from the Administration group. [Ltr]

08/??/93 - In gathering information for the D&O renewal, BH first learned of the McKenzie lawsuit and filed a claim with KSBE’s insurance carrier, United Educators (a company M&M helped form). Aipa takes "control" and refuses to give any information regarding the case to me or the insurance carrier.

09/16/93 - A letter from UE's claims manager, Joseph McCullough, to Nathan Aipa states:

I would like to acknowledge receipt of the fax from Marsh & McLennan advising us that there is a law suit filed in Texas by M. McKenzie and McKenzie Methane Corporation against Royal Hawaiian Shopping Center, Inc. among others. This fax was our first notice of claim. This fax does not contain enough information for us to determine the allegations being made and therefore we are unable to advise you of what coverage, if any, is available under the KS/BE policies with United Educators.

I have made at least 6 phone calls to you in an effort to get information about this claim. I have talked to Bobby Harmon who advises you are the person with information about this case. I have asked that if anyone else in the legal department has the necessary information, that they contact me. To date, I have been contacted by no one from the legal department. I have attempted to get additional information from Marsh & McLennan but they advise they have no additional information.

I must advise you that the policy requires that insureds cooperate with the company in reporting and investigating claims. Failure to cooperate may result in coverage that may otherwise be available may be lost to an insured.

The first notice received indicated that `settlement discussions are currently in progress'. While I currently have no idea whether there is any coverage available to any of the defendants in the lawsuit, United does not consent to any settlement that is entered into with out our informed consent.

Therefore, if you believe that any defendant is entitled to coverage under any of the policies issued by United Educators to Kamehameha Schools/Bishop Estates, your failure to cooperate with the carrier is jeopardizing such coverage. . . .

02/16/94 - UE’s McCullough informed Aipa by fax re the McKenzie claim:

In deference to your request, United Educators, in an effort to us of the investigation and pleadings arising from this lawsuit based on your belief that the case would settle and that you would not be seeking coverage for the settlement under the KS/BE insurance policy with United. With the settlement not being finalized and the trial scheduled for May of this year, we requested that you overnight information on this case on 2/1/94.

That was 2 weeks ago and we have not received any information...

...I strongly urge you to cooperate with us and provide the information I have been requesting immediately. I must inform you that your failure to provide this information may have already prejudiced United with respect to this claim, and that the longer you withhold information, even if we have not yet been prejudiced, the more likely it is that we are prejudiced.

Based on the fact that United does not have information for the matter, we must iterate our position that this request is to determine what coverage, if any, may be available to the defendants... On the contrary, we have absolutely no information on which to determine whether there is any coverage under the terms of the policy or whether any prejudice exists based on late notice or failure to provide information.

Based on the above, I will wait to hear from you. If, in a reasonable period of time, additional information is not forthcoming, I will simply close our file. In that way, you won't be inconvenienced with having to contact me if in your opinion that is not necessary.

BH: Aipa did not respond to McCullough's letter and UE closed their file without any payments being made. No defense costs were paid from my insurance account, so I do not know the total costs incurred in this long and complex lawsuit, but I estimate that defense costs could have exceeded $1 million. Defendants included subsidiaries and individual employees in addition to KSBE and its trustees. I question whether or not these subsidiaries and individuals were properly advised by Aipa of the fact they had potential protection under UE’s policy, and that these coverages were essentially waived by Aipa's failure to cooperate. I also question if these subsidiaries and individuals paid their fair share of these defense costs, or did all funds come from the estate?

08/09/94 - Ltr fm Mark McConoghy, Price Waterhouse to Myron Mitsuyasu (KSBE Legal Group):

“Over the past few months you have had several conversations with myself and various different people from our office regarding KSBE's formation of a captive insurance company. Many of our earlier discussions were based on the captive insurance company proposal submitted to you by Marsh and McClennan (MM). . . . you indicated that MM believes there are a number of non-tax reasons to form a captive, such as:

- A captive would provide more stability in the areas of worker's compensation, property, general liability and auto liability insurance since those particular insurance markets are unstable in Hawaii;

- The captive would be used as a long term planning objective;

- The captive would provide stability and predictability in cash flows and investment income;

- The captive could, in the future, provide pollution and environmental liability insurance;

- The captive would have direct access to the re-insurance market as a means of reducing costs.

A large portion of our discussions revolved around the implications a captive insurance subsidiary may have on the tax-exempt status of KSBE. We discussed that in order to preserve KSBE's tax exempt status, it is important that the captive does not create a situation where a private individual receives a benefit from KSBE's involvement in the captive. Arm's-length relationships between KSBE and the captive would be absolutely necessary to prevent private inurement (benefits flowing to insiders such as trustees and directors) and/or private benefit (benefits flowing to third parties such as other subsidiaries) from becoming a problem. In this context, for example, premiums paid into the captive by all the entities involved would need to be actuarially appropriate in order to prevent the IRS from taking the position that KSBE is improperly subsidizing a for-profit subsidiary. While the IRS may take the position that this might result in private inurement, we do not agree.

It is necessary that the corporate governance (i.e. the board of directors and the corporate officers) be independent, in order to maintain the corporate separateness between KSBE and the captive subsidiary. It is important to keep the captive's business activities separate from the tax-exempt activities of KSBE, so as not to create a situation where the captive's activities could be collapsed into the activities of KSBE.

An independent board of directors would also show that KSBE does not control the captive. Some KSBE employees may be directors on the board. However, it is important to maintain a balance between outside independent board members and employee board members. We would recommend that a majority of the directors be outsiders.

At your instruction, we did not have our insurance actuaries review the financial projections of the captive insurance project. Our comments are based on our discussions over the past few months with both KSBE and MM personnel and the text materials provided in the MM proposal.

Unknown In a Legal Dept. meeting with Nathan Aipa a section of what appeared to be draft staff report to the Trustees, believed to have been prepared by Price-Waterhouse recommended alternative policies which would improve upon the arms-length relationship between KSBE and its for-profit affiliates:.

-- Formalize and Employ Proper Channels and Methods of Communication between KSBE and its Corporate Affiliates and with Outside Parties to Avoid Treating KSBE's Affiliates as Merely Alter Egos of KSBE. Written Communications Should be on Appropriate Letterhead and Addressed to the Proper Parties, Including Pertinent Position Titles. RHSC or any other subsidiary should not use KSBE letterhead for communications with KSBE or any other party. In investments in which a subsidiary is the direct investor, primary communications regarding the status of the investment, financial reporting, etc. should be directed to that subsidiary with the necessary cc’s to KSBE. (For example, Goldman Sachs' quarterly and other financial reports regarding RHSC’s partnership investment should be addressed to RHSC rather than to KSBE.) In situations where KSBE's subsidiary is involved in litigation, bankruptcy proceedings, or negotiations with 3rd parties, it must be made abundantly clear to the 3rd party that the subsidiary itself control’s the negotiations and litigation and not KSBE, and that all correspondence and communications from the 3rd party should be directed to our subsidiary rather than to KSBE.

-- Identify and Delineate the Roles of KSBE and its Corporate Affiliate When Participating Jointly in a Multi-Level Transaction or Project. Often times, KSBE's investments are multi-leveled with debt financing provided by KSBE and equity investment by a subsidiary. in such cases, the record should reflect that proper due diligence had been conducted by KSBE in its role as lender, and by the subsidiary in its role as equity investor. The equity investment should be in line with the investment philosophies of the subsidiary rather than at the request of KSBE. All financing provided by KSBE to its subsidiary, or to any entity in which KSBE's subsidiary has an equity interest, should be on terms similar with the market. Investments transferred from KSBE to a subsidiary should be consistent with the operational goals and objectives of the subsidiary, and should be justifiable for business and economic reasons and not solely for tax reasons. If a subsidiary's debt to a 3^rd party is credit enhanced by KSBE, the subsidiary should properly compensate KSBE at market fee rates for providing such credit enhancement.

-- Establish a Cost-Sharing Procedure for Support Services Rendered by KSBE Staff to a Subsidiary. Most of the departments within KSBE have provided professional and other services to KSBE's subsidiaries. These include legal advice and consultation, engineering and appraisal services, etc. Perhaps the simplest & most cost effective way to continue to provide these services while maintaining an arms-length relationship is to develop a cost-sharing arrangement with the subsidiaries. Staff at KSBE would need to keep accurate time sheets to record all time they devote on subsidiary matters so that the cost of these services may be charged back to the subsidiaries.

-- The Current Directors and Officers of Each KSBE Subsidiary Should be Reviewed in order to Maintain the Integrity of an Arms-Length Relationship Between KSBE and its Subsidiaries: The majority of the directors of a subsidiary should not be Trustees or employees of KSBE. The CEO of a subsidiary should not be a Trustee or an employee of KSBE. The directors and officers of a subsidiary should not be dominated by or subject to the control of individuals who are Trustees, officers or directors of KSBE.

-- Establish Meaningful Consulting Agreements for Management Services Rendered by KSBE Staff for Subsidiary Matters. To the extent that KSBE staff is called upon or needed to assist in the management of a subsidiary's project such as investments transferred by KSBE to a subsidiary, KSBE should be reimbursed by the subsidiary for the consulting services provided by KSBE's staff. As an alternative, if such consulting services are expected to consume an inordinate amount of KSBE's staff's time, then transfer of such staff employee from KSBE to the subsidiary might be considered. KSBE should be careful not to allow consulting agreements between KSBE and a subsidiary to proliferate to the point that KSBE is essentially managing the day-to-day operations of its subsidiary.

– Establish a Subsidiary Compensation Policy for Directors and Officers of Subsidiaries. To the extent that subsidiaries are operating entities, its directors and officers acting on behalf of the subsidiary should be compensated appropriately by the subsidiary in order to demonstrate the separateness between a subsidiary and KSBE. The shareholders of the subsidiary, rather than KSBE's Trustees, should establish the compensation of the directors of the subsidiary. The directors of the subsidiary, rather than the Trustees, should establish the compensation of the officers and employees of the subsidiary. The employment practices of each subsidiary (e.g., hiring, determination of wage scales, employee benefits, pension plans, disciplinary actions, etc.) should not be controlled or managed by KSBE or its personnel department. Any indication of control or management by the parent of a subsidiary's employment practices would be pivotal in the determination of an arms-length relationship

-- Maintain Arms-Length Relationship with Captive Insurance. KSBE is now contemplating the establishment of a captive insurance company for KSBE and its affiliates. Since this captive insurance company will be an affiliate of KSBE, it is important that KSBE maintain an arms-length relationship with this captive insurance company. As reflected by the HIG insurance case, failure by KSBE to maintain an arms-length relationship with its captive insurance company may render KSBE liable for all claims against and debts of the captive insurance company. KSBE should comply with all state regulatory requirements in forming the captive. The board of directors of the captive should have a majority comprised of individuals who are not Trustees or employees of KSBE. The chief executive officer of the captive should not be a Trustee or employee of KSBE. Management of the daily operations of the captive insurance company, including claims administration and investing of the captive's capital, should be largely free of influence or control by KSBE’s Trustees and staff.

The foregoing alternatives/policies would likely operate to improve the arms-length relationship between KSBE and its affiliates, and thereby further KSBE's mission of perpetuating the legacy of Bernice Panahi Bishop by protecting its assets and maintaining its tax exempt status.

Little, if any, costs or expenses are expected to be incurred if the foregoing alternatives/policies were adopted. These alternatives/policies are intended to correct certain routine practices of KSBE and its affiliates which can be easily corrected without significant costs to KSBE. On the other hand, failure to implement appropriate policies to maintain an arms-length relationship between KSBE and its affiliates may result in significant adverse impact and costs to KSBE.

10/01/94 - As a result of the advice of Price Waterhouse, BH drafted "arms length" guidelines:

GUIDELINES - P&C INSURANCE COMPANY. INC. - ARMS-LENGTH RELATIONSHIPS

The following are certain guidelines which should be utilized to maintain arms-length relationships between P&C Insurance Company, Inc. and its Parent and Corporate Affiliates:

1. Written communications should be on appropriate letterhead and signed by the proper parties, including pertinent position titles (e.g., any correspondence concerning business matters of P&C Insurance Company, Inc. must be on P&C letterheads and signed by the Captive Manager or by an Officer or Director of the corporation).

2. P&C should not invest any of its funds in any subsidiary of the Parent, nor in any entity in which the Parent or any subsidiary has a substantial financial interest. Primary communications, financial reporting, etc., must be between P&C and the investment firms.

3. In situations where P&C is involved in litigation, bankruptcy proceedings, or negotiations with third parties (e.g., John Mullen & Co.), it must be made abundantly clear to the third party that P&C itself is in control of the negotiations and litigation and not KSBE or Pauahi Holdings Corporation (PHC), and that all correspondence and communications from the third party should be directed to P&C rather than to KSBE or any subsidiary.

4. All financing provided by PHC to P&C should be on terms similar with the market.

5. Any services provided to P&C by KSBE or PHC personnel should be charged back to P&C.

(BH Note: This was never done!)

6. The majority of the directors and majority of officers of P&C should be persons who are not Trustees or employees of KSBE or PHC.

7. The Chief Executive Officer of P&C should not be a Trustee or an employee of KSBE.

8. The directors and officers of P&C should not be dominated by or subject to the control of individuals who are Trustees, officers or directors of KSBE or PHC.

9. To the extent that KSBE or PHC staff is called upon or needed to assist in the management of a P&C project, a Consulting Agreement should be entered into aud P&C should reimburse KSBE or PHC for the consulting services provided by their staff. As an alternative, if such management consulting services is expected to consume an inordinate amount of KSBE’s staff's time, then transfer of such staff employee from KSBE to the subsidiary should be considered. (P&C should be careful not to allow consulting agreements with KSBE or PHC to proliferate to the point that KSBE or PHC is essentially managing P&C's day-to-day operations.)

10. A Compensation Policy should be established so that P&C's Directors and Officers are compensated appropriately by P&C in order to demonstrate the separateness between P&C and KSBE and PHC. The shareholder(s) of P&C should establish this compensation.

11. The employment practices of P&C (e.g., hiring, determination of wage scales, employee benefits, pension plans, disciplinary actions, etc.) should not be controlled or managed by KSBE or PHC. (Any indication of control of management by KSBE or PHC of P&C's employment practices would be pivotal in the determination of an arms-length relationship.)

12. P&C must comply with all state regulatory requirements, including by not limited to sufficient capitalization and appointment of a qualified, licensed agent to manage the operations of the captive insurance company.

13. Management of the daily operations of Pac, including claims administration and investing of P&C's capital, should be largely free of influence or control by KSBE's (or PHC's) Trustees and staff.

14. In general, P&C should not reinsure its risks with any reinsurer on whose boards of directors KSBE (or its subsidiaries) has representation. (In the event this should occur, however, KSBE's representative on the board should recuse himself from voting on any matter which may come before the reinsurer's board concerning the captive insurance company.) Since P&C Insurance Company, Inc. is an affiliate of KSBE and PHC, it is important that both KSBE and PHO maintain arms-length relationships with P&C at all times. (As reflected by the HIG/HEI insurance case, failure by KSBE or PHC to maintain an arms-length relationship may render KSBE and/or PHC liable for claims against, and debts of, the captive subsidiary.)

The foregoing policies should operate to establish and maintain the appropriate arms-length relationships.

94/95/96 - BH: During the period when the formation of the captive insurance company was under discussion, I recommended to Aipa that I be transferred from KSBE to the captive in large part due to the arms-length issues. I drafted a staff report for this transfer which was submitted to Aipa for review and approval. My recommendation was that I be transferred to P&C and KSBE contract with P&C for risk management services... I included an estimated $200,000 in the initial budget for P&C to establish and operate a separate office. This staff report was never presented to trustees by Aipa.

Aipa directed that I make changes to these staff reports... He indicated that he had discussed the report with Peters, and that Peters seemed to be in favor of the transfer. However, the staff report was never presented to the full board of trustees by Aipa. I placed this proposal for my transfer to P&C on the agenda for P&C's 1996 Annual Board of Directors Meeting. During discussion on the issue, Peters indicated that the matter should be presented first to the estate's trustees for approval, so the board's decision was deferred. Aipa still would not present my staff report to trustees.

Little concern was shown by Aipa re work being performed for P&C by KSBE management and staff at no charge to the subsidiaries. I spent hundreds of hours on KSBE time performing work for P&C which was never charged to it Others providing "free" services included Virginia Mau, David Dunnigan, C. Wong, Kam and Aipa. According to Price Waterhouse's letter, this might be considered by the IRS as "improperly subsidizing a for-profit subsidiary.”

06/??/94 - Investor’s Equity Life Insurance Co. declared insolvent and placed in receivership by the Insurance Commissioner, State of HI.

09/??/94 - P&C Insurance Co., Inc. (“P&C”) chartered as captive insurance company in Hawaii, a for-profit subsidiary of Pauahi Holdings Corporation (“PHC”), which is a for-profit subsidiary of KSBE.

10/20/94 - P&C wrote its first insurance policies.

11/??/94 - Harmon named President of P&C. Peter Lowe, M&M, is V.P.; William Richardson is Sec/Treas.; Nathan Aipa is Asst. Sec/Treas. Board of Directors: Henry Peters, Chairman; William Richardson; Gil Tam.

01/31/95 - INSURANCE MANAGEMENT AGREEMENT between M&M Ins Mgt Services, Inc. and P&C signed by Peter Lowe and B. Harmon. Key agreements: “Whereas, P&C has received authority from the Commissioner of State of Hawaii Insurance Division (the “Commissioner”) under the provisions of Chapter 431, Article 19, Hawaii Revised Statutes to engage in the underwriting of various classes of ins. and reins. As a captive insurance company; and Whereas, in conjunction with such underwriting P&C will require management, administrative and consulting services and IMS in willing to furnish such services; and Whereas, the parties desire to enter into an agreement whereby IMS will render itself or through others retained by IMS, management, administrative and consulting services with regard to the operation of P&C. . . . 1. IMS’ SERVICES. IMS will render the following services with regard to the business of P&C . . .a) Underwriting of Insurance . . . b) . . . Policy holder Services. . . . IMS shall issue and endorse policies . . . and issue notices of cancellation. IMS shall bill, receive and render receipts for premiums due . . . IMS shall have full authority hereunder to take whatever action it deems necessary or appropriate to attempt to collect premiums . . . 2. OFFICE RECORDS . . . BOOKS . . . c) Reports and Examinations. All federal and state reports, other than federal tax returns, and all other applications and reports as shall be required by Chapt. 431,Article 19, HRS shall be prepared and filed by IMS after review by P&C. . . . g) Authority of IMS. IMS shall have all the power and authority necessary or desirable to carry out its duties and obligations under this Agreement, which shall include the right to engage, as an independent contractor, any person, corporation or other organization to perform any functions to be performed hereunder by IMS. The authority granted hereunder shall specifically include the right to engage other operating units within Marsh & McLennan, Inc., or any subsidiary or affiliated company thereof, to perform such functions. 3. RELATIONSHIP BETWEEN PARTIES; LIMITATION OF RESPONSIBILITY. a) Independent Contractors . . . b) Compliance with Laws. IMS shall use its best efforts to advise P&C regarding compliance with the insurance laws of the State of Hawaii. . . c) Scope of Services. The obligations of IMS hereunder are limited to the good faith performance of the services to P&C set forth herein and IMS shall have no liability to P&C or any other person for any action taken pursuant hereto other than as a result of its wilful misconduct or gross negligence. d) Indemnification. P&C shall indemnify and hold harmless IMS, its officers, directors, employees, agents and affiliates from and against any losses, claims, damages, liabilities, cost of expenses, including reasonable attorney fees and expenses of investigation (collectively, “Losses”), to which IMS may become subject in connection with the services it provides hereunder; provided, however, that P&C shall not be liable under the foregoing indemnity in respect of an Losses to the extent that a court having jurisdiction shall have determined by a final judgment that such Loss resulted from IMS’ wilful misconduct or gross negligence. The provisions of this section shall survive the expiration or termination of this Agreement, including any extensions thereof . . . f) Entire Agreement. All prior negotiations and agreement between the parties hereto relating to the subject matter hereof are superseded by the Agreement, and there are no representations, warranties, understandings or agreements other than those expressly set forth herein, except as modified by an instrument signed by the parties hereto. . . g) Waivers. . . . Any waiver by either party of any breach of any provision hereof shall not be construed as a waiver of any continuing or succeeding breach of such provision, a waiver or modification of the provision itself, or a waiver or modification of any other right under this Agreement. . . . COMPENSATION AND EXPENSE PROVISION . . . (A) Annual Fee. In consideration for the services to be performed by IMS, P&C agrees to pay IMS a fee on a time and expense basis. . . .(D) Billing and Payments. IMS shall render, within 30 days after the end of each month, a statement to P&C setting forth the reimbursable costs and expenses incurred during the immediately preceding month. . .

BH: Nothing in M&M’s original proposal or this Management Contract mentioned anything about a FLAT ANNUAL CHARGE OF $200,000 from M&M to P&C for any type of services. The additional $200,000 charges were apparently fraudulent and arranged through a conspiracy between Peters, Aipa, Kam, Sansone and Lowe. There was a conflict of interest as Lowe was SR. V.P. for M&M IMS, as well as V.P. for P&C. Lowe had a duty of loyalty to P&C to make sure that P&C was obtaining competitive bids from independent contractors (including M&M), and that the company was not being defrauded by being sent false invoices for services not rendered and not under contract. BH was only performing his legitimate duties as P&C’s president when he obtained alternative quotations for insurance services and coverages for P&C. Aipa and Kam, as KSBE employees, did not have legal authority to: 1) supercede this Management Contract between P&C and M&M IMS -- especially orally; 2) question Harmon’s authority to obtain competitive bids for P&C from M&M or any other independent contractor; 3) question Harmon’s authority to require a written fee proposal and contract from M&M; and 4) question Harmon’s refusal to pay M&M any service fees not under a legal contract. In actuality, M&M was charging fees for policy services, safety services, claims services, etc. for which they were also receiving commissions from the standard insurance companies they represented — including Federal Insurance Co. and AMRE.

02/??/95 - An article in the Honolulu Advertiser discloses the names of individual investors in the McKenzie deal. Even though I was responsible for the handling of these insurance claims, this was my first knowledge that Trustees, managers, employees and independent contractors had invested in this deal including: Henry Peters, Gil Tam, Mitch Gilbert, Gil Ishikawa (KSBE’s Tax Administrator), Rodney Park (KSBE Controller) and Wally Chin (Asst Controller). Mark McConoghy, of Price Waterhouse, KSBE’s tax consultant, was also an investor.

02/27/95 The Honolulu Advertiser, under the headline, "Monitoring groups not told about deals," reported:

“Both the state Probate Court and the state Attorney General's Office are required to annually review Bishop Estate operations."

"Neither agency knew about the personal investments estate trustees and employees made in connection with the estate's McKenzie Methane investment, according to court records and interviews."

"Peter Trask...made no mention of the McKenzie Methane or HAK Partners investments in his report to the court."

"James Duffy, who reviewed Bishop Estate operations last year for the state Probate Court, said he was unaware of the McKenzie Methane investment and had never heard of the HAK partnerships."

"Benjamin Matsubara, the current court master, also said he was unaware of the HAK Partnerships ..."

"Deputy Attorney General Kevin Wakayama, who reviews Bishop Estate activities for the state, said personal investments by estate trustees and staffers in estate-related business deals have `never been publicly reported by the estate.'"

02/28/95 - The Honolulu Advertiser under the headline, "Bishop Estate tax-exempt status scored," discloses:

"...Peters (attorney Ronald Peters, not Henry Peters) pointed out yesterday that the estate trustees told James Duffy, court-appointed master for the estate's 1989-90 fiscal year, that `they have not undertaken any transactions with members of their families, business associates, employees of the state, or members of immediate families of employees of the estate except such as are disclosed to the master...'"

"The estate had no comment yesterday on questions about why the existence and activities of the HAK partnerships were not reported to court masters since 1989."

"The estate also had no immediate comment on whether it was obligated to report the HAK partnership transactions on its federal income tax returns."

"... in 1989 then-trustee Matsuo Takabuki, his wife, three children, family corporation and a longtime company employee invested $1.5 million in the HAK Partnerships."

"Then-trustees Myron "Pinky" Thompson and William Richardson, invested $510,000 and $210,000, respectively. Trustee Henry Peters...invested $220,000..."◂

"The estate, as a charitable institution, files a `Form 990' federal tax return. One section of that return requires the estate to report whether it has furnished `goods, services or facilities' to any taxable organization in which a trustee or estate principal officer has a management affiliation."

"The estate reported nothing about the HAK partnerships on tax returns ... since 1989..."

"The HAK partnerships were organized and administered by Mitchell Gilbert, financial assets manager of the estate from 1988 to September 1994, according to Texas court records. Gilbert and his relatives invested $72,000 in the HAK partnerships."

"The mailing address for all five partnerships was Bishop Estate headquarters at Kawaiahao Plaza..."

In the same edition, an article under the headline, “Estate's Washington link disclosed," states:

"Robert Rubin, U.S. Treasury secretary, has an important personal financial connection to Hawaii's Bishop Estate, as does one of Rubin's predecessors at the Treasury, former secretary William E. Simon."

"The estate has guaranteed an undisclosed rate of return on Rubin's holdings in Goldman, Sachs & Co., the giant New York-based investment bank in which Bishop Estate has invested $500 million..."

"Rubin was co-chairman of Goldman, Sachs from 1992 through 1994, the same period in which the Bishop Estate made two separate $250 million investments in the firm."

"When Rubin left the bank to join President Bill Clinton's cabinet last month as Treasury Secretary, he secured an `insurance policy' from the estate that underwrites the value of his personal holdings in Goldman, Sachs..."

"...former Treasury Secretary Simon has been the estate's business partner in several major banking deals both in Hawaii and in Asia in recent years."

"Simon also personally invested, along with four estate trustees and numerous senior estate staffers, in a Houston-based methane gas drilling project that is now mired in federal bankruptcy court proceedings."

"The estate itself invested some $85 million in the same energy deal."

03/23/95 - An article in USA Today reports:

"...Bishop Estate - which is strongly tied to the Democratic political machine here - is attracting attention outside Hawaii because of its ties to Treasury Secretary Robert Rubin."

"In an unusual deal, Rubin pays hundreds of thousands of dollars a year to the Bishop Estate in exchange for a guarantee that he'll never lose money on a multimillion- dollar investment in his former firm, Goldman Sachs investment bank."

"Rubin was co-chairman of Goldman Sachs before joining the Clinton administration."

"Rubin could face a conflict of interest if an Internal Revenue Service investigation into the Bishop Estate's tax-exempt status reaches his desk. As Treasury secretary, Rubin oversees the IRS."

"And some Republicans question whether Rubin's actions - especially his role in the Mexican bailout - have been designed to help Goldman Sachs."

"...Bishop Estate is now fighting release of its 1992-93 financial reports..."

"Bishop Estate spokesman Elisa Yadao says the estate doesn't want competitors to see the financial statements."

"But secrecy may also keep hidden the details of the Rubin-Bishop Estate deal, which was made in February 1993."

"Treasury officials won't give details either, except to say Rubin pays the estate hundreds of thousands of dollars a year."

"...First as Clinton's economic adviser and now as Treasury secretary, Rubin could influence interest rates, foreign currencies and other factors crucial to his former firm's health."

"To avoid a conflict of interest, he sold his Goldman Sachs partnership to the firm. A price wasn't disclosed, but the value of a senior partnership could exceed $50 million."

"When buying out partners, Wall Street firms are reluctant to deplete cash reserves, the lifeblood of an investment bank. So Goldman Sachs gave Rubin a note that promised to pay principal and interest over a number of years."

"This still left Rubin with a potential conflict: a gigantic investment in Goldman Sachs that could be affected by his official government actions."

"If Goldman Sachs had financial troubles, Rubin might not get paid, possibly costing him tens of millions of dollars."

"Rubin's solution was to buy an insurance policy on his investment, so he would get paid even if Goldman Sach's finances ran into trouble."

“Rubin got the insurance from the Bishop Estate, rather than a major financial firm, because it was least likely to be affected by his government work, says Treasury general counsel Ed Knight..."

"Bishop Estate critic Ronald Peters, a Honolulu lawyer, has asked the IRS to investigate whether the Bishop Estate should lose its tax-exempt status for allegedly improper business deals by the trustees."

"Hawaii's attorney general has sent the challenge to the IRS, too."

". . . He says Rubin has been under particular scrutiny since he sent a letter to former Goldman Sachs clients saying he looked forward to working with them in his new capacity..."

04/03/95 The Honolulu Advertiser reported, "Estate had $26.9 million in AutoFuel - Its investment coincides with bank loans":

"The Bishop Estate is AutoFuel's single largest secured creditor."

"According to paperwork filed by the Bishop Estate at the Bureau of Conveyances here, the estate and AutoFuel signed a business agreement October 16, 1990. On the same day, the Bank of Hawaii and Bank of New York signed a revolving credit agreement and loan agreement with AutoFuel..."

"In December 1991, AutoFuel signed a stock pledge and security agreement with Bishop Estate..."

"The Bank of Hawaii was also involved in another estate deal in Texas. According to bankruptcy records in Houston, the estate guaranteed loans made by the Bank of Hawaii to individuals and companies that invested in McKenzie Methane Inc. The estate later assumed those loans when the borrowers failed to make payments to the bank."

"AutoFuel Co. entered bankruptcy reorganization in Dallas in March 1993. Some four months later, a wholly owned Texas subsidiary of Bishop Estate called Kukui Inc. filed a claim in the AutoFuel bankruptcy for recovery of $26.9 million."◂

"Of that total debt, $24.76 million was fully secured by unspecified collateral, according to the claim."

"The remainder, $2.16 million, was unsecured..."

"Kukui Inc. is a subsidiary of Royal Hawaiian Shopping Center Inc., itself a profit-making subsidiary of the nonprofit, charitable Bishop Estate."

04/25/95 - The Wall Street Journal, under the headline, "Bishop's Gambit - Hawaiians Who Own Goldman Sachs Stake Play Clever Tax Game - Their Trust Is Educational But Investments Produce Big Incomes for Trustees" reported:

"The giant Hawaiian trust that now owns 11% of Goldman, Sachs & Co. bills itself as a charity. It's an increasingly tough sell."

"...a close look at the trust reveals a much-different operation, one that has more in common with a big investment concern like Goldman Sachs than with even the busiest U.S. charities.

"Take executive pay: For the year ended June 30, 1993, Bishop's five governing trustees earned $820,000 each - payments calculated, in unusual fashion, partly as a percentage of the trust's tax-free investment income. In their best year, the trustees got $925,000 apiece. In contrast, the highest paid official at the American Red Cross earned $342,700 in 1993.

"Wheeling and Dealing - Bishop Estate doesn't invest like a traditional charity either: Instead of passively pursuing rent, interest and dividends, Bishop wheels and deals in the world of shopping centers, apparel chains and drilling ventures. Several of its investment partners say that when deals turn sour, the Bishop trustees don't hesitate to intervene aggressively."

"Then there is the critical matter of taxes. With the help of more than two decades' worth of private rulings from the Internal Revenue Service, the trust has managed to surf to the limits of the law. As a result, potentially taxable deals are conducted on a tax-free basis, and trust properties migrate between taxable and tax-free subsidiaries to reduce the government's take.

"Also, despite $8 billion to $10 billion in assets - which make Bishop the nation's wealthiest charity - the trust has attracted nearly $30 million in federal subsidies for native Hawaiians since 1987. Maintaining support for such largess falls to Hawaii's Democratic congressional delegation, which has close ties to Bishop's trustees, many of whom are former top Democratic politicians."

"Mr. Takabuki's hands-on approach to investing meant that Bishop officials increasingly selected and helped supervise their corporate investments, particularly in times of trouble. Such work...ate up more and more of the trustees' time... In turn, trustees became less involved, local critics charged, in their educational mission."

"Trustees didn't seem to be very interested in expanding school activities as fast as the cash was coming in," says Guido Giacometti, head of Bishop's asset-management group until he left the trust in 1990..."

"...by the late 1980's, Mr. Takabuki's acquisitions were turning Bishop into a diversified investment concern with two distinct branches: taxable units the trust played a role in operating and traditional tax-free holdings. Then, innovatively, the trustees started moving investments from one branch to the other."

"The first big move involved the Royal Hawaiian Shopping Center, Inc... In 1986, Mark McConoghy, an influential tax lawyer at the accounting giant Price Waterhouse, concluded that the shopping center could be transferred from the taxable subsidiary to its tax-free parent..."

"Mr. McConoghy's coup also markedly enhanced the trustees' income, since under Hawaiian law the board members are paid 2% of the trust's tax-free revenue..."

"...Bishop Estate's principal watchdog is a "special master," who each year files a report on the trust's educational and investment activities to the probate court that is supposed to enforce the terms of the princess's will. But Bishop foots the bill for these reports, which usually lag several years behind, and even special masters have been caught up in Bishop's tangled web of business dealings."

"In 1990, for instance, when special master Peter Trask was reviewing the estates activities for the year ended June 30, 1989, Bishop was finalizing what would become a $27 million investment in a company whose subsidiary employed his father, David. BH note: The subsidiary is Auto Fuel Company (AFCO). The young Mr. Trask also did legal work for the company..."

"Bishop's cozy rapport with the state's entrenched Democratic Party also helps insulate it from scrutiny."

"...Many (trustees) are drawn from the upper reaches of Hawaii's political and judicial life... Current trustee Mr. Peters actually became a trustee while still speaker of the state House of Representatives. Until 1993 the newest trustee, Gerard Jervis, was chairman of the selection commiss