                       T.C. Memo. 2009-130



                     UNITED STATES TAX COURT



  HIE HOLDINGS, INC., HAWAIIAN ISLES KONA COFFEE CO., LTD., AND
     ROYAL HAWAIIAN WATER CO., LTD., ET AL.,1 Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5045-05, 5046-05,    Filed June 8, 2009.
                 5047-05.



     William C. McCorriston, Jonathan H. Steiner, Lisa W.

Cataldo, R. John Seibert, Paul B. K. Wong, Christopher J. Cole,

Brian R. Lynn, Christopher S. Rizek, Lawrence Inouye, Richard W.

Craigo, and John Gaims, for petitioners.2


     1
      Cases of the following petitioners are consolidated
herewith: Hawaiian Isles Enterprises, Inc., docket No. 5046-05;
and Michael H. Boulware, docket No. 5047-05.
     2
      On Mar. 15, 2005, Sidney E. Boulware, Jr. (an officer),
filed the petitions with the Court in docket Nos. 5045-05 and
                                                   (continued...)
                                 - 2 -

     Kenneth C. Peterson, Paul K. Webb, Gordon L. Gidlund, and

L. Katrine Shelton, for respondent.


                               CONTENTS

FINDINGS OF FACT............................................. 21

     I.         Preliminaries................................... 21

     II.        NODs............................................ 22

           A.    NOD Issued to HIE..............................   22
                  1. General Information.......................    22
                  2. First Adjustment--Disallowance of Portion
                      of Deductions for NOLs....................   22
                       a. Overview.............................    22
                       b. Primary Determination................    22
                       c. Alternate Determination..............    23
                            i.     Overview.....................   23
                            ii.    Adjustments Related to
                                   Criminal Indictment..........   24
                            iii.   Adjustments Unrelated to
                                   Criminal Indictment..........   25
                            iv.    Some Specifics of
                                   Adjustments..................   26
                  3. Second Adjustment--Disallowance of Portion
                      of Deductions for Professional Fees.......   27
                       a.   Overview............................   27



     2
      (...continued)
5046-05, and Michael H. Boulware filed the petition with the
Court in docket No. 5047-05. Richard W. Craigo and John Gaims
entered their appearances in each of the three resulting cases on
Dec. 9 and 21, 2005, respectively, and were allowed to withdraw
from those cases on Nov. 15 and Sept. 22, 2006, respectively.
Lawrence Inouye, Jonathan H. Steiner, William C. McCorriston,
Lisa W. Cataldo, R. John Seibert, Paul B. K. Wong, Brian R. Lynn,
Christopher S. Rizek, and Christopher J. Cole entered their
appearances in each of the cases on Jan. 19, 2006, July 10, 2006,
July 14, 2006, Sept. 8, 2006, Nov. 27, 2006, Dec. 1, 2006, Dec.
7, 2006, Dec. 7, 2006, and July 9, 2007, respectively.
                              - 3 -

                    b.   Personal Expenses of Michael
                         Boulware............................   28
                    c.   Unsubstantiated Expenses............   29
                    d.   Capital Expenditures................   29
                    e.   Summary.............................   30
              4.   Third Adjustment--Disallowance of
                   Deduction for Bad Debt....................   31

       B.    NOD Issued to Holdings......................... 31
              1. General Information....................... 31
              2. Sole Relevant Adjustment--Disallowance of
                  Portion of Deductions for Professional
                  Fees...................................... 31

       C.    NOD Issued to Michael Boulware................. 32
              1. General Information....................... 32
              2. Sole Relevant Adjustment--Constructive
                  Dividends................................. 33

III.        Background of Michael Boulware.................. 33

IV.         Relevant Corporations........................... 34

       A.    HIE............................................    34
              1. Formation of Business.....................     34
              2. Officers and Directors....................     36
                   a.   Initially...........................    36
                   b.   August 31, 1982, to July 10, 1991,
                        or Thereabouts .....................    37
                   c.   On or About July 10, 1991, Through
                        an Effective Date of April 15, 2000.    38
                   d.   Effective April 15, 2000............    39
                   e.   Board Meetings......................    40
              3. Shareholders..............................     40
              4. Michael Boulware’s Control................     42

       B.    Holdings....................................... 42

       C.    Other Corporations Organized in 1994........... 43

       D.    Restructuring of HIE........................... 43

       E.    Royal Hawaiian Water........................... 44

       F.    Holdings After the Restructuring............... 44
                            - 4 -

      G.    Payment of Common Costs........................ 45

      H.    Various Names Used by HIE To Conduct Its
            Business During the Subject Years.............. 45

      I.    No Payment of Formal Dividends by HIE.......... 46

      J.    E&P of HIE and Its Predecessor for 198206
            Through 198806.................................   46
             1. 198206....................................    46
             2. 198306....................................    46
             3. 198406....................................    46
             4. 198506....................................    47
             5. 198606....................................    47
             6. 198706....................................    48
             7. 198806....................................    49

      K.    E&P of Holdings for 199706 and 199806..........   50
             1. 199706....................................    50
                  a. Accumulated E&P......................    50
                  b. Current E&P..........................    50
             2. 199806....................................    50

      L.    Number of Holdings and HIE Employees........... 50

V.         Officer Loan Account............................ 50

      A.    Overview....................................... 50

      B.    Mechanics of Account........................... 50

      C.    Repayment of Officer Loans..................... 52

      D.    Michael Boulware’s Claimed Coffee
            Transactions................................... 52

      E.    Promissory Notes............................... 54

      F.    Lack of Collection on Promissory Notes......... 55

VI.    Personal Bank Accounts........................... 55

      A.    Michael Boulware Individually.................. 55

      B.    Michael Boulware and Mal Sun Boulware Jointly.. 56
                               - 5 -

        C.    Jin Sook Lee................................... 56

VII.         Mal Sun Boulware................................ 56

VIII.        Jin Sook Lee.................................... 57

        A.    Background..................................... 57

        B.    Jin Sook Lee Meets Michael Boulware............ 58

        C.    Paradise Roasting.............................. 60

        D.    Video Consultant............................... 62

               1.   Overview.................................. 62

               2.   Formation................................. 62

               3.   Payments From HIE for False Invoices...... 63

        E.    Michael Boulware’s Divorce From Mal Sun
              Boulware.......................................   64
               1. Discussions Concerning Divorce............    64
               2. Glenn Lee Boulware Trust..................    65
               3. Divorce Proceeding........................    66

        F.    Transfers of HIE Assets to Jin Sook Lee........   68
               1. Overview..................................    68
               2. Atkinson Condominium......................    69
               3. Makaiwa House.............................    70
               4. Koloa House...............................    71
               5. Punahou Condominium.......................    73
               6. Understanding as to the Transferred
                   Assets....................................   74
               7. Jin Sook Lee’s Use of the Transferred
                   Funds.....................................   75
               8. Michael Boulware Takes Some of the
                   Transferred Funds From Jin Sook Lee
                   Without Her Knowledge.....................   76

IX.          Off-Book Bank Accounts.......................... 77

X.           Off-Book Activities............................. 78

        A.    Overview....................................... 78
                     - 6 -

B.   OTC Sales of Tobacco Products.................. 79

C.   Michael Boulware’s Personal Sales of HIE Coffee
     Unknown at the Time to HIE.....................   81
      1. Overview..................................    81
      2. Sales to Hawaii Misuzu....................    82
      3. Sales to Pele Trading.....................    83
      4. Referenced Coffee Sold by Michael Boulware
          Included in HIE’s COGS....................   85

D.   Bonded Construction............................   85
      1. Background................................    85
      2. Michael Boulware Causes HIE To Pay to
          Remodel Jin Sook Lee’s Residence..........   85
      3. Paving of the Back Lot at HIE.............    86
           a.   Overview............................   86
           b.   Automated Equipment.................   87

E.   Michael Boulware’s Fictitious Leasing
     Transactions...................................   88
      1. Overview..................................    88
      2. Michael Boulware’s First Scheme...........    89
      3. Michael Boulware’s Second Scheme..........    90
           a.   Need for the Second Scheme..........   90
           b.   HIE’s Relationship With GECC........   91
           c.   Seven False Invoices................   92
                 i.    Overview.....................   92
                 ii.   Four False Invoices Totaling
                       $271,382.80..................   92
                 iii. Three False Invoices
                       Totaling $224,432............   93
           d. First Four Referenced False Invoices.    94
           e. Last Three Referenced False Invoices.    95
      4. Funds Transferred to Lorin Kushiyama......    96

F.   Michael Boulware’s International Circular Flow
     of Funds....................................... 96
      1. Overview.................................. 96
      2. Relevant Foreign Entities................. 97
           a.   Forest Trading...................... 97
           b.   Pacific Vendors..................... 98
           c.   Harvest International............... 99
                 i.    Roxca Limited................ 99
                ii.    Reinvoicing Operation........ 99
                iii.   Bank Accounts................100
                              - 7 -

                        iv.    Rationale Underlying
                               Formation....................101
                        v.     Actual Operation.............101
                        vi.    False Invoices From Harvest
                               International................101
                             1. Overview...................101
                             2. Payments of Invoices.......102
                             3. Transfers From Harvest
                                 International..............103
                                  a. Overview..............103
                                  b. Transfers to Personal
                                      Account of Michael
                                      Boulware..............103
                                  c. Transfers on Behalf of
                                      Michael Boulware to
                                      Paragon Coffee, Gloria
                                      Oh Young, and
                                      Antoinette Hirai......103
                                  d. Transfer on Behalf of
                                      Michael Boulware to
                                      Briggs Cockerham......104
                        vii.   Coffee Rebagging.............105
             3.   Role of Nathan Suzuki.....................105
             4.   Harold Okimoto............................106
                   a.   Overview............................106
                   b.   Harold Okimoto’s Employment.........106
                   c.   Administration of Harold Okimoto’s
                        Estate..............................107
                   d.   U.S. Attorney Contacts Okimoto
                        Family..............................109
                   e.   Claim of an Approximately $1.7
                        Million Debt........................110
                   f.   After-the-Fact Creation of
                        Promissory Notes....................110

XI.        Michael Boulware’s Removal of Funds From the
           Off-Book Bank Accounts..........................111

      A.    Overview.......................................111

      B.    Michael Boulware Causes Checks To Be Cashed for
            Him by Employees and Friends...................112
             1. Stanley Hirai and Antoinette Hirai........112
             2. Morris Miyasota...........................113
             3. Thomas Okimoto............................114
                               - 8 -

               4.   Milton Ikeda..............................115
               5.   Sydney Murayama...........................116
               6.   Neal Taira................................116
               7.   Paul Takekawa.............................116
               8.   John Torres...............................117
               9.   Other Check Cashers.......................118

XII.         Criminal Investigation of Michael Boulware......118

        A.    Jerry Yamachika Contacts and Meets With
              Michael Boulware...............................118

        B.    Michael Boulware Obtains Professional
              Representation.................................120

        C.    Focus of Criminal Investigation................122

        D.    Applicability of HIE’s Indemnification
              Provision Relating to Certain Personal Legal
              Fees Incurred by Its Directors and Officers....124

XIII.        Civil Litigation Initiated by Jin Sook Lee......126

        A.    Background.....................................126

        B.    JSL Litigation.................................127
               1. Complaint.................................127
               2. Counterclaim..............................129

        C.    Trust Case.....................................131

        D.    Shareholder Derivative Case....................132

        E.    HIE’s Perception of Civil Litigation...........133

        F.    Actions Taken by HIE Board of Directors........133
               1. Resolution................................133
               2. Payment of Legal Expenses.................134

XIV.         Referral of Michael Boulware for Prosecution
             and Michael Boulware’s Grand Jury Indictment....134

        A.    Referral to DOJ for Prosecution................134

        B.    Referral to Grand Jury.........................137
                              - 9 -

        C.    Grand Jury Indictment..........................138

XV.          Resolution of JSL Litigation....................139

        A.    Overview.......................................139

        B.    Jury Verdict...................................140

        C.    Equitable Issues Decided by State Court........140

        D.    Final Judgment Entered.........................142

        E.    HIE Records Receivable From Jin Sook Lee.......142

XVI.         Bankruptcy Case of Jin Sook Lee.................142

        A.    Overview.......................................142

        B.    Property Transfers and Claims..................143

        C.    Adversary Proceedings Commenced in 1998........145

        D.    Settlement of 1997 Adversary Proceeding........146

        E.    May 1998 Settlement Agreement..................147
               1. Overview..................................147
               2. Property Distributions....................147
                    a.   Cash and Cash Equivalents...........147
                    b.   Automobiles.........................147
                    c.   Real Properties.....................147
                    d.   Jewelry and Furs....................148
                    e.   Judgment Against Michael Boulware...148
                    f.   Summary.............................148
               3. Disbursements by HIE......................149

        F.    Settlement of 1998 Adversary Proceedings.......149

        G.    Claimed Bad Debt Deductions Related to Amounts
              Considered Due From Jin Sook Lee, Trustee......151

XVII.        NOL Adjustments.................................151

        A.    HIE’s Filing of Its Federal Income Tax Returns
              for 198906 Through 199906......................151
                          - 10 -

     B.    Pre-199806 Reported NOLs and Applications......152

     C.    HIE Claims on Its Federal Income Tax Return for
           199806 That Its NOL Carryover From Earlier
           Years Is Larger Than That Previously Reported..153

     D.    Source of Larger NOL Carryover Reported For
           199806.........................................154

     E.    HIE’s 199906 Federal Income Tax Return.........155
            1. Overview..................................155
            2. Exhibit 18-J..............................156
            3. Claim to Additional COGS..................158

     F.    HIE’s Position as to Its NOL Carryovers
           Reported for 199806 and Later Years............159
            1. Overview..................................159
            2. HIE’s Liability for Hawaii Tobacco Tax....160
            3. HIE’s Purported Overpayment of Hawaii
                Tobacco Tax...............................160
            4. Tobacco Tax Liability Adjustment..........162
            5. HIE’s Monthly Book Adjustments............164
            6. HIE’s AJEs................................165
            7. Tobacco Tax Refund Income Claimed Reported
                and Reportable by HIE.....................166
                 a. Income Claimed Reportable............166
                 b. Income Claimed Reported Through
                     Monthly Adjustments..................167
                 c. Income Claimed Reported Through AJEs.168
                 d. Summary..............................168
            8. HIE’s Purported Income Shift..............169

XVIII.    Michael Boulware’s Criminal Trials..............169

     A.    First Trial....................................169
            1. General Information.......................169
            2. Relevant Evidence and Arguments...........169
            3. Jury Verdict..............................170

     B.    Sentencing Phase and First Appeal..............171
            1. Positions as to Sentencing................171
            2. Sentence Imposed..........................171
            3. Appeal of Conviction......................172

     C.    Michael Boulware’s Retrial.....................172
                            - 11 -

       D.    Criminal Case Heard by U.S. Supreme Court......173

       E.    Remand From U.S. Supreme Court.................174

XIX.        Civil Examinations and Requests for
            Information.....................................175

       A.    Start of Civil Examinations....................175

       B.    Requests for Information.......................175
              1. HIE.......................................175
              2. Holdings..................................177
              3. Actions During This Proceeding............180

XX.         Professional Fees...............................180

       A.    Overview.......................................180

       B.    Source of Professional Fees....................181
              1. HIE.......................................181
              2. Holdings..................................182

       C.    Categories of Disputed Professional Fees.......182
              1. Overview..................................182
              2. Specifics of Expenses in Each Category....183
                   a.   Criminal Investigation..............183
                   b.   Grand Jury Proceedings..............183
                   c.   Michael Boulware’s Criminal Trial...184
                   d.   Fees Involving Jin Sook Lee.........184
                   e.   Fees Accepted as Ordinary and
                        Necessary...........................185
                   f.   Other Fees..........................185
              3. Amounts of Fees Attributable to Each
                  Category..................................185

       D.    Providers of the Professional Services
             Underlying the Legal Costs.....................186
              1. Criminal Investigation....................186
                   a.   Representation of HIE Employees.....186
                         i.    Overview.....................186
                         ii.   Peter Wolff..................186
                         iii. Benjamin Cassidy.............186
                   b.   Damon Key...........................187
                   c.   Irell Manella.......................188
                   d.   Shiotani Inouye.....................188
               - 12 -

      e.   Wachi Watanabe......................189
2.   Grand Jury Proceedings....................190
      a.   Birney Bervar.......................190
      b.   Brook Hart..........................190
      c.   Chee Markham........................191
      d.   Damon Key...........................191
      e.   Graham James........................192
      f.   Hochman Salkin......................194
      g.   Howard Chang........................194
      h.   Irell Manella.......................195
      i.   Lopeti Foliaki......................195
      j.   Perkin Hosoda.......................195
      k.   Reinwald O’Connor...................196
      l.   Shiotani Inouye.....................198
      m.   Stephen Pingree.....................198
      n.   Wachi Watanabe......................198
3.   Criminal Trial............................199
      a.   Accucopy............................199
      b.   Ayabe Chong.........................199
      c.   Bird Marella........................200
      d.   Bowen Hunsaker......................200
      e.   Brook Hart..........................201
      f.   Candon Consulting/John Candon.......201
      g.   Chicoine Hallett....................203
      h.   Corniel.............................203
            i.   Overview......................203
            ii. Specifics.....................204
      i.   Damon Key...........................204
      j.   Gaims Weil..........................204
      k.   Goodenow............................205
      l.   Graham James........................205
      m.   Hawaii National Bank................205
      n.   Leonard Sharenow....................206
      o.   Lyle Hosoda Associates..............206
      p.   McCorriston Miller..................206
      q.   Michael McCarthy....................207
      r.   Nathan Suzuki.......................207
      s.   Perkin Hosoda.......................207
      t.   PWC.................................207
      u.   Professional Image..................208
      v.   Reinwald O’Connor...................208
      w.   Robert Waters.......................209
      x.   Saranow Pagani......................210
      y.   Sherman Sherman.....................210
      z.   Sheila Balkan.......................211
                    - 13 -

           aa.  Shiotani Inouye.....................211
                 i.    200006.......................211
                 ii.   200106.......................211
                 iii. 200206.......................212
           bb. Squire Sanders......................212
           cc. Stephen Platt.......................213
           dd. Wachi Watanabe......................213
           ee. Wilmington Institute ...............213
      4. Fees Concerning Jin Sook Lee..............214
           a.   Chee Markham........................214
           b.   Damon Key...........................214
           c.   Gaims Weil..........................215
           d.   Glenn Lee Boulware Trust............216
           e.   Reinwald O’Connor...................216
      5. Fees Accepted as Ordinary and Necessary...217
           a.   Carlsmith Ball......................217
           b.   Damon Key...........................217
           c.   Marr Hipp...........................218
           d.   Seyfarth Shaw.......................218
           e.   Other Legal.........................219
      6. Other Fees................................219
           a.   Accucopy............................219
           b.   Case Bigelow........................219
           c.   Damon Key...........................220
           d.   Foley Jones.........................221
           e.   GMK Consulting......................221
           f.   King King...........................222
           g.   Laird Christianson..................222
           h.   Louis Wai...........................222
           i.   Michael McCarthy....................223
           j.   Nathan Suzuki.......................223
           k.   Robert Holland......................223
           l.   Yoshida, Inc........................223
           m.   Other Legal.........................224
E.   Other Professional Fees........................224
      1. Fees Related to Criminal Trial............224
      2. Fees Accepted as Ordinary and Necessary...224
           a.   Antoneita DeWang-Seo................224
           b.   Applied Computer....................224
           c.   ASI Food Safety.....................225
           d.   Back to Basics Plus.................225
           e.   Brewer Environmental................225
           f.   Business Consulting.................225
           g.   Ceridian Employer...................225
           h.   Charles Abraham.....................226
                 - 14 -

      i.     COLIFORM............................226
      j.     Commercial Plumbing.................226
      k.     Communications Pacific..............226
      l.     Datahouse...........................227
      m.     Dataprofit Corp.....................227
      n.     Dunn Bradstreet.....................227
      o.     Electra Form........................227
      p.     EMS Solutions.......................227
      q.     Fidelity Investments................228
      r.     Foley Jones.........................228
      s.     Food Products.......................228
      t.     GEM Communications..................229
      u.     GT Service..........................229
      v.     Hawaiian Hardware...................229
      w.     Intrastate..........................229
      x.     IW..................................229
      y.     John Ching..........................230
      z.     Kimura International................230
      aa.    KPMG................................230
      bb.    L.C. Financial .....................230
      cc.    Leung Pang..........................231
      dd.    Melvin Kam..........................231
      ee.    Michael Toigo.......................231
      ff.    Pension Services....................231
      gg.    Procomm.............................232
      hh.    Professional Image..................232
      ii.    Profit Concepts.....................232
      jj.    Quadrel Labeling....................232
      kk.    Rhanda Kim..........................232
      ll.    Richard Kitagawa....................233
      mm.    RJR Packaging.......................233
      nn.    Servend of Hawaii...................233
      oo.    Stewart Engineering.................233
      pp.    Tricia Young........................233
      qq.    Wayne Arakaki.......................234
3.   Other   Fees................................234
      a.     Henry Yokogawa......................234
      b.     Kobayashi Doi.......................234
             i.    Overview......................234
             ii.   199806........................235
             iii. 199906........................235
             iv.   200006........................236
             v.    200106........................236
             vi.   200206........................236
      c.     Lorin Kushiyama.....................236
                                 - 15 -

                        d.   Richard Kitagawa....................236
                        e.   TRI Pac.............................237
                        f.   Vending Consulting..................237
                        g.   Watson Wyatt........................237
                        h.   Amortization........................237

     XXI.        Kona Coffee.....................................238

            A.    Background.....................................238

            B.    Season for Kona Coffee.........................239

            C.    Shelia David...................................239

OPINION......................................................241

     I.      Perception of Witnesses..........................241

     II.     Burden of Proof..................................244

            A.    Overview.......................................244

            B.    Applicability of Section 7491..................245

            C.    Claim That NODs Are Arbitrary..................249

     III.    NOL Deduction....................................251

     IV.     Bad Debt Deduction...............................263

     V.      Professional Fees................................269

            A.    Overview of Dispute............................269

            B.    Applicable Law in General......................270
                   1. Deduction of Ordinary and Necessary
                       Business Expenses.........................270
                   2. Corporate Taxpayer’s Burdens Underlying
                       Deduction.................................271
                   3. Payment of Another Taxpayer’s Expense.....272
                        a. First Prong of Two-Prong Test........273
                        b. Second Prong of Two-Prong Test.......275

            C.    Whether HIE Incurred Any of the Disputed
                  Expenses.......................................278
                          - 16 -

      D.   Whether All Expenses Were Substantiated........280

      E.   “Fees Accepted as Ordinary and Necessary” and
           “Other Fees”...................................281

      F.   Expenses of Michael Boulware’s Criminal
           Defense........................................282
            1. Background................................282
            2. Expenses Stemmed From Personal Pursuits...284

      G.   Professional Fees Related to Civil Litigation
           Initiated by Jin Sook Lee......................288
            1. Overview..................................288
            2. Analysis..................................289
                 a. Fees Determined To Be Capital
                     Expenditures.........................289
                 b. Fees Determined To Be Michael
                     Boulware’s Personal Expenses.........290

      H.   Applicability of Indemnification Agreement.....292
            1. Overview..................................292
            2. Arrangements Under Section 62(a)(2)(A)....293
            3. Mandatory Indemnity.......................295
                 a. Overview.............................295
                 b. Analysis.............................296
            4. Permissive Indemnity......................298
            5. Repayment Obligation......................299

VI.    Constructive Dividends...........................300

      A.   Overview.......................................300

      B.   Rules Applicable to Distributions..............301

      C.   E&P............................................302
            1. Background................................302
            2. Lack of Comprehensive Definition..........302
            3. Calculation...............................303
                 a. Overview.............................303
                      i. ATI.............................303
                      ii. Increases and Decreases to ATI..304
                 b. Current E&P..........................306
                 c. Accumulated E&P......................307
                 d. Summary of Calculation...............307
                                  - 17 -

             D.   Adjustments Applicable to These Cases..........309
                   1. Overview..................................309
                   2. First Adjustment..........................309
                   3. Second Adjustment.........................309
                   4. Third Adjustment..........................310
                   5. Fourth Adjustment.........................310
                   6. Fifth Adjustment..........................311

             E.   Conclusion.....................................311

     VII.     Additions to Tax.................................312

     VIII.    Epilog...........................................313

Appendix A...................................................314

Appendix B...................................................321

Appendix C...................................................322


                  MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:       These cases are before the Court consolidated

for purposes of trial, briefing, and opinion.3      In docket No.

5045-05, HIE Holdings, Inc. (Holdings), and two of its

subsidiaries, Hawaiian Isles Kona Coffee Co., Ltd. (Hawaiian

Isles Kona Coffee), and Royal Hawaiian Water Co., Ltd. (Royal

Hawaiian Water), petitioned the Court to redetermine respondent’s

determination of deficiencies of $242,546, $77,602, $470,461,

$280,489, and $519,760 in the affiliated group’s Federal income

taxes for its taxable years ended June 30, 1997, 1999, 2000,


     3
      The cases were consolidated on Feb. 27, 2006, pursuant to
the joint motion of the parties.
                              - 18 -

2001, and 2002, respectively.4   In docket No. 5046-05, Hawaiian

Isles Enterprises, Inc. (HIE), petitioned the Court to

redetermine respondent’s determination of deficiencies of

$1,057,181, $125,317, $175,524, and $799,433 in HIE’s Federal

income taxes for 199806, 200006, 200106, and 200206,

respectively, and a $264,295 addition to HIE’s 199806 tax under

section 6651(a)(1).5   In docket No. 5047-05, Michael Boulware

petitioned the Court to redetermine respondent’s determination of

deficiencies of $497,926, $603,406, $935,124, $1,339,019, and

$874,551 in Michael Boulware’s 1998 through 2002 Federal income

taxes, respectively.




     4
      We hereinafter refer to each relevant fiscal year by using
a six-digit number. The first four digits refer to the year in
which the fiscal year ended. The last two digits refer to the
month in which the fiscal year ended.
     5
      Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded to the dollar. References to sections and
chapters of the Bankruptcy Code are to tit. 11 of the United
States Code after the effective date of amendments made thereto
by the Bankruptcy Reform Act of 1994, Pub. L. 103-394, 108 Stat.
4106, that were effective for bankruptcies filed on and after
Oct. 22, 1994. Id. sec. 702, 108 Stat. 4150. Throughout this
Memorandum Opinion, we reference various law, accounting, and
other professional firms, many of which changed their names
during the relevant period. We refer to each firm by one of its
names and include within that name each of the firm’s relevant
predecessors and successors.
                             - 19 -

     Following a trial of these cases held primarily in Honolulu,

Hawaii, we decide five issues.6   First, we decide whether to

sustain respondent’s disallowances of HIE’s deductions of net

operating losses (NOLs), reported as arising from NOL carryovers

from 198906 through 199606, to the extent of $1,636,322 for

199806 and of $1,184,192, $324,767, and $145,145 for 200006,



     6
      These cases were originally scheduled to be tried in Los
Angeles, California, but the Court granted the parties’ joint
motion to change the situs of trial to Honolulu, Hawaii, where
most of the witnesses resided. Because Michael Boulware would
otherwise have been detained at a U.S. penitentiary in California
during the trial, the Court, pursuant to sec. 7456 and joint
motions of the parties, issued writs of habeas corpus ad
testificandum causing the U.S. Marshal for the District of Hawaii
to move Michael Boulware to a prison in the vicinity of Honolulu
and then to transport Michael Boulware (under the escort of
Deputy U.S. Marshals) to and from the courtroom in Honolulu on
each day that Michael Boulware wanted to attend his trial. For
purposes of the trial, the parties generally made electronic
copies of each document that was introduced into evidence, and
petitioners caused five large electronic screens (including a
42-inch screen) to be present in the courtroom. The parties
generally used those screens to display to themselves, to the
Court, and to each witness any exhibit that was the subject of
the witness’s testimony. The Court imposed a time limit on each
side’s presentation of evidence. On Aug. 28, 2007, these cases
were initially submitted to the Court for decision. On Mar. 3,
2008, the U.S. Supreme Court decided Boulware v. United States,
552 U.S.    , 128 S. Ct. 1168 (2008), a case involving Michael
Boulware and much of the same evidence that is in the record
here. In the light of that case, this Court granted petitioners’
request to reopen the record in these cases so that they could
solicit additional testimony and present additional documents
during a further trial in Honolulu. The issues tried at the
further trial were limited to determinations of the earnings and
profit (E&P) of HIE and Holdings and a determination of Michael
Boulware’s adjusted basis in each of those corporations.
                               - 20 -

200106, and 200206, respectively.7      We shall sustain those

disallowances in full.    Second, we decide whether to sustain

respondent’s disallowance of a $905,340 bad debt deduction HIE

claimed for 199806.   We shall sustain none of that disallowance.

Third, we decide whether to sustain respondent’s disallowances of

professional fees deducted by HIE to the extent of $1,241,995,

$1,159,635, $1,156,364, and $2,208,588 for 199806, 200006,

200106, and 200206, respectively, and of professional fees

deducted by Holdings to the extent of $228,240, $1,383,710,

$794,404, and $2,253,652 for 199906 through 200206, respectively.

We shall sustain those disallowances to the extent stated herein.

Fourth, we decide whether to sustain respondent’s determinations

that Michael Boulware received constructive dividends of

$1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120

for 1998 through 2002, respectively, primarily because the

just-referenced professional fees were paid by his constructive

withdrawals of funds from HIE and Holdings (collectively, subject

corporations).   We shall sustain those determinations to the

extent stated herein.    Fifth, we decide whether to sustain

respondent’s determination that HIE is liable for the addition to



     7
      For 199806, HIE claimed an NOL deduction of $2,086,891.
Respondent determined that the NOL deduction was $450,569; i.e.,
$1,636,322 less than claimed.
                                - 21 -

tax under section 6651(a).    We shall sustain that determination

in full.8

                           FINDINGS OF FACT

I.   Preliminaries

      Many facts were stipulated, and those facts are found

accordingly.   The approximately 2,000 stipulated facts and the

thousands of exhibits submitted therewith are incorporated herein

by this reference.   The trial transcripts total 5,255 pages, and

the number of pages in the exhibits total approximately 50,000.

The Court has recorded on the docket sheets of these cases over

900 index entries.

      The subject corporations are C corporations that during the

relevant years used accrual methods to report their income and

expenses for Federal income tax purposes on the basis of fiscal

years ended on June 30.9    When the petitions commencing these


      8
      In their posttrial briefs, petitioners attempt to raise
certain issues that were not pleaded in their petitions. We
decline to decide those issues as they are not properly before
us. See Rules 34(b)(4), 41(a) and (b); see also Bob Wondries
Motors, Inc. v. Commissioner, 268 F.3d 1156, 1161 (9th Cir.
2001), affg. Toyota Town, Inc. v. Commissioner, T.C. Memo.
2000-40; Foil v. Commissioner, 92 T.C. 376, 418 (1989), affd. 920
F.2d 1196 (5th Cir. 1990).
      9
      The Federal income tax   return of a corporate taxpayer such
as HIE or Holdings that uses   a fiscal year ending on June 30 is
generally due on Sept. 15 of   the year in which its fiscal year
ends, unless the corporation   receives an extension to file its
return 6 months later; i.e.,   by Mar. 15 of the following year.
                                    - 22 -

cases were filed, the principal place of business of each subject

corporation was in Hawaii.10        Also at that time, the “legal

residence” of Michael Boulware as stipulated by the parties was

in Hawaii; we understand him then to have been imprisoned at a

U.S. penitentiary in California, specifically, the Lompoc

Correctional Facility in Lompoc, California.

II.   NODs

      A.     NOD Issued to HIE

              1.   General Information

      On December 15, 2004, respondent issued a notice of

deficiency (NOD) to HIE for 199806 and 200006 through 200206.

The NOD contained three adjustments which are relevant herein.

              2.   First Adjustment--Disallowance of Portion of
                   Deductions for NOLs

                    a.   Overview

      Respondent disallowed HIE’s claim of NOL deductions for each

year, except for $450,569 that was allowed for 199806.

                    b.   Primary Determination

      Respondent determined primarily that HIE failed to establish

that it was entitled to an NOL deduction for 199806 of more than

$450,569 or that it had an NOL carryover to apply to any of the



      10
      Unless otherwise noted, all references to Hawaii are to
the State of Hawaii.
                                 - 23 -

other subject years.     As part of this primary determination,

respondent also determined that HIE was entitled to reduce its

“miscellaneous income related to HIE’s tobacco tax ‘self-

correction’” (discussed infra) by $1,927,648 for 200006 and

$962,426 for 200106.11

               c.   Alternate Determination

                       i.   Overview

     Respondent determined alternatively that adjustments to

HIE’s income and deductions for 198906 through 199706, the years

in which HIE claims its NOL carryover to 199806 originated,

limited HIE’s NOL carryover to 199806 (and hence HIE’s NOL

deduction for that year) to $450,569 and resulted in no NOL

carryover to any of the other subject years.     Many of those

adjustments, as discussed infra, related to the criminal

indictment of Michael Boulware in part with respect to his 1989

through 1997 Federal income taxes.12




     11
      During respondent’s civil examination of HIE, respondent
also verified that HIE had reported as taxable income for 199906
“miscellaneous income related to HIE’s tobacco tax ‘self-
correction’”. Respondent did not determine a deficiency for that
year.
     12
      As discussed infra, Michael Boulware’s indictment also
related in part to certain false invoicing schemes.
                               - 24 -

                     ii.   Adjustments Related to Criminal
                           Indictment

     The adjustments for 198906 through 199706 that were related

to the criminal indictment reflected the following determinations

by respondent:   (1) For 199006 through 199306, HIE failed to

report $3,583,725 of income that was diverted to Michael Boulware

from HIE’s over-the-counter (OTC) sales of tobacco; (2) for

198906 through 199206, HIE failed to report $1,335,132 of income

that was diverted to Michael Boulware and/or his mistress, Jin

Sook Lee, from HIE’s sales of coffee beans to Pele Trading, Inc.

(Pele Trading); (3) for 199006 through 199306, HIE failed to

report $1,265,458 of income that was diverted to Michael Boulware

and/or Jin Sook Lee from HIE’s sales of coffee beans to Hawaiian

Kona Coffee Co., d.b.a. Hawaii Misuzu Coffee Co., Ltd. (Hawaii

Misuzu);13 (4) for 199006, HIE improperly deducted $50,785 that

HIE paid to Bonded Construction Co., Ltd. (Bonded Construction),

for work that HIE reported was performed at HIE’s coffee plant

but which actually was performed to renovate Jin Sook Lee’s

residence in Honolulu at 1017 Makaiwa Street (Makaiwa house);

(5) for 199306, HIE improperly deducted $638,427 that was

diverted from HIE to Michael Boulware through certain fictitious



     13
      Hawaii Misuzu and Hawaiian Isles Kona Coffee are different
entities and are unrelated.
                               - 25 -

leasing arrangements; (6) for 199506 through 199706, HIE

improperly deducted $1,731,000 that HIE paid to a foreign entity,

Harvest International King Coffee, Ltd. (Harvest International),

which was then transferred to Michael Boulware through a second

foreign entity, Forest Trading Corp. (Forest Trading); (7) for

199506, HIE improperly deducted $29,984 that HIE paid to Harvest

International, which was then transferred on behalf of Michael

Boulware to a domestic entity, Briggs Cockerham, L.L.C. (Briggs

Cockerham); and (8) for 199506 and 199606, HIE improperly

deducted $89,936 that HIE paid to Harvest International, which

was then transferred on behalf of Michael Boulware to Anthony Oh

Young and Gloria Oh Young through a foreign entity, Pacific

Vendors Equipment, Ltd. (Pacific Vendors).

                     iii.   Adjustments Unrelated to Criminal
                            Indictment

     The adjustments for 198906 through 199706 that were

unrelated to the criminal indictment of Michael Boulware

reflected respondent’s determinations that HIE was not entitled

to deduct:   (1) Salaries totaling $1,040,000 reportedly paid

during 198906 through 199406 to Michael Boulware’s then wife, Mal

Sun Boulware; (2) payments totaling $385,000 that HIE made during

198906 and 199006 to Paradise Roasting, Inc. (Paradise Roasting),

a nonoperating entity that was the alter ego of Jin Sook Lee and
                              - 26 -

was established to hide the transfer of HIE funds to Jin Sook

Lee; (3) professional fees totaling $175,000 reportedly paid to

Jin Sook Lee’s sole proprietorship, Video Consultant, during

199006 and 199106;14 (4) bad debts totaling $1,800,000 that were

written off during 199306, 199406, 199506, and 199706 as

uncollectible but otherwise due HIE from Jin Sook Lee in her

capacity as the sole trustee of the Glenn Lee Boulware Trust, a

trust established for the primary benefit of the oldest son of

Jin Sook Lee and Michael Boulware; and (5) certain other

professional fees totaling $4,269,980 for 199406 through 199706.

                    iv.   Some Specifics of Adjustments

     Some specifics of the adjustments for 198906 through 199706

are as follows:




     14
      The record sometimes lists this entity as “Video
Consultant” and other times as “Video Consultants”. We
consistently refer to this entity in the singular.
                                                             - 27 -
              198906      199006     199106      199206       199306      199404     199506      199606      199706      Total

OTC sales        -0-      $506,464 $1,337,213    $719,755    $1,020,293    -0-         -0-         -0-         -0-     $3,583,725
Pele Trading $264,790    1,029,963     21,175      19,204         -0-      -0-         -0-         -0-         -0-      1,335,132
Hawaii
  Misuzu         -0-      116,832     382,403    347,866       418,357     -0-         -0-         -0-         -0-     1,265,458
Bonded
  Construction   -0-       50,785       -0-        -0-           -0-       -0-         -0-         -0-         -0-        50,785
Leasing
  arrangement    -0-        -0-         -0-        -0-         638,427     -0-         -0-         -0-         -0-       638,427
Forest Trading   -0-        -0-         -0-        -0-           -0-       -0-      $837,000    $819,000     $75,000   1,731,000
Briggs
  Cockerham      -0-        -0-         -0-        -0-           -0-       -0-        29,984       -0-         -0-        29,984
Anthony Oh
  Young and
  Gloria Oh
  Young          -0-        -0-         -0-        -0-           -0-      -0-         34,986      54,950       -0-        89,936
Salaries        30,000     95,000     190,000    275,000       300,000 $150,000        -0-         -0-         -0-     1,040,000
Paradise
  Roasting     185,000    200,000       -0-        -0-           -0-       -0-         -0-         -0-         -0-       385,000
Video
  Consultant     -0-       84,000      91,000      -0-           -0-        -0-        -0-         -0-         -0-       175,000
Bad debts        -0-        -0-         -0-        -0-         300,000    100,000    700,000       -0-       700,000   1,800,000
Other
  professional
  fees           -0-         -0-         -0-        -0-          -0-      521,690     903,695   1,296,308   1,548,287 4,269,980
  Total        479,790   2,083,044   2,021,791   1,361,825   2,677,077    771,690   2,505,665   2,170,258   2,323,287 16,394,427

                3.       Second Adjustment--Disallowance of Portion of
                         Deductions for Professional Fees

                          a.       Overview

       For each subject year, respondent disallowed a portion of

HIE’s deduction for professional fees.                                     The disallowed fees

totaled $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for

199806, 200006, 200106, and 200206, respectively.                                               Respondent

determined that some disallowed fees were the personal expenses

of HIE’s controlling shareholder, Michael Boulware.                                                 Respondent

determined that other disallowed fees were unsubstantiated.

Respondent determined that the remaining disallowed fees were

capital expenditures incurred in connection with HIE’s

acquisition of property from the bankruptcy estate of Jin Sook

Lee.
                               - 28 -

                b.   Personal Expenses of Michael Boulware

     The disallowed fees determined to be personal expenses of

Michael Boulware stemmed from professional representation that he

received in his individual capacity.    He received some of that

representation while respondent’s Criminal Investigation Division

(CID) was conducting a criminal investigation of Michael Boulware

and Jin Sook Lee as to their personal Federal income taxes

(criminal investigation); while a grand jury was conducting its

investigation of Michael Boulware, proceeding to his indictment

(grand jury proceedings); and during Michael Boulware’s first

criminal trial and his appeal of his conviction resulting from

that trial.15   Michael Boulware received the remainder of that

representation while he and HIE were involved in civil litigation

initiated by Jin Sook Lee.   Respondent determined that 50 percent

of the expenses related to that civil litigation were the

personal expenses of Michael Boulware and that the other 50

percent were the business expenses of HIE.




     15
      As discussed infra, the criminal investigation began on or
about June 16, 1993; the grand jury proceedings began at or about
the beginning of August 1997; Michael Boulware was indicted on
May 19, 1999 (a superseding indictment and second superseding
indictment occurred on Apr. 6, 2000, and Feb. 14, 2001,
respectively); the jury in Michael Boulware’s first criminal
trial convicted him on Nov. 29, 2001; and Michael Boulware
appealed that conviction in May 2002.
                                             - 29 -

      In sum, the amounts of Michael Boulware’s personal expenses

determined to be attributable to the criminal and civil cases are

as follows:16

                            199806      199906      200006       200106     200206     Total

 Criminal investigation,
   grand jury proceedings,
   first criminal trial,
   and appeal               $598,602   $810,688   $1,016,103   $1,156,364     -0-    $3,581,757
 50 percent of expenses
    related to civil
    litigation initiated
    by Jin Sook Lee          411,678     36,245       58,588        -0-       -0-       506,511
      Total                1,010,280    846,933    1,074,691    1,156,364     -0-     4,088,268


                      c.    Unsubstantiated Expenses

      The disallowed fees determined to be unsubstantiated totaled

$103,313 for 199806, $10,000 for 199906, $66,671 for 200006, and

$2,208,588 for 200206.

                      d.    Capital Expenditures

      Respondent determined that $157,979 of the total disallowed

fees was capital expenditures attributable to various assets that

HIE acquired from the bankruptcy estate of Jin Sook Lee.                               The

specific amounts underlying the $157,979 were $128,402 for

199806, $11,304 for 199906, and $18,273 for 200006 ($128,402 +

$11,304 + $18,273 = $157,979).                    The acquired assets were the

Makaiwa house, a condominium in Honolulu at 1117 Punahou Street

(Punahou condominium), a condominium in Honolulu at 475 Atkinson


      16
      Although 199906 is not a year that was the subject of the
NOD issued to HIE, we include that year in our findings because
it relates to the constructive dividends determined in the NOD
issued to Michael Boulware.
                                              - 30 -

Drive (Atkinson condominium), a 1992 Rolls Royce, and jewelry and

furs.     Of the $157,979, respondent determined that $16,391,

$60,134, $22,308, $19,398, and $39,747 were allocable to those

respective assets.             Respondent determined the allocable amounts

as follows:

                                            Applicable            Percent of        Capitalized
                                               Value                 Whole              Fees

   Makaiwa house                             $845,000
     Less: A life estate
       retained by Jin Sook
       Lee in the house                        760,500
     Acquired interest                          84,500               10.38             $16,391
   Punahou condominium                         310,000               38.06              60,134
   Atkinson condominium                        115,000               14.12              22,308
   1992 Rolls Royce                            100,000               12.28              19,398
   Jewelry and furs                            204,900               25.16              39,747
     Total                                     814,400              100.00             157,979

For each of the taxable years 200006, 200106, and 200206,

respondent determined that HIE was entitled to deduct $2,459 of

depreciation as to the capital expenditures.                              Respondent

determined that depreciation as follows:

                            Capitalized   Allocation      Depreciable
                                Fees      to Building        Basis        200006    200106   200206

 Punahou condominium         $60,134           85%          $51,114       $1,859    $1,859   $1,859
 Atkinson condominium         22,308           74            16,508          600       600      600
   Total                                                                   2,459     2,459    2,459

                     e.      Summary

        In sum, the disallowed professional fees are as follows:

                               199806      199906      200006        200106        200206    Total

 Personal expenses           $1,010,280   $846,933   $1,074,691    $1,156,364        -0-   $4,088,268
 Unsubstantiated expenses       103,313     10,000       66,671         -0-     $2,208,588 2,388,572
 Capital expenditures           128,402     11,304       18,273         -0-          -0-      157,979
   Total                      1,241,995    868,237    1,159,635     1,156,364    2,208,588 6,634,819
                               - 31 -

          4.    Third Adjustment--Disallowance of Deduction
                for Bad Debt

     For 199806, respondent disallowed HIE’s claimed bad debt

deduction of $905,340.   That deduction was attributable to HIE’s

writeoff of a further portion of the debt reportedly due to HIE

from Jin Sook Lee in her capacity as trustee of the Glenn Lee

Boulware Trust.   Respondent determined that the deduction was not

allowed primarily because HIE had failed to establish a

debtor/creditor relationship with Jin Sook Lee.   Respondent

determined alternatively that the deduction was not allowed

because HIE had failed to establish the accuracy of the amount

claimed as the deduction or its worthlessness.

     B.   NOD Issued to Holdings

           1.   General Information

     On December 15, 2004, respondent issued an NOD to Holdings

for 199706 and 199906 through 200206.   The NOD related to

Holdings and to its wholly owned subsidiaries, Hawaiian Isles

Kona Coffee and Royal Hawaiian Water.

           2.   Sole Relevant Adjustment--Disallowance of Portion
                of Deductions for Professional Fees

     The NOD contained one adjustment which is relevant herein;

i.e., respondent disallowed a portion of Holdings’ deduction of
                                      - 32 -

professional fees for 199906 through 200206.17            The disallowed

fees totaled $228,240, $1,383,710, $794,404, and $2,253,652 for

199906 through 200206, respectively.           Respondent determined that

some of the disallowed fees were the personal expenses of Michael

Boulware.    Those personal expenses were determined to stem mainly

from the professional representation Michael Boulware received

during the criminal investigation; during the grand jury

proceedings; and during Michael Boulware’s first criminal trial

and his appeal of his conviction resulting from that trial.

Respondent determined that the remaining disallowed fees were

unsubstantiated.    Respondent determined the specific amounts

attributable to the two reasons for disallowance as follows:

                             199906       200006      200106      200206

 Personal expenses             -0-      $1,110,435   $575,114   $1,678,579
 Unsubstantiated expenses   $228,240       273,275    219,290      575,073
   Total                     228,240     1,383,710    794,404    2,253,652

     C.   NOD Issued to Michael Boulware

            1.   General Information

     On December 15, 2004, respondent issued an NOD to Michael

Boulware for 1998 through 2002.



     17
      For 199706, Holdings had carried back and claimed a
deduction for a $713,370 NOL from 200206. Because respondent’s
disallowance of the amount of professional fees Holdings deducted
for 200206 was greater than $713,370, respondent determined that
Holdings did not have an NOL for 200206 and thus was not entitled
to its claimed NOL deduction for 199706.
                                              - 33 -

                2.   Sole Relevant Adjustment--Constructive Dividends

       The NOD contained one adjustment which is relevant herein;

i.e., respondent determined that most of the above-mentioned

unsubstantiated expenses and personal expenses were personal

withdrawals of funds by Michael Boulware from the subject

corporations and that the amounts of these funds were includable

in Michael Boulware’s taxable income as constructive dividends.

Respondent determined that the constructive dividends totaled

$1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120

for 1998 through 2002, respectively,                        Respondent determined these

amounts as follows:

   Distribution            1998        1999       2000         2001        2002         Total

   HIE 199806             $891,242      -0-         -0-         -0-          -0-       $891,242
   HIE 199906              400,981   $472,235       -0-         -0-          -0-        873,216
   HIE 200006                -0-      477,969    $596,722       -0-          -0-      1,074,691
   HIE 200106                -0-        -0-       485,610    $670,754        -0-      1,156,364
   HIE 200206                -0-        -0-         -0-     1,104,294   $1,104,294    2,208,588
     Subtotal            1,292,223    950,204   1,082,332   1,775,048    1,104,294    6,204,101

   Holdings 199906
     Unsubstantiated       114,120    114,120       -0-         -0-          -0-        228,240
   Holdings 200006
     Personal expenses       -0-      312,094     798,341       -0-          -0-      1,110,435
     Unsubstantiated         -0-      136,637     136,638       -0-          -0-        273,275
   Holdings 200106
     Personal expenses       -0-        -0-       205,687     369,428        -0-        575,115
     Unsubstantiated         -0-        -0-       109,645     109,645        -0-        219,290
   Holdings 200206
     Personal expenses       -0-       -0-          -0-       839,290      839,290    1,678,580
     Unsubstantiated         -0-       -0-          -0-       287,536      287,536      575,072
       Subtotal            114,120   562,851    1,250,311   1,605,899    1,126,826    4,660,007
         Total           1,406,343 1,513,055    2,332,643   3,380,947    2,231,120   10,864,108


III.    Background of Michael Boulware

       Michael Boulware was born on the Island of Maui on March 14,

1948, and he was raised on the Island of Oahu in a lower-middle-

income neighborhood.               He attended college for approximately 2
                                - 34 -

years and then served in the National Guard through 1970.       He

later attended college for one more semester and then quit school

to work for a telephone company.    He subsequently stopped working

for the telephone company and performed a variety of jobs

including driving a cab and working at a restaurant bar.

IV.   Relevant Corporations

      A.   HIE

            1.   Formation of Business

      In the late 1970s, Michael Boulware started his own

business, the operation of a pool hall, and he began working for

that business.    On the premises of the business were pool tables,

video games, and vending machines.       In or about 1980, Michael

Boulware changed his business to one of video games.       Shortly

thereafter, on July 10, 1981, Michael Boulware transferred most

if not all of the assets and liabilities of his video game

business to a newly formed corporation, M&S Vending, Inc. (M&S

Vending), in exchange for all of its stock.

      M&S Vending was initially a cash business that involved

owning and maintaining coin-operated video games and jukebox,

pinball, karaoke, and vending machines (including vending

machines that sold cigarettes) and leasing those games and

machines to hotels, bars, restaurants, and other establishments

for use on their premises.    M&S Vending generally shared the cash
                             - 35 -

receipts of each of its games and machines with the establishment

in which the game or machine was located.    The establishment

generally received 50 percent of the cash receipts in each game

or machine (other than a cigarette machine) located on its

premises; sometimes, the establishment received the first 10

percent of the cash receipts plus 50 percent of the remaining

cash receipts (in other words, the establishment received 55

percent of the cash receipts).   As to the cigarette machines, M&S

Vending paid an establishment 10 percent of the receipts from

those machines on the premises of that establishment.    In

addition to the remaining 90 percent of the cigarette machine

receipts that it kept as income, M&S Vending also earned income

from cigarette manufacturers that paid M&S Vending to place their

brands in the cigarette machines.

     In or about the mid-1980s’, M&S Vending expanded its

business to include the purchase of cigarettes and the sale of

those cigarettes through its leased cigarette machines.

Initially, M&S Vending purchased its cigarette inventory from

Island Tobacco, a local wholesaler owned by Harold Okimoto and

run by his brother Thomas Okimoto.    Because M&S Vending had a lot

of cigarette machines, it was eventually able to (and did)

purchase cigarettes directly from the manufacturers (e.g., Philip

Morris), rather than from the wholesalers.
                                 - 36 -

     M&S Vending eventually changed its name to Hawaiian Isles

Vending and later, on or about June 30, 1987, to HIE.    Shortly

thereafter, HIE expanded its business further to include the sale

of coffee and candy through its vending machines.    HIE’s coffee

business involved selling coffee to business offices through

machines that HIE lent to the businesses.    In 1988 or 1989, HIE

expanded its business even further to include the processing and

distribution of a blend of Kona coffee.    Kona coffee is grown and

sold at approximately 600 small farms in a central region of

Kona, a section of the Island of Hawaii, and Kona coffee is one

of the most expensive coffees in the world.18    In order to be

labeled and sold as “Kona coffee”, a blend of coffee must contain

at least 10 percent Kona coffee.     HIE’s blend of Kona coffee was

a mix of 10 percent Kona coffee beans and 90 percent coffee beans

grown in places such as Brazil, Costa Rica, or Sumatra.

          2.   Officers and Directors

                a.   Initially

     Initially, Michael Boulware was the president, treasurer,

and secretary of M&S Vending, and he was one of two directors on

its board.   Through August 31, 1982, M&S Vending’s vice president

and only other director was Matthew S.K. Pyun, Jr.


     18
      The average size of each of the approximately 600 farms is
less than 5 acres, and the owners of those farms are natives.
                                - 37 -

               b.     August 31, 1982, to July 10, 1991, or
                      Thereabouts

     From August 31, 1982, through July 10, 1991, or thereabouts,

Michael Boulware was the only officer of HIE (inclusive of its

predecessor), serving simultaneously as president, vice

president, secretary, and treasurer.      During that time, Michael

Boulware also was either the sole director on the corporation’s

board or one of its two directors.       Stanley Hirai was the other

director of HIE (and its predecessor) during some of that time.

     Stanley Hirai helped Michael Boulware form the business that

became the business of M&S Vending and was one of M&S Vending’s

original employees.    Stanley Hirai’s role as a director of HIE

(and its predecessor) was limited and scripted by Michael

Boulware; among other things, Stanley Hirai signed corporate

documents as directed by Michael Boulware, without fully reading

the documents or understanding them.      In or about 1991, Stanley

Hirai contracted diabetes and was instructed by Michael Boulware

not to come into the office but to remain at home on full salary.

Afterwards, Stanley Hirai was paid approximately $50,000 per year

through at least 1997, and he performed few services for HIE in

return for that salary.
                                - 38 -

                 c.    On or About July 10, 1991, Through an
                       Effective Date of April 15, 2000

     From July 10, 1991, or thereabouts, through an effective

date of April 15, 2000, HIE had two directors in addition to

Michael Boulware.     One was Michael Boulware’s brother, Sidney E.

Boulware, Jr. (Sidney Boulware).    The other was Merwyn Manago, a

friend of a friend of Michael Boulware.

     Sidney Boulware began working for HIE in or about 1983.

Before that time, Sidney Boulware had worked for the Department

of Education as a counselor at a high school.    Sidney Boulware

worked part time for HIE through June 1987, at which time he

began (and has continued) to work full time for HIE as a chief

operations officer.    As of July 10, 1991, Sidney Boulware also

took over Michael Boulware’s role as vice president of HIE.

     Merwyn Manago began working for HIE in or about November

1988.   His position at that time was chief financial officer

under the title of controller.    Merwyn Manago has continued to

date to work for HIE (and later also Holdings) as chief financial

officer.    Merwyn Manago also served as a board member of HIE (and

Holdings) through 2006.    In 2006, Michael Boulware removed Merwyn

Manago from the board and replaced him with Michael Boulware’s

daughter.
                                - 39 -

     When Merwyn Manago began working for HIE, HIE’s accounting

department was weak to inadequate, and its accounting records

were not current.     Merwyn Manago aimed to make that department

stronger.    Initially, Merwyn Manago caused HIE to hire a vending

accountant and an assistant controller.     Later, in 1995 or 1996,

Merwyn Manago caused HIE to hire another assistant controller.

Scott Yoshida, an employee of HIE and then Holdings from December

1991 to date, was employed as assistant controller through

December 1995.   In December 1995, Scott Yoshida was promoted to

controller of Hawaiian Isles Kona Coffee.

                 d.    Effective April 15, 2000

     Effective April 15, 2000, Michael Boulware resigned his

position as president, secretary, and treasurer of HIE.     HIE’s

board (Michael Boulware, Sidney Boulware, and Merwyn Manago)

accepted that resignation and appointed Sidney Boulware and

Florence Boulware as HIE’s sole officers for the next corporate

year.19   Sidney Boulware was appointed president, vice president,

and treasurer.   Florence Boulware was appointed secretary.

Sidney Boulware has continued to date to work for HIE as its

president.



     19
      While we find in the record that Florence Boulware is
related to Michael Boulware, we are unable to find the specific
relationship between the two.
                                - 40 -

                 e.   Board Meetings

     HIE’s board of directors met frequently (either formally or

informally) and memorialized those meetings in minutes.    The

minutes were typically typed into form by an administrative

secretary of HIE, who was not at the meeting but who would

receive from either Michael Boulware or Sidney Boulware the

statements that she would type.    The typed document would then be

circulated to the officers who were present at the meeting for

their signature.

           3.   Shareholders

     Initially, Michael Boulware was the sole shareholder of M&S

Vending.   Through September 8, 1987, Michael Boulware also was

the sole shareholder of HIE.    On September 8, 1987, Michael

Boulware transferred 50 percent of his stock in HIE to Jin Sook

Lee as trustee of the Glenn Lee Boulware Trust.20    Jin Sook Lee

was Michael Boulware’s mistress from 1982 through 1994, and she

is the mother of their two children.     Their oldest child is Glenn

Lee Boulware.

     At the time of the transfer, HIE did not issue a stock

certificate to Jin Sook Lee, as trustee, or otherwise record the


     20
      Immediately before this transfer, Michael Boulware’s
adjusted basis in his HIE stock was $1,000. Immediately after
the transfer, Michael Boulware’s adjusted basis in his HIE stock
was $500.
                               - 41 -

transfer in its books.   In 1995, Jin Sook Lee, as trustee,

commenced a lawsuit in the Circuit Court of the First Circuit of

Hawaii by filing with the court a “Petition of Jin Sook Lee to

Enforce Trust and For An Accounting in Favor of Glenn Lee

Boulware, A Minor, Beneficiary” (trust case).   The court docketed

the trust case as No. 95-0029.   On June 14, 1996, while the

lawsuit was pending, HIE issued a stock certificate to Jin Sook

Lee, as trustee, reflecting the ownership of 47.5 percent of the

outstanding shares of HIE.   Contemporaneously, HIE also issued

stock to Sidney Boulware so that thereafter Sidney Boulware

reportedly owned a 5-percent interest in HIE and Michael Boulware

and Jin Sook Lee, as trustee, each reportedly owned a 47.5-

percent interest in HIE.

     On or about March 15, 1998, Sidney Boulware rescinded his

reported 5-percent interest in HIE so that thereafter Michael

Boulware and Jin Sook Lee, as trustee, each owned 50 percent of

HIE’s stock.   Sidney Boulware’s action of rescission was in

response to a ruling made by the court in the trust case.

Specifically, on July 31, 1997, the court ruled that the Glenn

Lee Boulware Trust was entitled to own 50 percent of the stock of

HIE as of September 8, 1987.
                              - 42 -

          4.    Michael Boulware’s Control

     Michael Boulware was viewed by the directors, officers, and

employees of HIE as the “boss”.   When he was a director on HIE’s

board, Michael Boulware always had the final say at board

meetings, and he always had the final say with respect to the

operation and the business of HIE.     Michael Boulware controlled

HIE during the relevant years, and its employees routinely

followed his directions and instructions without questioning the

propriety of his actions.

     B.   Holdings

     On April 4, 1994, Holdings was formed by Michael Boulware as

a corporation with 1,000 outstanding shares all owned by HIE.

Holdings began its operations in and filed its initial Federal

corporate income tax return for 199706.    As of the first day of

that taxable year, i.e., July 1, 1996, Michael Boulware caused

HIE to effect a tax-free reorganization (spinoff) through which

it transferred its shares in Holdings as follows:    475 shares to

Michael Boulware, 475 shares to Jin Sook Lee, as trustee of the

Glenn Lee Boulware Trust, and 50 shares to Sidney Boulware.    As

of the first day of the following taxable year, i.e., July 1,

1997, Holdings reverse-split its stock tenfold so that thereafter

Holdings had 100 outstanding shares and the numbers of shares
                                   - 43 -

owned by the three just-mentioned individuals were 47.5, 47.5,

and 5, respectively.

     For each of the taxable years 199906 through 200206, Michael

Boulware was Holdings’ principal officer, principal employee, and

controlling shareholder.     At some point, Sidney Boulware also

served as a director of Holdings.       From 199706 to date, Sidney

Boulware worked for Holdings as an officer, including as its

president from April 15, 2000, or thereabouts, to date.

     C.    Other Corporations Organized in 1994

     Three other relevant corporations also were organized in

1994:     Hawaiian Isles Vending, Inc.; Hawaiian Isles Distributors,

Ltd.; and Hawaiian Isles Kona Coffee.       HIE owned all of the

shares of each of these corporations.

     D.     Restructuring of HIE

     Effective June 30, 1995, Michael Boulware and HIE entered

into an Agreement and Plan of Reorganization and Corporate

Separation (restructuring).     Pursuant to the restructuring,

Hawaiian Isles Vending, Inc., changed its name to Holdings, and

all shares of Hawaiian Isles Kona Coffee owned by HIE were

transferred to Holdings.     Also pursuant to the restructuring, HIE

reorganized its businesses so that thereafter HIE generally sold

cigarettes and Holdings generally sold and leased vending

machines and processed and sold coffee.
                                 - 44 -

     E.   Royal Hawaiian Water

     Royal Hawaiian Water bottles purified drinking water and

sells that bottled water to retailers in Hawaii.   Royal Hawaiian

Water conducts its business under the name “Hawaiian Isles Water

Company”.   Royal Hawaiian Water is presently a subsidiary of

Holdings.

     In September 1995, Michael Boulware formed Royal Hawaiian

Water as his wholly owned corporation and elected to have that

corporation taxed as an S corporation.    As of July 1, 1997 (but

after the reverse split mentioned supra), Michael Boulware

contributed the net assets of Royal Hawaiian Water to Holdings in

exchange for 162.5 newly issued shares of Holdings.   This

transaction increased Michael Boulware’s ownership interest in

Holdings to 210 shares (47.5 + 162.5 = 210) or in other words to

80 percent of its stock (210/(100 + 162.5) = 80%).

     F.   Holdings After the Restructuring

     As now relevant, the primary business of Holdings and its

subsidiaries is the wholesaling, distribution, leasing, and

maintenance of vending machines (it was the largest vending

company in Hawaii before its vending operation was sold on

December 29, 2006); the bottling, wholesaling, and distribution

of purified drinking water (it has approximately 40 percent of

the market in Hawaii); and the processing, wholesaling, and
                               - 45 -

distribution of coffee (it has approximately 60 percent of the

“gourmet end coffee” market in Hawaii).    Holdings conducts most

of its business in Hawaii but also exports coffee to the

continental United States and to some foreign countries.

     For 199706, 199906, 200006, 200106, and 200206, Holdings had

the following compensated officers, each of whom received the

indicated compensation:

          Taxable Year          Officer          Compensation

             199706        Michael Boulware       $1,372,008
                           Sidney Boulware           126,322
             199906        Michael Boulware          375,700
                           Sidney Boulware           177,769
             200006        Michael Boulware        1,496,006
                           Sidney Boulware           192,200
             200106        Michael Boulware          396,006
                           Sidney Boulware           142,000
             200206        Michael Boulware          396,006
                           Sidney Boulware           142,000

     G.    Payment of Common Costs

     At all relevant times, Holdings shared certain common costs

with HIE, d.b.a. Hawaiian Isles Distributors.    At one point,

Holdings began paying HIE’s overhead and other expenses.

     H.    Various Names Used by HIE To Conduct Its Business
           During the Subject Years

     During the subject years, HIE sometimes did business as

Hawaiian Isles Distributors, sometimes as Hawaiian Isles Vending,

or sometimes as Kona Coffee Service.
                               - 46 -

     I.   No Payment of Formal Dividends by HIE

     From in or about November 1988 until the end of 2005, HIE

paid no formal dividends.

     J.   E&P of HIE and Its Predecessor for 198206 Through 198806

            1.   198206

     As of June 30, 1982, the accumulated E&P of HIE’s

predecessor, M&S Vending, was $189,252.

            2.   198306

     For 198306, the current E&P of M&S Vending was $234,989.

The current E&P reflected M&S Vending’s taxable income as

reported on its Federal income tax return for 198306 ($339,960),

less negative adjustments totaling $104,971 for Federal income

taxes ($103,324) and political contributions and penalties

($1,647).    As of June 30, 1983, the accumulated E&P of M&S

Vending was $424,241 ($189,252 + $234,989).

            3.   198406

     For 198406, the current E&P of M&S Vending was $341,224.

The current E&P reflected M&S Vending’s taxable income as

reported on its Federal income tax return for 198406 ($424,392),

less negative adjustments totaling $83,168 for Federal income

taxes ($77,319) and political contributions and penalties

($5,849).    As of June 30, 1984, the accumulated E&P of M&S

Vending was $765,465 ($424,241 + $341,224).
                               - 47 -

          4.   198506

     For 198506, the current E&P of M&S Vending was $126,955.

The current E&P reflected M&S Vending’s taxable income as

reported on its Federal income tax return for 198506 ($151,550),

plus a $34,779 positive adjustment to reflect an error on that

return, less negative adjustments totaling $59,374 for Federal

income taxes ($45,589), political contributions and penalties

($8,649), prior period income included in the return ($136), and

a bad debt ($5,000).    In addition to that year’s current E&P, the

calculation of the accumulated E&P of M&S Vending as of June 30,

1985, included a $10,110 positive adjustment to reflect an

overaccrual of prior years’ taxes.      As of June 30, 1985, the

accumulated E&P of M&S Vending was $902,530 ($765,465 + $126,955

+ $10,110).

          5.   198606

     For 198606, the current E&P of M&S Vending was $252,942.

The current E&P reflected M&S Vending’s taxable income as

reported on its Federal income tax return for 198606 ($271,420),

less the sum of various positive and negative adjustments

totaling negative $18,478.   The positive adjustments totaled

$133,981 and were attributable to a prior year adjustment for

“FA” ($120,000), bad debt reversals ($4,000), depreciation

($3,733), an NOL carryover ($5,798), and a recording of the
                               - 48 -

correct book value of “FA” ($450).      The negative adjustments

totaled $152,459 and were attributable to Federal income taxes

($70,001), depreciation adjustments ($11,094), an overaccrual of

tax ($60,871), and penalties ($10,493).      In addition to that

year’s current E&P, the calculation of the accumulated E&P of M&S

Vending as of June 30, 1986, included two positive adjustments.

The first positive adjustment, $17,132, was made to reflect an

adjustment to HIE’s net income for 198506 as reported in its

books.   The second positive adjustment, $16,283, was made to

reflect an adjustment to HIE’s net income as reported in its

books for years before 198506.   As of June 30, 1986, the

accumulated E&P of M&S Vending was $1,188,887 ($902,530 +

$252,942 + $17,132 + $16,283).

            6.   198706

     For 198706, the current E&P of M&S Vending was negative

$329,574.    The current E&P reflected M&S Vending’s taxable loss

as reported on its Federal income tax return for 198706

($367,487), less the sum of various positive and negative

adjustments totaling negative $37,913.      The positive adjustments

totaled $68,912 and were attributable to a Federal income tax

refund ($39,377) and depreciation ($29,535).      The negative

adjustments totaled $30,999 and were attributable to Federal

income taxes ($1,193), goodwill ($4,065), depreciation on capital
                              - 49 -

leases ($10,815), contribution carryovers ($2,473), bad debt

expenses ($5,955), and book depreciation greater than tax

depreciation ($6,498).   As of June 30, 1987, the accumulated E&P

of M&S Vending was $859,313 ($1,188,887 + (-$329,574)).

           7.   198806

     For 198806, the current E&P of HIE was negative $859,431.

The current E&P reflected HIE’s taxable loss as reported on its

Federal income tax return for 198806 ($813,106), less the sum of

various positive and negative adjustments totaling negative

$46,325.   The positive adjustments totaled $930,937 and were

attributable to an income tax benefit ($273,200), depreciation

($21,393), and a lease rental expense ($636,343).   The negative

adjustments totaled $977,262 and were attributable to Federal

income taxes ($107), an adjustment to a bad debt reserve

($2,250), gain on investment property ($132,978), inventory

capitalization ($18,000), pension contribution adjustments

($96,858), goodwill ($6,093), interest on leases ($103,942),

further depreciation ($5,500), contribution carryover ($1,425),

depreciation on leases ($436,761), penalties ($172,877), and

meals ($471).   As of June 30, 1988, the accumulated E&P of HIE

was negative $118 ($859,313 + (-$859,431)).
                                  - 50 -

     K.    E&P of Holdings for 199706 and 199806

            1.   199706

                  a.   Accumulated E&P

      As a result of HIE’s spinoff of Holdings on July 1, 1996,

45.9206 percent of HIE’s accumulated E&P is allocated to Holdings

as of that date.

                  b.   Current E&P

      For 199706, the current E&P of Holdings was $722,937.

            2.   199806

      For 199806, the current E&P of Holdings was $346,579.

      L.   Number of Holdings and HIE Employees

      At all relevant times, HIE and Holdings each had fewer than

500 employees.

V.   Officer Loan Account

      A.   Overview

      Before the restructuring, an officer loan account was kept

on the books of HIE.      After the restructuring, that account was

kept on the books of Holdings.

      B.   Mechanics of Account

      Michael Boulware routinely requested that checks be written

to him from HIE’s checking accounts.       Those checks were written

as requested.    HIE did not always know how Michael Boulware would

use the funds reflected in those checks.      Merwyn Manago
                             - 51 -

anticipated that the dollar amounts of the checks written to

Michael Boulware would be charged to Michael Boulware’s officer

loan account (officer loan account) as borrowings by him and that

the officer loan account would be reduced by any amount repaid by

or on behalf of Michael Boulware.

     Merwyn Manago kept a running balance of the amounts that he

knew that Michael Boulware borrowed (including by way of checks

written to him) and that Michael Boulware repaid.   Merwyn Manago

generally caused those transactions to be recorded in the officer

loan account contemporaneously with the transactions.   As

discussed infra, Michael Boulware participated in certain

transactions that were not reported on the books of either

subject corporation (off-book activities), and he caused deposits

and withdrawals to be made to and from two bank accounts (off-

book bank accounts) that were neither reported on the books of

either subject corporation nor known about by Merwyn Manago or

the other independent (of Michael Boulware) managers of the

subject corporations (collectively, independent managers).

Merwyn Manago did not know about the funds that were deposited

into or withdrawn from the off-book bank accounts, and he did not

reflect those funds in the officer loan account.    Merwyn Manago

did not know about or cause HIE to record contemporaneously in
                              - 52 -

the officer loan account transactions related to the off-book

activities.

     C.   Repayment of Officer Loans

     Bonuses were declared to Michael Boulware at the end of each

year to repay some of the balance in the officer loan account.

Merwyn Manago caused to be recorded as reductions of the officer

loan account any portion of a loan to Michael Boulware that was

repaid.   Michael Boulware’s repayments were not always made in

cash.

     D.   Michael Boulware’s Claimed Coffee Transactions

     Michael Boulware told Merwyn Manago that Michael Boulware

was using HIE funds in his individual capacity to purchase coffee

for resale to HIE.   Merwyn Manago caused the balance of the

officer loan account to be increased by the amount of HIE funds

that Merwyn Manago believed that Michael Boulware was using for

that purpose.   Michael Boulware told Merwyn Manago when Michael

Boulware purportedly sold and delivered coffee to HIE, and Merwyn

Manago recorded those sales and alleged deliveries as reductions

to the balance in the officer loan account.

     Merwyn Manago told Michael Boulware that HIE needed invoices

to document any coffee transaction between him and HIE.

Afterwards, Michael Boulware gave Merwyn Manago invoices stating

that Michael Boulware had sold Kona coffee to Hawaiian Isles Kona
                               - 53 -

Coffee or to HIE and that he had delivered that coffee to the

purchasing corporation.   Michael Boulware did not always give

those invoices to HIE contemporaneously with the dates that

Michael Boulware said he had delivered coffee to HIE.    Other than

through Merwyn Manago’s receipt of the invoices from Michael

Boulware and Merwyn Manago’s related discussions with Michael

Boulware, Merwyn Manago did not attempt to verify that HIE

received the coffee Michael Boulware said he sold to HIE; Merwyn

Manago relied primarily upon the representations and actions of

Michael Boulware.

     From November 1988 through June 1994, Michael Boulware gave

HIE various invoices for coffee that he purportedly sold to HIE

or one of its subsidiaries.    These invoices for the most part are

consecutively numbered.   One invoice stated that Michael Boulware

sold and delivered to Hawaiian Isles Kona Coffee 80,000 pounds of

Kona coffee.   Merwyn Manago did not see this coffee but credited

Michael Boulware’s loan account for the $500,000 sales price

listed on the invoice.    Nor did Merwyn Manago verify that

Hawaiian Isles Kona Coffee had received 40,000 pounds of Kona

coffee that a second invoice stated that Michael Boulware had

sold and delivered to Hawaiian Isles Kona Coffee for $250,000.

Merwyn Manago also did not verify that Hawaiian Isles Kona Coffee

received 200,000 pounds of Kona coffee that a third invoice
                             - 54 -

stated that Michael Boulware had sold and delivered to Hawaiian

Isles Kona Coffee for $800,000.   Michael Boulware did not

actually deliver this 320,000 pounds of coffee (200,000 + 40,000

+ 80,000 = 320,000) but through the officer loan account was

credited with doing so.21

     E.   Promissory Notes

     Before 1993, the year in which the CID investigation began,

Michael Boulware was not required to sign promissory notes for

checks written to him from an HIE account.   Afterwards, at the

end of each year, Merwyn Manago generally took the total amount

of checks written to Michael Boulware in each month of that year

and drafted promissory notes for each of those months.    None of

the funds that were deposited into the off-book bank accounts

were reflected in the promissory notes.

     Payment of the promissory notes was not secured.    The

promissory notes set forth a repayment date within 24 months

after their making and stated that a holder of a note in default

could declare that the entire unpaid balance was immediately due

and payable.




     21
      In addition to these amounts credited to the officer loan
account as coffee repayments, we are unable to verify other items
for which Merwyn Manago credited the officer loan account.
                               - 55 -

      F.   Lack of Collection on Promissory Notes

      Some of the loans recorded as made to Michael Boulware were

not repaid, and defaults occurred on the related and some of the

other promissory notes.    Merwyn Manago never declared that any

amount due under a promissory note related to Michael Boulware

was immediately due and payable.    Nor did Merwyn Manago ever

attempt to collect repayment of an obligation of Michael Boulware

that was in default; Merwyn Manago viewed Michael Boulware as the

owner of the subject corporations and, hence, as the boss of

Merwyn Manago and every other employee of one or both of the

subject corporations.    When the period of limitations expired on

the enforcement of a promissory note related to Michael Boulware,

Merwyn Manago never recorded on the books of either subject

corporation that those amounts were uncollectible.    The board of

directors never took any action with respect to collection on the

promissory notes.

VI.   Personal Bank Accounts

      A.   Michael Boulware Individually

      As relevant herein, Michael Boulware had three personal bank

accounts listed in his name.    These accounts were checking

account No. 05-389054 at First Interstate Bank of Hawaii,

checking account No. 49-507151 at First Hawaiian Bank, and

checking account No. 09-365508 at First Hawaiian Bank.    Michael
                                - 56 -

Boulware also maintained a checking account at the Bank of Hawaii

in his reported capacity as president, treasurer, and secretary

of his wholly owned corporation, Automated Equipment, Ltd.

(Automated Equipment).     That account number was 17-134698.

       B.   Michael Boulware and Mal Sun Boulware Jointly

       Michael Boulware and Mal Sun Boulware had a joint savings

account, account No. 17-009762 at Liberty Bank.     They also had a

joint checking account, account No. 37-251410 at First Hawaiian

Bank.

       C.   Jin Sook Lee

       Jin Sook Lee had a personal checking account, account No.

65-565579 at First Hawaiian Bank.     Jin Sook Lee also maintained a

savings account at First National Bank in her capacity as trustee

of the Glenn Lee Boulware Trust.     That account number was

65-570109.

VII.    Mal Sun Boulware

       Mal Sun Boulware was born in Korea in 1944, and she moved to

the United States in 1963.     She was married to Michael Boulware

from 1975 through May 5, 1994.     She and Michael Boulware have one

child, Karen Min Boulware, a Korean girl whom they adopted.

Karen Min Boulware was born on May 2, 1979.

       M&S Vending reportedly paid Mal Sun Boulware wages of

$16,560 and $21,210 during 1981 and 1982, respectively, and
                                - 57 -

$24,000 during each of the years 1983 through 1986.       HIE

reportedly paid Mal Sun Boulware wages of $47,000, $59,000,

$60,000, $130,000, $250,000, $300,000, $300,000, and $75,000

during 1987 through 1994, respectively.       Mal Sun Boulware

generally received her reported wages in equal installments

throughout the corresponding year.       For 198906 through 199406,

HIE deducted wages paid to Mal Sun Boulware of $30,000, $95,000,

$190,000, $275,000, $300,000, and $150,000, respectively.

Respondent disallowed the deductions for 198906 through 199406 in

the total amount of $1,040,000.

     Mal Sun Boulware has just a few years of education, all in

Korea, and she reads little English.       She did not have either an

office or a desk at HIE (or at any related entity).       Mal Sun

Boulware performed no meaningful work for HIE (or M&S Vending)

that would support characterizing the disputed payments to her as

compensation.

VIII.     Jin Sook Lee

        A.   Background

        Jin Sook Lee was born in Seoul, Korea, in 1955, and she

moved to the United States in 1980.       When she moved, Jin Sook Lee

had a high school education and had been married for

approximately 2 years to a man who lived in Hawaii.       Shortly

after her move, Jin Sook Lee divorced her husband because he was
                               - 58 -

jobless and, she believed, incapable of supporting her desired

lifestyle.

     After her divorce, Jin Sook Lee started working at a Korean

hostess bar in Hawaii as a hostess retained by the bar owners to

socialize with their patrons and to allure the patrons to buy a

lot of drinks from the bar.    Such bars usually involve

prostitution and are generally staffed with young women from

Korea who speak little English, have few job skills, and are

looking for someone to take care of them.     Jin Sook Lee and the

other hostesses were paid for their services at the Korean

hostess bar through commissions earned on the drinks they caused

to be sold and through their receipt of tips left for them by the

patrons.

     B.    Jin Sook Lee Meets Michael Boulware

     In or about 1981, Jin Sook Lee met Michael Boulware at the

Korean hostess bar where and while she was working.        Shortly

thereafter, Michael Boulware and Jin Sook Lee began an intimate

relationship which Michael Boulware endeavored to keep hidden

from Mal Sun Boulware and others.22     Throughout their

relationship, Michael Boulware provided Jin Sook Lee with housing

and supported her financially.


     22
      Merwyn Manago, for example, did not know of Jin Sook Lee
until June 1993 or thereafter.
                               - 59 -

     Jin Sook Lee stopped working at the Korean hostess bar soon

after she met Michael Boulware, and she moved from her studio

apartment to what she considered to be Michael Boulware’s

Atkinson condominium.    Jin Sook Lee lived at the Atkinson

condominium rent free.   Later, Jin Sook Lee moved from the

Atkinson condominium to what she considered to be Michael

Boulware’s house in Honolulu at Hawaii Kai, 3 Lumahai Street.

She lived at that house rent free.      Later, after Mal Sun Boulware

learned that Jin Sook Lee was living at the house at 3 Lumahai

Street, Jin Sook Lee moved from that house to the Punahou

condominium, which Jin Sook Lee bought with money given to her by

Michael Boulware.   Jin Sook Lee has not worked since she stopped

working at the Korean hostess bar.      During her relationship with

Michael Boulware, Jin Sook Lee attended business college, and she

received a diploma and certificate in 1994.     Jin Sook Lee

currently receives $10,000 a year from HIE as a “settlement”.

     Jin Sook Lee began her relationship with Michael Boulware

because she thought she would be better off financially, and she

almost daily told him during their relationship that they should

get married to each other.    Michael Boulware eventually told Jin

Sook Lee that they would marry but that he first had to divorce

Mal Sun Boulware.   Jin Sook Lee repeatedly fought with Michael

Boulware about his not getting a divorce, and Jin Sook Lee
                                 - 60 -

repeatedly told Michael Boulware that she would leave him unless

he got a divorce.     Michael Boulware informed Jin Sook Lee that he

would divorce Mal Sun Boulware in due time.     Jin Sook Lee did not

believe that Michael Boulware actually wanted to or would divorce

Mal Sun Boulware.

     During their relationship, Jin Sook Lee and Michael Boulware

had two children together.      Both of those children were planned.

The older child, Glenn Lee Boulware, was born on September 15,

1985.     The younger child, Steven Boulware, was born on October

13, 1988.     Currently, Michael Boulware’s relationship with each

of his sons is good.

     C.     Paradise Roasting

        Beginning at least in 1986, Michael Boulware caused M&S

Vending to pay Jin Sook Lee wages although she did not perform

any work for M&S Vending in return for the wages.     After M&S

Vending was renamed HIE, HIE continued to pay Jin Sook Lee wages

although she performed no work for HIE in return for the wages.

        In or about 1987, Mal Sun Boulware learned that Michael

Boulware was having an affair with Jin Sook Lee and that Michael

Boulware and Jin Sook Lee had a son, Glenn Boulware.     Because

Michael Boulware believed he could no longer cause HIE to pay

wages to Jin Sook Lee, he sought an indirect, surreptitious way

to give her money.     Michael Boulware helped Jin Sook Lee form
                               - 61 -

Paradise Roasting as her wholly owned corporation and instructed

her to open a bank account for Paradise Roasting in part so that

he could give her money in the form of checks.    Jin Sook Lee was

named president of Paradise Roasting, and her sister, Hong Sun

Hirai, was named vice president.    During 198906 and 199006,

Paradise Roasting had no employees.

     Paradise Roasting sent invoices to HIE indicating it had

sold coffee to HIE, and Michael Boulware caused HIE to pay those

invoices.   During 198906, HIE generally sent Paradise Roasting

one check every month.   The first four checks were each in the

amount of $10,000.   The next three checks were each in the amount

of $15,000.   The last five checks were each in the amount of

$20,000.    During 199006, HIE generally sent to Paradise Roasting

one check in the amount of $20,000 for each of the first 10

months.    In total, HIE paid Paradise Roasting $185,000 and

$200,000 during 198906 and 199006, respectively.    HIE deducted

those payments for Federal income tax purposes.

     Paradise Roasting never sold or delivered any coffee to HIE.

Nor did Paradise Roasting ever have a business, ever have any

customers, or ever sell any goods (e.g., coffee) or perform any

services.   Jin Sook Lee used the money that HIE transferred to

Paradise Roasting as she pleased, including to pay her living

expenses, to travel, and to purchase expensive jewelry for
                                - 62 -

herself.   When HIE wrote the above-referenced checks to Paradise

Roasting, HIE did not reflect those checks as loans on its books.

Except by means of the adjusting journal entries (AJEs) discussed

infra, HIE did not ever record those payments as loans on its

books.

     D.    Video Consultant

            1.   Overview

     HIE also paid Jin Sook Lee at least $175,000 during the

2-year period beginning in July 1988 purportedly for work as a

video consultant.    Jin Sook Lee received those funds through

Video Consultant, an entity that was formed as her sole

proprietorship.    Jin Sook Lee was not a video consultant, and she

has never worked as such.     Nor did Video Consultant ever have any

employees or any customers.    Michael Boulware caused that money

to be paid to Jin Sook Lee for her living expenses and for her

other desires.

            2.   Formation

      Michael Boulware helped Jin Sook Lee form Video Consultant

as another way to get money to her indirectly and surreptiously.

Michael Boulware filled in a form application for a general

excise license for Video Consultant, and he had Jin Sook Lee sign

the application.    Michael Boulware caused Jin Sook Lee to open an

account at First Interstate Bank of Hawaii in the name of Jin
                                - 63 -

Sook Lee d.b.a. Video Consultant.     That account, No. 24-100804,

was a market interest investment account, with check writing

privileges.

          3.     Payments From HIE for False Invoices

     During 198906 and 199006, Video Consultant invoiced HIE for

goods or services totaling $84,000 and $91,000, respectively, and

Michael Boulware caused HIE to pay Video Consultant the amount of

the invoices and to deduct those payments on HIE’s Federal income

tax returns.     HIE paid those amounts to Video Consultant through

22 checks.     During 198906, 12 of those checks were written

monthly in the amount of $7,000.     During 199006, the first three

monthly payments were in the amount of $7,000 and the next seven

monthly payments were in the amount of $10,000.     All 22 payments

were received by Video Consultant and deposited into First

Interstate bank account No. 24-100804.

     Neither Jin Sook Lee nor Video Consultant performed any

service for or provided any good to HIE in exchange for any of

the 22 payments.     Jin Sook Lee spent the money that HIE

transferred to Video Consultant as she pleased.     When HIE wrote

the above-referenced checks to Video Consultant, HIE did not

reflect those checks as loans on its books.     Except by means of

the AJEs discussed infra, HIE did not ever record those payments

as loans on its books.     Although Michael Boulware knew Jin Sook
                               - 64 -

Lee was not performing any service for HIE as Video Consultant,

he never told that to Merwyn Manago during the period she was

being paid by HIE.   It was not until later that Merwyn Manago

learned that Video Consultant was related to Jin Sook Lee.

     E.   Michael Boulware’s Divorce From Mal Sun Boulware

           1.   Discussions Concerning Divorce

     In 1987, Michael Boulware informed his attorney, Michael

McCarthy, a general practitioner who is now deceased, that he

wanted to divorce Mal Sun Boulware and to marry Jin Sook Lee.23

Mal Sun Boulware had recently informed Michael Boulware that she

knew he was having an affair with Jin Sook Lee and that Jin Sook

Lee and Michael Boulware had a child from that relationship.     Mal

Sun Boulware also informed Michael Boulware that they should

divorce and that she desired as a condition of their divorce one-

half of the value of HIE, which she estimated had a total value

of at least $10 million, plus their house in Honolulu at 382 Puu

Ikena Drive, which she believed was worth $1 million.   Michael

Boulware contemplated that HIE would be the source of any cash

that he needed to effect his divorce from Mal Sun Boulware, and


     23
      Shortly thereafter, Michael Boulware informed Jin Sook Lee
that their relationship was over because of actions she had taken
against Glenn Lee Boulware. At or about that time, Michael
Boulware also agreed with Mal Sun Boulware that he would end his
relationship with Jin Sook Lee. Michael Boulware later made up
with Jin Sook Lee.
                                - 65 -

Mal Sun Boulware was content to postpone their divorce until

Michael Boulware had the necessary funds to pay her.   Michael

Boulware understood from his conversations with Michael McCarthy

that Mal Sun Boulware might be entitled to receive less than $5

million as to HIE (i.e., one-half of the $10 million that Mal Sun

Boulware believed HIE was then worth) if the value of HIE as

shown on its books decreased from the current date to the

applicable valuation date for his divorce.

            2.   Glenn Lee Boulware Trust

     In 1987, while Michael Boulware and Mal Sun Boulware were

discussing the terms of their divorce, Jin Sook Lee became

concerned about the welfare and future of herself and Glenn Lee

Boulware should Michael Boulware die before that divorce.    Jin

Sook Lee asked Michael Boulware to transfer one-half of his

shares in HIE to her for the future benefit of Glenn Lee

Boulware.    Michael McCarthy advised Michael Boulware not to put

the shares in the name of Jin Sook Lee personally but to transfer

the shares to Jin Sook Lee as trustee of a trust that Michael

Boulware could establish for the benefit of Glenn Lee Boulware.

Michael Boulware understood from his conversations with Michael

McCarthy that it was not permissible for him (as an employee,

officer, or director of HIE) to give HIE property to Jin Sook Lee

to hold for his divorce from Mal Sun Boulware.
                                - 66 -

     On September 8, 1987, Michael Boulware established the Glenn

Lee Boulware Trust as an irrevocable trust with Jin Sook Lee as

the sole trustee.    Michael Boulware funded the trust with $500

plus 50 percent of his stock in HIE.     The principal beneficiary

of the trust was Glenn Lee Boulware, who at the sole discretion

of Jin Sook Lee, as trustee, could receive distributions of

income and/or principal until he was 35 years old; alternatively,

until that time, Jin Sook Lee, as trustee, had sole discretion to

expend any or all of the principal or income of the trust for the

benefit of Glenn Lee Boulware.    The trust was stated to terminate

when Glenn Lee Boulware became 35 years old, at which time he

would receive all of the trust estate.    If Glenn Lee Boulware

died beforehand, the trust was stated to terminate upon his death

at which time all of the trust estate would be distributed to Jin

Sook Lee.    Under the terms of the trust, Jin Sook Lee, as

trustee, was entitled to receive compensation for ordinary

services, and Jin Sook Lee, as trustee, was entitled to receive

additional compensation for extraordinary services.

            3.   Divorce Proceeding

     On May 5, 1994, the Family Court of the First Circuit of

Hawaii decreed in the uncontested divorce proceeding of Boulware

v. Boulware, FC-D No. 94-1225, that Michael Boulware and Mal Sun
                               - 67 -

Boulware were thereafter divorced.24    The court ordered as part

of the property settlement that Michael Boulware pay Mal Sun

Boulware $3.65 million and transfer to her full ownership of

their property in Honolulu at 382 Puu Ikena Drive.    The court

also ordered Michael Boulware to pay Mal Sun Boulware child

support of $1,500 per month, starting April 5, 1994, to maintain

sufficient health coverage for his daughter, and to pay for his

daughter’s education.    The court also ordered Michael Boulware to

pay off the approximately $1,350,000 mortgage debt on the

property at 382 Puu Ikena Drive, by February 20, 1999.    As to the

division of property, the court order states:

       The parties assume and intend that the division of
       property incident to their divorce shall not itself
       result in any tax consequences. Each party will take
       each property interest awarded to him or her at its
       pre-divorce basis, and that any tax which must be paid
       upon the subsequent sale or exchange of such interest
       shall be paid by the party who received and
       subsequently sold or exchanged such interest.

       Immediately after his divorce, Michael Boulware informed Jin

Sook Lee about the divorce, and he asked Jin Sook Lee to marry

him.    Jin Sook Lee declined, and she ended their relationship.

Michael Boulware and Jin Sook Lee presently speak to each other

very little, and they have difficulty dealing with each other.


       24
      Following their divorce, Michael Boulware and Mal Sun
Boulware continue to have a good relationship, and his
relationship with their daughter is excellent.
                                - 68 -

When Jin Sook Lee testified at the trial of these cases, it was

the first time that Michael Boulware had seen her in

approximately 18 months.

       Mal Sun Boulware has yet to receive all of the payments that

Michael Boulware owes her incident to their divorce.     Mal Sun

Boulware lost through gambling most of the money she received

from Michael Boulware incident to their divorce.

       F.   Transfers of HIE Assets to Jin Sook Lee

             1.   Overview

       From 1987 through 1994, Michael Boulware delivered to Jin

Sook Lee a total of at least $6.7 million of assets diverted from

HIE.    During that time, Michael Boulware also regularly gave Jin

Sook Lee at least another $2 million in cash and other assets

(e.g., jewelry).     Michael Boulware did not contemporaneously

record or otherwise keep track of the funds and other assets that

he gave to Jin Sook Lee.25

       The diverted assets included primarily cash obtained by

Michael Boulware mainly by way of checks drawn against HIE’s bank



       25
      Michael Boulware testified at trial that he kept accurate
records of the funds of HIE that he transferred to Jin Sook Lee.
We consider that testimony incredible. Michael Boulware at
various times has stated the total amount of funds as drastically
different amounts. Moreover, at trial, he failed to produce any
accurate documentation and admitted that no such documentation
existed as of the time he testified at trial.
                              - 69 -

accounts and against the off-book bank accounts, and from funds

sourced in the off-book activities.    The diverted assets also

reflected at least four real properties in Honolulu that were

purchased with HIE funds and that were put in the name of Jin

Sook Lee without any offsetting debt.    The four real properties

were the Atkinson condominium, a house at 1050 Koloa Street

(Koloa house), the Makaiwa house, and the Punahou condominium.

     Michael Boulware diverted HIE’s assets from HIE to hide the

assets from Mal Sun Boulware in connection with their divorce and

to accumulate personal wealth for what he hoped to be the benefit

of himself, Jin Sook Lee, and their children.    Michael Boulware

diverted those assets from HIE for his personal use in that he

then gave the underlying assets to Jin Sook Lee to use, hold, or

spend as she desired, but with his expectation and belief

(neither told to her) that she would chose on her own to hold,

use, or spend the assets for the common benefit of himself, her,

and their children.

          2.   Atkinson Condominium

     On September 9, 1987, Jin Sook Lee purchased the Atkinson

condominium for $115,000.   Jin Sook Lee paid for that purchase

with funds that came from Michael Boulware which in turn came

from HIE without the knowledge of the independent managers.
                               - 70 -

     Jin Sook Lee rented the Atkinson condominium out to tenants,

she freely spent the money received as rent, and she reported

that rent as her taxable income.   Michael Boulware never told Jin

Sook Lee to save the rent money from the Atkinson condominium for

his divorce or that the rent money was his or HIE’s.    Michael

Boulware never told Jin Sook Lee that she would someday have to

transfer the Atkinson condominium to him or to HIE.    Michael

Boulware never told Jin Sook Lee that the Atkinson condominium

would be used (or was otherwise needed) to effect his divorce

from Mal Sun Boulware.

     After the start of the criminal investigation discussed

infra, the Atkinson condominium was added to the books of HIE by

recording it as an asset of HIE.

          3.   Makaiwa House

     On or about March 21, 1989, Jin Sook Lee purchased the

Makaiwa house from an unrelated party for $560,000.    Jin Sook Lee

paid for that purchase with money that came from Michael Boulware

which in turn came from HIE without the knowledge of the

independent managers.    Michael Boulware never told Jin Sook Lee

that she would someday have to transfer the Makaiwa house to him

or to HIE.   Michael Boulware never told Jin Sook Lee that the

Makaiwa house would be used (or was otherwise needed) to effect

his divorce from Mal Sun Boulware.
                               - 71 -

     Jin Sook Lee lived (and continues to live) in the Makaiwa

house.   Jin Sook Lee has never paid any rent to live in the

Makaiwa house.    After the start of the criminal investigation

discussed infra, the Makaiwa house was added to the books of HIE

by recording it as an asset of HIE.

            4.   Koloa House

     On February 7, 1991, Jin Sook Lee purchased the Koloa house

from an unrelated party for $1,150,000, and the property was

placed in the name of Jin Sook Lee.     Jin Sook Lee paid for that

purchase with funds that came from Michael Boulware which in turn

came from HIE without the knowledge of the independent managers.

Michael Boulware never told Jin Sook Lee that she would someday

have to transfer the Koloa house back to him or to HIE.    Michael

Boulware never told Jin Sook Lee that the Koloa house would be

used (or was otherwise needed) to effect his divorce from Mal Sun

Boulware.

     On or about November 24, 1992, in connection with a rift

between Michael Boulware and Jin Sook Lee, Michael Boulware

forged Jin Sook Lee’s name without her permission to the deed for

the Koloa house, caused a notary who was an employee of HIE to

attest in writing that Jin Sook had signed the deed personally,

and caused that property to be transferred into the name of

Michael Boulware.    Contemporaneously, Michael Boulware deeded the
                              - 72 -

Koloa house to HIE in return for a credit against the amount

reflected in his officer loan account.

     Afterwards, when Jin Sook Lee did not receive the tax bill

for the Koloa house as she usually did, Jin Sook Lee learned that

Michael Boulware had transferred the Koloa house from her name.

Jin Sook Lee was upset and confronted Michael Boulware about the

transfer.   Michael Boulware promised Jin Sook Lee that he would

pay her back for inappropriately taking the Koloa house from her.

On July 25, 1993, Michael Boulware agreed in a writing bearing

his signature to pay Jin Sook Lee $1.2 million, the amount they

agreed was the value of the Koloa house, and to secure his

payment of the $1.2 million with a security interest in HIE’s

vending machines.   The writing states:26

          I, Michael H. Boulware, president of Hawaiian
     Isles Enterpr. Inc. do hereby acknowledge that I owe
     Jin Sook Lee of 1017 Makaiwa St. the sum of One
     Million, Two Hundred Thousand Dollars, $1,200,000. For
     which I agree to pay the sum of Twenty Thousand
     Dollars, $20,000, for each and every month starting
     September 1, 1993 up until August 1, 1993 [sic]. On
     September 1, 1994 a balloon payment of the balance is
     on demand + payable on this day.

          The loan will be secured by way of vending
     machines equal to the balance of Loan even by ways of
     Auction or any other means.



     26
      Michael Boulware stated in the writing that he was the
president of HIE as a way to further identify himself in his
individual capacity.
                                - 73 -

     Michael Boulware later signed and executed a more formal,

but undated, promissory note promising to pay $1.2 million to Jin

Sook Lee as follows:    $25,000 on September 1, 1993, and on the

first day of each of the 12 months thereafter; and on September

1, 1994, any amount remaining due on the note.    The note stated

that interest accrued on any unpaid amount at the rate of 12

percent per year.    The note stated that it was secured by a

“Security Agreement and Financing Statement of even date

herewith”.

            5.   Punahou Condominium

     Jin Sook Lee purchased and initially lived in the Punahou

condominium with money that came from Michael Boulware which in

turn came from HIE without the knowledge of the independent

managers.    Subsequently, Jin Sook Lee rented the Punahou

condominium out to a tenant, she freely spent the money received

as rent, and she reported that rent as her taxable income.

Michael Boulware never told Jin Sook Lee to save the rent money

from the Punahou condominium for his divorce or that the rent

money was his or HIE’s.    Michael Boulware never told Jin Sook Lee

that she would someday have to transfer the Punahou condominium

to him or to HIE.    Michael Boulware never told Jin Sook Lee that

the Punahou condominium would be used (or was otherwise needed)

to effect his divorce from Mal Sun Boulware.
                                - 74 -

       After the start of the criminal investigation discussed

infra, the Punahou condominium was added to the books of HIE by

recording it as an asset of HIE.

            6.   Understanding as to the Transferred Assets

       Jin Sook Lee understood that the funds that Michael Boulware

gave her during their relationship came from Michael Boulware,

and not from HIE, and that the funds were hers to spend as she

desired.    Michael Boulware never told Jin Sook Lee she had to

save the money he gave her so that he could use the money for his

divorce.    Nor did HIE’s board of directors sign any resolution

that specifically approved of Michael Boulware’s taking HIE money

for him to save for his divorce from Mal Sun Boulware.

       Jin Sook Lee believed that Michael Boulware was giving her

money because she was his girlfriend and the mother of one (and

later two) of his children.    Jin Sook Lee sometimes demanded

money from Michael Boulware; other times, he just gave money to

her.    On one occasion, in or about December 1992, Michael

Boulware asked Jin Sook Lee to lend him $200,000 to use for his

divorce from Mal Sun Boulware.

       Michael Boulware claims that he transferred HIE’s assets to

Jin Sook Lee between 1987 and 1994 for her to hold and to save

for him so he could accumulate funds to satisfy his property

settlement incident to his divorce from Mal Sun Boulware.
                                - 75 -

Michael Boulware claims that Jin Sook Lee wanted to hold the

money that he was saving for his divorce, that Jin Sook Lee knew

the money he was giving her was to be saved for his divorce, and

that Jin Sook Lee agreed to give the money back to him upon his

request.   We find these claims incredible.   Michael Boulware

never told Jin Sook Lee any reason for giving her money or what

she had to do with the money.    Jin Sook Lee understood that

Michael Boulware gave her the money to use as her own for

whatever she desired.

           7.   Jin Sook Lee’s Use of the Transferred Funds

     Jin Sook Lee spent the transferred funds as she desired, and

Michael Boulware knew that Jin Sook Lee was spending a lot of the

funds that he gave her.   During their relationship, Michael

Boulware provided Jin Sook Lee with an extravagant lifestyle that

included her driving a Mercedes, z Porsche, a Rolls Royce, and a

BMW (some of which she owned), her owning and wearing expensive

designer clothes and jewelry (e.g., a $70,000 diamond), her

traveling to foreign countries and to New York City, and her

regularly receiving cash from Michael Boulware.    Jin Sook Lee

charged freely and extravagantly on her credit cards (e.g.,

charging more than $240,000 from August 24, 1991, through

December 15, 1994), and she paid her credit card bills with money

that Michael Boulware gave to her.
                              - 76 -

     Jin Sook Lee used some of the funds that she received from

Michael Boulware to purchase certificates of deposit earning over

$220,000 in interest in 1992 and 1993.    Michael Boulware did not

tell Jin Sook Lee that the interest was not hers, and Jin Sook

Lee spent that interest on herself and otherwise as she desired.

Jin Sook Lee transferred out of the country some of the funds she

received from Michael Boulware, including at least $100,000 that

she sent to her mother in Korea.    After commencing the civil

litigation against Michael Boulware and HIE, Jin Sook Lee paid to

her attorneys approximately $1 million using some of the funds

given to her by Michael Boulware.

          8.   Michael Boulware Takes Some of the Transferred
               Funds From Jin Sook Lee Without Her Knowledge

     Jin Sook Lee kept in a safe at her house (the Punahou

condominium) some of the funds given to her by Michael Boulware.

The combination to the safe was known by both Jin Sook Lee and

Michael Boulware.   On one occasion, in or about the fall of 1990,

Michael Boulware removed from the safe $840,000 of the

approximately $1.5 million that was then there.   Jin Sook Lee was

upset by that action, and she demanded that Michael Boulware give

the money back to her because it was hers.    Michael Boulware gave

Jin Sook Lee a check drawn on HIE’s corporate bank account in

return for the money he removed from the safe.    Michael Boulware
                               - 77 -

promised Jin Sook Lee that he would not borrow or steal any money

from her again.

IX.   Off-Book Bank Accounts

      Michael Boulware surreptiously caused the opening of the two

off-book bank accounts.   In or about October 1990, the first

account, No. 03-038866, was opened at Hawaii National Bank in the

name of “Hawaiian Isles Distributors, Inc.”    In or about October

1991, the second account, checking account No. 01-06586-6, was

opened at Central Pacific Bank in the name of “Hawaiian Isles

Enterprises, Inc. DBA Hawaiian Isles Distributors”.    Activity in

the earlier off-book bank account stopped shortly after the later

off-book bank account was opened.   Activity in the later off-book

bank account stopped 2 days after Michael Boulware learned he was

under criminal investigation by the CID.    The deposits into the

off-book bank accounts totaled at least $6,139,567 during 199006

through 199306.

      The off-book bank accounts were not reported on the books of

any of the relevant corporations (including the subject

corporations), and those accounts (and the deposits therein and

the withdrawals therefrom) were kept secret during the subject

years from the independent managers.    Michael Boulware told

Sidney Boulware about the off-book bank accounts so that Sidney

Boulware could oversee those accounts personally and could keep
                                - 78 -

the accounts secret from the independent managers.       Sidney

Boulware kept the deposit slips for the off-book bank accounts in

his office.    The deposit slips for the subject corporations’ bank

accounts which the independent managers knew about were kept

outside Sidney Boulware’s office by others.

X.   Off-Book Activities

      A.   Overview

      During the relevant years, Michael Boulware engaged in a

number of off-book activities and other improper transactions

(collectively, off-book activities).       The off-book activities

were OTC sales of HIE tobacco products, Michael Boulware’s

personal sales of HIE coffee to Pele Trading and Hawaii Misuzu,

Michael Boulware’s fabrication of work performed for HIE by

Bonded Construction, Michael Boulware’s fictitious equipment

leasing transactions by HIE, and Michael Boulware’s fictitious

international transactions by HIE.       Michael Boulware kept the

off-book activities secret from the independent managers.         Much

of the money that Michael Boulware diverted from HIE through the

off-book activities was deposited into the off-book bank accounts

or into a personal account of Michael Boulware or Jin Sook Lee.

      Michael Boulware caused Jin Sook Lee to receive at least

$3,147,923 of the funds deposited into the off-book bank

accounts.     When Jin Sook Lee received those funds, and during
                               - 79 -

198906 through 199306, HIE did not record those receipts as loans

on its books and records.    The $3,147,923 received by Jin Sook

Lee was in addition to the payments that Jin Sook Lee received

through Paradise Roasting and Video Consultant (i.e., at least

$385,000 and $175,000, respectively).     Jin Sook Lee also received

other amounts from Michael Boulware that he diverted from HIE.

Jin Sook Lee used some of the funds referenced in this paragraph

to purchase the Punahou condominium, the Atkinson condominium,

the Makaiwa house, and the Koloa house.

     B.   OTC Sales of Tobacco Products

     HIE had a “cash and carry business” where small wholesalers

and retailers (mostly mom-and-pop type stores and employees of

the subject corporations) came to HIE’s warehouse and bought

HIE’s tobacco products over the counter by paying cash or by

using checks.   The warehouse was separate from the building that

housed HIE’s accounting department.     The warehouse had a

register, an order desk, and a computer to use with respect to

HIE’s OTC sales.   The register in the warehouse related to the

cash and carry business, and the computer in the warehouse was

neither connected to HIE’s main computer nor part of HIE’s

regular accounting system.

     Each day, the receipts from the OTC sales were given to

Irene Takamiya, a cashier at HIE.    Irene Takamiya forwarded those
                               - 80 -

receipts to Sidney Boulware, either directly or through Thomas

Okimoto, the general manager of Hawaiian Isles Distributors.

Sidney Boulware, or sometimes Thomas Okimoto, deposited those

receipts into the off-book bank accounts.    Sidney Boulware never

told the independent managers about the receipts from the OTC

sales or that those receipts were deposited into the off-book

bank accounts.    HIE’s accounting department also did not know

that OTC proceeds were deposited into the off-book bank accounts.

Unbeknownst to the independent managers, Michael Boulware caused

HIE’s OTC sales not to be recorded on HIE’s invoice register, not

to be reported in HIE’s books, and not to be reported as income

by HIE.

     The funds deposited into the off-book bank accounts came

primarily from the receipts of HIE’s OTC sales.    Of the total

deposits into those accounts, the funds that Michael Boulware

diverted from OTC sales totaled $506,464, $1,337,213, $719,755,

and $1,020,293 for 199006 to 199306, respectively, or $3,583,725

in total.   When those OTC proceeds were deposited into the off-

book bank accounts, the transactions were not recorded as loans

on HIE’s books.   Nor were the proceeds reflected in the

promissory notes related to the officer loans.
                              - 81 -

     C.   Michael Boulware’s Personal Sales of HIE Coffee Unknown
          at the Time to HIE

           1.   Overview

     HIE sold blended coffee to consumers.    HIE purchased coffee

beans from third parties, and the beans were delivered directly

to HIE’s warehouse, where they were stored.   When coffee beans

were delivered to HIE, an HIE employee checked the shipping

document to see that the coffee purchased was in fact delivered.

HIE’s accounting department relied on the shipping document and

the signature of a designated employee to verify that the coffee

beans were delivered.

     As relevant herein, Robert Kong was the employee designated

by HIE to sign the shipping documents verifying that the coffee

beans purchased by HIE were delivered.   Upon the request of

Sidney Boulware, Robert Kong sometimes signed such shipping

documents after the coffee was supposedly delivered.   The

shipping documents did not always list the date on which the

coffee was purportedly received, and Robert Kong did not always

read the invoices that he signed.   When Robert Kong signed

shipping documents upon the request of Sidney Boulware, Robert

Kong neither read those documents nor checked them for accuracy.

     Merwyn Manago knew that Michael Boulware was selling coffee

beans to companies other than the subject corporations, and
                              - 82 -

Michael Boulware led Merwyn Manago to believe that the coffee

beans sold by Michael Boulware were not from HIE’s inventory.

Unbeknownst to the independent managers, Michael Boulware sold

coffee beans that were inventoried by HIE to at least two

purchasers and diverted from HIE the proceeds from those sales.

The first purchaser, Hawaii Misuzu, was a coffee roasting company

that during the relevant years was buying Kona coffee from HIE

regularly.   The second purchaser, Pele Trading, was an

independent company that also bought coffee from HIE.

          2.   Sales to Hawaii Misuzu

     Hawaii Misuzu purchased and roasted coffee beans and then

sold the roasted coffee to its customers.   From 199006 through

199306, Michael Boulware sold HIE’s coffee beans to Hawaii Misuzu

and caused HIE to invoice Hawaii Misuzu for those sales.    Michael

Boulware caused HIE to specify on the invoices that payment be

made directly to Michael Boulware, or in some cases directly to

Jin Sook Lee, or in still other cases directly to HIE.    Hawaii

Misuzu paid the invoices by check made payable to the payee

specified on the invoice; i.e., Michael Boulware, Jin Sook Lee,

or HIE.   Of the amount that Hawaii Misuzu paid for HIE’s coffee,

at least $1,265,458 was deposited into bank accounts controlled

by either Michael Boulware or Jin Sook Lee; the deposits totaled

$116,832 for 199006, $382,403 for 199106, $347,866 for 199206,
                                 - 83 -

and $418,357 for 199306.     These payments were not reflected as

officer loans at the time of the transactions.     Merwyn Manago did

not know that Michael Boulware was selling coffee to Hawaii

Misuzu and causing Hawaii Misuzu to pay Michael Boulware or Jin

Sook Lee directly.     Neither HIE nor Michael Boulware reported

these payments as income.

            3.    Sales to Pele Trading

     In 1989, Pele Trading was an exporter of coffee that was

seeking a new supplier of coffee beans.     Timothy Inoue was Pele

Trading’s vice president who was responsible for purchasing

coffee beans for Pele Trading.     From 1989 through 1993, Timothy

Inoue purchased coffee from Michael Boulware and from Marvin

Fukumitsu, an HIE employee, believing that HIE was the seller of

the coffee.      Timothy Inoue received his purchased coffee in HIE

burlap bags, and he received invoices from HIE for the purchases.

     At the direction of Michael Boulware, Timothy Inoue paid for

his coffee purchases with checks that he made payable to Michael

Boulware.    Those checks totaled at least $1,335,132; by taxable

year, the deposits underlying this total aggregated $264,790 for

198906, $1,029,963 for 199006, $21,175 for 199106, and $19,204

for 199206.      All but seven of such checks received from Timothy

Inoue were deposited into a personal checking account of Michael

Boulware, specifically, account No. 05-389054 or account No.
                               - 84 -

49-507151.    In one instance, a check in the amount of $73,500 was

deposited in 199006 into Jin Sook Lee’s trustee account No.

65-570109.    In a second instance, a check in the amount of

$65,000 was deposited in 199006 into Jin Sook Lee’s personal

account No. 65-570109.    On five other instances, a check was

cashed in 199006, rather than deposited; those five checks

totaled $196,532.    Some of the checks were written payable to

HIE, but at the direction of Michael Boulware, “HIE” was crossed

out by Timothy Inoue and the name of Michael Boulware (or in one

case Jin Sook Lee) was written in.      The proceeds from the checks

rewritten to Michael Boulware ended up in the accounts he

controlled.    The proceeds from the check rewritten to Jin Sook

Lee ended up in her account.

     At the time of the transactions, Merwyn Manago did not know

that Michael Boulware was selling coffee to Pele Trading or that

HIE was supplying coffee sold to Pele Trading.     The $1,335,132

that Pele Trading paid Michael Boulware was not directly recorded

as income on HIE’s books.    From 1989 through 1993, the coffee

sales to Pele Trading were not booked as loans to Michael

Boulware.    Michael Boulware did not report these payments as

income.
                                - 85 -

     4.   Referenced Coffee Sold by Michael Boulware Included in
          HIE’s COGS

     As to its coffee sales, HIE computes its cost of goods sold

(COGS) using a system that takes into account the difference in

weight (i.e., shrinkage) between actual coffee bean inventory at

the beginning and end of the accounting period.       That “shrinkage”

is a plug number that reflects the loss in weight from roasting

coffee beans and from any other unexplained loss in weight of

inventory between the inventory dates.       The coffee that Michael

Boulware sold to third parties was included in HIE’s COGS as

shrinkage.

     D.   Bonded Construction

           1.    Background

     Bonded Construction is a general construction company owned

and operated by John Yamada.    Bonded Construction performed work

for both HIE and Michael Boulware.       Bonded Construction rented

and occupied a warehouse from HIE.

           2.    Michael Boulware Causes HIE To Pay to Remodel
                 Jin Sook Lee’s Residence

     In 199006, Bonded Construction completely renovated the

Makaiwa house where Jin Sook Lee lived (and continues to live

today) and which was then titled in her name.       The renovation

cost $156,647.    Bonded Construction invoiced HIE for part of the

work and at the direction of Michael Boulware stated on two of
                                 - 86 -

the invoices that a total of $50,785 of the work was done on

HIE’s coffee roasting plant.27    At the direction of Michael

Boulware, Merwyn Manago caused HIE to pay both of those invoices

upon receipt.

          3.     Paving of the Back Lot at HIE

                 a.   Overview

     HIE paid Bonded Construction to “fill” (i.e., raise the

elevation of) and pave a 70,000-square-foot lot owned by HIE and

located at the back of its property behind the warehouse leased

by Bonded Construction.    Bonded Construction was the general

contractor of the project, and Automated Equipment was the sole

subcontractor.    Michael Boulware had asked John Yamada to act as

general contractor and to use Automated Equipment as the

subcontractor.    HEI paid Bonded Construction for the job, and

Bonded Construction then paid Automated Equipment with some of

the money that Bonded Construction had just received from HIE.

Merwyn Manago authorized the payments to Bonded Construction not




     27
      The first invoice, dated Mar. 15, 1990, stated that
$23,580 was due for “Materials and Labor needed to make necessary
improvements to the Coffee Roasting Plant according per
instructions”. The second invoice, dated Apr. 11, 1990, stated
that $27,205 was due for “Materials and Labor to fabricate and
modify certain areas in the coffee plant to accept the new mill
assembly as per instructed”.
                                 - 87 -

knowing that part of the payments would then be transferred to

Automated Equipment.

     James Kunihiro and Rodney Nohara owned a construction

company named Jayar Construction (Jayar).     In 1994, Jayar was

working on a large excavation project in downtown Honolulu at the

site of the Bank of Hawaii.     The project required that Jayar haul

away from the site approximately 100,000 cubic yards of soil in

the form of coral material.     James Kunihiro and Michael Boulware

discussed Michael Boulware’s need for approximately 4,000 cubic

yards of that type of soil to fill HIE’s back lot.     Jayar sold

Michael Boulware approximately 4,000 cubic yards of the soil

excavated from the downtown project.      Jayar also trucked, dumped,

and spread that soil at HIE’s back lot.

     Jayar received at least $31,000 for the job.     James Kunihiro

and Rodney Nohara were each paid separately for the job through

checks that were payable to them personally from the bank account

of Automated Equipment.     James Kunihiro received $17,000 through

three checks in the amounts of $9,000, $5,000, and $3,000.

Rodney Nohara received at least $14,000 through two checks in the

amounts of $9,000 and $5,000.

                       b.   Automated Equipment

     On or about December 22, 1993, Michael Boulware asked his

attorney, Michael McCarthy, to form quickly for Michael Boulware
                                - 88 -

a wholly owned corporation known as Automated Equipment.      Michael

McCarthy did so on December 22, 1993, using form documents that

he had previously used to set up other corporations and listing

himself as the only initial officer.     Approximately 3 weeks

later, Michael Boulware replaced Michael McCarthy as the sole

officer of Automated Equipment.     Michael Boulware did not tell

his and the subject corporations’ accountants, Kobayashi, Doi &

Lum CPAs LLC (Kobayashi Doi), about the formation or existence of

Automated Equipment.

     In 1993, HIE started making monthly payments of

approximately $35,000 to Automated Equipment for a lease of

equipment.    HIE did not actually lease any equipment from

Automated Equipment.     When HIE was making these payments, Merwyn

Manago did not know that Michael Boulware owned Automated

Equipment.

     E.    Michael Boulware’s Fictitious Leasing Transactions

             1.   Overview

     Lorin Kushiyama owned three businesses named Aloha Games,

Automatic Coin Equipment, Inc. (Automatic Coin Equipment), and

NA, Inc.     Lorin Kushiyama has known Michael Boulware since the

1960s.    In the early 1990s, Lorin Kushiyama asked Michael

Boulware to lend him approximately $25,000.     Michael Boulware

refused to do so.     Later, in 1992, Michael Boulware asked Lorin
                               - 89 -

Kushiyama in exchange for money to assist him in two false

invoicing schemes that would eventually underlie one or more of

the counts for which Michael Boulware was indicted.   Lorin

Kushiyama agreed to do so.   Eventually, as a result of Lorin

Kushiyama’s participation in Michael Boulware’s false invoicing

schemes, Lorin Kushiyama was named an unindicted coconspirator

with Michael Boulware regarding a count of his indictment that,

as discussed infra, alleged a conspiracy knowingly to make a

false statement and report for purposes of influencing the action

of an institution insured by the Federal Deposit Insurance

Corporation.

           2.   Michael Boulware’s First Scheme

     On or about January 8, 1992, Michael Boulware asked Lorin

Kushiyama to cause Aloha Games to prepare and deliver to HIE an

invoice purporting to show that HIE paid $157,612 to purchase

video games identified in the invoice.   Lorin Kushiyama agreed to

do so and caused Aloha Games to issue HIE an invoice stating that

Aloha Games had sold 48 games to HIE on January 8, 1992, at a

total cost of $157,612 (inclusive of 4-percent Hawaii tax of

$6,062).   On January 8, 1992, HIE issued a $75,000 check to Aloha

Games to pay part of the invoice.   On the same day, Lorin

Kushiyama wrote a $70,000 check from Aloha Games to Michael

Boulware, which Michael Boulware deposited on that day into his
                               - 90 -

First Hawaiian Bank account No. 49-507151.   On January 10, 1992,

HIE issued a $82,612 check to Aloha Games to pay the remainder of

the invoice.   The $82,612 check was endorsed by Lorin Kushiyama

and deposited into one of the off-book bank accounts, Central

Pacific Bank account No. 01-06586-6.    HIE deducted the $157,612

in payments on its 199206 Federal income tax return.   Neither

Lorin Kushiyama nor Aloha Games sold or otherwise transferred to

HIE any of the games listed on the invoice; HIE already owned

those games.

          3.   Michael Boulware’s Second Scheme

                a.   Need for the Second Scheme

     Michael Boulware asked Merwyn Manago to make additional

payments to Aloha Games for the purchase of video games but did

not submit to Merwyn Manago any additional invoices to support

those additional payments.   Merwyn Manago made the additional

payments to Aloha Games and recorded those payments as personal

loans to Michael Boulware.   Michael Boulware devised a second

scheme to obtain invoices in response to the actions of Merwyn

Manago.

     Under the second scheme, Lorin Kushiyama prepared false

invoices for Michael Boulware showing a sale of equipment to HIE

from one of Lorin Kushiyama’s businesses, and Michael Boulware

received financing on those invoices from General Electric Credit
                                - 91 -

Corporation Financial Corporation (GECC).      GECC financed

purchases of equipment secured by a security interest in the

equipment, and transactions with GECC were structured as if the

borrower was leasing the equipment from GECC.      The typical

transaction facilitated by GECC involved GECC as the lessor and a

commercial customer as the lessee seeking to lease equipment from

a particular vendor that the customer had selected.      Because HIE

was a regular and well-rated customer of GECC with respect to

HIE’s prior purchases of video games, GECC generally required

from HIE just an invoice to finance any purchase price shown on

the invoice.

                 b.   HIE’s Relationship With GECC

     HIE and GECC had had a financial relationship since October

8, 1985, and HIE had had an account with GECC since at or about

the same time.   On April 10, 1989, HIE and GECC entered into a

“Master Lease Agreement” (MLA) under which GECC agreed to lease

to HIE and HIE agreed to lease from GECC equipment as described

in subsequent schedules to the MLA.      The MLA appointed HIE as

GECC’s agent for inspection and acceptance of equipment from a

supplier, and HIE upon receipt of equipment was required to

execute a certificate of acceptance and a delivery receipt

acknowledging receipt of the equipment in good condition.        Under
                                    - 92 -

the MLA, the equipment remained the property of GECC while HIE

made payments under the lease schedule.

                  c.    Seven False Invoices

                         i.    Overview

     In early 1992, Michael Boulware asked Lorin Kushiyama to

cause Aloha Games and Automatic Coin Equipment to prepare and

deliver to HIE seven invoices purporting to show the purchase of

video games at a total cost of $495,814.80.        Lorin Kushiyama

agreed to do so.       Lorin Kushiyama prepared in the names of his

businesses four false invoices totaling $271,382.80 and three

false invoices totaling $224,432.

                         ii.    Four False Invoices Totaling $271,382.80

     Lorin Kushiyama caused his businesses to issue four false

invoices in the total amount of $271,382.80.        First, Lorin

Kushiyama caused Automatic Coin Equipment to prepare and deliver

to HIE an invoice dated February 3, 1992, listing that Automatic

Coin Equipment had sold 17 games to GECC (on behalf of HIE) at a

total cost of $54,563.60 (inclusive of 4-percent Hawaii tax of

$2,098.60).   Second, Lorin Kushiyama caused Aloha Games to

prepare and deliver to HIE an invoice dated February 5, 1992,

listing that Aloha Games had sold 15 games to GECC (on behalf of

HIE) at a total cost of $42,900 (inclusive of 4-percent Hawaii

tax of $1,650).    Third, Lorin Kushiyama caused Automatic Coin
                               - 93 -

Equipment to prepare and deliver to HIE an invoice dated February

10, 1992, listing that Automatic Coin Equipment had sold 15 games

to GECC (on behalf of HIE) at a total cost of $53,851.20

(inclusive of 4-percent Hawaii tax of $2,071.20).   Fourth, Lorin

Kushiyama caused Automatic Coin Equipment to prepare and deliver

to HIE an invoice dated March 6, 1992, listing that Automatic

Coin Equipment had sold 35 games to GECC (on behalf of HIE) at a

total cost of $120,068 (inclusive of 4-percent Hawaii tax of

$4,618).   As noted above, the amounts of these 4 invoices total

$271,382.80 ($54,563.60 + $42,900 + $53,851.20 + $120,068 =

$271,382.80).

                     iii.   Three False Invoices Totaling $224,432

     Lorin Kushiyama caused his businesses to issue three other

false invoices in the total amount of $224,432.   First, Lorin

Kushiyama caused Aloha Games to prepare and deliver to HIE an

invoice dated March 3, 1992, listing that Aloha Games had sold 22

games to GECC (on behalf of HIE) at a total cost of $66,705.60

(inclusive of 4-percent Hawaii tax of $2,565.60).   Second, Lorin

Kushiyama caused Automatic Coin Equipment to prepare and deliver

to HIE an invoice dated March 11, 1992, listing that Automatic

Coin Equipment had sold 22 games to GECC (on behalf of HIE) at a

total cost of $65,442 (inclusive of 4-percent Hawaii tax of

$2,517).   Third, Lorin Kushiyama caused Aloha Games to prepare
                                - 94 -

and deliver to HIE an invoice dated March 17, 1992, listing that

Aloha Games had sold 28 games to GECC (on behalf of HIE) at a

total cost of $92,284.40 (inclusive of 4-percent Hawaii tax of

$3,549.40).   As noted above, the amounts of these three invoices

total $224,432 ($66,705.60 + $65,442 + $92,284.40 = $224,432).

                d.   First Four Referenced False Invoices

     On March 3, 1992, HIE submitted the February 3, 5, 10 and

March 6, 1992, invoices to GECC as if the invoices reflected

typical leasing arrangements.    GECC processed the invoices as

such and on March 10, 1992, joined with HIE in executing a

document with respect thereto stating that HIE had to make

monthly payments to GECC of $8,833.51.    One day later, on March

11, 1992, GECC issued a $42,900 check payable to Aloha Games and

a $228,482.80 check payable to Automatic Coin Equipment.    Neither

Lorin Kushiyama nor either of his businesses, Aloha Games and

Automatic Coin Equipment, sold or otherwise transferred to HIE or

GECC any of the games listed on the four just mentioned invoices;

HIE already owned those games.

     On March 12, 1992, Lorin Kushiyama caused Aloha Games to

transfer $32,900 to the Bank of Hawaii and caused the Bank of

Hawaii to issue a $32,900 cashier’s check to Michael Boulware in

return for the transfer.   Also on that day, Lorin Kushiyama

caused NA, Inc., to issue a $228,482.80 check payable to Michael
                                - 95 -

Boulware; on the same day, Michael Boulware deposited that check

into his First Hawaiian Bank account No. 49-507151.    On March 13,

1992, Michael Boulware deposited the $32,900 cashier’s check into

his First Hawaiian Bank account No. 49-507151.

     HIE paid GECC each of the $8,833.51 monthly payments and

deducted those payments on its 199206 through 199506 Federal

income tax returns.

               e.     Last Three Referenced False Invoices

     On March 23, 1992, HIE submitted the March 3, 11, and 17,

1992, invoices to GECC as if the invoices reflected typical

leasing arrangements.    GECC processed the invoices as such and on

March 27, 1992, joined with HIE in executing a document with

respect thereto stating that HIE had to make monthly payments to

GECC of $7,206.51.    On April 1, 1992, GECC issued a $66,705.60

check payable to Aloha Games, a $92,284.40 check payable to Aloha

Games, and a $65,442 check payable to Automatic Coin Equipment.

Neither Lorin Kushiyama nor either of his businesses, Aloha Games

and Automatic Coin Equipment, sold or otherwise transferred to

HIE or GECC any of the games listed on the three just mentioned

invoices; HIE already owned those games.    On April 1, 1992, the

$66,705.60, $92,284.40, and $65,442 checks were all deposited

into one of the off-book bank accounts, Central Pacific Bank

account No. 01-06586-6.
                              - 96 -

     HIE paid GECC each of the $7,206.51 monthly payments and

deducted those payments on its 199206 through 199506 Federal

income tax returns.

          4.   Funds Transferred to Lorin Kushiyama

     After Lorin Kushiyama prepared and delivered the false

invoices for Michael Boulware, Michael Boulware lent Lorin

Kushiyama the money he had previously requested.   Later, in 1999

and 2000, HIE paid Lorin Kushiyama as a full-time consultant

although he performed no meaningful substantive activity for HIE.

     F.   Michael Boulware’s International Circular Flow of Funds

          1.   Overview

     Respondent determined in the NOD issued to HIE that HIE

improperly deducted $1,731,000 for 199506 through 199706 as to

funds transferred from HIE to various foreign entities and then

to Michael Boulware; that HIE improperly deducted $29,984 for

199506 as to funds transferred from HIE to various foreign

entities and then to Briggs Cockerham, an entity in Amarillo,

Texas, as a potential personal investment by Michael Boulware;

and that HIE improperly deducted $89,936 for 199506 and 199606 as

to funds transferred from HIE to various foreign entities and

then to Anthony Oh Young and Gloria Oh Young to pay off a

personal gambling debt of Michael Boulware.
                               - 97 -

     Nathan Suzuki was a tax adviser to Michael Boulware and to

the subject corporations and a former certified public accountant

elected in 1992 (and continuing to serve through 1996) as a

member of the Hawaii House of Representatives.     On or about March

25, 2004, Nathan Suzuki pleaded guilty to conspiring with Michael

Boulware from June 16, 1993 or thereabouts, to February 10, 2000,

to defraud the United States by impeding, impairing, obstructing,

and defeating the lawful functions of the Internal Revenue

Service in the ascertainment, computation, assessment, and

collection of Michael Boulware’s Federal income taxes.     That plea

related in part to the formation and operation of Forest Trading,

Pacific Vendors, and Harvest International, the relevant foreign

entities referred to in the prior paragraph.

          2.   Relevant Foreign Entities

                a.   Forest Trading

     On April 7, 1992, Forest Trading was established in Hong

Kong as a corporate type entity.      Its original shareholders were

Sek Nga Kwan and Raymond Lam Man Shing (Raymond Lam), each

holding 50 percent of its shares.     The office of Forest Trading

in an office building in Hong Kong.     The office was staffed by

Raymond Lam, his wife, and a third individual.
                                - 98 -

                b.    Pacific Vendors

     Harold Okimoto was a close personal friend of Michael

Boulware.   Harold Okimoto referred either Nathan Suzuki or a

Tongan national named V. Hemaloto Alatini (Hemaloto Alatini) to

Barney Shiotani for assistance in forming for Michael Boulware a

corporate type entity in the Kingdom of Tonga.28    On or about

December 9, 1994, Nathan Suzuki and Hemiloto Alatini incorporated

that entity, Pacific Vendors, as a private company in and under

the laws of the Kingdom of Tonga (in other words, an entity that

was similar to a corporation in the United States).    Subsequently

in December 1994, Barney Shiotani contacted the officials of the

Kingdom of Tonga inquiring as to why the corporate charter had

not as of then been issued for Pacific Vendors.    Barney Shiotani

was informed that the charter was “well on its way”.    The charter

was later issued.

     Pacific Vendors was owned nominally for Michael Boulware.

Originally, its nominal shareholders were Nathan Suzuki, owning

80 percent of the shares of the company, and Hemaloto Alatini,

owning the rest.     Hemaloto Alatini was nominally given shares in



     28
      As discussed infra, Barney Shiotani is an attorney who
became a close confidant of Michael Boulware after Michael
Boulware learned that he was under criminal investigation.
Barney Shiotani advised Michael Boulware on ways to defeat that
investigation.
                                  - 99 -

Pacific Vendors to facilitate its creation and the opening of its

bank accounts in the Kingdom of Tonga.       Nathan Suzuki was

appointed secretary and director of Pacific Vendors.

     Pacific Vendors and its bank accounts were established by

Nathan Suzuki and Michael Boulware to help Michael Boulware avoid

the consequences of the criminal investigation of Michael

Boulware and to impede, impair, obstruct, and defeat that

investigation.   Merwyn Manago was not aware of Pacific Vendors.

                 c.   Harvest International

                       i.    Roxca Limited

     In or before 1994, Harold Okimoto contacted Barney Shiotani

because Harold Okimoto wanted to form a corporate type entity in

and under the laws of Hong Kong.      Barney Shiotani referred Harold

Okimoto to a Hong Kong law firm named King & Co. (King Co.).         The

desired entity, Roxca Limited, was incorporated in Hong Kong on

October 14, 1994.

                       ii.    Reinvoicing Operation

     James Chan was a friend of Nathan Suzuki and of Raymond Lam.

Sometime during 1993 through 1995, Nathan Suzuki asked James Chan

to help him establish an offshore reinvoicing operation in Hong

Kong.   James Chan asked Raymond Lam, who was then in Hong Kong,

if he would assist Nathan Suzuki in that matter.       Raymond Lam

agreed to do so.
                                - 100 -

     James Chan referred Nathan Suzuki to Raymond Lam, and Nathan

Suzuki and Raymond Lam formed Harvest International on or about

January 12, 1995, by changing the name of Roxca Limited to

Harvest International.   Harvest International had no personnel,

and its office in Hong Kong was the same office as that of Forest

Trading.   The office had a separate phone and fax line for

Harvest International.   Harvest International reported that its

initial directors were Harold Okimoto and Pacific Vendors and

that its initial shareholders also were Harold Okimoto and

Pacific Vendors.    Harold Okimoto owned 1 percent of the shares in

Harvest International as a nominee of Pacific Vendors and of

Michael Boulware, and Pacific Venders owned the other 99 percent

of the shares.   Harold Okimoto’s shares were formally transferred

to Pacific Vendors after Harold Okimoto died of colon cancer on

October 12, 1996.

                      iii.   Bank Accounts

     From March 24, 1995, until his death, Harold Okimoto was the

sole signatory on Harvest International’s bank accounts.   Those

accounts were a “HK Dollar Current Account” and a “US Dollar

Savings Account” opened on or about March 24, 1995, at the

Hongkong & Shanghai Banking Corporation Limited.
                                 - 101 -

                     iv.    Rationale Underlying Formation

     Nathan Suzuki had explained to James Chan that he wanted to

form a reinvoicing company in Hong Kong to buy coffee from HIE on

credit and then to sell the coffee to overseas customers, the end

users, who would receive their purchased coffee as drop shipments

from HIE.   Further, Nathan Suzuki explained, the reinvoicing

company would collect payments on its sales long before the time

that it would have to pay its credit owed HIE and could lend the

excess cashflow to Forest Trading which in turn could lend the

money to Michael Boulware net of certain fees.    James Chan often

acted as a messenger and translator for Nathan Suzuki and Raymond

Lam regarding Harvest International, and James Chan later learned

that the excess cash was wired directly to Michael Boulware

rather than lent to him.

                     v.    Actual Operation

     HIE did not actually sell coffee to Harvest International.

                     vi.    False Invoices From Harvest
                            International

                            1.   Overview

     False invoices were prepared that reported that Kona coffee

was sold from Harvest International to HIE.    From March 1, 1995,

through January 6, 1997, Harvest International issued HIE at

least the following invoices with respect to Kona coffee:
                                       - 102 -

    Invoice
      Date      Pounds   Price/Lb.     Invoice Amount            Note

     3/1/95     30,600    $6.50           $198,900.00    Shipped Dec.   1994
     3/1/95     10,000     6.50             65,000.00    Shipped Nov.   1994
     3/1/95     35,000     6.50            227,500.00    Shipped Mar.   1995
    4/24/95     35,000     6.50            227,500.00    Shipped Apr.   1995
    5/30/95        -                       (89,129.03)   Credit memo:   Inferior
                                                           Product
    6/15/95     35,000     7.25            253,750.00           ---
    7/31/95     35,000     7.25            253,750.00           ---
   10/15/95     40,000     7.25            290,000.00           ---
   12/13/95     35,000     7.50            262,500.00           ---
     2/8/96     40,000     8.00            320,000.00    Shipped Feb.   & Mar. 1996
     3/3/96      6,500    10.75             69,875.00    Shipped Mar.   1996
     4/9/96     38,000     8.00            304,000.00           ---
    6/29/96     38,000     8.00            304,000.00           ---
   10/10/96     38,000     8.50            323,000.00           ---
    12/1/96     38,000     8.50            323,000.00           ---
     1/6/97     38,000     8.50            323,000.00           ---
       Total                             3,656,595.97

Not all of these invoices were received contemporaneously with

the corresponding date on which the coffee was stated on the

invoices to have been shipped.

                                  2.   Payments of Invoices

     During 199506 through 199706, HIE paid the Harvest

International invoices through checks and wire transfers.                     At

least $3,361,827.62 was sent by wire.              With respect to the

$3,361,827.62, Michael Boulware caused HIE to wire $3,037,984.19

directly to Harvest International and $323,843.43 directly to

King Co.      Michael Boulware then caused $164,067.01 of the

$323,843.43 to be wired from King Co. to Harvest International.
                               - 103 -

                          3.   Transfers From Harvest International

                                a.   Overview

     As just mentioned, Michael Boulware caused $3,202,051.20 to

be wired to Harvest International ($3,037,984.19 + $164,067.01 =

$3,202,051.20).   Michael Boulware then caused Harvest

International and others to transfer portions of the

$3,202,051.20 in the manner that he directed.

                                b.   Transfers to Personal Account
                                     of Michael Boulware

     During 199507 through 199706, Michael Boulware caused

Harvest International to transfer $1,805,128 to Forest Trading

and then caused Forest Trading to transfer $1,731,000 of the

$1,805,128 to his First Hawaiian Bank account No. 09-365508.

Specifically, Michael Boulware caused $837,000, $819,000, and

$75,000 to be transferred to his account in 199506, 199606, and

199706, respectively ($837,000 + $819,000 + $75,000 =

$1,731,000).

                                c.   Transfers on Behalf of Michael
                                     Boulware to Paragon Coffee,
                                     Gloria Oh Young, and
                                     Antoinette Hirai

     During 199507 through 199706, Michael Boulware caused

Harvest International to transfer $1,095,943.62 to Pacific

Vendors and then caused Pacific Vendors to transfer the

$1,095,943.62 to Paragon Coffee Trading Co., L.P. (Paragon
                               - 104 -

Trading), Gloria Oh Young, and Antoinette Hirai.     Paragon Coffee

was a seller of green (i.e., unroasted) Colombian coffee beans,

and Sidney Boulware assisted Harold Okimoto in purchasing coffee

for Harvest International by placing orders with Paragon Coffee.

Gloria Oh Young, the then wife of Anthony Oh Young, was hired to

collect a $500,000 gambling debt from Michael Boulware.      Michael

Boulware agreed to pay Anthony Oh Young approximately $100,000.

During 199606 and 199706, Pacific Vendors wired $69,961 and

$19,975 to the bank account of Gloria Oh Young, as payments that

Michael Boulware agreed to make to Anthony Oh Young related to

the gambling debt.    As discussed infra, Antoinette Hirai was the

then wife of Stanley Hirai, and both of them cashed checks for

Michael Boulware as directed by him so as to minimize any

connection that Michael Boulware had to the off-book activities

and to the off-book bank accounts.

                                d.    Transfer on Behalf of
                                      Michael Boulware to Briggs
                                      Cockerham

     On August 16, 1995, Michael Boulware (through Harold

Okimoto) caused Harvest International to transfer $29,984 to

Briggs Cockerham.    The $29,984 represented a speculative

investment by Michael Boulware.      That investment was the purchase

of a minority ownership interest in a possible bank venture in

Ecuador.   Barney Shiotani had learned of the investment in July
                                - 105 -

1995 through some of his acquaintances at Briggs Cockerham, and

he relayed that information to Michael Boulware.    The bank

venture ultimately failed.

                      vii.   Coffee Rebagging

     Additional moneys were wired from Harvest International to a

Swiss bank account for the benefit of Michael Norton.    Michael

Norton used Harvest International to evade his own tax

liabilities by transferring funds he obtained by selling

Colombian coffee as Kona coffee.    Michael Boulware sent empty

burlap bags marked “Kona coffee” to Michael Norton in Berkeley,

California, with the intent that Michael Norton buy South

American coffee, fill those bags with it, and send it back to HIE

as Kona coffee.

          3.   Role of Nathan Suzuki

     Nathan Suzuki used the official facsimile line in his

legislative office to authorize transfers from the bank accounts

of Pacific Vendors.   As part of his plea agreement, Nathan Suzuki

admitted that he conspired with Michael Boulware to transfer

money from HIE to Michael Boulware by way of Harvest

International and Pacific Vendors to help Michael Boulware defeat

the criminal investigation of Michael Boulware.
                                  - 106 -

           4.    Harold Okimoto

                  a.   Overview

     Michael Boulware claims that the $1,731,000 transferred to

him from Harvest International was actually a loan from Harold

Okimoto through Forest Trading.      Michael Boulware never made any

payments on the purported loan.      Nor did Harold Okimoto have

sufficient assets to lend Michael Boulware $1,731,000.      Harold

Okimoto was a heavy gambler who expended almost all of his assets

during his lifetime.      Harold Okimoto died with minimal assets and

huge debts, including a debt of more than $1 million to the

Internal Revenue Service.

     During the last few years of his life, Harold Okimoto was

dependent financially on his two sons, Blake Okimoto and Bruce

Okimoto.   Blake Okimoto is an attorney with a general practice, a

per diem (part time) district court judge for the First Circuit

of Hawaii, and a member of the disciplinary board of the Hawaii

Supreme Court.    Bruce Okimoto owns a business that supplies

construction materials.

                  b.   Harold Okimoto’s Employment

     Harold Okimoto owned Island Tobacco for a period that ended

in or about 1985.      When Island Tobacco was dissolved, Harold

Okimoto went to work for HIE.      Harold Okimoto was an employee of

HIE from May 1, 1986, through April 1, 1995.
                               - 107 -

                c.   Administration of Harold Okimoto’s Estate

     Harold Okimoto’s estate was not probated.      When he died on

October 12, 1996, his survivors (including Blake Okimoto, Bruce

Okimoto, and their mother Clara Okimoto (collectively, Okimoto

family)) believed that Harold Okimoto did not have enough assets

to require a probate of his estate.      The only assets that they

knew that Harold Okimoto owned at the time of his death were a

car, some jewelry, some personal effects, and four checks written

as payable to him by Michael Boulware in the aggregate amount of

$143,500.29   Two of the checks were in the amounts of $28,500 and

$30,000 and were payable from Michael Boulware’s First Hawaiian

Bank account No. 49-507151; those checks were dated October 27

and November 8, 1993.   The other two checks were in the amounts

of $30,000 and $55,000 and were payable from one of the off-book

bank accounts, Central Pacific Bank account No. 01-06586-6; those

checks were dated 1992 and January 15, 1993.30     When Harold

Okimoto was dying, he told Blake Okimoto about the 4 checks but

did not mention any money that Harold Okimoto had lent Michael

Boulware.

     29
      When Harold Okimoto died, the house in which he had been
living was owned by an irrevocable trust, the beneficiaries of
which were Bruce Okimoto and Blake Okimoto.
     30
      The check dated 1992 has no corresponding month or date on
its face. We also note that this check is No. 386, while the
check dated Jan. 15, 1993, is No. 376.
                               - 108 -

     Approximately 2 months after Harold Okimoto died, Blake

Okimoto asked Michael Boulware to pay him the aggregate amount of

the uncashed checks.   Michael Boulware was a heavy gambler on

sporting events, and he used to place bets with Harold Okimoto,

who was his gambling bookie.31   Harold Okimoto and Michael

Boulware also used to travel together to gamble in Las Vegas,

Nevada.    When taking bets from Michael Boulware, Harold Okimoto

would take Michael Boulware’s personal check as a substitute for

a promissory note; if Michael Boulware lost the bet, Harold

Okimoto would give the check back to Michael Boulware when

Michael Boulware paid Harold Okimoto cash in the amount of the

check.    The uncashed checks reflected amounts that Michael

Boulware owed to Harold Okimoto on lost bets.    Michael Boulware

denied that he owed Harold Okimoto any money and insisted that

Harold Okimoto owed him money for funds that Michael Boulware had

lent Harold Okimoto.    The Okimoto family decided not to pursue

collection of the amounts reflected in the four checks, and those

checks have never been paid.




     31
      Mal Sun Boulware also was a heavy gambler. Michael
Boulware paid gambling debts of hers aggregating at least
$300,000 to $600,000.
                                - 109 -

                 d.   U.S. Attorney Contacts Okimoto Family

     Shortly after the Okimoto family decided not to pursue

collection of the four checks, Blake Okimoto was approached by

Assistant U.S. Attorney J. Michael Seabright (who is now a U.S.

District Court judge) with respect to the Kingdom of Tonga bank

accounts that were at issue in a then-ongoing criminal case

involving Michael Boulware.    Harold Okimoto had ties to that

account that allowed Blake Okimoto to consent to a request by the

United States to receive records on the account, and the United

States wanted Blake Okimoto to give such consent.    Shortly

thereafter, Michael Boulware strongly suggested to Blake Okimoto

that he not give any such consent and requested that the two meet

to discuss certain matters.    Blake Okimoto immediately contacted

the U.S. Attorney’s Office to report that request.    Blake Okimoto

then learned that Michael Boulware wanted to pay the Okimoto

family approximately $1.7 million that Michael Boulware said

Harold Okimoto had lent him beginning in 1995 through monthly

wire transfers from Hong Kong.    Blake Okimoto also learned that

Michael Boulware wanted to hire Blake Okimoto’s law firm to

represent HIE.   Before he died, Harold Okimoto had routinely and

regularly disclosed his personal finances and other matters to

Blake Okimoto, and Blake Okimoto neither heard from his father

that he had lent Michael Boulware approximately $1.7 million, nor
                               - 110 -

believed that his father had the funds to lend that amount to

Michael Boulware.

               e.    Claim of an Approximately $1.7 Million Debt

     Approximately 1 year after Harold Okimoto’s death, Michael

Boulware telephoned Bruce Okimoto unexpectedly and asked that

they meet at Michael Boulware’s house.   Shortly thereafter, the

two of them met alone next to Michael Boulware’s garage, and

Michael Boulware told Bruce Okimoto that Michael Boulware owed

Harold Okimoto approximately $1.7 million and had a promissory

note to that effect.   Bruce Okimoto was aware of no such debt and

did not believe that his father had enough money to have lent

anyone anything.    Bruce Okimoto and his brother, Blake Okimoto,

did not do anything about collecting the money from the alleged

loan because they did not believe that the loan existed.   Michael

Boulware asked Bruce Okimoto to send him a demand letter for the

money, but Bruce Okimoto declined.   The Okimoto family never

received payment for the approximately $1.7 million loan that

Michael Boulware said he owed Harold Okimoto.

               f.    After-the-Fact Creation of Promissory Notes

     Sometime after Harvest International was formed, James Chan

met with Barney Shiotani and Nathan Suzuki in Nathan Suzuki’s

legislative office at the State Capitol.   At this meeting, the

three men acknowledged the absence of a promissory note or other
                               - 111 -

document indicating that the funds previously transferred from

the foreign entities to Michael Boulware were loans.    The three

men discussed their desire to create promissory notes for that

purpose.    The three men agreed that Barney Shiotani would draft

promissory notes from Michael Boulware to Harvest International

for funds previously transferred to Michael Boulware.

XI.   Michael Boulware’s Removal of Funds From the Off-Book Bank
      Accounts

      A.   Overview

      A total of $4,058,732 deposited into the off-book bank

accounts was removed through transfers to Michael Boulware’s

personal bank accounts, by checks written directly to Jin Sook

Lee, by checks written directly to Mal Sun Boulware, or by checks

cashed for Michael Boulware mostly by his loyal employees and

friends.    Of the $4,058,732, $1,356,100 was transferred to

Michael Boulware’s personal account No. 05-389054; $641,412 was

transferred to Michael Boulware’s personal account No. 49-507151;

$151,000 was transferred to Jin Sook Lee through checks written

to her; $601,700 was transferred to Mal Sun Boulware through

checks written to her; and $1,308,520 was received by Michael

Boulware through a check cashing arrangement where Michael

Boulware wrote a check payable to cash or to the name of a loyal

(to him) individual, and the individual cashed the check and gave
                                - 112 -

the proceeds to Michael Boulware.    When these checks were cashed,

in 1989 through 1992, Michael Boulware had not yet filed his

Federal income tax returns for any of those years.

     B.   Michael Boulware Caused Checks To Be Cashed for Him by
          Employees and Friends

            1.   Stanley Hirai and Antoinette Hirai

     Michael Boulware gave Stanley Hirai and his then wife,

Antoinette Hirai, various checks usually payable either to cash

or to Antoinette Hirai.    As directed by Michael Boulware (or

sometimes in the case of Antoinette Hirai at the direction of

Stanley Hirai), Antoinette Hirai, or sometimes Stanley Hirai or

their daughter, cashed the checks and gave the cash to Michael

Boulware.    Antoinette Hirai did not know why she was cashing the

checks; she simply cashed the checks, put the cash in an

envelope, and gave the envelope to Stanley Hirai who in turn gave

the money to Michael Boulware.    From 1992 through 1994, Michael

Boulware wrote $230,000 of checks payable to cash or to

Antoinette Hirai; those checks were payable from an off-book bank

account, from one of Michael Boulware’s personal accounts, or

from the Automated Equipment bank account.    Michael Boulware told

Stanley Hirai that the money was Michael Boulware’s personal

funds and that he was giving those funds to Jin Sook Lee.
                                       - 113 -

                2.   Morris Miyasota

        Morris Miyasota has worked for Holdings (and its

predecessor) since 1983 and was its human resource manager in

1990 and 1991.        In the late 1980s to early 1990s, Morris Miyasota

cashed at the request of Michael Boulware approximately 150

checks totaling approximately $2 million.          The amounts payable on

approximately 30 percent of the checks were greater than $10,000,

and most of the checks were made payable to cash; sometimes, the

checks were made payable to Morris Miyasota.          As directed by

Michael Boulware, Morris Miyasota gave the proceeds to Michael

Boulware upon cashing the checks.           On at least one occasion, when

Morris Miyasota was asked to fill out a cash transaction report

for one of the transactions, he reported that he, rather than

Michael Boulware, was receiving the proceeds.32          Morris Miyasota

knew it was not typical for someone in his position with Holdings

(and its predecessor) to cash checks.

     The checks written as payable to Morris Miyasota totaled

$198,600 and were written from February 1992 through January

1993.        Of those checks, $147,700 was payable from one of the

off-book bank accounts, Central Pacific Bank account No.



        32
      Currency transaction reports are generally required to be
filed by banks as to deposits or withdrawals (including by way of
check) exceeding $10,000.
                                 - 114 -

01-06586-6; $3,700 was payable from Michael Boulware’s First

Interstate Bank of Hawaii account No. 05-389054; and $47,500 was

payable from Michael Boulware’s First Hawaiian Bank account No.

49-507151.

     The checks written as payable to cash totaled $1,791,700 and

were written from January 1989 through February 1992.     Of those

checks, $3,000 was payable from one of the off-book bank

accounts, Central Pacific Bank account No. 01-06586-6; $1,681,200

was payable from Michael Boulware’s First Interstate Bank of

Hawaii account No. 05-389054; and $107,500 was payable from

Michael Boulware’s First Hawaiian Bank account No. 49-507151.

          3.    Thomas Okimoto

     Thomas Okimoto began working for HIE in 1984, and he worked

for HIE until he retired in 1997.     Thomas Okimoto was the manager

of HIE who oversaw its OTC sales.     Thomas Okimoto also was the

brother of Harold Okimoto.   During 1994, Michael Boulware wrote

nine checks totaling $44,800 that were payable to Thomas Okimoto.

None of the individual checks was payable in an amount greater

than $10,000.   Two of the nine checks were payable from Michael

Boulware’s First Hawaiian Bank account No. 49-507151 in the total

amount of $9,800.    The remaining checks were payable from Michael

Boulware’s Automated Equipment account No. 17-134698 in the total

amount of $35,000.   As directed by Michael Boulware, Thomas
                                - 115 -

Okimoto cashed each of the nine checks and gave the proceeds to

Michael Boulware.    Thomas Okimoto never asked Michael Boulware

why he was cashing checks for him.

            4.   Milton Ikeda

     Milton Ikeda was employed by HIE (or its predecessor) as a

karaoke machine salesman from the early 1980s through sometime in

the 1990s, and he was a good friend of Michael Boulware.    From

1991 through 1993, Michael Boulware wrote at least 80 checks

totaling $1,394,663 that were payable to Milton Ikeda.    The

amount payable on most of the individual checks was greater than

$10,000.    Of the at least 80 checks, $426,143 was payable from

Michael Boulware’s First Hawaiian Bank account No. 49-507151;

$806,920 was payable from one of the off-book bank accounts,

Central Pacific Bank account No. 01-06586-6; and $161,600 was

payable from Michael Boulware’s First Interstate Bank of Hawaii

account No. 05-389054.    As directed by Michael Boulware, Milton

Ikeda cashed each of the checks and gave the proceeds to Michael

Boulware.    Milton Ikeda knew that check cashing was not part of

his job, but he did it as a favor to Michael Boulware.    No one at

HIE, besides Michael Boulware, knew that Milton Ikeda was cashing

checks for Michael Boulware.
                                 - 116 -

          5.   Sydney Murayama

     Sydney Murayama was an employee of HIE.    From February 4,

1994, through September 21, 1996, Michael Boulware wrote checks

payable to Sydney Murayama totaling $64,000.    Of those checks,

$47,000 was payable from one of Michael Boulware’s personal

accounts, and the balance of $17,000 was payable from Michael

Boulware’s Automated Equipment account.    As directed by Michael

Boulware, Sydney Murayama cashed the checks and gave the proceeds

to Michael Boulware.

          6.   Neal Taira

     Neal Taira was an employee of HIE.    In September and October

1992, Michael Boulware wrote five checks that were payable to

Neal Taira in the total amount of $39,400.    None of the

individual checks was payable in an amount greater than $10,000.

In September 1992, Michael Boulware also wrote a check payable to

Harold Okimoto in the amount of $9,800.    All six of these

referenced checks were payable from one of the off-book bank

accounts, Central Pacific Bank account No. 01-06586-6.      As

directed by Michael Boulware, Neal Taira cashed each of the six

checks and gave the proceeds to Michael Boulware.

          7.   Paul Takekawa

     Paul Takekawa was an employee of HIE.    During 1993, Michael

Boulware wrote five checks totaling $20,000 that were payable to
                                 - 117 -

cash or to Paul Takekawa.      One of the checks was written in

January 1993 and was made payable in the amount of $4,000 from

one of the off-book bank accounts, Central Pacific Bank account

No. 01-06586-6.    The remaining checks were written in October

through December 1993 and were made payable in the total amount

of $16,000 from Michael Boulware’s First Hawaiian Bank account

No. 49-507151.    None of the individual checks was payable in an

amount greater than $10,000.      As directed by Michael Boulware,

Paul Takekawa cashed each of the five checks and gave the

proceeds to Michael Boulware.

          8.     John Torres

     John Torres was an employee of HIE.      In 1990 and 1992,

Michael Boulware wrote 14 checks payable to John Torres in the

total amount of $103,400.      One check was written in March 1990

and was made payable in the amount of $5,000 from Michael

Boulware’s First Interstate Bank of Hawaii account No. 05-389054.

Ten of the checks were written in January through December 1992

in the total amount of $84,400 and were payable from one of the

off-book bank accounts, Central Pacific Bank account No. 01-

06586-6; the amount payable on 1 of the 10 checks was greater

than $10,000.    The remaining three checks were written in January

through August 1992 in the total amount of $14,000 and were

payable from Michael Boulware’s First Hawaiian Bank account No.
                                - 118 -

49-507151.    None of the individual checks was payable in an

amount greater than $10,000.    As directed by Michael Boulware,

John Torres cashed each of the 14 checks and gave the proceeds to

Michael Boulware.

            9.   Other Check Cashers

       In addition to the checks mentioned above, from 1989 through

1996 Michael Boulware wrote 85 checks payable to cash in the

total amount of $465,382 and gave those checks to individuals

other than those discussed above.      The amounts payable on four of

the checks were greater than $10,000.     Of the 85 checks, $132,282

was payable from Michael Boulware’s First Hawaiian Bank account

No. 49-507151; $181,600 was payable from one of the off-book bank

accounts, Central Pacific Bank account No. 01-06586-6; $133,000

was payable from Michael Boulware’s First Interstate Bank of

Hawaii account No. 05-389054; and $18,500 was payable from

Michael Boulware’s First Hawaiian Bank account No. 09-365508.      As

directed by Michael Boulware, these individuals cashed the checks

and gave the proceeds to Michael Boulware.

XII.    Criminal Investigation of Michael Boulware

       A.   Jerry Yamachika Contacts and Meets With Michael Boulware

       On or about June 16, 1993, the CID began a criminal income

tax investigation of Michael Boulware.     The criminal

investigation stemmed from respondent’s receipt of information
                              - 119 -

that showed that Michael Boulware was enjoying an extravagant

lifestyle and might have realized substantial income during the

recent years but not reported that income on his personal Federal

income tax returns.   This information included, inter alia,

hundreds of currency transaction reports related to Michael

Boulware that numerous banks in Honolulu had filed with the

Commissioner.   This information also included, inter alia, other

independent reports that the referenced banks had filed with the

Commissioner to notify him of transactions with respect to

Michael Boulware that appeared to have been structured to avoid

the filing of a currency transaction report.

     Jerry Yamachika was an experienced special agent in the CID.

As part of the criminal investigation, Jerry Yamachika met with

Michael Boulware on or about June 16, 1993, advised him of his

constitutional rights, and informed him that he was under

criminal investigation for failing to file his personal Federal

income tax returns for 1988 through at least 1991.33   This was

the first time that Michael Boulware was notified by the CID that

he was under criminal investigation.    Jerry Yamachika ascertained



     33
      Michael Boulware told Jerry Yamachika at that meeting that
Michael Boulware had just recently filed his 1989 through 1991
Federal income tax returns. Jerry Yamachika later verified that
claim. Michael Boulware filed those returns on June 12, 1993.
Michael Boulware filed his 1992 return on or after June 8, 1993.
                               - 120 -

at or before the meeting that Michael Boulware had received large

sums of income from HIE as to those years and had received

certain personal benefits through his relationship with his

corporation (e.g., receipt of proceeds lent from HIE, use of

automobiles owned by HIE).    At the meeting, Jerry Yamachika gave

Michael Boulware a request for his personal income tax documents

and a summons for the records of HIE, explaining as to the

summons that it was necessary because HIE was Michael Boulware’s

controlled entity.34   Michael Boulware perceived from the meeting

that he and not any of the subject corporations was the focus of

the criminal investigation.

     B.   Michael Boulware Obtains Professional Representation

     Shortly after meeting with Jerry Yamachika, Michael Boulware

traveled to California to ask Barney Shiotani to represent him in

the criminal investigation.   Barney Shiotani is an attorney

licensed to practice law in California.   Barney Shiotani and

Michael Boulware had never met before they spoke on that

occasion, but they knew of each other from an investment that

Michael Boulware had made in a program managed by Barney

Shiotani.   Barney Shiotani declined Michael Boulware’s request to



     34
      All summonses issued during the criminal investigation
were in the names of Michael Boulware or possibly Jin Sook Lee,
but not HIE.
                              - 121 -

represent him because Barney Shiotani was not a criminal tax

attorney or a litigator.   Barney Shiotani recommended to Michael

Boulware that he retain Martin Gelfand, a criminal tax litigator.

Following the meeting of Barney Shiotani and Michael Boulware,

Barney Shiotani became and remains a close confidant and adviser

to Michael Boulware and to a lesser extent to the subject

corporations.

     In 1993, shortly after meeting with Barney Shiotani, Michael

Boulware retained Martin Gelfand and his California law firm,

Irell & Manella L.L.P. (Irell Manella), to represent Michael

Boulware in connection with the criminal investigation.    At and

after that time, Barney Shiotani remained a close confidant and

adviser to Michael Boulware and to the subject corporations on

the topic of Federal income taxes and, with respect to Michael

Boulware, on theories to pursue to avoid any possible criminal

conviction as to the subject matter of the investigation; e.g.,

by arguing that there was no tax loss as to either Michael

Boulware or HIE, and by formulating steps that Michael Boulware

should take to maximize the chance of such an avoidance.    Barney

Shiotani retained the services of Nathan Suzuki, whom he had

known for at least 10 years, to assist him as a “Kovel
                              - 122 -

accountant”35 with respect to accounting matters as well as to

advise Michael Boulware and the subject corporations.     HIE was

informed by Barney Shiotani and Martin Gelfand that HIE was a

target of the criminal investigation.36     HIE did not retain any

attorney to represent solely its interests in the criminal

investigation.

     C.   Focus of Criminal Investigation

     During the criminal investigation, Jerry Yamachika focused

on the books, records, and transactions of HIE and considered

making HIE and various other entities or individuals targets in

the investigation.   Jerry Yamachika was concerned as to whether

HIE’s tax returns were correct, and he sought and received

documents from HIE to develop criminal cases primarily against


     35
      We understand petitioners to use the term “Kovel
accountant” to refer to an accountant described in United States
v. Kovel, 296 F.2d 918 (2d Cir. 1961). The court held in that
case that an accountant who assists an attorney in communicating
effectively with the attorney’s client does not serve to waive
any attorney-client privilege that would otherwise apply to
privileged information that was disclosed to the accountant. We
use that term for simplicity and do not mean to suggest that we
have found that any of the “Kovel accountants” whom we refer to
herein meet the specifics of United States v. Kovel, supra.
     36
      A target of a criminal investigation is a person or entity
that the CID is investigating for a possible criminal violation
of a Federal statute. A “target” becomes a “subject” (i.e., the
target is “subject numbered”) if the CID concludes that the CID
has sufficient evidence to indicate that the statute was violated
and that the CID has jurisdiction to pursue a prosecution as to
that violation.
                              - 123 -

Michael Boulware and Jin Sook Lee but, if warranted, against HIE

or others as well.   Jerry Yamachika thoroughly reviewed HIE’s

records because he considered HIE to be Michael Boulware’s sole

source of funds and believed that any income that Michael

Boulware failed to report as relevant to the criminal

investigation would have come from that corporation.

     On January 11, 1995, Martin Gelfand and Barney Shiotani met

with Jerry Yamachika and two of his colleagues, and Barney

Shiotani asked Jerry Yamachika whether the criminal investigation

included any subjects other than Michael Boulware, Jin Sook Lee,

and HIE.   Jerry Yamachika heard and understood the question and

recorded it in his notes as such.   Jerry Yamachika did not deny

that HIE was a subject of the investigation and indicated that

there might be other subjects later if, for example, a conspiracy

was found to have existed with respect to the subject matter of

the investigation.   Throughout the criminal investigation, Jerry

Yamachika contemplated characterizing as conspirators numerous

persons including Barney Shiotani, Lorin Kushiyama, John Yamada,

and the various individuals who cashed checks for Michael

Boulware at his direction.

     Jerry Yamachika never formally made HIE a subject of his

investigation because he concluded that HIE was a victim of

crimes perpetrated primarily by Michael Boulware.   Applicable
                                - 124 -

internal procedures pertaining to the CID would have required in

order to have made HIE a subject that Jerry Yamachika recommend

in writing that HIE be made a subject, that this recommendation

be approved by his chief/manager, and that HIE be “subject-

numbered”.   While each of these three steps happened in the cases

of Michael Boulware and Jin Sook Lee (subject-numbered as 99-93-

3-0525 and 99-93-3-0559, respectively), none of those steps

happened with respect to HIE.    Applicable procedures also would

have required that Jerry Yamachika notify the officials of HIE at

the beginning and end of his investigation.

     D.   Applicability of HIE’s Indemnification Provision
          Relating to Certain Personal Legal Fees Incurred by Its
          Directors and Officers

     Early on in the criminal investigation, Michael Boulware

asked HIE to indemnify him for any personal legal fees that he

incurred with respect to the investigation.   Michael Boulware

based his request on provisions set forth in the articles of

incorporation and/or bylaws of HIE and the other relevant

corporations of which he was an officer.   Each of those

provisions states that officers and directors of the corporation

shall be indemnified by the corporation for all reasonable legal

fees and costs actually and necessarily incurred in connection

with a claim in which that officer or director is involved “by

reason of his being or having been a director or officer of the
                              - 125 -

corporation”.   The provisions except matters as to which an

officer or director “shall be finally adjudged in such action,

suit, proceeding, investigation or inquiry to be liable for

willful misconduct, willful neglect or negligence toward the

corporation in the performance of his duties as such director or

officer”.   The provisions state as to the just-quoted exception

that absent such a final adjudication, the board of directors may

conclusively rely on the opinion of legal counsel.

     In addition to receiving legal advice on the subject from

Michael McCarthy and Martin Gelfand, Michael Boulware (both

personally and in his capacity as an officer of HIE) sought and

received legal advice from Douglas Smith of the Hawaii law firm

Damon Key Bocken Leong Kupchak (Damon Key).   Sidney Boulware and

Merwyn Manago, in their capacities as members of HIE’s board, met

informally with Douglas Smith and discussed the propriety of the

subject corporations’ paying Michael Boulware’s legal fees.

Douglas Smith advised HIE’s board that Michael Boulware and the

other HIE employees were entitled to indemnification from HIE

under the referenced provisions to the extent that he and the

other HIE employees were acting in the best interest of HIE.

Douglas Smith researched the issue (including reading the statute

and the applicable corporate provisions) and rendered that advice
                                - 126 -

strictly on the basis of his assumption of facts that had been

provided to him by one or more members of HIE’s board.

     Upon receiving the advice of Douglas Smith, HIE’s board of

directors determined that Michael Boulware was acting in the best

interests of HIE and that he was entitled to indemnification for

his legal fees.     In connection with such indemnification, Damon

Key asked Michael Boulware to pledge (and as of July 21, 1999, he

did pledge) his HIE shares to HIE in exchange for debts that he

might owe HIE, including any debt that arose from the

indemnification for legal fees for which it was not proper to

indemnify him.37

XIII.     Civil Litigation Initiated by Jin Sook Lee

     A.     Background

     As relevant herein, Jin Sook Lee initiated three civil

lawsuits involving Michael Boulware and/or HIE.     First, Jin Sook

Lee sued Michael Boulware and HIE for recovery of the $840,000

that he took from her safe and for an award equal to the value of


     37
      In early 2006, after Michael Boulware was convicted
following his first criminal trial, discussed infra, Damon Key
became aware that provisions under the revised model business
code had been adopted requiring more stringent affirmation in
writing. The then current members of HIE’s board of directors
(Sidney Boulware, Karen Min Boulware, and Merwyn Manago as
outgoing director) executed an affirmation (i.e., a consent of
directors) as to the pledge and recorded in HIE’s board minutes
the board’s approval for indemnification of Michael Boulware’s
legal fees.
                              - 127 -

the Koloa house that he had taken from her through his forged

signature of her name (JSL litigation).   Michael Boulware and HIE

made a counterclaim in the JSL litigation to recover

approximately $5 million of funds received by Jin Sook Lee and to

recognize HIE as the owner of the four relevant real properties.

Second, Jin Sook Lee, as trustee of the Glenn Lee Boulware Trust,

commenced the trust case by petitioning a Hawaii State court to

enforce the trust and to order an accounting.   Michael Boulware,

as trustor, counterpetitioned the court in the trust case to

remove Jin Sook Lee as trustee, to appoint a substitute trustee

designated by him, and to order an accounting of all funds that

he or HIE had transferred to Jin Sook Lee from September 8, 1987,

through that time.   Third, Jin Sook Lee, as trustee of the trust,

commenced a shareholder derivative case (shareholder derivative

case).

     B.   JSL Litigation

           1.   Complaint

     On October 7, 1994, Jin Sook Lee sued HIE and Michael

Boulware in the Circuit Court of the First Circuit of Hawaii.

That case, the JSL litigation, was captioned by the court as Jin

Sook Lee v. Michael Boulware and Hawaiian Isles Enterprises,

Inc., and docketed as Civil No. 94-3799-10.   At or about the time

the complaint was filed in that court, Michael Boulware also was
                              - 128 -

a litigant in two other lawsuits ongoing in a Hawaii family

court.   The first lawsuit was the uncontested divorce proceeding

of Michael Boulware and Mal Sun Boulware.   The second lawsuit,

Michael Boulware v. Jin Sook Lee, was a paternity action.

     Jin Sook Lee’s complaint in the JSL litigation alleged in

part that:   (1) Michael Boulware individually and as an agent of

HIE stole $840,000 from the safe in her house and wrongfully

converted the cash to himself or to HIE, (2) Michael Boulware

wrongfully acquired the Koloa house from her and transferred the

house to HIE through a fraudulent conveyance by which he

unlawfully forged her signature on the deed of conveyance from

her to him, (3) payment was due and owing to her on the $1.2

million promissory note given to her by Michael Boulware to

compensate her for the approximate value of the Koloa house

wrongfully taken from her, and (4) Michael Boulware and HIE were

unjustly enriched by their acquisition of the Koloa house and the

$840,000 in cash.   The complaint alleged as relevant facts that

Michael Boulware had written an $840,000 check on January 22,

1991, from HIE to Jin Sook Lee to compensate her for the loss,

that he had asked her not to cash the check until he informed her

that sufficient funds were available to pay the check, that he

had not yet informed her that sufficient funds were in the

account, and that she had yet to attempt to cash the check.    In
                               - 129 -

addition, the complaint alleged, Michael Boulware had made a

single payment of $25,000 to Jin Sook Lee under the promissory

note, had now defaulted on the note, and had refused her demand

to make further payments on the note.    The complaint sought a

joint and several judgment against Michael Boulware and HIE for

$840,000 plus interest, $1,200,000 (the value of the Koloa house)

plus interest, consequential damages, punitive damages, attorney

fees, and her other costs of litigation.    The complaint also

sought that Michael Boulware be held liable for the $1,175,000

unpaid portion of the promissory note, plus interest accrued

thereon.

           2.   Counterclaim

     On November 17, 1994, Michael Boulware and HIE made a

counterclaim in the JSL litigation alleging in part that HIE was

entitled to recover over $5 million in cash and real property

(specifically, the Atkinson condominium, the Makaiwa house, and

the Punahou condominium) held by Jin Sook Lee in constructive

trust pursuant to her oral agreement to return the property on

demand but which she refused to return after demand.    The

counterclaimants prayed in the counterclaim for a return of the

transferred funds and real properties and for an award of

punitive damages.   The counterclaimants also prayed that the

court declare void the $840,000 check payable by HIE to Jin Sook
                              - 130 -

Lee and the $1.2 million promissory note from Michael Boulware to

Jin Sook Lee; the counterclaimants alleged that those instruments

were procured by Jin Sook Lee through duress, fraud, and undue

influence, and, alternatively, without adequate consideration.

The counterclaimants alleged in the counterclaim as relevant

facts that:   (1) Michael Boulware had to accumulate substantial

funds to buy out Mal Sun Boulware’s marital interest in HIE and

their other joint assets as part of their divorce agreement;

(2) HIE had advanced funds to Michael Boulware with the

understanding that he would repay HIE all amounts not used on its

behalf; (3) Michael Boulware transferred or caused HIE to

transfer approximately $5 million to Jin Sook Lee with the same

understanding, with her knowledge that Michael Boulware needed

the funds to finalize his divorce, and pursuant to her agreement

that she would return the funds to Michael Boulware and HIE upon

request; and (4) some of the funds transferred to Jin Sook Lee

were used to purchase in the name of Jin Sook Lee, as an agent of

Michael Boulware and HIE, the Atkinson condominium, the Koloa

house, the Makaiwa house, and the Punahou condominium.    The

counterclaimants alleged in the counterclaim that Jin Sook Lee

had breached her contract with Michael Boulware and HIE to return

the transferred funds and properties upon demand (which had been

made); that she had breached her fiduciary duty as a constructive
                               - 131 -

trustee to do the same; and that she had converted money and

other assets belonging to Michael Boulware and HIE and was

unjustly enriched.

     C.    Trust Case

     On April 21, 1995, Jin Sook Lee, as trustee of the Glenn Lee

Boulware Trust, commenced the trust case by filing the petition

referenced supra with the Circuit Court of the First Circuit of

Hawaii.    The trust case was docketed by the court as T. No.

95-0029.    As relevant herein, the petition underlying the trust

case sought:    (1) A judgment declaring that the Glenn Lee

Boulware Trust was valid and enforceable or alternatively, if the

trust was unenforceable, a judgment declaring and imposing a

resulting trust and adjudging that Jin Sook Lee, as trustee, was

entitled to receive 50 percent of the stock of HIE as of

September 8, 1987, and all profits and earnings therefrom; (2) an

accounting of the E&P of HIE from September 8, 1987, through that

time; and (3) reimbursement of the costs of the lawsuit and an

award of attorney’s fees and other appropriate amounts.

     On June 26, 1995, Michael Boulware, as trustor of the Glenn

Lee Boulware Trust, responded to Jin Sook Lee’s petition in the

trust case and admitted that the trust was established, that the

trust was funded with 50 percent of the shares of HIE, and that

the trust was valid.    Contemporaneously, Michael Boulware, as
                              - 132 -

trustor, filed with the court a counterpetition to remove Jin

Sook Lee as trustee of the Glenn Boulware Trust for breaches of

fiduciary duty, conflicts of interest, and conversion of trust

funds; to appoint a substitute trustee as designated by him; and

to order an accounting of all funds received by Jin Sook Lee from

HIE or Michael Boulware from September 8, 1987, through present.

     The trust case and the JSL litigation were initially

consolidated for all purposes because the counterclaims filed in

those cases essentially mirrored each other.   The cases were

later severed on or about June 16, 1997, at which time the trial

of the JSL litigation commenced before a jury.

     D.   Shareholder Derivative Case

     On January 15, 1997, Jin Sook Lee, as trustee of the Glenn

Lee Boulware Trust, commenced in the Circuit Court for the First

Circuit of Hawaii a shareholder derivative case against HIE, its

board of directors (Michael Boulware, Sidney Boulware, and Merwyn

Manago), and its employee Mal Sun Boulware (shareholder

derivative case).   The shareholder derivative case was docketed

by the court as Civil No. 97-0197-01.   The shareholder derivative

case primarily sought to enforce the rights of a shareholder

(including access to corporate records) afforded to Jin Sook Lee,

as trustee of the Glenn Lee Boulware Trust, to throw out the
                              - 133 -

existing board of directors, and to appoint a receiver to control

and manage HIE.

     On July 1, 2004, the court dismissed the shareholder

derivative case for lack of any activity since June 7, 2002.

     E.   HIE’s Perception of Civil Litigation

     HIE did not perceive Jin Sook Lee as posing an actual threat

through her filing and prosecution of the aforementioned civil

litigation.

     F.   Actions Taken by HIE Board of Directors

           1.   Resolution

     As of June 30, 1995, HIE’s board of directors (Michael

Boulware, Sidney Boulware, and Merwyn Manago) resolved that only

the persons listed as shareholders in the books of HIE would be

permitted to exercise the rights of shareholders.   The board

noted that Jin Sook Lee was claiming as trustee of the Glenn Lee

Boulware Trust to own a legal or beneficial interest in the

shares of HIE, that Jin Sook Lee was not then shown as a

shareholder on the books of HIE, that judicial proceedings were

ongoing to remove Jin Sook Lee as trustee of the Glenn Lee

Boulware Trust, that the court in the judicial proceedings had

not yet determined Jin Sook Lee’s interest in the shares of HIE,

and that the board had determined that under the circumstances it

was neither proper nor in the best interests of HIE to recognize
                                 - 134 -

Jin Sook Lee as a shareholder of HIE or to allow her to exercise

any rights afforded to shareholders of HIE.

             2.   Payment of Legal Expenses

       HIE’s board of directors determined that it was proper to

pay the legal expenses associated with the trust case and Michael

Boulware’s counterpetition in that case.      HIE’s board of

directors determined that it was proper to pay for the legal

expenses associated with the defense of Michael Boulware, Sidney

Boulware, Merwyn Manago, and Mal Sun Boulware in the shareholder

derivative case.

XIV.    Referral of Michael Boulware for Prosecution and Michael
        Boulware’s Grand Jury Indictment

       A.   Referral to DOJ for Prosecution

       Sometime before June 10, 1996, Jerry Yamachika recommended

to one of his superiors, the chief of the CID, Pacific-Northwest

Division, that Michael Boulware and Jin Sook Lee be prosecuted

for attempting to evade Federal income tax for 1989 through 1992

and 1990, respectively.     Jerry Yamachika also recommended to the

chief that Michael Boulware be prosecuted for filing false

Federal corporate income tax returns for HIE for 199006 through

199206 and that Jin Sook Lee be prosecuted for aiding in the

preparation of those corporate income tax returns.      Jerry

Yamachika also recommended to the chief that Michael Boulware and
                              - 135 -

Jin Sook Lee be prosecuted for conspiracy to defraud by filing or

causing the filing of false corporate and individual Federal

income tax returns.   On June 10, 1996, the chief concurred in all

of Jerry Yamachika’s recommendations and forwarded Jerry

Yamachika’s final report to the District Counsel, Honolulu,

Hawaii.   The forwarded documents included the chief’s approval

(under the signature of the district director) of the

recommendations set forth in Jerry Yamachika’s final report.

     By a writing dated June 10, 1996, the CID notified Michael

Boulware (with copies to Martin Gelfand and Barney Shiotani) that

it was recommending that Michael Boulware be prosecuted

criminally in connection with the subject matter of the criminal

investigation.   The writing stated in part:

     The investigation conducted by the Criminal
     Investigation Division has developed evidence
     indicating you conspired to defraud the Internal
     Revenue Service by impeding and obstructing its lawful
     function of determining and assessing the relevant tax
     liabilities for yourself, as well as HAWAIIAN ISLES
     ENTERPRISES, INC. The evidence further indicates that
     you willfully subscribed to false Federal corporate tax
     returns for HAWAIIAN ISLES ENTERPRISES, INC., for the
     fiscal years 9006 through 9206; and that you willfully
     evaded your personal income tax liabilities by
     subscribing to false Federal individual income tax
     returns for the years 1989 through 1992. The
     violations alleged are Title 18, United States Code,
     Section 371; Title 26, Internal Revenue Code, Section
     7206(1); and Title 26, Internal Revenue Code, Section
     7201 * * *
                              - 136 -

     On June 26, 1996, Martin Gelfand spoke with Carol Muranaka,

an attorney in the Office of District Counsel, Western Region,

and requested a conference with the Office of District Counsel to

discuss the matter.   In a letter dated June 27, 1996, Martin

Gelfand was informed that the requested conference was set for

July 10, 1996, and that Michael Boulware was entitled at that

conference to present any information in his defense.

Afterwards, the Office of District Counsel (through Carol

Muranaka) concurred in Jerry Yamachika’s recommendation of the

prosecution of Michael Boulware but did not agree with Jerry

Yamachika’s recommendation of the prosecution of Jin Sook Lee.

As to the latter, the Office of District Counsel did not believe

that the case against Jin Sook Lee was strong enough because it

believed that all amounts received by Jin Sook Lee could be

viewed as gifts (and not taxable income) to her.

     On September 11, 1996, respondent notified Martin Gelfand

that the criminal investigation was being referred to the

Department of Justice (DOJ) for its consideration of criminal

prosecution of Michael Boulware.   Subsequently, on November 18,

1996, in connection with a conference held with the DOJ, Martin

Gelfand was given a breakdown of numbers related to alleged tax

deficiencies of both Michael Boulware and HIE.   The numbers

included amounts that the United States could allege were false
                              - 137 -

on HIE’s 199006, 199106, and 199206 Federal income tax returns

and would directly affect Michael Boulware.    Specifically, the

DOJ informed Martin Gelfand that HIE had failed to report income

of $1,518,579 in 199006, $403,578 in 199106, and $366,070 in

199206.

     B.   Referral to Grand Jury

     After a criminal prosecution is approved by the DOJ, the

case is usually returned to the local Office of the U.S. Attorney

for criminal prosecution.   At or about the beginning of August

1997, the recommended criminal prosecution of Michael Boulware

was approved by the DOJ, his case was returned to the U.S.

Attorney for Hawaii, and a grand jury proceeding was commenced to

determine whether Michael Boulware should be indicted in

connection with his diverting of HIE income.    The United States

did not seek an indictment of HIE in that the United States

viewed HIE as the victim of criminal activities perpetrated by

Michael Boulware.   Applicable policy of the DOJ as set forth in

sections 9-11.150 through 9-11.153 of the U.S. Attorneys’ Manual

(October 1, 1990) would have required that HIE be notified that

it was a “target” in the grand jury phase if the United States

had sought HIE’s indictment by the grand jury.
                               - 138 -

     C.   Grand Jury Indictment

     On May 19, 1999, the grand jury returned a 10-count

indictment against Michael Boulware.     The indictment charged

Michael Boulware with four counts under section 7206(1) of filing

false personal Federal income returns for 1989 through 1992, one

count under 18 U.S.C. section 371 of conspiring to make a false

statement to a federally insured financial institution (namely,

GECC), and four counts under 18 U.S.C. section 1014 of making the

referenced false statements.   The 10th count sought forfeiture of

funds associated with the false statements.     The indictment

alleged in part that Michael Boulware

     certified, as a representative of Hawaiian Isles
     Enterprises, Inc., that he had inspected and accepted
     delivery of arcade games, pool tables, and jukeboxes
     from Aloha Games and Automatic Coin Equipment, Inc.,
     and that the equipment was in good condition and
     repair, whereas defendant MICHAEL H. Boulware knew that
     the listed equipment had not been received from Aloha
     Games and Automatic Coin Equipment, Inc.

     On April 6, 2000, and February 14, 2001, a superseding

indictment and second superseding indictment, respectively, added

five additional counts under section 7206(1) of filing false

personal Federal income tax returns for 1993 through 1997 and

four new counts under section 7201 of tax evasion for 1994

through 1997 and amended the factual allegations of the

conspiracy count.   Although the referral for criminal prosecution
                              - 139 -

had been for tax evasion regarding both his personal and HIE’s

corporate tax returns, Michael Boulware was not indicted for

false statements on HIE’s corporate tax returns.   Afterwards,

during Michael Boulware’s first criminal trial, the false tax

return counts for 1994 through 1997 were severed, redacted from

the indictment, and dismissed with prejudice.

      The grand jury indictments against Michael Boulware centered

on his diversion of HIE’s income during 1989 through 1997.

XV.   Resolution of JSL Litigation

      A.   Overview

      The legal issues in the JSL litigation were the subject of

an approximately 2-week jury trial in June and July 1997.    By

consent of the parties in the JSL litigation, the court reserved

and later decided without a jury the equitable issues of unjust

enrichment and the formation of a constructive trust regarding

the cash and checks of HIE that were delivered by Michael

Boulware to Jin Sook Lee.   As to those equitable issues, the

parties in the JSL litigation and the trust case stipulated that

the court could consider all of the evidence presented in the

trial of the JSL litigation as if such evidence had been
                              - 140 -

presented before the court sitting without a jury in the trust

case.

     B.   Jury Verdict

     By special verdict rendered on July 3, 1997, the jury in the

JSL litigation found that Jin Sook Lee was holding $4,551,931 in

constructive trust for HIE and ordered Jin Sook Lee to return

that money to HIE.   Most specifically, the jury found that:

(1) None of the cash and checks that Michael Boulware and HIE

transferred to Jin Sook Lee from March 1987 through May 1994 were

gifts to her, that the moneys (listed as totaling $4,551,931)

belonged to HIE, and that Jin Sook Lee owed HIE the $4,551,931;

(2) HIE did not convert title to the Koloa house from Jin Sook

Lee; (3) the $840,000 that Michael Boulware took from the safe

did not belong to Jin Sook Lee; (4) Michael Boulware was

obligated to pay Jin Sook Lee $250,000 pursuant to the $1.2

million promissory note that he had given her; and (5) Jin Sook

Lee owned the Atkinson condominium, the Punahou condominium, and

the Makaiwa house.   The jury awarded Jin Sook Lee $250,000 on the

promissory note and ownership of the three just-referenced real

properties.

     C.   Equitable Issues Decided by State Court

     As to the equitable issues reserved by the court for its

decision, the court noted that the jury in the JSL litigation had
                              - 141 -

found that “$4,551,931 in cash and checks delivered to Plaintiff

belonged to HIE and that Plaintiff should return that sum to

HIE”, and the court stated as a fact that “The Court agrees with

the jury’s verdict, and likewise finds that the $4,551,931

delivered to Plaintiff was not a gift and belongs to HIE.”    In

addition, the court found that Michael Boulware had given the

$4,551,931 to Jin Sook Lee without receiving any consideration in

return and that Jin Sook Lee would be unjustly enriched by

retaining those moneys.   In relevant part, the court concluded:

          3. There was a binding agreement between
     Plaintiff [Jin Sook Lee], [Michael] Boulware and HIE
     for Plaintiff to hold monies belonging to HIE to pay
     Mal Sun Boulware for her marital interest in HIE.
     Pursuant to that agreement, monies belonging to HIE
     were entrusted to Plaintiff until such time the monies
     were needed to pay Mal Sun for her interest in HIE.

          4. The $4,551,931 held by Plaintiff belongs to
     HIE and Plaintiff wrongfully refused to return the sum
     to HIE.

          5. For Plaintiff to retain the $4,551,931
     belonging to HIE for which she paid no consideration
     would be unjust.

          6. The Court said in Small v. Badenhop, 67 Haw.
     626 (1985), “it is axiomatic that ‘a person who has
     been unjustly enriched at the expense of another is
     required to make restitution to the other.’” 67 Haw.
     at 636.

          7. “A constructive trust will be imposed where
     the evidence is clear and convincing that one party
     will be unjustly enriched if allowed to retain the
     entire property.” Maria v. Freitas, 73 Haw. 266
     (1992). Based upon the Court’s finding that Plaintiff
                                  - 142 -

       would be unjustly enriched, a constructive trust is
       imposed on the $4,551,931 and Plaintiff is deemed to be
       holding those monies for HIE.

The court ordered, adjudged, and decreed that “Jin Sook Lee holds

$4,551,931 in trust for HIE and should return such sums to HIE.”

             D.    Final Judgment Entered

       On August 29, 1997, a final judgment was entered in the JSL

litigation.       Part of that judgment was against Jin Sook Lee in

favor of HIE in the amount of $4,551,931.

             E.    HIE Records Receivable From Jin Sook Lee

       After the JSL litigation had concluded, Merwyn Manago set up

a receivable from Jin Sook Lee on HIE’s books.       Merwyn Manago

established that receivable, entitled “Due From Trustee, JSL”, at

the direction of Nathan Suzuki and Barney Shiotani.       The

receivable reported a balance due of $6,518,965 as of June 30,

1992.

XVI.    Bankruptcy Case of Jin Sook Lee

       A.   Overview

       In early September 1997, HIE sought to garnish assets of Jin

Sook Lee and to levy against her personal and real property to

collect the $4,551,931 judgment due it from the JSL litigation.

On September 29, 1997, Jin Sook Lee filed a chapter 7 petition in

the U.S. Bankruptcy Court for the District of Hawaii, commencing
                              - 143 -

the case of In re Jin Sook Lee, BK Case No. 97-03203.38    The

Internal Revenue Service was not initially listed as a creditor

but was added on October 2, 1997, in an amended list of

creditors.

     Jerald Guben was a partner at the Hawaii law firm Reinwald

O’Connor & Playdon (Reinwald O’Connor) and specialized in

bankruptcy, reorganization, and insolvency.   In 1997, shortly

after the chapter 7 petition was filed on behalf of Jin Sook Lee,

Jerald Guben and Reinwald O’Connor were retained by HIE to

represent HIE in the bankruptcy case and, most specifically, to

collect from Jin Sook Lee’s bankruptcy estate (or otherwise to

satisfy) the $4,551,931 judgment awarded HIE in the JSL

litigation.   Jerald Guben and Reinwald O’Connor continued to

represent HIE as to that matter through June 1999.

     B.   Property Transfers and Claims

     Paul Sakuda was the chapter 7 trustee in Jin Sook Lee’s

bankruptcy case.39   On or about October 15, 1997, Jin Sook Lee

delivered to Paul Sakuda, as chapter 7 trustee, cash, cashier’s

checks, and cash equivalents valued by Jin Sook Lee at the net

fair market value of $1,550,600.   Within 60 days of her filing of

     38
      We use the term “chapter 7 petition” to refer to a
petition under ch. 7 of the Bankruptcy Code.
     39
      We use the term “chapter 7 trustee” to refer to a trustee
under ch. 7 of the Bankruptcy Code.
                              - 144 -

her chapter 7 petition in the bankruptcy court, Jin Sook Lee

moved that court to convert her case to one under chapter 11 of

the Bankruptcy Code.   In that Jin Sook Lee’s bankruptcy case was

then pending under chapter 7, Paul Sakuda, as chapter 7 trustee,

held the assets of Jin Sook Lee in her bankruptcy estate.   The

motion, if granted, would have allowed Jin Sook Lee to continue

to possess her assets as a “debtor in possession” under chapter

11 of the Bankruptcy Code.   HIE, objecting to Jin Sook Lee’s

motion, asserted that Jin Sook Lee was not eligible to be such a

debtor in possession because of her prepetition conduct.

     On November 3, 1997, HIE filed in the bankruptcy court a

“Complaint for Declaratory and Injunctive Relief that Property Be

Turned over to Plaintiff Hawaiian Isle Enterprises, Inc.”   That

filing named Paul Sakuda, as chapter 7 trustee, as a defendant

and resulted under rule 7001(2) of the Federal Rules of

Bankruptcy Procedure in an “adversary proceeding” docketed as

Hawaiian Isles Enterprises, Inc., v. Paul Sakuda, Trustee of the

Estate of Jin Sook Lee, Adv. Pro. No. 97-0142 (1997 adversary

proceeding).   The complaint alleged that Jin Sook Lee had no

interest in the cash, cashier’s checks, and cash equivalents held

by Paul Sakuda, as chapter 7 trustee, in that those assets were

subject to the prepetition constructive trust referenced in the

judgment in the JSL litigation entered before the commencement of
                              - 145 -

Jin Sook Lee’s bankruptcy case.   Thus, the complaint stated,

those assets were not part of Jin Sook Lee’s bankruptcy estate

and should be turned over to HIE as payment of the $4,551,931

debt owed to HIE under the judgment.

     On November 24, 1997, Jin Sook Lee’s bankruptcy case was

converted to one under chapter 11 of the Bankruptcy Code.   Eighty

days later, on February 12, 1998, the Internal Revenue Service

filed with the court a proof of claim asserting pursuant to 11

U.S.C. sec. 507(a)(8) an unsecured priority claim of $21,661 for

unassessed 1990 Federal income tax.40   The only other claim filed

in Jin Sook Lee’s bankruptcy case was by HIE.

     C.   Adversary Proceedings Commenced in 1998

     On March 2, 1998, HIE commenced an adversary proceeding

against Jin Sook Lee, Hawaiian Isles Enterprises, Inc. v. Lee,

Adv. Pro. No. 98-0026, relating to a request that the bankruptcy

court determine the dischargeability of Jin Sook Lee’s debts to

HIE and to the Glenn Lee Boulware Trust.   Four days later, the

chapter 7 trustee and Michael Boulware each commenced a similar

proceeding, Boulware v. Lee, Adv. Pro. No. 98-0029, and Boulware

v. Lee, Adv. Pro. No. 98-0031, respectively.



     40
      A proof of claim is a form that is filed with a bankruptcy
court by a creditor listing the creditor’s claim against the
debtor and the debtor’s bankruptcy estate.
                                - 146 -

     D.   Settlement of 1997 Adversary Proceeding

     Paul Sakuda, as chapter 7 trustee, agreed with the relief

requested by HIE in the 1997 adversary proceeding, i.e., that he

turn over the disputed assets to HIE, and he moved the court on

November 12, 1997, to order as much.      Jin Sook Lee opposed that

motion and succeeded Paul Sakuda, as chapter 7 trustee, as the

defendant in the 1997 adversary proceeding.     On May 8, 1998, the

bankruptcy court called the motion for hearing.     Present were

counsel for HIE, counsel for Jin Sook Lee, counsel for Michael

Boulware, and counsel for the Glenn Lee Boulware Trust.     Jin Sook

Lee then withdrew her opposition to the motion, and the parties

in the 1997 adversary proceeding informed the bankruptcy court

that they had settled their dispute underlying that proceeding.

     The settlement agreement was executed by HIE and Jin Sook

Lee and was reflected in a written document entered into on or

about May 8, 1998 (May 1998 settlement agreement).     The May 1998

settlement agreement included a specific reference to and

provision for “IRS Claims”, and oral notice of a hearing as to

the settlement agreement was given to the United States and to

the Internal Revenue Service.    Neither the United States nor the

Internal Revenue Service objected to the May 1998 settlement

agreement.   On May 11, 1998, the bankruptcy court entered an

order granting the November 12, 1997, motion and incorporating
                                  - 147 -

within its order the terms and conditions set forth in the

settlement agreement.       That action resolved the relevant disputes

of the parties in the 1997 adversary proceeding except to the

extent that those disputes were at issue in the three adversary

proceedings commenced in 1998.

     E.   May 1998 Settlement Agreement

           1.    Overview

     The May 1998 settlement agreement stated that HIE would

receive cash (inclusive of cash equivalents) and property valued

at $2,611,062.

           2.    Property Distributions

                  a.   Cash and Cash Equivalents

     The May 1988 settlement agreement stated that all cash, cash

equivalents, and accounts held by Paul Sakuda, as chapter 7

trustee, would be turned over to HIE.       Those amounts had an

aggregate value of $1,546,662, plus accrued interest.

                  b.   Automobiles

     The May 1988 settlement agreement stated that Jin Sook Lee

would retain title to a Mercedes Benz but had to relinquish any

claim to a Rolls Royce.      The Rolls Royce was valued at $100,000.

                  c.   Real Properties

     The May 1998 settlement agreement stated that Jin Sook Lee

would convey to HIE title to the Makaiwa house, with a
                               - 148 -

reservation of a life estate for her, and that she would convey

to HIE fee title to the Atkinson condominium and to the Punahou

condominium.   The fee simple interest in the Makaiwa house was

valued at $84,500.   The values of the other two real properties

were $115,000 and $310,000, respectively.

                d.   Jewelry and Furs

     The May 1998 settlement agreement stated that HIE would

receive from Paul Sakuda, as chapter 7 trustee, title to jewelry

and furs collectively valued at $204,900.

                e.   Judgment Against Michael Boulware

     The May 1998 settlement agreement stated that HIE would

receive the $250,000 judgment against Michael Boulware received

by Jin Sook Lee in the JSL litigation.

                f.   Summary

     In sum, the May 1998 settlement agreement stated that HIE

would receive the following assets:

   Cash and cash equivalents                        $1,546,662
   Automobile:
     Rolls Royce                                         100,000
   Real properties:
     Atkinson condominium                $115,000
     Makaiwa house                         84,500
     Punahou condominium                  310,000      509,500
   Jewelry and Furs                                    204,900
   Judgment against Michael Boulware                   250,000
     Total                                           2,611,062
                                - 149 -

            3.   Disbursements by HIE

     HIE was required to make three disbursements from the assets

turned over to it.    First, HIE was required to pay certain

administrative expenses related to Jin Sook Lee’s bankruptcy

proceedings.     The amount of each of these expenses was relatively

minimal.    Second, HIE was required to disburse $100,000 to Jin

Sook Lee to “pay and satisfy any and all federal and State of

Hawaii income tax liabilities for 1990 and all penalties and

interest therein”.    Once those liabilities were satisfied, the

settlement agreement stated, Jin Sook Lee was required to provide

HIE with proof of such satisfaction and could retain any portion

of the $100,000 that was not needed to pay those liabilities.

Third, HIE was required to satisfy a judgment in the amount of

$123,000 rendered against Jin Sook Lee in favor of the Glenn Lee

Boulware Trust in the trust case; Jin Sook Lee in turn was

required to relinquish her interest in that trust as a contingent

beneficiary.

     F.    Settlement of 1998 Adversary Proceedings

     HIE, Michael Boulware, Jin Sook Lee (individually and as the

former trustee of the Glenn Lee Boulware Trust), and Florence

Boulware (as the then-current trustee of the Glenn Lee Boulware

Trust) entered into a settlement (1999 settlement) of the subject

matter of the three 1998 adversary proceedings.    Jin Sook Lee
                              - 150 -

filed an unopposed motion in the bankruptcy court, requesting

that the 1999 settlement be approved.   The Internal Revenue

Service did not object to the requested approval.     On June 9,

1999, the bankruptcy court approved the 1999 settlement through

an Amended Order Granting Debtor Jin Sook Lee’s Motion to Approve

Settlement Agreement.   The 13-month delay between the 1999

settlement and the May 1998 settlement of the 1997 adversary

proceeding was attributable to allowing the earlier filed case to

remain open for the resolution and liquidation of the Internal

Revenue Service’s Federal income tax claim against Jin Sook Lee.

     The 1999 settlement stated in part that HIE and Jin Sook Lee

would execute a stipulated judgment in HIE’s adversary proceeding

in favor of HIE in the amount of $2 million and that the

stipulated judgment would be good for 10 years.41   The 1999

settlement also stated that the parties thereto would dismiss the

other two remaining adversary proceedings with prejudice.      The

1999 settlement also stated that upon the entry of the final

order in Jin Sook Lee’s bankruptcy case, on or about June 2000,

none of the parties involved in the bankruptcy case could attempt

to collect on a debt accrued before September 1997.



     41
      The $2 million judgment to be entered for HIE supplemented
the payment of $2,611,062 to be made under the earlier settlement
agreement.
                                   - 151 -

     G.   Claimed Bad Debt Deductions Related to Amounts
          Considered Due From Jin Sook Lee, Trustee

     As discussed infra, HIE filed its Federal income tax returns

for 199306 through 199506 in March or April 1997; HIE filed its

Federal income tax return for 199706 in March 1998; and HIE filed

its Federal income tax return for 199806 in October 1999.       On

those returns, HIE reported bad debt deductions in the following

amounts in connection with its book writedown of the “Due From

Trustee, JSL” account as uncollectible:

               Period Ended          Bad Debt Deduction

               June   30,   1993         $300,000
               June   30,   1994        1,000,000
               June   30,   1995          700,000
               June   30,   1997          700,000
               June   30,   1998          905,340

The reporting and amounts of these writeoffs came from Nathan

Suzuki and Barney Shiotani.        The claimed bad debts related to the

portion of the $4,551,931 judgment in the JSL litigation that

went unpaid.

XVII.   NOL Adjustments

     A.   HIE’s Filing of Its Federal Income Tax Returns for
          198906 Through 199906

     HIE filed its Federal income tax returns for 198906 through

199906 on or about the following dates:
                               - 152 -

                       Taxable Year       Filing Date

                           198906            3/15/90
                           199006            3/24/91
                           199106            3/20/92
                           199206            3/20/93
                           199306            3/19/97
                           199406             4/8/97
                           199506            3/27/97
                           199606            3/21/97
                           199706            3/19/98
                           199806            10/1/99
                           199906            7/14/00

     B.   Pre-199806 Reported NOLs and Applications

     On its Federal income tax returns for 198906 through 199706,

HIE reported the following amounts of taxable income or NOLs:

               Taxable Year     Taxable Income or NOL

                  198906                $711,246
                  199006               1,867,628
                  199106                 146,663
                  199206                 317,325
                  199306                 (30,604)
                  199406                 190,543
                  199506               2,013,243
                  199606              (2,355,508)
                  199706                (439,557)

HIE had a $788,939 NOL carryover from taxable years before 198906

and used the full amount of that carryover to offset income on

its Federal income tax returns for 198906 and 199006.      HIE did

not carry over any of the $30,604 NOL reported for 199306.       Of

the $2,355,508 NOL reported for 199606, HIE carried back $190,543

to 199406 and $2,013,243 to 199506, leaving $151,722 of the

$2,355,508 available for carryover.      With the $439,557 NOL
                              - 153 -

reported for 199706, HIE’s NOL carryover from 199706 as reported

on its Federal income tax returns totaled $591,279 (i.e.,

$151,772 from 199606 + $439,557 from 199706).   HIE’s Federal

income tax return for 199706 did not explicitly report that HIE

had any NOL carryover from prior years.

     C.   HIE Claims on Its Federal Income Tax Return for 199806
          That Its NOL Carryover From Earlier Years Is Larger Than
          That Previously Reported

     On its Federal income tax return for 199806, HIE reported

$2,086,891 of taxable income before application of any NOL

deduction, claimed a $5,718,663 NOL carryover to that year, and

applied $2,086,891 of the carryover to reduce its reported

taxable income for 199806 to zero.   HIE did not claim NOLs on its

Federal income tax returns for 198906 through 199706, as

originally filed, that would generate or otherwise support the

$5,718,663 NOL carryover claimed on its return for 199806.    Nor

did HIE file any amended Federal income tax return for the

earlier years that would generate or support the claimed

$5,718,663 NOL carryover.   In or about June 1997, HIE amended its

Federal income tax returns for 199406 and 199506 to reflect its

carryback to those years of $190,543 and $2,013,243,

respectively, of the originally reported $2,355,508 NOL for

199606.   Those amended returns do not reflect any NOLs or other
                              - 154 -

items that would generate or support the claimed $5,718,663 NOL

carryover.

     The 199806 return included a statement that reported that

the claimed $5,718,663 NOL carryover was attributable to the

following:

      Taxable       Loss        Loss Previously      Loss
       Year       Sustained         Applied        Remaining

      198906    $1,082,577       $1,082,577            -0-
      199006       789,355          789,355            -0-
      199106       401,319          401,319            -0-
      199206       709,192          186,049         $523,143
      199306     2,056,262            -0-          2,056,262
      199406     1,449,457            -0-          1,449,457
      199606     1,689,801            -0-          1,689,801
        NOL carryover available this year          5,718,663

Subsequently, HIE used the $5,718,663 NOL carryover (as modified

in later years) to offset fully taxable income of $2,086,891,

$541,268, $1,184,192, $324,767, and $145,145 that HIE reported

for 199806 through 200206, respectively.

     D.   Source of Larger NOL Carryover Reported for 199806

     Merwyn Manago did not know about the specifics of the

increase in the amount of the NOL carryover as calculated from

HIE’s Federal income tax return for taxable years before 199806

from that reported on HIE’s Federal income tax return for 199806.

The increase was calculated by Nathan Suzuki and Barney Shiotani

during the criminal investigation of Michael Boulware and was

given to HIE’s tax preparer, Kobayashi Doi, to report on HIE’s
                                - 155 -

tax returns.42    Nathan Suzuki worked for HIE, first as its

controller (immediately before Merwyn Manago) and then as an

independent contractor.     Nathan Suzuki was a classmate of Sidney

Boulware and a longtime friend of both Sidney Boulware and

Michael Boulware.    Nathan Suzuki prepared Michael Boulware’s

Federal income tax returns from the 1980s through 1994 and during

1995 through 1997 worked with HIE’s attorneys as a Kovel

accountant with respect to the criminal investigation.

     E.   HIE’s 199906 Federal Income Tax Return

           1.    Overview

     When HIE filed its Federal income tax return for 199906, it

again reported that its NOL carryover from 198906 to 199606 was

calculated on the basis of NOLs not reported on its previously

filed returns for those years.     HIE also reported on its 199906

return that its NOL carryover to 199906 was calculated using NOLs

in amounts different from those underlying the $5,718,663 NOL

carryover that it had calculated the previous year for 199806.

     Specifically, HIE reported on its Federal income tax return

for 199906 that its NOL carryover to 199906 totaled $5,104,261.




     42
      Kobayashi Doi was a mere pawn for Michael Boulware and the
subject corporations and accepted at face value (and without any
meaningful review) all information provided by or on behalf of
Michael Boulware and the subject corporations.
                                  - 156 -

HIE included within its 199906 return a statement listing the

calculation of that amount as follows:

        Taxable          Loss        Loss Previously       Loss
         Year         Sustained          Applied        Remaining

        198906    $1,408,949       $1,408,949               -0-
        199006     1,097,485        1,097,485               -0-
        199106       511,610          511,610               -0-
        199206       784,670          784,670               -0-
        199306     2,642,615          416,083          $2,226,532
        199406     2,771,257            -0-             2,771,257
        199606        67,207            -0-                67,207
        199706        39,265            -0-                39,265
          NOL carryover available for 199906            5,104,261

HIE applied the reported $5,104,261 NOL carryover as follows:

$541,268 to 199906; $1,184,192 to 200006; $324,767 to 200106; and

$145,145 to 200206.

            2.   Exhibit 18-J

     The record includes as Exhibit 18-J a one-page document that

was prepared by Nathan Suzuki in consultation with Barney

Shiotani.    The document was prepared on one or more days during

the period between the filings of HIE’s Federal income tax

returns for 199806 and 199906.      The document purports to list for

the relevant years the off-book activity income that respondent

was claiming was unreported by HIE (as perceived by HIE’s

representatives through conversations with representatives of

respondent), the actual income that was reported by HIE through

the monthly adjustments and AJEs discussed infra, and HIE’s
                              - 157 -

realization of NOLs greater than those reported on HIE’s Federal

income tax returns as originally filed.   The amounts of the

realized NOLs reported on this exhibit correspond to the amounts

reported as “Loss Sustained” on the statement included in HIE’s

199906 Federal income tax return.

     HIE’s recomputation of its NOLs is grouped into three main

categories:   Adjustments related to Michael Boulware’s activities

that were part of the evidence presented during his criminal

trial (i.e., the income from the off-book activities),

adjustments labeled “Cost of Sales Coffee”, and adjustments

relating to HIE’s treatment of Hawaii tobacco tax refunds.     The

document shows that the reportable income and the reported income

for 198906 through 200106 each total $28,471,824 and reflects

HIE’s view that all HIE income at issue in the criminal

prosecution of Michael Boulware was actually reported by HIE.

Petitioners assert that the document establishes that $21,625,236

of the $28,471,824 in monthly adjustments and AJEs was related to

tobacco tax refunds and that the remaining $6,846,588 was related

to HIE’s reporting of income from the off-book activities

($21,625,236 + $6,846,588 = $28,471,824).   Petitioners also make

an alternative assertion as to HIE’s reporting of income from the

off-book activities.   Specifically, petitioners assert, if the

$6,846,588 was not included in the monthly adjustments and AJEs,
                              - 158 -

then the monthly adjustments and the amortization adjustments

were overstated by $6,846,588, which was enough to cover

respondent’s determined unreported income from the off-book

activities.

     We consider Exhibit 18-J to be incredible and unreliable,

and we give it no significant weight.     Nor do we give any

significant weight to Exhibit 2136-P, a purported updated version

of Exhibit 18-J.   The later exhibit states that HIE reported

$3,440,904 of income greater than the amount of income that was

actually reportable for 198906 through 200106.     Upon our review

of the credible evidence in the record, we conclude that both

documents were prepared simply to attempt to support through a

writing a position of Barney Shiotani that the United States

could not prevail on any criminal or civil issue if Michael

Boulware and HIE could make all of their income tax deficiencies

“disappear”.

          3.   Claim to Additional COGS

     In computing the amounts reported as “Loss Sustained” on the

statement included in HIE’s Federal income tax return for 199906

(and on exhibit 18-J), HIE claimed an extra $1,963,973 in COGS

for Kona coffee cash purchases.   Petitioners have not

substantiated that HIE is entitled to a larger amount of COGS

than that reported as COGS on its filed returns.
                               - 159 -

     F.   HIE’s Position as to Its NOL Carryovers Reported for
          199806 and Later Years

           1.    Overview

     HIE’s NOL carryovers claimed on its Federal income tax

returns for 199806 and later years are attributable to HIE’s

position that:    (1) HIE prematurely reported on its 198906

through 199506 Federal income tax returns approximately

$21,440,00043 of income from Hawaii tobacco tax refunds that was

properly reported in, and now had to be shifted to, 199506

through 200106, and (2) “self-help” tobacco tax credits and net

income from the off-book activities that were the bases of

Michael Boulware’s grand jury indictments were included in

monthly adjustments reported on HIE’s tax returns or,

alternatively if the monthly adjustments did not include the

referenced net income, the monthly adjustment were overreported

on account of tobacco tax adjustments by an amount sufficient to

cover that net income.44

     43
      We hereinafter consistently refer to the amount of refund
income that HIE claims to have prematurely reported as totaling
$21,440,000. Petitioners have not been as consistent. Our
holdings herein would be the same regardless of the actual total
amount of refund income that HIE claims to have prematurely
reported.
     44
      As discussed infra, we decline to find on the basis of the
credible evidence in the record that HIE reported any of the
referenced net income for Federal income tax purposes. Merwyn
Manago did not believe that the monthly adjustments included the
                                                   (continued...)
                              - 160 -

          2.   HIE’s Liability for Hawaii Tobacco Tax

     HIE was required to pay tobacco tax to Hawaii with respect

to HIE’s tobacco/cigarette business, and HIE was required to file

with Hawaii monthly tobacco tax returns with respect thereto.

(We set forth in appendix A the relevant Hawaii statutory

provisions underlying its tobacco tax.)   HIE was required to

report on those returns the amount of its tobacco tax liability

for the month and to enclose with the return a payment of any

reported liability.   Before July 1, 1993, the tobacco tax

liability of a wholesaler such as HIE equaled 40 percent of the

total of its wholesale and retail tobacco sales for the month.

After that date, the tobacco tax liability of a wholesaler such

as HIE equaled at least 40 percent of that amount.

          3.   HIE’s Purported Overpayment of Hawaii Tobacco Tax

     Before 1989, HIE paid tobacco tax to Hawaii on the basis of

the prices at which HIE sold its cigarettes to customers.    In

1989, Thomas Okimoto informed Michael Boulware that some of HIE’s

competitors were instead computing that tax on the basis of the


     44
      (...continued)
off-book activities; he adjusted the tobacco tax returns by the
full monthly adjustment amount and never tried to correct them.
HIE’s tax and accounting records could not have included the net
income from the off-book activities; HIE’s return preparer was
unaware of those activities and of Michael Boulware’s story that
the monthly adjustments included those activities until 6 years
after the start of the off-book activities.
                              - 161 -

lower cost that the competitors paid to purchase the cigarettes

for resale.   Michael Boulware asked Michael McCarthy for legal

advice on the matter.

     Later in 1989, Michael McCarthy advised Merwyn Manago and

Michael Boulware that HIE had arguably miscalculated and overpaid

its Hawaii tobacco tax liability in periods before 1989 (for the

reasons referenced by Thomas Okimoto) and, if there was such an

overpayment, that the overpayment was approximately $5 million.45

If in fact HIE had overpaid its tobacco tax liability, Michael

Boulware wanted to recover the overpayment sooner than later.

Michael Boulware, however, was hesitant to notify Hawaii about

his possible argument as to an overpayment (i.e., that HIE should

have computed its tax on the basis of the cost that HIE paid to

purchase the cigarettes for resale, rather than of the prices at

which HIE sold its cigarettes to customers) because he thought

that Hawaii would review the merits of the argument and disagree

with it.   Michael McCarthy told Michael Boulware and Merwyn

Manago that over time HIE arguably could discreetly recover any

perceived overpaid Hawaii tobacco tax through “self-help”; in



     45
      The record contains no credible evidence establishing any
specific amount of tobacco tax HIE purportedly overpaid before
1989 or the precise years of any such overpayment. Nor has HIE
stated consistently the specific amount of tobacco tax it claims
to have overpaid.
                               - 162 -

other words, by understating its tobacco tax liabilities for the

then-current and future months without notifying Hawaii.    Michael

McCarthy made no earnest attempt to discuss this issue with

anyone working for Hawaii.   Nor did HIE or any of its other

representatives make an earnest attempt to do so.

     The self-help method described by Michael McCarthy was not

an appropriate method to claim a refund of Hawaii tobacco taxes.

From 1989, the recognized procedure to claim a refund of overpaid

Hawaii tobacco tax was to file an amended return with the Hawaii

Department of Taxation.   Hawaii did not have a specific form

(such as a Form 1040-X, Amended Return), on which to file such an

amended return.

          4.   Tobacco Tax Liability Adjustment

     Merwyn Manago prepared and filed HIE’s monthly tobacco tax

returns for February 1989 through at least June 1995.   Without

notifying Hawaii, Michael Boulware caused each of those returns

to underreport the amount of that month’s tobacco sales (and thus

HIE’s Hawaii tobacco tax liability for that month) to take into

account an adjustment to HIE’s tobacco tax liability (tobacco tax

liability adjustment).    Michael Boulware, who had no accounting

background, gave the amounts of the tobacco tax liability

adjustments to Merwyn Manago without any supporting documentation

and instructed Merwyn Manago to incorporate those adjustments
                              - 163 -

into the returns by reducing the actual amounts of HIE’s tobacco

sales reported on those returns.   For each of those months,

Merwyn Manago reduced the amount of tobacco sales that HIE

reported on its monthly tobacco tax return so as achieve the

requested reduction in tobacco tax liability.   HIE then reported

to Hawaii that HIE’s actual tobacco sales for the month was the

amount of the tobacco sales as reduced by Merwyn Manago.   HIE

(through Merwyn Manago) included in its cost of sales the amount

of tobacco tax owed to Hawaii as computed on the reduced sales.

Merwyn Manago neither asked Michael Boulware about the specifics

of the tobacco tax liability adjustments nor attempted on his own

to verify or recalculate those adjustments.   For 198906 through

199506, the tobacco tax liability adjustments totaled $1,400,000,

$3,320,000, $1,960,000, $2,420,000, $4,280,000, $4,510,000, and

$3,550,000, respectively, or $21,440,000 collectively.   (We set

forth in appendix B the amounts underlying these annual amounts.)

     None of the referenced tobacco tax returns showed the actual

gross tobacco sales for a month, showed the tobacco tax liability

adjustment reported for the month, or indicated that HIE was

offsetting its current tobacco tax liability by any perceived

prior overpayment.   The Hawaii monthly tobacco tax return, Form

M-19 (rev. 1971), did not change between 1971 and June 1993 and

had at the bottom a line entitled “Adjustments (Explain Fully)”.
                              - 164 -

As to each of the referenced tobacco tax returns, HIE did not use

this line to disclose to Hawaii that HIE was adjusting the amount

of its actual tobacco tax sales or a reason why HIE was doing so.

In other instances, HIE typed specific unrelated adjustments on

the returns with explanations.

     During some of the period HIE was underreporting its tobacco

sales, HIE was on a payment plan to Hawaii as to tobacco taxes

that were past due.   The payment plan started sometime in the

early 1990s.

          5.   HIE’s Monthly Book Adjustments

     For each of the months from February 1989 through June 1995,

HIE incorporated the corresponding tobacco tax liability

adjustment into its books through monthly adjustments that

reduced the actual amount of HIE’s tobacco sales to the amount

reported on that month’s tobacco tax return and increased the

amount of HIE’s nontobacco sales by an amount corresponding to

that of the reduction.   Initially, Nathan Suzuki, the controller

at the time, showed Sidney Boulware, who lacked an accounting

background, how to compute the amount of tobacco sales that

needed to be recharacterized as nontobacco sales in order to

correspond to the tobacco tax liability adjustment supplied by

Michael Boulware.   Later, Merwyn Manago did the monthly
                              - 165 -

recharacterization calculation and reflected that calculation in

HIE’s books.

     HIE’s regular practice was to record the amount of tobacco

taxes payable by HIE to Hawaii as a debit to HIE’s purchase

account (pertaining to tobacco) and a credit to HIE’s tobacco

taxes payable account.   In order to reflect the monthly

adjustments, Merwyn Manago recorded the amounts in those accounts

for each month as what otherwise would have been the proper

amounts for that month less the monthly adjustment.   The amounts

in the purchase and payable accounts, therefore, reflected the

amount of tobacco tax that HIE would actually pay to Hawaii for

each month.

          6.   HIE’s AJEs

     In 1997, Nathan Suzuki, with assistance by Barney Shiotani,

devised and began preparing AJEs for HIE to make either to report

additional income or to appear to report additional income.

These AJEs were confusing on their face, and they were

unintelligible in their descriptions as to their purpose.   Many

of the AJEs were intended in part to attempt to persuade the jury

in the JSL litigation that HIE viewed the funds at issue there as

owed to HIE by Jin Sook Lee, without alerting the jury that the

AJEs had just recently been recorded.   One group of the AJEs was

designed in part to record as a loan to Michael Boulware the
                                - 166 -

unreported income uncovered by Jerry Yamachika.    Another group of

the AJEs was labeled by HIE “amortization adjustments”.    Similar

to the monthly adjustments, these amortization adjustments

reduced (debited) HIE’s tobacco tax liability to Hawaii and did

not include an offsetting credit to any income account of HIE.

The effect of the amortization adjustments was that the

adjustments reported HIE’s tobacco tax expense to the amount of

tobacco tax that was actually paid.

     Beginning in or about 1997, Merwyn Manago began entering the

AJEs into HIE’s books at the direction of Nathan Suzuki and

Barney Shiotani.     Merwyn Manago did not independently verify the

numbers in any of the AJEs, nor was he sure of their accuracy.

Among other things, the AJEs reclassified some of the monthly

adjustments that Merwyn Manago had previously recorded in HIE’s

books.

     On its 200006 and 200106 Federal income tax returns, HIE

reported amortization adjustments of $1,927,648 and $962,426,

respectively, as “Forgiveness of Debt--Tobacco Taxes”.

          7.   Tobacco Tax Refund Income Claimed Reported and
               Reportable by HIE

                a.    Income Claimed Reportable

     Petitioners claim that the tobacco tax refund income was

properly reportable by HIE in 198906 through 200106 as follows:
                              - 167 -

                     198906          -0-
                     199006          -0-
                     199106          -0-
                     199206          -0-
                     199306          -0-
                     199406          -0-
                     199506     $3,095,400
                     199606      2,773,800
                     199706      1,648,200
                     199806      3,638,100
                     199906      4,347,000
                     200006      4,055,600
                     200106      1,850,000
                                21,408,100

               b.   Income Claimed Reported Through Monthly
                    Adjustments

     Petitioners claim that HIE from 198906 through 199506

reported the following amounts of income from tobacco tax

refunds:

                     198906     $1,420,939
                     199006      3,393,432
                     199106      1,890,360
                     199206      2,496,304
                     199306      4,364,201
                     199406      2,831,800
                     199506      2,050,000
                                18,447,036

Petitioners claim that HIE reported those amounts as income

through their posting of the $21,440,000 of monthly adjustments,

which they later reduced to $18,447,036 by two AJEs in the

amounts of $1.7 million and $1.5 million made for 199406 and

199506, respectively.
                               - 168 -

               c.   Income Claimed Reported Through AJEs

     Petitioners claim that HIE from 199506 through 200106

reported through the AJEs the following amounts as “amortization

adjustments” related to tobacco tax refunds income, on the basis

of its view that this income was reportable as the Hawaii period

of limitations (as to its tobacco tax) expired:

                     199406        $230,000
                     199506       1,074,875
                     199606       1,294,293
                     199706       1,739,529
                     199806       4,276,360
                     199906       1,442,274
                     200006       1,927,648
                     200106         962,426
                                 12,947,405

               d.   Summary

     In sum, petitioners’ view as to the reported and reportable

income from HIE’s tobacco tax refund income is as follows:

                Monthly                   Reported    Reportable
              Adjustments       AJEs       Income       Income

   198906     $1,420,939         -0-     $1,420,939        -0-
   199006      3,393,432         -0-      3,393,432        -0-
   199106      1,890,360         -0-      1,890,360        -0-
   199206      2,496,304         -0-      2,496,304        -0-
   199306      4,364,201         -0-      4,364,201        -0-
   199406      2,831,800      $230,000    3,061,800        -0-
   199506      2,050,000     1,074,875    3,124,875   $3,095,400
   199606          -0-       1,294,293    1,294,293    2,773,800
   199706          -0-       1,739,529    1,739,529    1,648,200
   199806          -0-       4,276,360    4,276,360    3,638,100
   199906          -0-       1,442,274    1,442,274    4,347,000
   200006          -0-       1,927,648    1,927,648    4,055,600
   200106          -0-         962,426      962,426    1,850,000
              18,447,036    12,947,405   31,394,441   21,408,100
                                - 169 -

            8.   HIE’s Purported Income Shift

     HIE moved the purported tobacco tax self-help credits from

earlier years (198906 thru 199506) to later years (199506 to

200106), thus generating the NOL carryover claimed in 199806.

Respondent determined in the applicable NOD that HIE was not

entitled to shift its tobacco tax credits from earlier to later

years and thus disallowed the resulting NOL and reduced HIE’s

income for 200006 and 200106 (the non-NOL years) by $1,927,648

and $962,426, respectively.    These are amounts HIE purports to

have already reported for the non-NOL years above the amount it

shows it was supposed to report even absent a timing shift.    The

NOD notes that HIE is entitled only to these $1,927,648 and

$962,426 adjustments if respondent’s disallowance of the NOL is

sustained.

XVIII.    Michael Boulware’s Criminal Trials

     A.    First Trial

            1.   General Information

     In November 2001, Michael Boulware was criminally tried for

the first time as to the 11 remaining counts stemming from the

subject matter of the criminal investigation.

            2.   Relevant Evidence and Arguments

     At Michael Boulware’s first trial, the United States

presented evidence relevant to HIE’s corporate taxes and
                                - 170 -

corporate activities.    Michael Boulware maintained that transfers

of moneys from HIE, which the United States alleged were for

Michael Boulware’s benefit, were actually for corporate purposes.

Michael Boulware maintained, as petitioners argue here, that all

amounts charged as income to Michael Boulware were reported by

HIE.

            2.   Jury Verdict

       On November 29, 2001, following a 6-day trial by jury and

2-1/2 days of jury deliberation, the jury convicted Michael

Boulware on all nine tax counts.    The jury also convicted Michael

Boulware on the single count under 18 U.S.C. section 1014 of

conspiring to make a false statement to influence a federally

insured financial institution.    The jury acquitted Michael

Boulware of the substantive false statement count.

       The tax counts related in part to the funds that Michael

Boulware diverted from HIE and failed to report on his personal

Federal income tax returns or to pay taxes on.    The indictment

alleged that the unreported income included over $1.7 million

that Michael Boulware received from nominee entities and bank

accounts located in the Kingdom of Tonga and Hong Kong.46


       46
      Michael Boulware asserts that the $1.7 million was not
income to him because he borrowed that money from Harold Okimoto.
We find that assertion incredible and decline to find the
                                                   (continued...)
                               - 171 -

Michael Boulware’s remaining convictions related to the

fraudulent leasing scheme involving HIE and GECC.

     B.   Sentencing Phase and First Appeal

           1.   Positions as to Sentencing

     At the sentencing phase, respondent prepared and caused to

be included in the presentence report as relevant conduct an

analysis wherein respondent asserted that HIE failed to report

$9,281,970 of income in addition to the tax losses stemming from

an underreporting of income by Michael Boulware.    The United

States advocated this position.    Counsel for Michael Boulware

tried to establish that HIE had fully reported all of the income

that the United States alleged had been underreported.

     Respondent also asserted and caused to be inserted in the

presentence report as relevant conduct that the monthly

adjustments by HIE caused a $21,402,640 tobacco tax loss to

Hawaii.   The United States advocated this position.   Counsel for

Michael Boulware tried to establish that HIE had not caused any

tobacco tax loss to Hawaii.

           2.   Sentence Imposed

     The U.S. District Court sentenced Michael Boulware to a

36-month term of imprisonment on each of the false tax return


     46
      (...continued)
assertion as a fact.
                                 - 172 -

counts, a 51-month term on each of the tax evasion counts, and a

51-month term on the conspiracy count, all terms to run

concurrently.     The court also imposed a 3-year term of supervised

release, fines, and forfeiture of $495,814.

             3.   Appeal of Conviction

     In May 2002, Michael Boulware appealed his criminal

conviction to the U.S. Court of Appeals for the Ninth Circuit.

On September 14, 2004, that court filed its opinion in United

States v. Boulware, 384 F.3d 794 (9th Cir. 2004), which reversed

and remanded Michael Boulware’s conviction on all nine tax counts

because certain evidence was improperly withheld from the jury.

The withheld evidence consisted of the judgment in the JSL

litigation wherein Jin Sook Lee was found to have received in

constructive trust for HIE, and not as a gift, the money Michael

Boulware had given her.     The U.S. Court of Appeals for the Ninth

Circuit affirmed the conspiracy conviction but remanded that

count to the U.S. District Court for resentencing.

     C.     Michael Boulware’s Retrial

     The United States retried Michael Boulware on the nine tax

counts for which he had been convicted at his first trial; i.e.,

five counts of filing false Federal income tax returns for 1989

through 1993 and four counts of tax evasion for 1994 through

1997.     On July 15, 2005, Michael Boulware was convicted a second
                                  - 173 -

time on all of those counts following a 9-day trial and 2 days of

deliberation.    The U.S. District Court again sentenced Boulware

to 36 months’ imprisonment on the false return counts, but

increased the sentence from 51 to 60 months on the tax evasion

and conspiracy counts, all to run concurrently.      The U.S. Court

of Appeals for the Ninth Circuit later affirmed that second

conviction upon appeal.    See United States v. Boulware, 470 F.3d

931 (9th Cir. 2006), vacated and remanded 552 U.S.        , 128 S.

Ct. 1168 (2008).    In so doing, the U.S. Court of Appeals for the

Ninth Circuit held that a criminal defendant such as Michael

Boulware could rely upon a return of capital defense as to the

taxability of funds diverted from a corporation only if it was

intended at the time of diversion that the funds be a return of

capital.    See id. at 933-935.

     D.    Criminal Case Heard by U.S. Supreme Court

     On May 11, 2007, Michael Boulware petitioned the U.S.

Supreme Court for a writ of certiorari to the U.S. Court of

Appeals for the Ninth Circuit.      The petition asked the U.S.

Supreme Court to decide the following two questions:

          1. What effect must a federal court give a final,
     non-collusive state court judgment adjudicating
     ownership of property in determining a taxpayer’s
     federal income tax liability arising from that
     property?
                               - 174 -

          2. “Whether    a taxpayer who seeks to invoke the
     return of capital   rule in a criminal tax case must show
     a contemporaneous   intent to treat the corporate
     distribution as a   return of capital?” * * *

On September 25, 2007, the U.S. Supreme Court granted Michael

Boulware’s petition limited to the following question:

     Whether the diversion of corporate funds to a
     shareholder of a corporation without earnings and
     profits automatically qualifies as a non-taxable return
     of capital up to the shareholder’s stock basis, see 26
     U.S.C. § 301(c)(2), even if the diversion was not
     intended as a return of capital.

See Boulware v. United States, 552 U.S.      , 128 S. Ct. 32

(2007).

     On March 3, 2008, the U.S. Supreme Court decided in Boulware

v. United States, 552 U.S.      , 128 S. Ct. 1168 (2008), that a

distributee accused of criminal tax evasion may claim

return-of-capital treatment without producing evidence that

either he or the corporation intended a capital return when the

distribution occurred.    On the basis of that opinion, the U.S.

Supreme Court vacated the judgment of the U.S. Court of Appeals

for the Ninth Circuit and remanded the case to the U.S. Court of

Appeals for the Ninth Circuit for further proceedings consistent

with the Supreme Court’s opinion.    Id.

     E.   Remand From U.S. Supreme Court

     Upon remand from the U.S. Supreme Court, the U.S. Court of

Appeals for the Ninth Circuit filed its opinion in United States
                                - 175 -

v. Boulware, 558 F.3d 971 (9th Cir. 2009).    The court decided in

that opinion whether Michael Boulware’s offer of proof was

sufficient to justify the presentation of a return of capital

theory to the jury in his second criminal trial.    The court held

it was not and affirmed the judgment of the U.S. District Court.

XIX.    Civil Examinations and Requests for Information

       A.   Start of Civil Examinations

       In July 2002, respondent began a civil Federal income tax

examination of HIE for 199806 through 200206.    Three months

later, in October 2002, respondent began a civil Federal income

tax examination of Holdings and its subsidiaries for 199806

through 200206.     In or about May 2004, respondent began a civil

Federal income tax examination of Michael Boulware’s 1998 through

2002 taxable years.

       B.   Requests for Information

             1.   HIE

       During the civil examination of HIE, respondent gave to HIE

written requests for documents and related information.    The

requests sought documents from HIE that would support its

professional fees deductions for 199406 through 199706.

Subsequently, on December 11, 2003, after the written requests

were not honored fully by HIE, respondent served a summons upon

Sidney Boulware in his capacity as HIE’s president.    The summons
                               - 176 -

requested documents that substantiated HIE’s professional fees

deductions for 199406 through 199706 and 200006 through 200206.

The summons requested information regarding the bad debt

deduction, the activities of Michael Boulware that were the

subject of his criminal trial, the deductions for the salary

payments to Mal Sun Boulware, and the reported businesses

Paradise Roasting and Video Consultant.    Shortly thereafter,

before Michael Boulware or HIE had produced any of the documents

referenced in the summons, Michael Boulware petitioned the U.S.

District Court for the District of Hawaii to quash the summons.

HIE joined in that petition.   On January 30, 2004, the U.S.

District Court dismissed that petition for lack of jurisdiction,

holding that neither Michael Boulware nor HIE was authorized to

petition the court to quash the summons.

     On April 21, 2004, the United States petitioned the U.S.

District Court to enforce the summons.    Michael Boulware moved to

intervene and requested an evidentiary hearing.    Following a

hearing on the matter, a magistrate judge found that the summons

met the requirements established in United States v. Powell, 379

U.S. 48 (1964), and that HIE failed to show that the summons was

issued in bad faith or as an abuse of process.    The magistrate

judge recommended that the petition to enforce the summons be
                              - 177 -

granted and that Michael Boulware’s motion to intervene be

denied.

     Michael Boulware and HIE objected to the findings and

recommendation of the magistrate judge.     On September 20, 2004,

the U.S. District Court for the District of Hawaii denied the

objections and ordered that the summons be enforced.     See United

States v. Boulware, 350 F. Supp. 2d 837 (D. Haw. 2004), affd.

203 Fed. Appx. 170 (9th Cir. 2006).     Michael Boulware appealed

the judgments of the U.S. District Court to the U.S. Court of

Appeals for the Ninth Circuit.    Those judgments were affirmed by

that court on October 19, 2006.   See United States v. Boulware,

203 Fed. Appx. 170 (9th Cir. 2006); see also Boulware v. United

States, 203 Fed. Appx. 172 (9th Cir. 2006).     On or about February

22, 2006, after the NOD as to HIE was issued and the related case

was commenced in this Court, petitioners produced to respondent

invoices within the subject matter described in the summons.

          2.   Holdings

     Holdings paid many of the legal fees deducted by HIE.     On

June 9, 2003, respondent issued Holdings an information document

asking for a schedule of professional fees and certain

professional fee invoices for 200006 through 200206, some of

which were deducted by HIE.   For each invoice for which the

business reason for the fee was not clearly indicated on the
                               - 178 -

invoice, respondent requested an explanation of the purpose of

the professional fee.   Holdings did not produce the requested

information at that time.

     On December 11, 2003, respondent served a summons upon

Sidney Boulware in his capacity as president of Holdings.     The

summons directed Sidney Boulware to appear, to give testimony,

and to produce for examination certain books, papers, records, or

other data described in the summons.     Respondent requested in the

summons, inter alia, a summary of the professional fees Holdings

deducted during 19906 through 200206; all invoices, agreements,

contracts, engagement letters, correspondence, memoranda, and

schedules to support the professional fees; and documentation to

substantiate the allocation to HIE of professional fees paid by

Holdings.   Holdings partially complied with the summons by

supplying some substantiation for the professional fees that it

deducted for 199906 through 200106.      Holdings did not supply any

substantiation for the professional fees expense that it deducted

for 200206, and Holdings did not at that time supply any

substantiation for the allocation of professional fees to HIE.

     On April 21, 2004, the United States moved to enforce the

summons.    Two days later, the matter was set for an order to show

cause hearing.   On May 14, 2004, Holdings filed with the U.S.

District Court a memorandum in opposition to the petition to
                              - 179 -

enforce the summons, and Michael Boulware filed with the U.S.

District Court a cross-motion for intervention and for

evidentiary hearing.   Michael Boulware at that time also filed

with the U.S. District Court a memorandum in support of

cross-motion and in opposition to order to show cause.    On

June 1, 2004, a hearing on the order to show cause was held

before a magistrate judge.   On day later, the magistrate judge

issued his findings and recommendation that the petition to

enforce the summons be granted.

     On August 16, 2004, Michael Boulware filed an objection to

the findings and recommendation of the magistrate judge.    On

November 16, 2004, the U.S. District Court for the District of

Hawaii affirmed those findings and recommendation and denied

Michael Boulware’s cross-motion.   Four weeks later, Michael

Boulware appealed the judgments of the U.S. District Court to the

U.S. Court of Appeals for the Ninth Circuit.   Those judgments

were affirmed by that court on October 19, 2006.   See United

States v. Boulware, 203 Fed. Appx. 168 (9th Cir. 2006); see also

Boulware v. United States, 203 Fed. Appx. 172 (9th Cir. 2006).

On or about February 22, 2006, after the NOD was issued to

Holdings and the related case was commenced in this Court,

petitioners produced to respondent invoices within the subject

matter described in the summons.
                                - 180 -

            3.   Actions During This Proceeding

      During this proceeding, petitioners have given respondent

what petitioners claim are 10,000 invoices that substantiate the

legal fees HIE and Holdings paid for 199806 through 200206.

XX.   Professional Fees

      A.   Overview

      Starting on or about June 30, 1996, the professional fees of

the subject corporations and their subsidiaries were generally

paid by Holdings, regardless of who actually incurred the fees.

The subject corporations are separate entities that are located

on the same premises and that share the same accounting offices

and other overhead.    Initially, Holdings also paid HIE’s other

administrative expenses.

      On a yearly basis, Holdings allocated to HIE a portion of

the total professional fees and administrative expenses that

Holdings paid during the year.    The specific percentage that was

applied to allocate those expenses was ascertained by the

management of the subject corporations.    When the allocation was

made, a receivable was booked in the same amount as owing by HIE

to Holdings.

      For 199906, 200006, and 200206, Holdings paid all of the

professional fees for the subject corporations, and portions of

those fees were allocated to HIE.    The portion of the fees
                               - 181 -

allocated to HIE for each of those respective years was 76

percent, 81.5 percent, and 45 percent.    For 199806 and 200006

through 200206, the total amounts that HIE deducted as

“professional fees” and “O/H allocations” and respondent’s

adjustments (in the NOD issued to HIE) to those amounts are set

forth below:

           Taxable     Reported     Deduction
             Year      Deduction     Allowed     Adjustment

           199806     $2,745,685   $1,503,690    $1,241,995
           200006      3,356,440    2,196,805     1,159,635
           200106      3,405,235    2,248,871     1,156,364
           200206      2,208,588        -0-       2,208,588

     For 199406 through 199706, the amounts that HIE deducted for

professional services through its claimed NOL deductions and

respondent’s adjustments (in the NOD issued to HIE) are set forth

below:

           Taxable     Reported     Deduction
             Year      Deduction     Allowed     Adjustment

           199406      $599,644       $77,954      $521,690
           199506     1,038,730       135,035       903,695
           199606     1,490,009       193,701     1,296,308
           199706     1,779,640       231,353     1,548,287

     B.   Source of Professional Fees

           1.   HIE

     During 199306 through 199506, 199706, 199806, and 200006

through 200206, HIE deducted professional fees related to:

(1) The criminal investigation, the grand jury proceedings, and
                               - 182 -

the first criminal trial of Michael Boulware; (2) Michael

Boulware’s uncontested divorce proceeding; (3) the JSL

litigation; (4) the 1997 adversary proceeding; (5) the trust

case; and (6) other matters.

           2.   Holdings

     During 199906 through 200206, Holdings deducted professional

fees related to:   (1) The criminal investigation, the grand jury

proceedings, and the first criminal trial of Michael Boulware;

(2) Michael Boulware’s uncontested divorce proceeding; (3) the

JSL litigation; (4) the 1997 adversary proceeding; (5) the trust

case; and (6) other matters.

     C.   Categories of Disputed Professional Fees

           1.   Overview

     The parties agree on six categories that the disputed

professional fees may be grouped into.   These categories are:

(1) Fees related to the criminal investigation, (2) fees related

to the grand jury proceedings, (3) fees related to Michael

Boulware’s first criminal trial, (4) fees involving the

litigation initiated by Jin Sook Lee, (5) fees that are not

included in any of the just-mentioned four categories and that

respondent concedes are ordinary and necessary expenses of some

entity, but not necessarily deductible, and (6) the remaining

(other) fees.
                                 - 183 -

            2.   Specifics of Expenses in Each Category

                  a.   Criminal Investigation

     The expenses in this category are for the legal and other

professional services related to the criminal investigation.

These services include all such legal and other professional

services provided from on or about June 16, 1993, up through the

start of the grand jury proceedings in or about the beginning of

August 1997.     Respondent disallowed the deduction of these

amounts.    Petitioners argue primarily that these amounts are

deductible in their entirety by either HIE or Holdings because

both Michael Boulware and the subject corporations were potential

targets of the criminal investigation and benefited from these

services.

                  b.   Grand Jury Proceedings

     The expenses in this category are for the legal and

professional services related to the grand jury proceedings up

though Michael Boulware’s initial indictment on May 19, 1999 (and

in some cases related to the grand jury proceedings afterwards up

through the superseding indictment and through the second

superseding indictment on April 6, 2000, and February 14, 2001,

respectively).     Respondent disallowed the deduction of these

amounts.    Petitioners argue primarily that these amounts are

deductible in their entirety by either HIE or Holdings because
                                 - 184 -

both Michael Boulware and the subject corporations were potential

targets of the investigation and benefited from these services.

                  c.   Michael Boulware’s Criminal Trial

     The expenses in this category are for the legal and

professional services related to Michael Boulware’s first

criminal trial (including his sentencing and his appeal of his

conviction in that trial) generally to the extent that the

underlying expenses were incurred after Michael Boulware’s

indictment; the expenses also are for services provided before

his indictment but related to matter to be used at his first

trial.   Respondent disallowed the deduction of these amounts.

Petitioners argue that these amounts are deductible in their

entirety by either HIE or Holdings because the subject

corporations were still potential targets and benefited from

these services.    Petitioners also argue that these amounts were

paid pursuant to the subject corporations’ obligation to

indemnify Michael Boulware.

                  d.   Fees Involving Jin Sook Lee

     The expenses in this category are for the legal and

professional services related to the civil litigation initiated

by Jin Sook Lee and to her bankruptcy proceedings.     Respondent

disallowed some of these fees and required that the remaining

fees be capitalized as incident to the acquisition of property
                                    - 185 -

from Jin Sook Lee’s bankruptcy estate.        Petitioners argue that

these amounts are deductible in their entirety by HIE because HIE

was the real party in interest in all of that litigation.

                  e.   Fees Accepted as Ordinary and Necessary

     The expenses in this category are for legal and professional

services and are the ordinary and necessary business expenses of

either HIE or Holdings, but respondent determined petitioners had

not substantiated which entity incurred the expenses or which

entity deducted the expenses.        Petitioners argue that these

amounts are deductible in their entirety by the entity that

claimed the deduction.

                  f.   Other Fees

     The expenses in this category are for the remaining legal

and professional services that do not fit within any of the other

categories.    Respondent disallowed deductions for these fees.

Petitioners argue that these amounts are deductible in their

entirety by either HIE or Holdings as ordinary and necessary

business expenses.

          3.     Amounts of Fees Attributable to Each Category

     We set forth in appendix C the amounts that we attribute to

each category.
                                   - 186 -

     D.   Providers of the Professional Services Underlying the
          Legal Costs

           1.   Criminal Investigation

                 a.   Representation of HIE Employees

                       i.     Overview

     In connection with the criminal investigation, HIE retained

two attorneys to represent some of its employees as to matters

arising from the investigation.

                       ii.     Peter Wolff

     In December 1994, HIE retained and paid Peter Wolff, Jr.

(Peter Wolff), a criminal defense attorney, to represent Merwyn

Manago in his interview by Jerry Yamachika.        The interview was

related to the criminal investigation.        Peter Wolff’s sole client

in the criminal investigation was Merwyn Manago.        Peter Wolff

represented Merwyn Manago in the criminal investigation through

no later than 1996.

                       iii.     Benjamin Cassidy

     On October 17, 1995, Martin Gelfand advised Michael Boulware

to cause HIE to hire and pay for an attorney to represent Stanley

Hirai and two other HIE employees, Morris Miyasato and Milton

Ikeda, as to their interviews by Jerry Yamachika in connection

with the criminal investigation.         Martin Gelfand informed Michael

Boulware and HIE that the employees were entitled to
                                 - 187 -

representation and that it was customary for HIE, as their

employer, to pay their legal fees.     HIE’s management also was

informed that HIE and certain of its employees could become

targets of the criminal investigation and that an employer in

such a situation commonly hires counsel to represent the

interests of its employees and not the interests of the company.

     One or both of the subject corporations retained an

attorney, Benjamin B. Cassidy III (Benjamin Cassidy), for that

purpose.   Benjamin Cassidy charged a flat $5,000 for his

services, which was paid by Holdings on December 18, 1997.     The

clients to whom Benjamin Cassiday rendered his services were

Morris Miyasota, Stanley Hirai, and Milton Ikeda.

                b.   Damon Key

     Michael Yoshida, an attorney, and his law firm Damon Key

were retained as an adviser to Michael Boulware as to the

criminal investigation.   For the most part, Michael Yoshida and

Damon Key produced HIE’s records in response to document requests

and subpoenas and advised Michael Boulware as to his criminal

defense and with respect to mail fraud.     Michael Yoshida and

Damon Key also discussed those issues with Barney Shiotani in

order to present a solid defense for Michael Boulware.     For July

1997, Damon Key charged $13,874.12 for services that it performed

in connection with the criminal investigation.     Damon Key
                               - 188 -

performed those services on behalf of its client, Michael

Boulware.   The charge for those services was paid by Holdings.

     After Michael Boulware was indicted but before his criminal

trial, Michael Boulware asked Michael Yoshida to offer to give

legal work to Blake Okimoto.   When Michael Yoshida appeared to

testify in this proceeding, the Court sustained his claim to

decline to answer certain questions related to Blake Okimoto on

the basis of the Self-Incrimination Clause of the Fifth Amendment

to the U.S. Constitution.

                c.   Irell Manella

     In 1993, Michael Boulware retained Martin Gelfand and his

law firm Irell Manella to represent Michael Boulware in

connection with the criminal investigation.   For services that

were provided in 199806 with respect to the criminal

investigation, Martin Gelfand and his firm charged $15,279.94.

Martin Gelfand’s client as to those services was Michael

Boulware.   The charge for those services was paid by Holdings.

                d.   Shiotani Inouye

     Barney Shiotani and his firm Shiotani & Inouye (Shiotani

Inouye) advised Michael Boulware and HIE on tax matters related

to the criminal investigation.   For 199806, Shiotani Inouye

charged $356,826.59 for a range of services that it provided to
                                - 189 -

Michael Boulware or to Michael Boulware and HIE jointly.47      Those

charges related to the criminal investigation and were paid by

Holdings.   Of the $356,826.59, $25,073.13 related mainly to

meetings, document preparation, and document review that Shiotani

Inouye undertook solely on behalf of Michael Boulware.    The

remaining $331,653.46 related to services that Shiotani Inouye

(or its Kovel accountant Nathan Suzuki) provided to Michael

Boulware and HIE jointly.    Of the $331,653.46, $259,355.24

related mainly to meetings, document preparation, and document

review undertaken by Shiotani Inouye, and $72,298.22 consisted of

accounting and consulting services provided by Nathan Suzuki.

                 e.   Wachi Watanabe

     During 199806, Stanley Wachi and his accounting firm, Wachi

& Watanabe, CPA, Inc. (Wachi Watanabe), charged $3,986.95 for

accounting services that it provided as to the criminal

investigation.   The services were performed from July 3 through

18, 1997, and concerned the fictitious leasing transactions

between HIE and GECC.    The charge for those services was paid by

Holdings.   The clients on whose behalf those services were

performed were Michael Boulware and HIE jointly.




     47
      In some cases, such as here, a professional provided a
service to one or more clients jointly.
                                    - 190 -

            2.   Grand Jury Proceedings

                  a.   Birney Bervar

     Birney Bervar was a criminal defense attorney who in March

2000 was retained by HIE (through one of its attorneys, Lyle

Hosoda) to represent Stanley Hirai in interviews with the U.S.

Attorney’s Office and as to any subsequent testimony that Stanley

Hirai could be subpoenaed to give before the grand jury during

the grand jury proceeding.     HIE agreed to pay for Birney Bervar’s

representation of Stanley Hirai.        Birney Bervar clarified to Lyle

Hosoda, on behalf of HIE, that this arrangement did not change

the fact that Birney Bervar’s sole client was Stanley Hirai.

During 200106, Birney Bervar charged a flat fee of $5,000 for his

services.    His client as to that fee was Stanley Hirai.      The fee

was paid by Holdings.

                  b.   Brook Hart

     Brook Hart was a criminal defense attorney who was retained

by HIE to represent Merwyn Manago in 1998 in interviews with the

U.S. Attorney’s Office and with regard to his grand jury

testimony.    Brook Hart was retained after Peter Wolff was unable

to continue that representation.        During 199806, 199906, and

200006, Brook Hart charged $13,049.23, $7,712.85, and $4,532.77,

respectively, for those services.        Holdings paid those charges.

Brook Hart’s client was Merwyn Manago.
                                 - 191 -

     Brook Hart believed that HIE could or might be a target of

the grand jury investigation, and he understood that there were

several potential targets, including HIE (if in fact HIE was not

already a target), Merwyn Manago, and possibly others.     As part

of his representation of Merwyn Manago, Brook Hart negotiated an

immunity agreement for Merwyn Manago.      At a meeting on April 27,

1998, Brook Hart made a proffer on behalf of Merwyn Manago,

following which Merwyn Manago disclosed, for the first time, the

monthly adjustments he made at the direction of Michael Boulware.

Thereafter, Merwyn Manago provided the documents related to the

monthly adjustments, was given immunity, and then was questioned

in front of the grand jury regarding the monthly adjustments.

                c.   Chee Markham

     During 200006, Kevin Chee of the law firm Chee & Markham

(Chee Markham) represented Mal Sun Boulware as to her involvement

in the grand jury proceedings.      Kevin Chee and his firm charged

$2,806.88 for that representation.     Holdings paid that charge.

Kevin Chee’s and Chee Markham’s client as to this charge was Mal

Sun Boulware.

                d.   Damon Key

     After the criminal investigation was referred to the grand

jury, Damon Key continued to advise Michael Boulware as to the

grand jury proceedings and began to a limited extent to represent
                                 - 192 -

HIE as to those proceedings as well.       During 199806 and 199906,

Damon Key charged $122,706.28 and $173,275.20 as to the grand

jury proceedings.      Holdings paid those charges.   Of the

$122,706.28, $121,214.19 related to services provided to Michael

Boulware as the client of Damon Key.       The balance, $1,492.09,

related to services provided to HIE as the client of Damon Key.

The $173,275.20 related entirely to services provided to Michael

Boulware as the client of Damon Key.

                  e.   Graham James

     In April 1997, William James, a business and tax

attorney/litigator, and his law firm Graham & James LLP (Graham

James) were contacted by Barney Shiotani and retained to

represent HIE and Michael Boulware from April 1997 through April

2000.   William James and his firm were retained primarily to

provide tax advice to Michael Boulware and to HIE as to the grand

jury proceedings and subsequently as to Michael Boulware’s first

criminal trial.    William James met initially with Barney

Shiotani.    During that meeting, Barney Shiotani expressed his

view that the United States could not prevail on any criminal or

civil issue if Michael Boulware and HIE could make all

deficiencies “disappear”.      Barney Shiotani explained a theory

that, if established, he believed would make the deficiencies

disappear.
                              - 193 -

     William James generally did not meet with Michael Boulware

but advised other attorneys working for Michael Boulware or for

HIE as to tax issues that might affect Michael Boulware, as well

as other issues that might affect Michael Boulware such as issues

arising from his first criminal trial and sentencing.   William

James advised Michael Boulware on a proposed plea agreement

between Michael Boulware and the U.S. Attorney’s Office.   William

James advised Michael Boulware on sentencing enhancements.

William James advised Michael Boulware on pretrial motions in his

first criminal trial.   William James advised Michael Boulware in

his first trial on the disqualification of Dennis O’Connor, Sr.

(Dennis O’Connor), and his law firm Reinwald O’Connor from

representing Michael Boulware at that trial (discussed infra).

William James provided Michael Boulware and HIE with legal advice

concerning the civil and criminal tax implications of Michael

Boulware’s lawsuits against Jin Sook Lee.

     The costs of the services of William James and his firm were

$56,848.50, $65,403.96, and $53,977.76 during 199806, 199906, and

200006, respectively.   The services underlying the $56,848.50

related to the grand jury proceeding, and the services underlying

the $53,977.76 related to Michael Boulware’s criminal trial.     Of

the $65,403.96, $41,371.59 related to the grand jury proceedings

and the balance of $24,032.37 related to Michael Boulware’s
                                 - 194 -

criminal trial.    Michael Boulware and HIE were joint clients as

to the $56,848.50 and the $65,403.96, and Michael Boulware was

the sole client as to the $53,977.76.      Holdings paid all of the

costs.

                  f.   Hochman Salkin

     Steven Toscher was an attorney with the law firm Hochman,

Salkin & DeRoy (Hochman Salkin), and he specialized in civil and

criminal tax litigation and controversy.     Steven Toscher was

approached by Barney Shiotani and then retained in or about May

1998 to represent Michael Boulware by providing him support and

consultation concerning criminal and potential civil tax matters

arising out of the grand jury proceedings.     Steven Toscher was

not retained to provide any services to either subject

corporation.   During 199806 and 199906, Steven Toscher and

Hochman Salkin charged $48,590.23 and $3,475.70, respectively,

for services that they provided as to the grand jury proceedings.

During 200006, Hochman Salkin issued a $10,000 refund as to those

charges.   The cost of the services provided by Hochman Salkin was

paid by Holdings.

                  g.   Howard Chang

     Howard Chang was a criminal defense attorney.     During 199806

through 200006, Howard Chang represented Michael Boulware in the

grand jury proceedings.     During 199806 through 200006, Howard
                                - 195 -

Chang charged $42,853.42, $20,638.78, and $16,837.64,

respectively, for those services.      Holdings paid those charges.

                 h.   Irell Manella

     Martin Gelfand and his firm Irell Manella continued to

represent Michael Boulware after his case was referred to the

grand jury.    For services that were provided in 199806 from

August 1, 1997, through March 31, 1998, Martin Gelfand and his

firm charged $29,121.20.    Martin Gelfand’s client as to those

services was Michael Boulware.    The charge for those services was

paid by Holdings.

                 i.   Lopeti Foliaki

     Lopeti Foliaki was a law practitioner in the Kingdom of

Tonga.   During 200006, he provided legal services to his client,

Nathan Suzuki, related to discovery conducted during the grand

jury proceedings.     The cost of the services, $13,579.50, was paid

by Holdings.

                 j.   Perkin Hosoda

     Lyle Hosoda was an attorney/civil litigator who worked first

for the law firm Perkin & Hosoda (Perkin Hosoda) and then for the

law firm Lyle Hosoda & Associates (Lyle Hosoda Associates).     In

December 1999, Lyle Hosoda and his firm were retained to

represent the interests of the subject corporations for potential

legal problems relating to the grand jury proceedings and charges
                                - 196 -

made against Michael Boulware.     Primarily, Lyle Hosoda met with

various employees of HIE who might be involved in the criminal

investigation and the grand jury proceedings and explained the

process to them.     He also acted as the facilitator of

communications between those employees and the various Government

and private attorneys involved in the process.     He also responded

to various subpoenas issued to HIE for documents.     Lyle Hosoda

and his firm continued to represent the subject corporations

through 2002.

     During 200006, Perkin Hosoda charged $44,480.01 for services

that it performed as to the grand jury proceedings.     That charge

was paid by Holdings.     Perkin Hosoda’s clients as to this charge

were Michael Boulware and HIE jointly.

                k.    Reinwald O’Connor

     In 1996, Dennis O’Connor, an attorney/litigator, and his law

firm Reinwald O’Connor were retained to represent HIE in the JSL

litigation in an attempt to reclaim HIE assets from Jin Sook Lee.

They did not represent Michael Boulware in that litigation.

Dennis O’Connor was HIE’s lead trial attorney, and he tried the

case on its behalf.

     Beginning in December 1997, Dennis O’Connor and Reinwald

O’Connor began assisting in the representation of HIE in the

grand jury proceedings.     Dennis O’Connor was told by Jerry
                               - 197 -

Yamachika and members of the U.S. Attorney’s Office that Michael

Boulware was the target of the grand jury proceedings and that

HIE and Merwyn Manago, among others, were potential targets.

Dennis O’Connor was never subsequently informed that HIE was no

longer a potential target.

     At or after the end of 1997, the U.S. Attorney’s Office in

Hawaii began serving HIE employees and other individuals

connected with HIE with subpoenas for grand jury testimony.

Reinwald O’Connor helped those witnesses prepare for their

testimony pursuant to its retention by HIE.    Dennis O’Connor and

Reinwald O’Connor also helped respond to numerous grand jury

subpoenas for HIE records, e.g., by challenging those subpoenas

and arguing those challenges in hearings before the U.S. District

Court.   The subpoenas focused on HIE records rather than on the

individual records of Michael Boulware.    Dennis O’Connor was

assisted in the hearings by Howard Chang.

     During 199806 and 199906, Reinwald O’Connor charged

$353,348.98 and $307,988.61, respectively, for services that it

performed in connection with the grand jury proceedings.

Reinwald O’Connor’s clients as to those charges were Michael

Boulware and HIE jointly.    Holdings paid those charges.
                               - 198 -

                l.   Shiotani Inouye

     For 199906, Shiotani Inouye charged $285,228.94 for a range

of services that it provided to Michael Boulware or to Michael

Boulware and HIE jointly.    Those charges were related to the

grand jury investigation and were paid by Holdings.    Of the

$285,228.94, $40,647.25 related mainly to meetings, document

preparation, and document review that Shiotani Inouye undertook

solely on behalf of Michael Boulware.    The remaining $224,581.69

related to services that Shiotani Inouye (or its Kovel accountant

Nathan Suzuki) provided to Michael Boulware and HIE jointly.     Of

the $224,581.69, $200,124.48 related mainly to meetings, document

preparation, and document review undertaken by Shiotani Inouye,

and $44,457.21 consisted of accounting and consulting services

provided by Nathan Suzuki.

                m.   Stephen Pingree

     In connection with the grand jury proceedings, Stephen

Pingree represented his client, Nathan Suzuki, from November 1998

until 2000.   During 199806, 199906, and 200006, Stephen Pingree

charged $15,117.06, $8,111.50, and $24,749.15, respectively, for

his services.   Holdings paid those charges.

                n.   Wachi Watanabe

     During 199806, Wachi Watanabe provided services related to

the grand jury proceedings.    Wachi Watanabe charged $17,486.87
                                 - 199 -

for those services.    Holdings paid those charges.   Wachi

Watanabe’s clients as to these charges were Michael Boulware and

HIE jointly.

          3.    Criminal Trial

                 a.   Accucopy

     In connection with Michael Boulware’s first criminal trial,

documents were photocopied at Accucopy, Inc. (Accucopy).      The

costs of those services were $8,665.37 during 200006, $5,000.58

during 200106, and $7,016.57 during 200206.    Holdings paid those

costs.

                 b.   Ayabe Chong

     In 1999, after Michael Boulware was indicted, Sidney Ayabe,

an attorney, and his law firm Ayabe, Chong, Nishimoto, Sia &

Nakamura LLP (Ayabe Chong) were retained as local counsel to

represent Michael Boulware in his first criminal trial; as

discussed infra, Micheal Boulware also was represented in that

matter by Leonard Sharenow (and later Vincent Marella).       Sidney

Ayabe and his firm continued to represent Michael Boulware

through 2002.   Michael Boulware was the client of Sidney Ayabe

and his firm, and the costs of the services of Sidney Ayabe and

his firm totaled $201,741.42, $61,982.97, and $93,953.20 during

200006, 200106, and 200206, respectively.    Holdings paid those

costs.
                               - 200 -

                c.   Bird Marella

     In or about May 2000, Michael Boulware replaced Leonard

Sharenow with Vincent Marella, a criminal defense

attorney/litigator with the law firm Bird, Marella, Boxer &

Wolpert (Bird Marella).   Neither Vincent Marella nor his firm was

retained to perform services for HIE or Holdings.     Vincent

Marella continued to represent Michael Boulware through his first

criminal trial until April 2002.      Michael Boulware was the client

of Vincent Marella and his firm, and the costs of the services of

Vincent Marella and his firm were $101,842.85, $1,018,262.37, and

$1,170,735.31 during 200006, 200106, and 200206, respectively.48

The cost of the services performed by Bird Marella was paid by

Holdings.

                d.   Bowen Hunsaker

     Mark Hunsaker was a certified public accountant and a

specialist in business valuation and litigation forensic

accounting.   Mark Hunsaker and his firm, Bowen Hunsaker

Consulting (Bowen Hunsaker), were retained by Reinwald O’Connor

in or about July 1999 to review accounting records of HIE with

respect to the first criminal trial of Michael Boulware and to



     48
      The cost for 200206 included invoices totaling
$1,279,335.32 less credit adjustments totaling $108,600.01
($1,279,335.32 - $108,600.01 = $1,170,735.31).
                                    - 201 -

testify with respect thereto at that trial.        The work of Mark

Hunsaker and his firm ceased as to the case when Reinwald

O’Connor was removed as counsel in the case.        Michael Boulware

was the client of Mark Hunsaker and his firm, and the cost of the

services of Mark Hunsaker and his firm was $100,887.28 during

200006.   Holdings paid this cost.

     Mark Hunsaker and his firm were retained a second time by

Reinwald O’Connor in the early part of 2000 or 2001 with respect

to Michael Boulware’s appeal, and then later the firm provided

services as to Michael Boulware’s second trial.

                  e.   Brook Hart

     Brook Hart began representing Merwyn Manago in connection

with the grand jury proceedings.        During 200206, Brook Hart

continued to represent Merwyn Manago.         At that time, Brook Hart

advised Merwyn Manago as to his testimony at Michael Boulware’s

first criminal trial and appeared at the trial to monitor Merwyn

Manago’s testimony.     Brook Hart also advised Merwyn Manago as to

his testimony during the sentencing phase of Michael Boulware’s

criminal trial.    Brook Hart charged $4,864.74 for his services

during 200206.    Holdings paid these costs.

                  f.   Candon Consulting/John Candon

     John Candon was a certified public accountant and a business

appraiser.   In 1998, John Candon and his firm Candon Consulting
                              - 202 -

Group LLC (Candon Consulting) were retained by Kobayashi Doi to

ascertain the fair market value of a 100-percent interest in

Royal Hawaiian Water as of June 30, 1997 and 1998.   The

engagement was later expanded to include an estimate of the

potential investment value of Royal Hawaiian Water to HIE if

acquired as of those two dates.   John Candon gave his finished

report to Kobayashi Doi on or about February 14, 2002.

     Kobayashi Doi also retained John Candon and his firm to

ascertain the value as of July 1, 1992, of a 100-percent interest

in Michael Boulware’s hypothetical coffee processing and

wholesaling business operated as a sole proprietorship.49   John

Candon gave his finished report to Kobayashi Doi on or about

March 12, 2002.

     John Candon testified in Michael Boulware’s first criminal

trial as an expert appraiser of businesses.   During that

testimony, John Candon referred to the analysis in the

aforementioned two reports.

     The costs of the services of John Candon and his firm were

$8,615, $5,002.28, and $11,761.55 during 200006, 200106, and

200206, respectively.   As to the services underlying those cases,




     49
      Michael Boulware acknowledged in this proceeding that he
did not have a coffee business that was separate from HIE.
                                  - 203 -

Michael Boulware was the client of John Candon and his firm.

Holdings paid these costs.

                  g.   Chicoine Hallett

     Bird Marella retained an attorney, Darrell Hallett, of the

tax law firm Chicoine & Hallett P.S. (Chicoine Hallett) to

testify as an expert in defense of Michael Boulware at his first

criminal trial.    Chicoine Hallett performed such services in

200206 and charged $34,784.24 for the services.    Chicoine

Hallett’s client in that matter was Michael Boulware.    Holdings

paid these costs.

                  h.   Corniel

                        i.   Overview

     HIE retained private investigators, Corniel & Associates

(Corniel) and Goodenow & Associates (Goodenow), to provide

surveillance services as to Jin Sook Lee and to investigate

background information and underlying facts regarding her.

Reinwald O’Connor believed that this investigation was necessary

because the Internal Revenue Service was doing a similar

investigation, and Reinwald O’Connor believed that any

information and facts that its investigators uncovered which were

favorable to Michael Boulware could be used by him at his

criminal trial were he to be indicted and prosecuted.
                                   - 204 -

                       ii.   Specifics

     Corniel performed its services during 199506 through 199806.

The cost of those services (inclusive of clerical, investigative,

and surveillance) for 199806 (specifically, for the period

generally from July 1997 through January 1998) was $18,559.93.

HIE issued checks to Corniel from 1994 through 1996.       Holdings

issued checks to Corniel from 1996 to 1998.       Corniel’s client as

to these services was Michael Boulware.

                 i.   Damon Key

     During 199906, 200006, 200106, and 200206, Damon Key

provided services to its client, Michael Boulware, in connection

with his first criminal trial.       The costs of these services in

the respective years were $25,864.59, $373,737.84, $47,055.32,

and $4,486.71.   Holdings paid these costs.

                 j.   Gaims Weil

     The law firm of Gaims, Weil, West & Epstein, LLP (Gaims

Weil) provided advice to Michael Boulware in connection with his

first criminal trial and provided to him related services, e.g.,

Gaims Weil prepared a motion that full faith and credit be given

to the State court judgment for purposes of the appeal of his

conviction, and Gaims Weil reviewed an appellate brief as to an

issue whether the trial court had improperly excluded reference

to that judgment.     For 200006, 200106, and 200206, Gaims Weil
                                  - 205 -

charged $36,927.34, $548.64, and $395, respectively, for services

that Gaims Weil provided to Michael Boulware incident to his

first criminal trial.     Holdings paid those charges.

                  k.   Goodenow

     Goodenow was the second of the two firms discussed supra

p. 203 that provided private investigation services to HIE.

During 199806, specifically for the months of July, August,

September, and November 1997, Goodenow provided the requested

services for investigation and surveillance of Jin Sook Lee at a

cost of $35,351.94.     Holdings paid these costs.   Goodenow’s

client as to these charges was Michael Boulware.

                  l.   Graham James

     We discussed supra in the section on the grand jury

proceedings that related to Graham James the facts related to the

services provided by Graham James as to Michael Boulware’s

criminal trial.

                  m.   Hawaii National Bank

     In connection with Michael Boulware’s criminal trial,

Holdings paid the travel and lodging expenses of some of the

attorneys representing Michael Boulware.      Holdings paid those

expenses from the account of Hawaii National Bank.       During 200106

and 200206, these expenses totaled $31,227.39 and $29,146.04,

respectively.
                                - 206 -

                n.   Leonard Sharenow

     Following the disqualification of Dennis O’Connor and his

firm, HIE (through a partner of Barney Shiotani) retained Leonard

Sharenow, a criminal defense attorney/litigator, in or about

September or October 1999 to represent Michael Boulware in his

first criminal trial.   Leonard Sharenow continued to represent

Michael Boulware through May 2000.      Leonard Sharenow never

represented HIE as to the subject matter at hand.     During 200006,

Leonard Sharenow charged $758,111.97 for his services.      Leonard

Sharenow invoiced HIE for the cost of his services, and that cost

was paid by Holdings.

                o.   Lyle Hosoda Associates

     Lyle Hosoda and his firm Lyle Hosoda Associates continued to

provide services to Michael Boulware during his first criminal

trial.   During 200106 and 200206, Lyle Hosoda charged $665.29 and

$15,667.22 for such services.    Holdings paid those charges.

                p.   McCorriston Miller

     During 200106 and 200206, McCorriston Miller Mukai Mackinnon

(McCorriston Miller) represented its client, Nathan Suzuki, in

defense of his criminal prosecution by the United States.        In

those respective years, McCorriston Miller charged $25,154.47 and

$9,343.61 as to those services.    Holdings paid those charges.
                                - 207 -

                 q.   Michael McCarthy

     During 200206, Michael McCarthy provided services to Michael

Boulware incident to his first criminal trial.     Michael McCarthy

charged $3,646.54 for those services.     That charge was paid by

Holdings.

                 r.   Nathan Suzuki

     During 200106, Holdings paid Nathan Suzuki $17,500 for

services previously performed as a Kovel accountant.

                 s.   Perkin Hosoda

     During 200106, Perkin Hosoda provided services to Michael

Boulware in connection with his first criminal trial.     Holdings

paid the cost of those services, $136.55.

                 t.   PWC

     During 200006, 200106, and 200206,     PriceWaterhouseCoopers

LLP (PWC) provided expert consultant services to its client,

Michael Boulware, incident to his first criminal trial.     For the

respective years, PWC charged $60,225.24, $56,023.89, and

$69,436.14.    Holdings paid those charges.

     Patrick Oki is a certified public accountant who worked for

PWC in 2003.    At that time, he performed work for Michael

Boulware for his first criminal trial.     The work involved a

project regarding unclaimed potential deductions or costs of

goods sold available to Michael Boulware.     One of those potential
                               - 208 -

deductions involved determining the price of green coffee beans

purchased by Michael Boulware, for the purpose of opining on

whether Michael Boulware had taken into account all of the costs

of goods sold attributable to coffee sales made to third parties.

                u.   Professional Image

     Professional Image is a photocopying company in Honolulu.

During 200006, Professional Image provided photocopying services

to Ayabe Chong on behalf of Michael Boulware with respect to his

first criminal trial.   The cost of those services, $5,763.36, was

paid by Holdings.

                v.   Reinwald O’Connor

     Dennis O’Connor and Reinwald O’Connor were asked to continue

to represent Michael Boulware and HIE after the grand jury

indictment.   The United States questioned whether such

representation would present a conflict of interest.   The United

States noted as to a potential conflict between HIE and Michael

Boulware that Dennis O’Connor was representing HIE and its

employees, including Merwyn Manago, that Dennis O’Connor had

acquired privileged information from that representation that he

would not otherwise have acquired, and that Merwyn Manago would

be called as a Government witness at Michael Boulware’s criminal

trial.   At a hearing on August 30, 1999, in response to a direct

question by then Chief U.S. District Court Judge David A. Ezra,
                                - 209 -

an attorney for the United States acknowledged that it was

possible that HIE might become a defendant in the case.    The

court ruled that Dennis O’Connor and his firm were disqualified

from representing Michael Boulware in his first criminal trial

because of a conflict of interest that could not be waived.50

     During 200006 and 200206, Reinwald O’Connor provided

services to Michael Boulware incident to his first criminal

trial.    Holdings paid the respective costs of those services,

$259,730.35 and $23,090.85.

                 w.   Robert Waters

     Robert Waters was a sole practitioner attorney who

specialized in sentencing and appeals.    In January 2002, he was

retained (at the request of Barney Shiotani) to represent Michael

Boulware in an appeal of his first conviction and later, at the

request of Vincent Marella, to represent Michael Boulware in the

sentencing phase of his first criminal trial.    Robert Waters did

not provide any of his services on behalf of HIE, and he did not

provide any services to either subject corporation.    Robert

Waters represented Michael Boulware until 2006.




     50
      In or about April 2002, Reinwald O’Connor provided
services to Michael Boulware as to his second criminal trial.
                                - 210 -

     During 200206, Robert Waters charged $158,073 for his

services.   That charge was paid by Holdings.    His client for

those services was Michael Boulware.

                x.    Saranow Pagani

     On or about March 3, 1996, Martin Gelfand and his firm

retained a certified public accountant, Ronald Saranow, as a

Kovel accountant to assist Martin Gelfand.     Most specifically,

Ronald Saranow was retained as an expert consultant to help

Martin Gelfand and his firm determine the taxable income of

Michael Boulware and HIE for “all relevant years through and

including 1995”.     During 200006, 200106, and 200206, Saranow

Pagani charged $31,345.34, $292,282.61, and $192,644.18 for its

services.   Holdings paid those charges.

                y.    Sherman Sherman

     Robert Waters recommended, and HIE retained, two criminal

defense attorneys, Victor Sherman and his partner Janet Sherman,

and their firm Sherman & Sherman (Sherman Sherman) to represent

Michael Boulware with regard to sentencing.     Sherman Sherman

represented its client, Michael Boulware, from February 2002

through May 2002, and the firm did not represent HIE.     During

200206, Sherman Sherman charged $91,179.04 for its services, and

that charge was paid by Holdings.
                                  - 211 -

                z.    Sheila Balkan

     Robert Waters recommended, and HIE retained, Sheila Balkan

as a sentencing consultant.      Sheila Balkan advised her client,

Michael Boulware, as to his sentencing.      Sheila Balkan charged

$32,430 for her services, and that charge was paid by Holdings.

                aa.    Shiotani Inouye

                       i.    200006

     For 200006, Shiotani Inouye charged $199,130.37 for services

that it provided to Michael Boulware or to Michael Boulware and

HIE jointly.   Those charges related to Michael Boulware’s first

criminal trial and were paid by Holdings.      Of the $199,130.37,

$96,458.27 related mainly to meetings, document preparation,

document review, and research that Shiotani Inouye undertook

solely on behalf of Michael Boulware.       The balance, $102,672.10,

related to services that Shiotani Inouye (or its Kovel accountant

Nathan Suzuki) provided to Michael Boulware and HIE jointly.      Of

the $102,672.10, $83,353.98 related mainly to meetings, document

preparation, document review, research, and pleadings undertaken

by Shiotani Inouye, and $19,318.12 consisted of accounting and

consulting services provided by Nathan Suzuki.

                       ii.    200106

     For 200106, Shiotani Inouye charged $124,213.60 for services

that it provided to Michael Boulware or to Michael Boulware and
                                - 212 -

HIE jointly.   Those charges related to Michael Boulware’s first

criminal trial and were paid by Holdings.    Of the $124,213.60,

$42,109.94 related mainly to meetings, document preparation,

document review, and research that Shiotani Inouye undertook

solely on behalf of Michael Boulware.     The balance, $82,103.66,

related to services that Shiotani Inouye provided to Michael

Boulware and HIE jointly.    Those services consisted primarily of

meetings, document preparation, document review, and research.

                      iii.   200206

     For 200206, Shiotani Inouye charged $56,266.17 for services

that it provided to Michael Boulware or to Michael Boulware and

HIE jointly.   Those charges related to Michael Boulware’s first

criminal trial and were paid by Holdings.    Of the $56,266.17,

$43,662.14 related mainly to meetings, document preparation, and

review that Shiotani Inouye undertook solely on behalf of Michael

Boulware.   The balance, $12,604.03, related to services that

Shiotani Inouye provided to Michael Boulware and HIE jointly.

Those services consisted primarily of meetings, document

preparation, and review.

                bb.   Squire Sanders

     During 200106, the law firm of Squire, Sanders & Dempsey

L.L.P. (Squire Sanders) provided $3,888.10 of services to Michael

Boulware in connection with his first criminal trial.    Those
                                 - 213 -

services consisted of legal research and advice as to the Federal

sentencing guidelines.

                  cc.   Stephen Platt

     Stephen Platt was the court reporter at the U.S. District

Court who prepared the trial transcripts for Michael Boulware’s

first criminal trial.     During 200206, Holdings paid $13,102.18

for trial transcripts related to that proceeding.

                  dd.   Wachi Watanabe

     During 200006 and 200206, Wachi Watanabe provided expert

consulting services to Michael Boulware incident to his first

criminal trial.    For 199906, 20006, and 200206, Wachi Watanabe

charged $10,000, $7,298.13, and $3,776.02, respectively, as to

those services.    Holdings paid those charges.

                  ee.   Wilmington Institute

     Wilmington Institute was retained to assist in the defense

of Michael Boulware at his first criminal trial.     Wilmington

Institute helped Vincent Marella with respect to jury polling and

preparing Michael Boulware for his testimony.     Wilmington

Institute charged $67,225 for services performed in May and June

2001 and $26,853 for services performed in late June 2001 and in

July and August 2001.     Holdings paid those charges.   Wilmington

Institute’s client as to these charges was Michael Boulware.
                                   - 214 -

           4.   Fees Concerning Jin Sook Lee

                  a.   Chee Markham

     Kevin Chee and his firm Chee Markham were retained to

represent Mal Sun Boulware from in or about March 1995 through

July 1998 in the shareholder derivative case and as to her

involvement as a witness in the JSL litigation and in the trust

case.   The costs of the services provided as to those matters by

Kevin Chee and his firm were $2,207.94 and $2,046.86 during

199806 and 199906, respectively.        Holdings paid those costs.

Chee Markham’s client as to these costs was Mal Sun Boulware.

                  b.   Damon Key

     Michael Yoshida and Damon Key first represented HIE and

Michael Boulware in or about October 1994 in connection with the

JSL litigation.    They were the second counsel to be retained by

the defendants in that case, retained as local counsel under a

pro hac vice process to assist the primary counsel, John Gaims

and Amy Rice of the law firm Gaims Weil.        Michael Yoshida and

Damon Key advised HIE with respect to reclaiming HIE’s cash and

property from Jin Sook Lee.        Apart from the JSL litigation,

Michael Yoshida and Damon Key also advised Holdings with respect

to ownership of its stock by the trustee of the Glenn Lee

Boulware Trust.    During 199806, 199906, 200006, and 200106, Damon

Key charged $227,005.66, $55,025.96, $5,762.90, and $438.25,
                                  - 215 -

respectively, as to services provided incident to the civil

matters related to Jin Sook Lee.      Holdings paid those charges.

With the exception of the portion of the charges related to the

referenced services provided to Holdings, the charges related to

services provided jointly to HIE and Michael Boulware as clients

of Damon Key.

                c.   Gaims Weil

     In or about October 1994, HIE and Michael Boulware retained

a business attorney/litigator, Amy Rice, and her law firm Gaims

Weil to represent HIE and Michael Boulware in the JSL litigation,

including pursuit of their counterclaim.      Reinwald O’Connor

subsequently entered the case as associate counsel and in or

about June 1996 replaced Gaims Weil as counsel of record for HIE;

Gaims Weil remained as counsel of record for Michael Boulware.

     In 1995, Michael Boulware retained Gaims Weil to represent

him in the trust case.   Gaims Weil neither represented HIE in

that case nor considered HIE to be a party to that case.

     In 1997, the individual directors listed as defendants in

the shareholder derivative case retained Gaims Weil to represent

them in that case.   HIE paid Gaims Weil’s bills regarding the

individual HIE directors.

     During 199806 and 199906, Gaims Weil charged $65,234.68 and

$11,558, respectively, as to services provided incident to the
                                 - 216 -

civil matters related to Jin Sook Lee.     Except for the portion of

the charges related to the above-referenced services paid by HIE,

the $65,234.68 and $11,558 were paid by Holdings.     Michael

Boulware and HIE jointly were the clients connected to the

services attributable to the portion of those charges paid by

Holdings.

                  d.   Glenn Lee Boulware Trust

     For 199906, petitioners seek a $35,000 deduction for amounts

paid to the Glenn Lee Boulware Trust.      On March 15 and April 14,

1999, Holdings paid the trust $25,000 and $10,000, respectively,

as a result of the JSL litigation and the resulting bankruptcy of

Jin Sook Lee.

                  e.   Reinwald O’Connor

     During 199806, 199906, 200006, and 200206, Kelvin Kaneshiro,

an attorney, and his firm Reinwald O’Connor provided services

related to the civil litigation involving Jin Sook Lee and to the

bankruptcy of Jin Sook Lee.     Kelvin Kaneshiro and his firm

represented HIE with respect to the shareholder derivative case,

the trust case, and Jin Sook Lee’s bankruptcy.     Kelvin Kaneshiro

and his firm provided legal services with respect to the Glenn

Boulware Trust.    Reinwald O’Connor did not represent Michael

Boulware in any of the litigation related to Jin Sook Lee.
                                   - 217 -

     For the respective years, Reinwald O’Connor charged

$180,142.72, $13,857.04, $534.10, and $452.64.       Holdings paid

those charges.    Reinwald O’Connor’s clients for these charges

were Michael Boulware and HIE.

          5.     Fees Accepted as Ordinary and Necessary

                  a.   Carlsmith Ball

     Carlsmith Ball was a Honolulu law firm.       During 199806

through 200206, it provided services to the subject corporations

jointly at costs of $14,258.83, $8,401.97, $14,272.77, $2,478.22,

and $5,026.03, respectively.       The services involved general

corporate matters that benefited both corporations.       The subject

corporations were the joint clients as to these services.       The

expenses were paid by Holdings or in some cases in 199806 and

200206 by Hawaiian Isles Kona Coffee.

                  b.   Damon Key

     During 199806, 200006, 200106, and 200206, Damon Key

provided services generally to the subject corporations at costs

of $2,831.89, $40,913.91, $6,792.73, and $1,977.36,

respectively.51    The services involved general corporate matters




     51
      As a single exception, Damon Key provided to Royal
Hawaiian Water $132.28 of the services included in the
$40,913.91. The services provided to Royal Hawaiian Water
related to general business matters.
                                 - 218 -

that benefited one or both of the subject corporations.     Holdings

paid these costs.

                c.   Marr Hipp

     Marr Hipp Jones & Pepper (Marr Hipp) was a Honolulu law

firm.   From 199806 through 200206, Marr Hipp provided general

legal services to the subject corporations in connection with a

sexual harassment lawsuit.   During the respective years from

199806 to 200206, Marr Hipp charged $825.26, $293.39, $771.14,

$465.10, and $469.79 for those services.   Holdings paid those

charges.   The clients for those charges were the subject

corporations jointly.

                d.   Seyfarth Shaw

     Seyfarth, Shaw, Fairweather & Geraldson (Seyfarth Shaw) was

an Illinois law firm that was involved with a tobacco class

action lawsuit that Hawaii commenced in the First Circuit Court

of Hawaii against Brown & Williamson Tobacco Corp. and others.

That lawsuit involved tobacco tax litigation brought by Hawaii

against all tobacco manufacturers and distributors.   During

199806, Seyfarth Shaw provided to HIE legal services related to

that lawsuit.   Seyfarth Shaw charged $122.50 for those services.

That charge was paid by Holdings.
                                 - 219 -

                e.   Other Legal

     For 199806 and 199906, petitioners claim deductions of $.23

and ($.16), respectively, related to “Other Legal”.      The record

contains no documentation for these claimed expenses.      Nor does

the record indicate the identity of the client related to these

expenses, the nature of the services purportedly provided, or

whether the expenses were ever paid.

          6.   Other Fees

                a.   Accucopy

     As discussed supra p. 199, documents were photocopied at

Accucopy, and the cost of those services for 200006 was

$8,665.37.   Holdings paid twice one of the underlying invoices

included in the $8,665.37.      The invoice paid twice was in the

amount of $893.25.

                b.   Case Bigelow

     For 200006, petitioners claim a $736.31 deduction related to

“Case Bigelow Lombardi” (Case Bigelow).      The record contains no

documentation for this claimed expense.      Nor does the record

indicate the identity of the client related to this expense, the

nature of the services purportedly provided, or whether the

expense was ever paid.
                                 - 220 -

                c.   Damon Key

     Douglas Smith, an attorney, and his law firm Damon Key began

representing HIE and Michael Boulware in 1994 or 1995 as to

certain corporate and tax issues.     Douglas Smith advised Michael

Boulware on estate planning, on stockholder’s rights, on general

legal matters concerning the theory of tobacco tax and coffee

sales, on legal matters concerning Jin Sook Lee’s bankruptcy, on

tax matters, and on matters related to Michael Boulware’s

indictment.   Douglas Smith advised Michael Boulware on matters

related to the JSL litigation, the trust case, and the

shareholder derivative case.     Douglas Smith advised HIE on

corporate tax matters, such as the restructuring, and on Hawaii

tobacco tax matters.   Douglas Smith advised Holdings on corporate

matters.

     During 199806, 199906, 200006, 200106, and 200206, Damon Key

billed $11,843.45, $58,569.60, $3,277.85, $9,604.45, and

$16,598.25 for services provided to the subject corporations

generally concerning general corporate matters.52    Holdings paid

all of these costs for 199806 through 200106.    For 200206,




     52
      As the single exception, Damon Key billed to its client,
Michael Boulware, $712.49 of the referenced charges for 199806.
The services underlying this exception involved personal estate
planning for Michael Boulware.
                                - 221 -

Holdings paid $14,387.24 of the $16,598.25; Hawaiian Isles Kona

Coffee paid the balance of $2,211.01.

                d.   Foley Jones

     Foley & Jones P.C. (Foley Jones) was a Las Vegas, Nevada,

law firm.   During 200006, Foley Jones performed services at a

cost of $1,459.50.   The client as to these services was Holdings.

The services related to an unidentified legal proceeding

occurring in June 1999.

                e.   GMK Consulting

     In 200206, Gary Kuba and his firm GMK Consulting charged HIE

and Holdings $9,374.94 as an “interim billing” for services

rendered in connection with valuation analyses of HIE and

Holdings as of June 30, 2001.      Approximately every 2 weeks from

June 17 through August 12, 2002, Holdings issued a $2,000 check

to Gary Kuba and GMK Consulting to pay the bill (in other words,

$10,000 in total).   Approximately every 2 weeks from August 26

through September 23, 2002, Holdings issued a $2,000 check to

Gary Kuba and GMK Consulting, and on October 14, 2002, Holdings

issued a $2,854.05 check to Gary Kuba and GMK Consulting (in

other words, $8,854.05 in total).     These latter checks were in

final payment of the services just referenced.     The total cost of

the services was $18,854.05.    Michael Boulware’s accountants at
                                - 222 -

Kobayashi Doi retained Gary Kuba and his firm to perform these

services on behalf of Michael Boulware personally.

               f.   King King

     For 200006, petitioners claim a $2,500 deduction related to

“King & King” (King King).    The record contains no documentation

for this claimed expense.    Nor does the record indicate the

identity of the client related to this expense, the nature of the

services purportedly provided, or whether the expense was ever

paid.

               g.   Laird Christianson

     For 200006 and 200106, petitioners claim $252.20 deductions

related to “Laird Christianson”.    The record contains no

documentation for these claimed expenses.      Nor does the record

indicate the identity of the client related to these expenses,

the nature of the services purportedly provided, or whether the

expenses were ever paid.

               h.   Louis Wai

     Louis Wai, an attorney, charged $5,000 for services that he

was asked to perform during 200006.       Louis Wai’s clients were the

subject corporations and Michael Boulware.      Holdings paid this

charge.
                                - 223 -

                i.    Michael McCarthy

     During 199806, 199906, 200006, 200106, and 200206, Michael

McCarthy charged $21,747.02, $18,193.49, $14,914.59, $2,019.44,

and $11,619.48, respectively, for services rendered to the

subject corporations jointly concerning general corporate

matters.   Holdings paid those costs.

                j.    Nathan Suzuki

     During 200006, Holdings paid Nathan Suzuki $1,118 for

services previously performed for the subject corporations as to

general corporate matters.

                k.    Robert Holland

     For 199806, petitioners claim a $925 deduction related to

“Robert Holland”.     The record contains no documentation for this

claimed expense.     Nor does the record indicate the identity of

the client related to this expense, the nature of the services

purportedly provided, or whether the expense was ever paid.

                l.    Yoshida, Inc.

     For 199906, petitioners claim a $1,894.04 deduction related

to “Yoshida, Inc.”     The record contains no documentation for this

claimed expense.     Nor does the record indicate the identity of

the client related to this expense, the nature of the services

purportedly provided, or whether the expense was ever paid.
                                 - 224 -

                  m.   Other Legal

     For 200006, 200106, and 200206, petitioners claim deductions

of $290.34, $298.77, and $270.51, respectively, related to “Other

Legal”.   The record contains no documentation for these claimed

expenses.    Nor does the record indicate the identity of the

client related to these expenses, the nature of the services

purportedly provided, or whether the expenses were ever paid.

     E.   Other Professional Fees

            1.   Fees Related to Criminal Trial

     Alan Kobayashi was a certified public accountant with

Kobayashi Doi.    During 200206, Alan Kobayashi and Kobayashi Doi

provided accounting assistance to Michael Boulware with regard to

his first criminal trial.     Kobayashi Doi charged $2,195.28 for

those services.    That charge was paid by Holdings.

            2.   Fees Accepted as Ordinary and Necessary

                  a.   Antoneita DeWang-Seo

     Antoneita DeWang-Seo was a computer consultant.       During

199806, Antoneita provided $7,000 of computer services to HIE.

Hawaiian Isles Kona Coffee paid that cost.

                  b.   Applied Computer

     Applied Computer Technologies (Applied Computer) was a

company that provided support on computer software.     During

199806 and 200206, respectively, Applied Computer provided $405
                                - 225 -

and $1,025 of such services to Royal Hawaiian Water.     Royal

Hawaiian Water paid those costs.

                 c.   ASI Food Safety

     During 199906, Hawaiian Isles Kona Coffee received a

manufacturing certification from “ASI Food Safety”.     The

certification cost $150.

                 d.   Back to Basics Plus

     During 200206, Back to Basics Plus charged Holdings $1,074

for sales training provided to Holdings.

                 e.   Brewer Environmental

     During 199806, 199906, 200006, 200106, and 200206, Brewer

Environmental charged Royal Hawaiian Water $145.83, $2,004.15,

$1,899.98, $2,158.32, and $1,999.98, respectively, for “HIW

testing”.    Royal Hawaiian Water paid those charges.

                 f.   Business Consulting

     Business Consulting Resources (Business Consulting) charged

the subject corporations jointly $19,999.93 during 199806 and

$4,999.98 during 199906 for management consulting services

provided to them.     Holdings paid those charges.

                 g.   Ceridian Employer

     During 200006, Ceridian Employer Services (Ceridian

Employer) charged Holdings $520 for payroll services provided to

Holding.    Holdings paid those charges.
                                 - 226 -

                h.    Charles Abraham

     Petitioners claim a $675 deduction for 200206 for “advance

price list services” provided by Charles Abraham.     The record

contains no documentation for this claimed expense.     Nor does the

record indicate the identity of the client related to this

expense or whether the expense was ever paid.

                i.    COLIFORM

     Petitioners claim a $145.83 deduction for 199906 related to

“COLIFORM”.   The record contains no documentation for this

claimed expense.     Nor does the record indicate the identity of

the client related to this expense, the nature of the services

purportedly provided, or whether the expense was ever paid.

                j.    Commercial Plumbing

     Petitioners claim a $125 deduction for 200006 for “HIW test

backflow preventor” provided by Commercial Plumbing.     The record

contains no documentation for this claimed expense.     Nor does the

record indicate the identity of the client related to this

expense or whether the expense was ever paid.

                k.    Communications Pacific

     During 200206, Communications-Pacific, Inc. (Communications

Pacific), provided $979.16 of public relations services to the

subject corporations.     Hawaiian Isles Kona Coffee paid that

charge.
                                  - 227 -

                l.    Datahouse

     During 199806, 199906, and 200106, Datahouse provided

computer consulting services to the subject corporations jointly

at costs of $1,588.53, $8,234.22, and $6,054.64, respectively.

The subject corporations paid those costs.

                m.    Dataprofit Corp.

     During 200006 and 200106, Dataprofit Corp. provided computer

consulting services to Holdings at costs of $53,532.46 and

$5,400, respectively.     Holdings paid the cost for 200006, and the

subject corporations paid the cost for 200106.

                n.    Dunn Bradstreet

     During 199806, Dunn & Bradstreet (Dunn Bradstreet) provided

credit and collection services to the subject corporations at a

cost of $158.22.     Hawaiian Isles Kona Coffee paid that cost.

                o.    Electra Form

     Electra Form, Inc. (Electra Form), was an “HIW Blowmolding

company”.   During 199906, Electra Form provided services to

Holdings at a cost of $10,302.58.       Royal Hawaiian Water paid that

cost.

                p.    EMS Solutions

     EMS Solutions, Inc. (EMS Solutions), was a company that

provided services related to the upgrade of software.      During

199806 and 199906, EMS provided such services to HIE.      During
                               - 228 -

200006, EMS provided such services to the subject corporations

jointly.   The costs of these services were ($90), $2,045, and

$21,970 during 199806, 199906, and 200006, respectively.

Holdings paid these costs.

                q.   Fidelity Investments

     Holdings had a section 401(k) profit sharing plan.     During

200006, Fidelity Investments provided Holdings with services as

to that plan.   Holdings paid the cost of these services,

$7,017.53.

                r.   Foley Jones

     Petitioners claim a $741 deduction for 199906 related to

services provided by Foley Jones in collecting a “vending debt”.

The record contains no documentation for this claimed expense.

Nor does the record indicate the identity of the client related

to this expense or whether the expense was ever paid.

                s.   Food Products

     During 199806, Food Products Laboratory (Food Products)

provided services to Royal Hawaiian Water related to an analysis

of Japanese drinking water.    Holdings paid the cost of those

services, $2,345.    During 199906 and 200006, Food Products

provided services to Holdings related to “HIW testing”.     Holdings

paid the respective costs of those services, $2,860 and $2,860.

During 200106, Food Products provided services to the subject
                                 - 229 -

corporations related to “HIW testing”.      Holdings paid the cost of

those services, $2,660.

               t.   GEM Communications

     During 200006, GEM Communications provided public relations

services to the subject corporations.      Holdings paid the total

cost of those services, $5,841.12.

               u.   GT Service

     During 200006, GT Service provided welding services to the

subject corporations at a cost of $1,080.

               v.   Hawaiian Hardware

     During 200006, Hawaiian Hardware Co. (Hawaiian Hardware)

provided the subject corporations with $324.76 of supplies.

               w.   Intrastate

     During 200006, Intrastate Communications (Intrastate)

charged the subject corporations $86.46 to broadcast on June 7,

1999, Michael Boulware’s plea of not guilty to the United States’

charge that he had underreported income.

               x.   IW

     During 199906, iW dba Italia Wang (IW) charged the subject

corporations $32,000 to produce a brochure.      Holdings paid that

charge.
                                  - 230 -

               y.    John Ching

     Petitioners claim a $1,075 deduction for 200006 related to

first aid classes provided by John Ching.      The record contains no

documentation for this claimed expense.      Nor does the record

indicate the identity of the client related to this expense or

whether the expense was ever paid.

               z.    Kimura International

     During 200106 and 200206, Kimura International provided

services to the subject corporations.       The services consisted of

the monitoring of groundwater proximate to the headquarters of

the subject corporations.    Holdings paid the charges for these

services, $19,428.68 and $11,562.42, respectively.

               aa.    KPMG

     During 199806 and 200006, KPMG Peat Marwick LLP (KPMG)

provided accounting services to the subject corporations jointly

as to their pension plans.    Holdings paid the costs of those

services, $17,291 and $8,854.11, respectively.

               bb.    L.C. Financial

     Petitioners claim a $451 deduction for 199806 related to

fees for collection services provided by L.C. Financial, Inc.

(L.C. Financial).    The record contains no documentation for this

claimed expense.    Nor does the record indicate the identity of
                               - 231 -

the client related to this expense or whether the expense was

ever paid.

               cc.   Leung Pang

     During 200006, Leung & Pang Associates (Leung Pang) provided

engineering services to the subject corporations.   The cost of

these services was $1,800.

               dd.   Melvin Kam

     Melvin Kam was a risk management consultant.   During 199806,

Melvin Kam provided insurance consulting services to the subject

corporations jointly.   Holdings paid the cost of those services,

$760.50.

               ee.   Michael Toigo

     Michael Toigo, an attorney, provided services to Holdings

during 199806 and 200006.    The services related to the collection

of a vending debt.   For the respective years, Michael Toigo

charged $246.75 and $1,291.60 for those services.

               ff.   Pension Services

     Pension Services Corp. (Pension Services) provided actuary

and administrator services for pension and profit sharing plans.

During 20006, Pension Services provided $781.20 of such services

to HIE as to its pension plan.    Holdings paid the cost of those

services.
                                 - 232 -

                 gg.   Procomm

     During 200006 and 200106, Procomm provided public relations

services to the subject corporations.       The costs of those

services in the respective years were $751.60 and $1,734.92.

                 hh.   Professional Image

     During 200206, Professional Image provided $125.68 of

photocopying services to the subject corporations.       That cost was

paid by Holdings.

                 ii.   Profit Concepts

     During 200006 and 200106, Profits Concepts International

(Profits Concepts) provided computer consulting services to

Holdings.    Holdings paid the costs of those services in the

respective years, $360 and $7,400.

                 jj.   Quadrel Labeling

     Petitioners claim a $14,142.33 deduction for 199806 for

“Field Service” provided by Quadrel Labeling Systems (Quadrel

Labeling).    The record contains no documentation for this claimed

expense.    Nor does the record indicate the identity of the client

related to this expense or whether the expense was ever paid.

                 kk.   Rhanda Kim

     During 200106 and 200206, Rhanda Kim, LLC (Rhanda Kim),

provided computer consulting services to Holdings.       Holdings paid
                                - 233 -

the costs of those services in the respective years, $7,127.56

and $7,658.81.

                 ll.   Richard Kitagawa

     Richard Kitagawa was an independent contractor.   For 200106

and 200206, petitioners claim deductions of $500 and ($1,000),

respectively, for services performed by Richard Kitagawa.

                 mm.   RJR Packaging

     During 200206, RJR Packaging provided $745 of film to

Holdings.

                 nn.   Servend of Hawaii

     Servend of Hawaii was a vending consultant.   During 199906,

Servend of Hawaii charged $2,500 for services provided to

Holdings.   Holdings paid that expense.

                 oo.   Stewart Engineering

     During 199906 and 200006, Stewart Engineering, Inc. (Stewart

Engineering), provided engineering services to the subject

corporations jointly.    Holdings paid the costs of these services

for the respective years, $8,853.60 and $2,197.78.

                 pp.   Tricia Young

     In connection with an audit of HIE’s cigarette cartoons,

Tricia Young provided $613.60 of services to HIE during 200006.
                                  - 234 -

                qq.   Wayne Arakaki

     Wayne Arakaki, an engineer, provided engineering services to

Holdings during 200106.      Holdings paid the cost of those

services, $353.60.

          3.    Other Fees

                 a.   Henry Yokogawa

     Henry Yokogawa, an independent contractor, provided services

concerning the manufacturing and sale of coffee.         For 200106 and

200206, petitioners claim deductions of $26,500 and $63,600,

respectively, for monthly payments of $5,300 that Hawaiian Isles

Kona Coffee made to Henry Yokogawa.         Holdings made 5 such

payments in 200106 and 12 such payments in 200206.

                 b.   Kobayashi Doi

                       i.    Overview

     As to services provided by Kobayashi Doi, petitioners claim

deductions of $65,837.29, $61,140.22, $57,966.64, $67,758.54, and

$76,116.85 for 199806, 199906, 200006, 200106, and 200206,

respectively.   From 1993 through 2002, Kobayashi Doi provided

accounting services to Michael Boulware and to the subject

corporations.   Those services included the compilation of

financial statements, the preparation of tax returns, and

litigation support as to accounting matters.         As to the tax

returns, Kobayashi Doi prepared Michael Boulware’s amended 1994
                                 - 235 -

through 2002 Federal income tax returns, HIE’s Federal corporate

income tax returns for 198906 through 200406, Holding’s Federal

corporate income tax returns for 199706 through 200206 and

200406, and Royal Hawaiian Water’s Federal corporate income tax

returns for 199506 through 199706.     As to the litigation support,

Kobayashi Doi provided accounting services to HIE in connection

with the civil litigation initiated by Jin Sook Lee and in

connection with the criminal investigation, the grand jury

proceedings, and Michael Boulware’s first criminal trial.

                      ii.    199806

     Of the $65,837.29 claimed for 199806, $63,268.56 related to

services provided to the subject corporations jointly; Holdings

paid those charges.   The balance, $2,568.73, related to services

provided to Royal Hawaiian Water; Royal Hawaiian Water paid that

balance.

                      iii.    199906

     Of the $61,140.22 claimed for 199906, $47,687.22 related to

services provided to the subject corporations jointly; Holdings

paid those charges.   The balance, $13,453, related to services

provided to Royal Hawaiian Water; Royal Hawaiian Water paid that

balance.
                                  - 236 -

                      iv.    200006

     Of the $57,966.64 claimed for 200006, $57,611.14 related to

services provided to the subject corporations jointly; Holdings

paid those charges.    The balance, $355.50, related to services

provided to Royal Hawaiian Water; Royal Hawaiian Water paid that

balance.

                       v.    200106

     All of the $67,758.54 claimed for 200106 related to services

provided to the subject corporations jointly.    Holdings paid

those charges.

                       vi.    200206

     Of the $76,116.85 claimed for 200206, we set forth supra

p. 224 our finding that $2,195.28 of the $76,116.85 was

attributable to Michael Boulware’s first criminal trial.    The

balance, $73,921.57, related to services provided to the subject

corporations jointly.

                 c.   Lorin Kushiyama

     For 199906, petitioners claim a deduction for a $20,000

payment that Holdings made to Lorin Kushiyama.

                 d.   Richard Kitagawa

     For 200006, petitioners claim a $4,500 deduction related to

Richard Kitagawa.
                                 - 237 -

                 e.    TRI Pac

     For 199906, petitioners claim a $10,000 deduction for two

$5,000 payments that Holdings made to TRI Pac Inquiries (Tri

Pac).   The subject corporations were joint clients of Tri Pac

during 199906.   The record contains no documentation for this

claimed expense.      Nor does the record indicate the nature of the

services provided.

                 f.    Vending Consulting

     For 200006 and 200106, petitioners claim deductions of

$60,000 and $15,000, respectively, for monthly payments of $5,000

that Holdings made to Vending Consulting Co. (Vending

Consulting).    Holdings made 12 such payments in 200006 and 3 such

payments in 200106.

                 g.    Watson Wyatt

     The firm of Watson & Wyatt (Watson Wyatt) provided financial

management consulting.     For 199906, petitioners claim a $15,857

deduction for payments made by Holdings to Watson Wyatt.     The

record contains no documentation for this claimed expense.     Nor

does the record indicate the identity of the client related to

this expense.

                 h.    Amortization

     The subject corporations amortized certain professional fees

over the period that those fees were estimated to have value and
                                 - 238 -

deducted that amortization.     These fees included, for example,

professional services related to consulting fees for technical

and computer support, coffee art work, and other expenses related

to coffee.    For 199806, 199906, 200006, 200106, and 200206, these

amortization deductions totaled $30,643.54, $116,176.10,

$38,387.03, $45,080.13, and $40,570.67, respectively.

XXI.   Kona Coffee

       A.   Background

       A Kona coffee plant grows fruit called cherries, and a

coffee bean is the seed found inside the cherry.     When a cherry

is removed from a coffee plant, the cherry is converted (milled)

into a parchment.     The parchment contains a thin layer of skin.

When that thin skin is removed, the product is referred to as a

green bean.     When the green bean is roasted, the result is

roasted coffee.      The process that mills cherries into parchment,

the process that makes parchment into green beans, and the

process that makes green beans into roasted coffee are each

separate stages that result in the coffee beans’ weighing less at

the end of the stage than at the start of the stage.     Five pounds

of Kona cherries typically yield one pound of green Kona coffee

beans.
                                - 239 -

     B.   Season for Kona Coffee

     The season for Kona coffee generally coincides with the

period during which the Kona coffee cherries are harvested from

the coffee plants and brought to market.   That season generally

extends from July to March, with the main part of the season

being from August to January.

     C.   Shelia David

     Kona farmers generally preferred to sell to relatives the

coffee the farmers grew.    Shelia David, a.k.a. Shelia Baptista,

was born in Kona, and she had family members in Kona who were

Kona coffee farmers and millers (i.e., individuals who mill

cherries into parchment).   In 1988, Marvin Fukumitsu worked for

HIE, and he did not have a familial connection with the Kona

farming community.   Marvin Fukumitsu approached Shelia David and

asked her if she would buy coffee for HIE as an independent

contractor of HIE.   Shelia David agreed to do so, and she bought

Kona coffee for HIE as an independent contractor from 1988

through 1990 (in other words, during the 1988-89 and 1989-90

coffee seasons).   Shelia David operated this business under the

name Kona Sunrise Farms.

     Shelia David and Marvin Fukumitsu set up bank accounts in

the name of Kona Sunrise Farms.    In order for Shelia David to buy

coffee, Marvin Fukumitsu deposited into the Kona Sunrise Farms
                                - 240 -

account the proceeds of HIE checks.       Marvin Fukumitsu got the

checks from Michael Boulware.    Michael Boulware also gave Marvin

Fukumitsu cash of approximately $10,000 to $20,000 to deposit

into that account.    When the petitions were filed in these cases,

copies of many of the bank records of Kona Sunrise Farms existed.

       Shelia David and her family operated in Kona dropoff

stations (i.e., places where farmers would bring their coffee

cherries to be weighed and purchased) solely to buy coffee for

HIE.    The Kona coffee farmers who sold Kona coffee to Shelia

David and her family accepted checks for the sales; no one

refused to sell coffee because he was not paid in cash.       During

each of the 1988-89 and 1989-90 Kona coffee seasons, Shelia David

and her family gave receipts to the farmers from whom they

purchased Kona coffee.    Shelia David retained copies of these

receipts until Marvin Fukumitsu took the receipts to HIE.       The

receipts indicated the weight, the dollar amount, the date, the

farmer, and “Kona Sunrise Farms”.

       During each of the 1988-89 and 1989-90 Kona coffee seasons,

Shelia David and her family bought Kona coffee for HIE.       After

Shelia David purchased that coffee, she had the coffee milled

into parchment and shipped the resulting product to Honolulu

through a company called Young Brothers.       Young Brothers gave to

Shelia David bills of lading for the shipments.       Marvin Fukumitsu
                                - 241 -

took those bills of lading back to Honolulu.     During each of the

1988-89 and 1989-90 Kona coffee seasons, Young Brothers was the

only company that shipped Kona coffee from the Island of Hawaii

to Honolulu.     Shelia David usually purchased coffee cherries for

HIE.     Shelia David wrote checks for parchment purchases at Marvin

Fukumitsu’s direction; no cash was used.

       In the spring of 1990, Shelia David received a cease and

desist letter from Kona Kai Farms telling her to stop purchasing

Kona coffee from the Kona coffee farmers.     Kona Kai Farms was

owned by Robert Regli and Michael Norton, and Shelia David’s

operation was taking business away from Kona Kai Farms.

       Marvin Fukumitsu worked for HIE from September 1982 to March

1991.     On March 11, 1991, Marvin Fukumitsu stopped working for

HIE and began working for Superior Coffee.     Marvin Fukumitsu did

not sell coffee to or purchase coffee for HIE or Michael Boulware

when he worked at Superior Coffee.     Marvin Fukumitsu left

Superior Coffee in March of 1997, and he began selling coffee to

HIE.     Marvin Fukumitsu died on April 17, 2005.

                                OPINION

I.   Perception of Witnesses

        We observe the candor, sincerity, and demeanor of each

witness in order to evaluate his or her testimony and to assign

weight to that testimony for the primary purpose of finding
                                - 242 -

disputed facts.     We determine the credibility of each witness,

weigh each piece of evidence, draw appropriate inferences, and

choose between conflicting inferences in finding the facts of a

case.     The mere fact that one party presents unopposed testimony

on its or his behalf does not necessarily mean that the elicited

testimony will result in a finding of fact in that party’s favor.

We will not accept a witness’s testimony at face value if we find

that our impression of the witness coupled with our review of the

credible facts at hand conveys to us an understanding contrary to

the spoken word.     See Neonatology Associates, P.A. v.

Commissioner, 115 T.C. 43, 84-87 (2000), affd. 299 F.3d 221 (3d

Cir. 2002); cf. Gallick v. Balt. & Ohio R. R., 372 U.S. 108,

114-115 (1963); Boehm v. Commissioner, 326 U.S. 287, 293 (1945);

Wilmington Trust Co. v. Helvering, 316 U.S. 164, 167-168 (1942);

Ruark v. Commissioner, 449 F.2d 311, 312 (9th Cir. 1971), affg.

per curiam T.C. Memo. 1969-48; Clark v. Commissioner, 266 F.2d

698, 708-709 (9th Cir. 1959), affg. in part and remanding T.C.

Memo. 1957-129.

        The parties called a total of 52 witnesses to testify at

trial.     We generally found the testimony of 34 of these witnesses

to be reliable in our finding of the facts underlying the issues

at hand.     Those witnesses were Trinidette Abaya-Wright, Birney

Bervar, Margery Bronster, James Chan, Shelia David, Martin
                                   - 243 -

Gelfand, Anthony Guffanti, Jerald Guben, Brook Hart, Antoinette

Hirai, Patty Hirai, Lyle Hosoda, Mark Hunsaker, Milton Ikeda,

William James, Kelvin Kaneshiro, James Kunihiro, Harry Lyckman,

Vincent Marella, Morris Miyasato, Dennis O’Connor, Blake Okimoto,

Bruce Okimoto, Thomas Okimoto, Larry Olson, Amy Rice, Leonard

Sharenow, Victor Sherman, Douglas Smith, Steven Toscher, Robert

Waters, Peter Wolff, John Yamada, and Jerry Yamichika.        We

generally did not find the entire testimony of any of the other

18 witnesses to be reliable for that purpose.53       As to 5 of those

18 witnesses, namely, Michael Boulware, Sidney Boulware, Nathan

Suzuki, Lorin Kushiyama, and Barney Shiotani, we find almost none

of their testimony to be reliable or helpful to petitioners’

case.        As to the remaining 13 of the 18 witnesses, including

among others Jin Sook Lee and Mal Sun Boulware, we found only

limited portions of their testimony to be helpful.        To the extent

that we disregarded or discounted any testimony given in these

cases, we generally perceived the witnesses giving that testimony



        53
      Nor do we rely heavily on the transcripts of testimony
given by various witnesses in prior proceedings that were
included in the record at hand through the parties’ stipulations.
We were unable to observe those witnesses during that testimony,
and we decline in the setting at hand to accept that prior
testimony merely on the basis of the written words. We have,
however, given that testimony proper regard in finding the facts
of these cases and do not simply reject that testimony out of
hand.
                               - 244 -

to be untrustworthy during that testimony or considered the

testimony self-serving, vague, elusive, uncorroborated, and/or

inconsistent with documentary or other reliable evidence.      We

also note that many of the witnesses in these cases testified

previously in administrative and/or legal proceedings as to the

subject matter at hand and that their testimony in these cases

was in that sense somewhat rehearsed and versed, rather than

given strictly on the basis of their memories.    We are not

required to rely on testimony that we consider to be

untrustworthy and/or unreliable, and we do not rely on any such

testimony given in these cases to support either our findings of

fact or our decisions with respect to the issues at hand.      See

Ruark v. Commissioner, supra at 312; Clark v. Commissioner, supra

at 708-709; Neonatology Associates, P.A. v. Commissioner, supra

at 84-87; see also Tokarski v. Commissioner, 87 T.C. 74, 77

(1986).

II.    Burden of Proof

      A.   Overview

      Petitioners argue that section 7491(a)(1) places the burden

of proof upon respondent with respect to the issues we decide

herein.    Alternatively, petitioners argue, respondent has the

burden of proof on all those issues because the NODs were

arbitrary and unreasonable.    Respondent disagrees with
                              - 245 -

petitioners on both points.   As respondent sees it, petitioners

bear the burden of proof on all issues that we decide herein.       We

agree with respondent.

     B.   Applicability of Section 7491

     Taxpayers generally bear the burden of proving by a

preponderance of evidence that the Commissioner erred as to any

determination in dispute.   See Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79 (1992); Welch v. Helvering, 290 U.S.

111, 115 (1933); Rockwell v. Commissioner, 512 F.2d 885-887 (9th

Cir. 1975), affg. T.C. Memo. 1972-133; see also Merkel v.

Commissioner, 109 T.C. 463, 476 (1997) (citing 2 McCormick on

Evidence, sec. 339, at 439 (4th ed. 1992), and stating that “the

proponent must prove that the fact is more probable than not” in

order to prove the fact by a preponderance of the evidence),

affd. 192 F.3d 844 (9th Cir. 1999).     In certain cases, the burden

of proof may shift to the Commissioner with respect to a factual

issue relevant to the taxpayer’s liability for tax.54    See sec.

7491(a)(1).   Such a shift may occur when the record establishes



     54
      Respondent determined that HIE is liable for an addition
to tax under sec. 6651(a) for 199806. While sec. 7491(c) places
a burden of production upon the Commissioner with respect to an
individual’s liability for an addition to tax under sec. 6651(a),
sec. 7491(c) has no applicability where, as here, the taxpayer is
a corporation. See NT, Inc. v. Commissioner, 126 T.C. 191
(2006); Beiner, Inc. v. Commissioner, T.C. Memo. 2004-219.
                               - 246 -

that the taxpayer produced credible evidence relating to the

issue; that the taxpayer met the requisite substantiation

requirements, maintained all requisite records, and cooperated

with the Commissioner’s reasonable requests for information,

documents, interviews, witnesses, and meetings; and, in the case

of a corporation, partnership, or trust, that such a taxpayer met

the net worth requirement of 28 U.S.C. sec. 2412(d)(2)(B)

(2000).55   See sec. 7491(a)(1) and (2); NT, Inc. v. Commissioner,

126 T.C. 191, 194-195 (2006); Santa Monica Pictures, LLC v.

Commissioner, T.C. Memo. 2005-104; see also H. Conf. Rept.

105-599, at 240, 242 (1998), 1998-3 C.B. 747, 994, 996.   For this

purpose, the term “credible evidence” connotes “‘the quality of

evidence which, after critical analysis, the court would find

sufficient upon which to base a decision on the issue if no

contrary evidence were submitted’”, Higbee v. Commissioner,

116 T.C. 438, 442 (2001) (quoting H. Conf. Rept. 105-599, supra

at 240, 1998-3 C.B. at 994), and the Court need not consider the

testimony of a witness to be credible simply because it is



     55
      As to a proceeding in this Court, a petitioning taxpayer’s
net worth is determined as of the time that the taxpayer’s
petition was filed with the Court. See Hubert Enters., Inc. &
Subs. V. Commissioner, 125 T.C. 72, 91 n.6 (2005), affd. in part
and remanded on another issue not relevant herein 230 Fed. Appx.
526 (6th Cir. 2007); Jondahl v. Commissioner, T.C. Memo. 2006-
142.
                             - 247 -

unopposed, see Blodgett v. Commissioner, 394 F.3d 1030, 1035-1038

(8th Cir. 2005), affg. T.C. Memo. 2003-212; Nichols v.

Commissioner, T.C. Memo. 2003-24, affd. 79 Fed. Appx. 282 (9th

Cir. 2003); see also H. Conf. Rept. 105-599, supra at 240-241,

1998-3 C.B. at 994-995 (stating that “A taxpayer has not produced

credible evidence for these purposes if the taxpayer merely makes

implausible factual assertions * * *.   The introduction of

evidence will not meet this standard if the court is not

convinced that it is worthy of belief.”).   Whether a taxpayer has

cooperated with the Commissioner is a factual determination that

turns on the unique facts and circumstances of the case.   See

Polone v. Commissioner, T.C. Memo. 2003-339, affd. 505 F.3d 966

(9th Cir. 2007); see also H. Conf. Rept. 105-599, supra at 240,

1998-3 C.B. at 994 (explaining the requirements of

“cooperation”).

     The record does not establish that petitioners met the

credible evidence or cooperation requirements.56   As to the former


     56
      Nor have petitioners established that they met the
substantiation requirement or that either HIE or Holdings met the
applicable net worth requirement. On the latter point,
petitioners rely upon consolidated financial statements for
Holdings and its subsidiaries that were admitted into evidence as
Exhibit 1123-P. Those statements were prepared on Nov. 17, 2005,
by Kobayashi Doi and purport to show the financial status of
Holdings as of June 30, 2005. The problems with the statements
are twofold. First, the statements state specifically that the
                                                    (continued...)
                               - 248 -

requirement, petitioners rely primarily upon the testimony of

Barney Shiotani.   As noted above, we find almost all of Barney

Shiotani’s testimony to be incredible and do not rely upon it.

As to the latter requirement, although petitioners (through

Kobayashi Doi) may have cooperated with respondent on some

matters during the audit, petitioners acknowledge that respondent

served them with various information document requests during the

audit and that they failed to honor those requests because,

petitioners state, they believed incorrectly that respondent was

improperly communicating with the DOJ in the criminal prosecution

of Michael Boulware.   Petitioners attempt to rectify that lack of

cooperation by stating that they ultimately gave the requested

information and other information to respondent after the notices

of deficiency were issued.   We consider that attempt unavailing.

Numerous court opinions detail petitioners’ continual resistance

to respondent’s attempts to uncover relevant facts underlying the

issues at hand.    See Boulware v. United States, 203 Fed. Appx.

172 (9th Cir. 2006) (affirming decision denying Michael

Boulware’s motion to quash summons issued to HIE); United States


     56
      (...continued)
information set forth therein is based entirely on the
representations of “the management” of Holdings and its
subsidiaries. Second, the values of many of the assets included
in the financial statements are reported at historic cost, rather
than at fair market value.
                               - 249 -

v. Boulware, 203 Fed. Appx. 170 (9th Cir. 2006) (affirming

decision enforcing summons issued to HIE and denying Michael

Boulware’s motion to intervene); United States v. Boulware,

203 Fed. Appx. 168 (9th Cir. 2006) (affirming decision enforcing

summons issued to third party); United States v. Boulware, 350 F.

Supp. 2d 837 (D. Haw. 2004).   Petitioners’ lack of cooperation

with respondent during the audit is not cured by their production

of documents after the notices of deficiency were issued.    See,

e.g., Polone v. Commissioner, supra; NHUSS Trust v. Commissioner,

T.C. Memo. 2005-236.

     C.   Claim That NODs Are Arbitrary

     Petitioners also argue that respondent bears the burden of

proof because the NODs are arbitrary or unreasonable.   We

disagree.   In order to prevail as to this issue, petitioners must

persuade us that the deficiencies determined in the respective

NODs do not bear the requisite relationship to the petitioner’s

liability or are without a rational factual foundation.   See

Zuhone v. Commissioner, 883 F.2d 1317, 1324-1326 (7th Cir. 1989),

affg. T.C. Memo. 1988-142; Clapp v. Commissioner, 875 F.2d 1396,

1402-1403 (9th Cir. 1989); see also Helvering v. Taylor, 293 U.S.

507, 514-515 (1935) (holding that the burden of going forward

with the evidence shifts to the Commissioner if the taxpayer
                               - 250 -

shows that the notice of deficiency underlying the proceeding is

arbitrary).    Petitioners have failed to make this showing.

     In an attempt to meet their burden as to this issue,

petitioners stress that the total amount of disallowed

professional fees in the NODs issued to the subject corporations

for 200006 through 200206 is substantially greater than the total

amount of professional fees the subject corporations deducted for

those years.   Unlike petitioners, we do not consider that fact to

be probative that the NODs issued to the subject corporations are

arbitrary.    The tax returns of the subject corporations, even

when viewed in the light of any additional information supplied

by petitioners during the audits of the subject corporations, do

not allow for a precise adjustment as to the professional fees

deducted by each of those corporations.    Thus, respondent argues,

and we agree, that respondent’s determinations in the NODs with

respect to deductible professional fees were made to foreclose a

potential whipsaw.   We have previously held in a similar setting

that the Commissioner may defend against an inconsistent result

by holding both parties to a transaction liable for the entire

deficiency resulting therefrom, until the claim of one of the

parties is resolved.   See, e.g., Maggie Mgmt. Co. v.
                                 - 251 -

Commissioner, 108 T.C. 430, 446 (1997).      We believe that this

same principle applies here.57

III.        NOL Deduction

       HIE claimed on its Federal income tax returns for 199806,

200006, 200106, and 200206 that it was entitled to deduct NOLs of

$2,086,891, $1,184,192, $324,767, and $145,145, respectively.

Respondent determined that HIE had established its entitlement

only to an NOL deduction of $450,569 for 199806.     Petitioners

argue that HIE established its entitlement to deduct NOLs in

amounts greater than those claimed on the referenced tax returns

(and thus in amounts greater than those allowed by respondent).

To that end, petitioners assert, HIE made monthly adjustments

that prematurely recognized $21,440,000 of tobacco tax income for

198906 through 199506 and is entitled to correct that mistake by

shifting the referenced income to the proper reporting years of

199506 through 200106.      Petitioners assert that HIE also recorded

AJEs recognizing $12,947,405 of additional income as to the

tobacco tax refunds and the off-book activities of Michael

Boulware.


       57
      Petitioners also assert that respondent arbitrarily
apportioned to each of Michael Boulware and HIE one-half of the
professional fees attributable to the civil litigation initiated
by Jin Sook Lee. We disagree. On the basis of the facts and
circumstances of these cases, we believe that this allocation was
neither arbitrary nor unreasonable.
                                - 252 -

     Section 172 allows a taxpayer to deduct an NOL for a taxable

year.     The amount of the NOL deduction equals the sum of the NOL

carryovers plus NOL carrybacks to that year.      See sec. 172(a).

Absent an election to the contrary, an NOL for a taxable year

must first be carried back 3 years and then may be carried

forward up to 15 years.    See sec. 172(b)(1)(A), (2), and (3).58

HIE, as a taxpayer attempting to deduct an NOL, bears the burden

of establishing both the existence of the NOL and the amount of

any NOL that may be carried over to the subject years.      See Rule

142(a)(1); United States v. Olympic Radio & Television, Inc.,

349 U.S. 232, 235 (1955); Keith v. Commissioner, 115 T.C. 605,

621 (2000).     Such a deduction is a matter of legislative grace;

it is not a matter of right.     United States v. Olympic Radio &

Television, Inc., supra at 235; Deputy v. du Pont, 308 U.S. 488,

493 (1940).

     HIE claimed on its return for 199806 that it was entitled to

carry over to that year a $5,718,663 NOL arising in prior years.

HIE claimed on its previous year’s return that its NOL for that

year equaled $439,557 and indicated that its NOL carryover as of

the end of 199806 totaled $591,279.       The increase in the amount


     58
      In 1997, sec. 172(b)(1)(A) was amended to generally
require a 2-year carryback and a 20-year carryover for NOLs for
taxable years beginning after Aug. 5, 1997. See Taxpayer Relief
Act of 1997, Pub. L. 105-34, sec. 1082, 111 Stat. 950.
                              - 253 -

of the NOL carryover reported for 199806 was purportedly

attributable to Barney Shiotani advising HIE that it had

prematurely reported Hawaii tobacco tax refunds as income for its

taxable years ended in 1989 through 1995 and that the reported

income for those years was required to be reduced by the amount

of tobacco tax income included therein.   We consider to be

unsupported by credible evidence petitioners’ claim that HIE

before the subject years prematurely reported $21,440,000 of

self-help tobacco tax refunds as Federal taxable income.59    The

Hawaii tobacco tax returns filed by HIE do not support the claim

that HIE received any such refund income from Hawaii in that the

returns report no “credits” or “offsets” for overpaid Hawaii

tobacco tax, notwithstanding that the returns specifically

contained a line for “Adjustments (Explain Fully)”.   Nor can we

reconcile petitioners’ unbelievable assertion that HIE opted to

recover millions of dollars in refunds through installments

spread over many years with Michael Boulware’s statement that he

would have preferred a single lump-sum refund, if in fact HIE was

entitled to one.   We also find that HIE never informed Hawaii of

HIE’s claimed situation and even went so far, purportedly, as to



     59
      Nor are we persuaded as to petitioners’ claim that HIE
included an additional $12,947,405 of taxable income through
amortization adjustments made in 199406 through 200106.
                               - 254 -

report surreptitiously false numbers on the later years’ tobacco

tax returns rather than to reveal to Hawaii that HIE was

attempting to recoup refunds through HIE’s self-help concept.    We

also find in part on the basis of the credible testimony of

Margery Bronster, a former attorney general of Hawaii, that HIE’s

concept of self-help that it purportedly employed to recover its

overpaid Hawaii tobacco taxes was not allowed under the

applicable laws of Hawaii.60   We do not find, on the other hand,

any credible written legal advice concerning the situation or for

that matter any credible contemporaneous documentation that we

believe a reasonable person in the same claimed position as HIE

would have caused to be prepared to document its belief (through

its management) that HIE was entitled to such a large recovery of

dollars.   We set forth supra pp. 118-120 our findings that

Michael Boulware learned in June 1993 that respondent was

starting a criminal investigation of Michael Boulware and that

Barney Shiotani subsequently advised Michael Boulware on theories



     60
      Petitioners assert that HIE’s self-help concept is
authorized in Haw. Rev. Stat. Ann. sec. 245-7(c) (LexisNexis
2008). Petitioners also assert that Hawaii audited HIE’s tobacco
tax returns and did not challenge its self-help concept. As to
the former assertion, we do not read the referenced section to
authorize HIE’s self-help concept. As to the latter assertion,
we do not know the specifics of any such audit and on the basis
of the record at hand consider that assertion to be of little
value to our decisions herein.
                              - 255 -

to pursue to try to avoid a criminal conviction of Michael

Boulware resulting from that investigation.   The purported

shifting of HIE’s income from earlier to later years appears to

us to reflect one of those theories.

     Petitioners assert as a point of fact that HIE made the

monthly adjustments in order to report the self-help tobacco

refunds received by HIE as taxable income for Federal income tax

purposes.   We decline on the basis of the record at hand to make

such a finding of fact.   Those adjustments reclassified some of

HIE’s tobacco sales from HIE’s account for taxable sales (i.e.,

sales subject to Hawaii tobacco tax) to HIE’s account for

nontaxable sales (i.e., sales not subject to Hawaii tobacco tax)

and reduced the COGS as to tobacco products to reflect the amount

of State tobacco tax that HIE actually paid as to its reported

taxable sales.   HIE did not report any “tobacco tax income” by

means of those monthly adjustments or otherwise pay Federal

income tax on the monthly adjustment amounts.   HIE simply

reported lower costs of goods sold attributable to lower State

tobacco taxes.

     We hold that petitioners have failed to establish that HIE

prematurely reported tobacco tax refund income that could be

shifted to later years so as to support petitioners’ claim to the

referenced NOLs, and we sustain respondent’s primary
                              - 256 -

determination that HIE has failed to substantiate its claim to an

NOL carryover greater than respondent determined.    Petitioners

argue that this holding means that HIE is entitled to receive

refunds for years to which it had shifted its income.    We

disagree.   The NOD issued to HIE reduced HIE’s 200006 and 200106

taxable income by $1,927,648 and $962,426, respectively, with

respect to this issue, and petitioners have not proven that they

are entitled to any further related adjustments.    We note once

again that petitioners have failed to persuade us that HIE

recognized the approximately $12.9 million of purported

amortization adjustments as income for 199506 through 200206.

     Before leaving this issue, we pause to set forth for

completeness our disagreement with petitioners’ position that the

referenced shift of income would have been proper because of the

all events test.   As petitioners see it, the all events test was

not met as to the refund income until the later years because

before those years the appropriate taxing authority had not made

its determination as to the appropriateness and accuracy of the

refunds (or self-help credits) and the period of limitations

remained open for such a determination.   Thus, petitioners

conclude, any taxable tax refund income that HIE had reported for

198906 through 199506 was properly reportable under the all

events test in the later years and HIE was required to shift the
                               - 257 -

income reported in the earlier years to the later years.    We

disagree with petitioners’ application of the all events test in

the setting of the issue at hand; in other words, even if we were

to assume for purposes of discussion that HIE did report its

self-help tobacco tax refunds as income, an assumption that we do

not actually find as a fact, those amounts were not reportable in

the years after 199506 as petitioners argue.

     Unless a taxpayer’s method of accounting dictates otherwise,

income must usually be recognized in the year in which the income

is actually or constructively received.   See sec. 451(a); sec.

1.451-1(a), Income Tax Regs.   HIE used an accrual method of

accounting for Federal income tax purposes, and income is

recognized under such a method when all the events have occurred

which fix the right to receive the income and the amount of the

income can be determined with reasonable accuracy.   See sec.

1.451-1(a), Income Tax Regs.   The all events test is met as to

income, i.e., income must be recognized, when the income is paid,

due, or earned, whichever occurs first.   See Schlude v.

Commissioner, 372 U.S. 128, 133 n.6 (1963); see also Old Harbor

Native Corp. v. Commissioner, 104 T.C. 191, 200 (1995) (stating

that section 451(a) provides that “An item of income is generally

included in a corporation’s gross income for the year that is no
                               - 258 -

later than the year during which the item is received by the

corporation”).

     In the case of State tax refunds, the Commissioner has ruled

that section 451 requires that an accrual method taxpayer

recognize State tax refunds for Federal income tax purposes upon

receipt of payment, or if earlier, when the taxpayer learns that

the State has approved the refund.    See Rev. Rul. 2003-3, 2003-1

C.B. 252.   If HIE had in fact been claiming Hawaii tobacco tax

refunds on each of its monthly returns by reducing the liability

that would otherwise have been reported thereon, HIE would have

received its State tax refunds upon its filing of those returns.

The mere possibility that Hawaii could ultimately learn that HIE

was surreptiously employing a self-help concept to receive

refunds and could compel the repayment of those refunded amounts

does not mean that the refunds are not currently reportable as

income under the all events test.    As noted by the Court in

Moritz v. Commissioner, 21 T.C. 622, 624 (1954):

     It has long been recognized that a taxpayer who keeps
     his books and reports his income on the accrual basis
     is subject to tax liability when the right to receive
     income becomes fixed. Spring City Foundry Co. v.
     Commissioner, 292 U.S. 182 (1934). The Court said in
     North American Oil Consolidated v. Burnet, 286 U.S.
     417, 424 (1932):

            If a taxpayer receives earnings under a claim
            of right and without restriction as to its
            disposition, he has received income which he
                                - 259 -

          is required to return, even though it may
          still be claimed that he is not entitled to
          retain the money, and even though he may
          still be adjudged liable to restore its
          equivalent. * * *

     Petitioners cite primarily Doyle, Dane, Bernbach, Inc. v.

Commissioner, 79 T.C. 101 (1982), for the proposition that “It is

well established that all events fixing the right to a refund do

not occur until the appropriate taxing authority has made its

determination on the issue”.    Petitioners’ reliance upon that and

the other related cases is misplaced.      In Doyle, Dane, Bernbach,

Inc., the Commissioner had argued that the taxpayer should accrue

refund income before receipt.    Here, by contrast, respondent

argues (and we agree) that HIE would have received its refund

income when it filed its Hawaii tobacco tax returns using its

self-help concept.   We also disagree with petitioners’ claim that

any of their cited cases dealing with taxability of option

payments supports their proposition.      While a degree of

uncertainty may be present about the character or taxability of

option payments when received by a taxpayer, no such uncertainty

is present here where Congress has specifically provided in

section 111 that a taxpayer that deducts a State tax on a prior

year’s return must include in the year of receipt any refund to

the extent that the deduction gave the taxpayer a tax benefit.

See also Hillsboro Natl. Bank v. Commissioner, 460 U.S. 370,
                              - 260 -

383-384 (1983); Frederick v. Commissioner, 101 T.C. 35, 41

(1993).   In addition, we note a fallacy in petitioners’ argument.

Specifically, if a State such as Hawaii has a provision similar

to the false or fraudulent return provision of section

6501(c)(1), that would allow the taxing authority to assess at

any time a tax attributable to a false or fraudulent return, then

pursuant to petitioners’ argument the refunds would never have to

be recognized absent a determination by the taxing authority.

Such would be the case because the period of limitations would

never expire to allow for an earlier recognition.

     We also are mindful that HIE’s claim to its change in the

reporting of its tobacco tax refund income was impermissibly done

without the consent of the Commissioner.   Pursuant to section

446(e) and section 1.446-1(e)(2)(i), Income Tax Regs., taxpayers

desiring to change a method of accounting, even an erroneous one,

must first obtain the Commissioner’s consent.   See Capital One

Fin. Corp. v. Commissioner, 130 T.C. 147, 164 (2008); see also

Lord v. United States, 296 F.2d 333, 335 (9th Cir. 1961) (stating

that prior consent is required because “If * * * [taxpayers] were

allowed to report income in one manner and then freely change to

some other manner, the resulting confusion would be exactly that

which was to be alleviated by requiring permission to change

accounting methods”).   The Commissioner has wide discretion to
                              - 261 -

decide whether to consent to a taxpayer’s request to change a

method of accounting, see Sunoco, Inc. & Subs. v. Commissioner,

T.C. Memo. 2004-29, and respondent has stated in these cases that

he would not now grant any such request by HIE but would require

HIE to continue accounting for its tobacco tax refund income in

1998 as it had done in prior years.     Given respondent’s lack of

consent to any such change in method of accounting by HIE, any

NOL resulting from an unauthorized change by HIE would not result

in a valid deduction of that NOL.

     Petitioners ask the Court not to consider respondent’s

argument that section 446(e) applies to HIE’s claim of its change

in its reporting of its tobacco tax refunds.    Petitioners note in

their reply brief that respondent first made this argument in his

opening posttrial brief and assert that the Court should reject

the argument as untimely because they “have been prejudiced as

they have been denied the opportunity to present any evidence

regarding whether §446 applies to the treatment of tobacco tax

refunds.”   Petitioners then spend approximately 5 pages of their

40-page reply brief arguing that HIE did not change its method of

accounting as to tobacco tax refund income or if it did that the

change either was impliedly consented to by respondent or did not

require the consent of respondent.    We do not believe that

petitioners are prejudiced by our consideration of respondent’s
                              - 262 -

argument as we do.   A taxpayer changes its method of accounting

when it changes either the “overall plan of accounting for gross

income or deductions” or “the treatment of any material item used

in such overall plan”, and a “material item is any item which

involves the proper time for the inclusion of the item in income

or the taking of a deduction.”   Sec. 1.446-1(e)(2)(ii)(a), Income

Tax Regs.; see also Wayne Bolt & Nut Co. v. Commissioner, 93 T.C.

500, 510 (1989).   HIE’s claim of its change in its reporting of

its tobacco tax refunds would have been such a change in method

of accounting requiring the prior consent of the Commissioner,

see, e.g., Capital One Fin. Corp. v. Commissioner, supra; Bank

One Corp. v. Commissioner, 120 T.C. 174, 282-283 (2003), affd. in

part and vacated in part sub nom. J P Morgan Chase & Co. v.

Commissioner, 458 F.3d 564 (7th Cir. 2006), and no additional

evidence that petitioners may have included in the record as to

this matter would have changed the fact that HIE never obtained

the requisite consent for such a change.61   We also note that

petitioners have not specifically set forth any reliable

testimony or document that they would have introduced into

evidence as to this matter or to support their assertion that


     61
      We disagree with petitioners’ assertions that respondent
impliedly consented to any such change or that such a change did
not require the consent of respondent because of the criminal
investigation.
                               - 263 -

they “have been prejudiced as they have been denied the

opportunity to present any evidence regarding whether §446

applies to the treatment of tobacco tax refunds.”

IV.   Bad Debt Deduction

      HIE claimed on its 199806 Federal income tax return that it

was entitled to deduct a bad debt of $905,340 with respect to an

amount recorded in HIE’s records as “Due From Trustee, JSL”.

Respondent determined in part that this deduction was improper

because HIE did not have a debtor/creditor relationship with Jin

Sook Lee.62   Respondent also determined that the deduction was

improper because HIE did not substantiate the accuracy of the

amount of the debt or the debt’s worthlessness.

      Petitioners argue that HIE is entitled to this deduction.

As for the requisite debtor/creditor relationship, petitioners

contend that Michael Boulware, on behalf of HIE, transferred the

money to Jin Sook Lee in her capacity as trustee of the Glenn Lee

Boulware Trust to hold in trust for HIE while HIE accumulated



      62
      Respondent also disallowed deductions for bad debts of
$300,000, $1 million, $700,000 and $700,000 for 199306, 199406,
199506, and 199706, respectively, in reduction of NOLs. HIE
claimed these deductions on the basis of its position that it was
unable to recover portions of approximately $6.7 million involved
in the JSL litigation. The $905,340 deduction at issue arose
from the same purported debt after the parties in the various
bankruptcy proceedings involving Jin Sook Lee settled those
proceedings.
                               - 264 -

enough funds to redeem Mal Sun Boulware’s marital interest in

HIE.    Petitioners point the Court to the State court’s holding in

the JSL litigation that “There is a binding agreement between

Plaintiff [Jin Sook Lee], [Michael] Boulware and HIE for

Plaintiff to hold monies belonging to HIE to pay Mal Sun Boulware

for her marital interest in HIE” and contend that the decision in

that proceeding is binding on this Court, or at least the most

persuasive evidence of the status in which Jin Sook Lee held the

funds.    Petitioners also argue that respondent was a party to Jin

Sook Lee’s bankruptcy proceeding and thus is bound by the

decision there.

       We agree with petitioners that HIE is entitled to deduct a

$905,240 bad debt for 199806, but we do so for other reasons.

Section 166 allows a taxpayer to deduct a bad debt under that

section where the taxpayer establishes:     (1) A valid

debtor-creditor relationship, (2) a bona fide debt created or

acquired in connection with a trade or business, (3) the amount

of the debt, (4) the worthlessness of the debt, and (5) the year

in which the debt became worthless.      See sec. 1.166-1, Income Tax

Regs.; see also Franchise Tax Bd. v. MacFarlane, 83 F.3d 1041,

1045 (9th Cir. 1996).

       HIE claims the bad debt deduction on the basis of the State

court’s finding in the JSL litigation that Jin Sook Lee held
                                - 265 -

property belonging to HIE.    Contrary to petitioners’ assertion,

we do not consider ourselves bound by the decision in the State

court proceeding as to the characterization of the disputed

funds.    See United States v. Boulware, 384 F.3d at 805.63   Nor do

we consider ourselves bound on this issue by anything that

occurred during Jin Sook Lee’s bankruptcy proceedings.    We find

in the record no indication that the bankruptcy court inquired

into either the specifics or the merits of Jin Sook Lee’s Federal

income tax liability in the process of confirmation, so as to

give the United States any incentive to participate actively in

the proceedings in that court.    See United States v. Berman, 884

F.2d 916, 922-923 (6th Cir. 1989) (noting that collateral

estoppel may not apply to a party who lacked an incentive to

litigate in the first trial).    In fact, the United States

apparently lacked any incentive to challenge the proceedings in

the bankruptcy court in that Jin Sook Lee’s Federal income tax

liability was set and secured.

     As we view the credible evidence before us, Michael Boulware

diverted the disputed funds from HIE for his personal benefit,


     63
      We also note that neither respondent nor the United States
was a party to (or effectively represented in) the JSL
litigation.   See United States v. Mendoza, 464 U.S. 154, 158
(1984); Commissioner v. Estate of Bosch, 387 U.S. 456, 463
(1967); cf. Robinson v. Commissioner, 102 T.C. 116, 129-133
(1994), affd. on this issue 70 F.3d 34 (5th Cir. 1995).
                               - 266 -

and he did not transfer those funds to Jin Sook Lee to hold as a

trustee for either him or HIE.    In fact, Michael Boulware’s

counsel, Michael McCarthy, had informed Michael Boulware before

the times of any of the relevant transfers that it was

inappropriate for Michael Boulware to transfer any HIE assets to

Jin Sook Lee for her to hold for his divorce from Mal Sun

Boulware, and Michael Boulware by his own admission clearly

understood from his conversations with Michael McCarthy that it

was neither proper nor wise for Michael Boulware to give HIE’s

property to Jin Sook Lee to hold for that purpose.    In addition,

HIE’s controller, Merwyn Manago, was unaware of any money that

Jin Sook Lee owed HIE before June 30, 1992, and did not even know

of Jin Sook Lee until more than a year after that date.

       We consider incredible petitioners’ story that Michael

Boulware on behalf of HIE transferred the funds to Jin Sook Lee

to safeguard the funds from dissipation for an ultimate return to

HIE.    Why would Michael Boulware stealthily have to give the

funds to his mistress for accumulation, let alone with no

interest being earned on those funds?    Why would Michael Boulware

have gone to such great lengths to establish the Glenn Lee

Boulware Trust formally in order to protect assets transferred to

the trust for the benefit of his oldest son, while not taking any

similar formal action to protect a dissipation of the disputed
                                 - 267 -

funds?      Why did Michael Boulware not allow HIE’s controller to be

aware of the transfers so that the funds were reported on HIE’s

books and records?64     Why would Michael Boulware through a promise

collateralized by HIE’s vending machines agree to repay Jin Sook

Lee $1.2 million for inappropriately taking the Koloa house from

her?    Why would Michael Boulware have given Jin Sook Lee an HIE

check for $840,000 when she demanded from him that he return to

her the money of hers that he had stolen from her safe?     Why

would Michael Boulware have asked Jin Sook Lee to lend him

$200,000 to use in his divorce from Mal Sun Boulware?     The jury

in the criminal trials apparently rejected any characterization

of the funds as loans between HIE and Jin Sook Lee, and we reject

that characterization as well.     Michael Boulware and Jin Sook

Lee, as they showed through both their words and actions,

believed those funds to be hers.65

       64
      As to this point, we do know that Merwyn Manago would not
have approved of any transfer of HIE funds to Jin Sook Lee to
hold and safeguard the funds for Michael Boulware’s divorce from
Mal Sun Boulware, had Merwyn Manago known about the transfer at
the time of the transfer.
       65
      In other words, as stated supra p. 69 in our findings of
fact, we find that Michael Boulware diverted the disputed assets
from HIE for his personal use in that he then gave the assets to
Jin Sook Lee to use or spend the assets as she desired (but with
his wish, but not his requirement, that she use or spend the
assets for the common benefit of him, her, and their children).
By diverting the money as he did, Michael Boulware stealthily
reduced the apparent value of HIE for purposes of determining how
                                                    (continued...)
                               - 268 -

     We are mindful, however, that the State court entered a

judgment in the JSL litigation that required that Jin Sook Lee

pay $4,551,931 to HIE.    Respondent sets forth no persuasive

argument that this judgment was invalid or unenforceable, and we

find that Jin Sook Lee was required by the judgment to pay HIE

$4,551,931.   We also find that HIE and Jin Sook Lee during the

latter’s bankruptcy case settled her liability for the $4,551,931

by her promise to pay to HIE a lesser amount and that their

settlement resulted in $905,340 of the $4,551,931 becoming

worthless in 199806.    The State court judgment establishes that

HIE and Jin Sook Lee’s relationship as to the $4,551,931 was that

of a debtor and a creditor and that the debt was a bona fide

business debt of HIE.    Given that the record also demonstrates

that $905,340 of the debt became worthless during 199806, we

sustain HIE’s deduction of that amount as a bad debt for 199806.

See sec. 1.166-2(c)(2), Income Tax Regs.




     65
      (...continued)
much he would have to pay Mal Sun Boulware for her share of the
corporation. Michael Boulware also disguised gifts to Jin Sook
Lee for which he presumably would be liable for the payment of a
significant amount of Federal gift tax. Federal gift tax is
imposed on transfers of property by gift by any individual during
a calendar year, whether the transfer is in trust or otherwise
and whether the gift is direct or indirect. See secs. 2501(a),
2511(a).
                                - 269 -

V.    Professional Fees

     A.   Overview of Dispute

     In the NODs issued to Holdings and to HIE, respondent

determined that the subject corporations are entitled to deduct

only some of the professional fees they seek to deduct.    The

parties dispute whether the subject corporations may deduct

certain professional fees that respondent has declined to allow

as deductions.   Respondent argues that the fees are not

deductible for various reasons.    First, respondent argues that

HIE has failed to establish that it incurred fees paid by

Holdings.   Second, respondent argues that petitioners have not

substantiated all of the fees.    Third, respondent argues that

some fees were Michael Boulware’s personal expenses and were not

an ordinary and necessary business expense of either subject

corporation.   Fourth, respondent argues that some fees related to

Jin Sook Lee’s bankruptcy proceedings are nondeductible because

they are capital expenditures.    Petitioners argue that HIE has

established that it incurred fees paid by Holdings, that all fees

claimed deductible by the subject corporations are substantiated,

that all of the fees were ordinary and necessary business

expenses, and that none of the fees related to Jin Sook Lee’s

bankruptcy proceedings are capital expenditures.    Petitioners

also argue that certain fees are deductible under certain
                               - 270 -

corporate and State statutory provisions.   Petitioners do not

argue, nor do we find, that any of the fees were deductible by

the corporations because at the time they were incurred they were

intended to be compensation to Michael Boulware.   See Neonatology

Associates, P.A. v. Commissioner, 115 T.C. at 92 (stating that

payments are deductible as compensation only if the payor intends

at the time that the payment is made to compensate the recipient

for services performed; see also Paula Constr. Co. v.

Commissioner, 58 T.C. 1055, 1058-1059 (1972), affd. without

published opinion 474 F.2d 1345 (5th Cir. 1973).

     B.   Applicable Law in General

           1.   Deduction of Ordinary and Necessary Business
                Expenses

     Section 162(a) provides that “There shall be allowed as a

deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business”.   The regulations prescribed under section 162 clarify

that only those ordinary and necessary business expenses

“directly connected with or pertaining to the taxpayer’s trade or

business” may be deducted.   Sec. 1.162-1(a), Income Tax Regs.

     Professional fees may qualify as an ordinary and necessary

expense of a business.   See Commissioner v. Tellier, 383 U.S.

687, 689-690 (1966); Bingham’s Trust v. Commissioner, 325 U.S.
                                - 271 -

365, 374 (1945); Guill v. Commissioner, 112 T.C. 325, 328-329

(1999).   Whether a professional fee qualifies as such is

generally a question of fact.    See Commissioner v. Heininger,

320 U.S. 467, 475 (1943).    In order to be “necessary”, the fee

must be “appropriate and helpful” to the development of the

taxpayer’s business.    See Commissioner v. Tellier, supra at 689;

Welch v. Helvering, 290 U.S. at 113-115.     In order to be

“ordinary”, the expense must be “normal, usual, or customary” in

the type of business involved.    See Deputy v. du Pont, 308 U.S.

at 495-496; see also Welch v. Helvering, supra at 113-115.

            2.   Corporate Taxpayer’s Burdens Underlying Deduction

     A corporate taxpayer’s deduction for professional fees is a

matter of legislative grace, and the corporation bears the burden

of proving its entitlement to the deduction.    See Commissioner v.

Natl. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149

(1974); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934); see also Boyd Gaming Corp. v. Commissioner, 177 F.3d

1096, 1098 (9th Cir. 1999), revg. on another issue T.C. Memo.

1997-445.    That burden extends not only to the professional fees

the corporation claims on its Federal income tax returns but also

to any professional fee that the corporation first claims as a

deduction after the Commissioner has issued to the corporation a

notice of deficiency for the year of the claimed deduction.    See
                              - 272 -

Lawler v. Commissioner, T.C. Memo. 1995-26.   In the case of a

deduction for professional fees claimed by a corporate taxpayer

such as HIE or Holdings, the corporation, like any other

taxpayer, is required by the Internal Revenue Code to maintain

sufficient records to substantiate that deduction.     See sec.

6001; New Colonial Ice Co. v. Helvering, supra at 440.

          3.   Payment of Another Taxpayer’s Expense

     A taxpayer generally may not deduct the payment of another

person’s expense.   See Deputy v. du Pont, 308 U.S. 488 (1940);

Dietrick v. Commissioner, 881 F.2d 336 (6th Cir. 1989), affg.

T.C. Memo. 1988-180; Lohrke v. Commissioner, 48 T.C. 679 (1967);

cf. Betson v. Commissioner, 802 F.2d 365, 368 (9th Cir. 1986)

(shareholder’s payment of corporate obligation is not ordinary

and necessary under section 162(a)), affg. T.C. Memo. 1984-264.

In limited cases, however, the taxpayer may be entitled to deduct

the other person’s expense upon the satisfaction of a two-prong

test.   See Lohrke v. Commissioner, supra at 688.    The analysis as

to whether a taxpayer may deduct the taxpayer’s payment of the

other person’s expense is essentially the same whether the payor

is an individual or a corporation.   See, e.g., Capital Video

Corp. v. Commissioner, 311 F.3d 458 (1st Cir. 2002), affg.

T.C. Memo. 2002-40; Hood v. Commissioner, 115 T.C. 172 (2000);

Bemidji Distrib. Co. v. Commissioner, T.C. Memo. 2001-260, affd.
                                - 273 -

sub nom. Langdon v. Commissioner, 59 Fed. Appx. 168 (8th Cir.

2003); Norman E. Duquette, Inc. v. Commissioner, T.C. Memo.

2001-3.   Given our findings that the subject corporations paid

the expenses of the attorneys and other professionals who

represented those corporations’ controlling shareholder, Michael

Boulware, in his defense of criminal income tax and false

statement charges brought against him (including the appeals of

his ensuing convictions), in civil litigation, and in various

other matters, we apply that two-prong test here to many of the

fees in dispute.

                a.   First Prong of Two-Prong Test

     Under the first prong of the two-prong test, the taxpayer

must have paid the other person’s expense primarily to benefit

its business, with the receipt by the other person of any benefit

from the payment being merely incidental.    See Capital Video

Corp. v. Commissioner, supra.    Where, as here, the payor and the

beneficiary of the payment are a corporation and a controlling

shareholder, the corporation’s payment of the shareholder’s

expense is closely scrutinized, and the showing of the primary

benefit to the corporation must be strong.    See Hood v.

Commissioner, supra at 179, 181.

     Generally, the first prong is more likely to be satisfied if

the shareholder is unable to pay the expense, thus requiring the
                              - 274 -

corporation to pay the expense in order to protect its own

interests.   See Square D Co. v. Commissioner, 121 T.C. 168, 200

(2003); cf. Dietrick v. Commissioner, supra at 339 (stating that

the first prong requires a finding of “‘a clear proximate danger

to the taxpayer and ... a payment made to protect an existing

business from harm’” and “Where the taxpayer fails to demonstrate

‘a direct nexus between the purpose of the payment and the

taxpayer’s business or income producing activities,’ the

deduction will not be allowed” (quoting Young & Rubicam, Inc. v.

United States, 187 Ct. Cl. 635, 410 F.2d 1233, 1243 (1969) and

Lettie Pate Whitehead Found., Inc. v. United States, 606 F.2d

534, 538 (5th Cir. 1979)).   The potential harm for which a

business is protected through the payment of the other person’s

expense must be direct and proximate.   See Hood v. Commissioner,

supra at 181 (holding that corporation could not deduct the

payment of its sole shareholder’s legal fees where it did not

appear that the corporation’s failure to pay the legal fees would

have caused it to go out of business);66 see also AMW Invs., Inc.


     66
      In Hood v. Commissioner, 115 T.C. 172 (2000), the
corporation had paid the legal expenses of its sole shareholder
who had been indicted for tax evasion. Although the shareholder
was “indispensable” to the corporation’s business, the Court held
that the expenses were not deductible by the corporation. The
Court stated that the record failed to establish that the
shareholder was unable to pay his legal expenses or that the
                                                    (continued...)
                               - 275 -

v. Commissioner, T.C. Memo. 1996-235 (holding that the corporate

taxpayer could not deduct legal fees incurred as to the sole

shareholder’s criminal tax violations where the corporation was

not a defendant in the criminal proceeding and was not under the

threat of prosecution or forfeiture).

                b.   Second Prong of Two-Prong Test

     Under the second prong of the two-prong test, the expense

must be an ordinary and necessary expense of the payor’s trade or

business.   See Capital Video Corp. v. Commissioner, supra at 464.

Whether the legal expenses of a controlling shareholder/employee

are such an ordinary and necessary expense may bring into play

the well established “origin and character of the claim” test of

United States v. Gilmore, 372 U.S. 39, 49 (1963).67   There, the

U.S. Supreme Court stated that “the origin and character of the

claim with respect to which an expense was incurred, rather than

its potential consequences upon the fortunes of the taxpayer, is

the controlling basic test of whether the expense was ‘business’

or ‘personal’ and hence whether it is deductible or not”.   Id. at

     66
      (...continued)
corporation “would have ceased operations if it did not pay the
legal fees”; thus, the shareholder was deemed the primary
beneficiary of the payment of his legal fees. Id. at 178, 181.
     67
      Petitioners argue that the origin of the claim test has no
applicability where, as here, the payors are corporations as
opposed to individuals. We disagree with such a narrow
interpretation.
                              - 276 -

49.   Thus, if the origin of the legal action is not in the

business activity of the taxpayer, the taxpayer may not deduct

the taxpayer’s payment of legal fees.    See id.   Nor are legal

expenses deductible under the origin and the character of the

claim test simply because the payor faces liability or acts to

prevent such liability.   As noted by the U.S. Supreme Court in

United States v. Gilmore, supra at 46-47 (quoting Lykes v. United

States, 343 U.S. 118, 125-126 (1952)):

           “Legal expenses do not become deductible merely
      because they are paid for services which relieve a
      taxpayer of liability. That argument would carry us
      too far. It would mean that the expense of defending
      almost any claim would be deductible by a taxpayer on
      the ground that such defense was made to help him keep
      clear of liens whatever income-producing property he
      might have. For example, it suggests that the expense
      of defending an action based upon personal injuries
      caused by a taxpayer’s negligence while driving an
      automobile for pleasure should be deductible. * * *

                *    *    *    *    *     *    *

      * * * It is not a ground for . . . [deduction] that the
      claim, if justified, will consume income-producing
      property of the defendant.” * * *

      A taxpayer’s payment of legal fees to defend criminal

charges may be deductible under section 162 if the charges found

their source in the taxpayer’s business activities; i.e., the

crime is directly connected to the taxpayer’s business.    In

Commissioner v. Tellier, 383 U.S. 687 (1966), for example, the

U.S. Supreme Court held that legal fees paid to defend the
                              - 277 -

taxpayer from criminal charges for securities fraud were

deductible where the taxpayer was a securities dealer.   Likewise,

in Commissioner v. Heininger, 320 U.S. 467 (1943), the U.S.

Supreme Court held that legal fees paid to defend the taxpayer

from mail fraud could be a business expense of the taxpayer’s

mail-order business.   Accord O’Malley v. Commissioner, 91 T.C.

352, 363, 366 (1988) (direct connection between the crime

(bribery of a politician concerning deregulation of the trucking

industry) and the individual taxpayer’s business (trucking));

Johnson v. Commissioner, 72 T.C. 340, 348 (1979) (direct

connection between crime of conspiracy to defraud the Government

and business of illegal tax refund schemes).

     Where the crime is not directly connected with a

corporation’s business, e.g., the crime arose out of the

shareholder’s activities and not out of the corporation’s profit-

making activities, the corporation may not deduct its payment of

legal fees to defend criminal charges brought against its

shareholder.   See Deputy v. du Pont, 308 U.S. at 497 (holding

that expenses were not “ordinary and necessary” business expense

although the expenses benefited the business).   For example, in

Nw. Ind. Tel. Co. v. Commissioner, 127 F.3d 643 (7th Cir. 1997),

affg. T.C. Memo. 1996-168, the corporate taxpayer paid the costs

of litigation to defend against an FCC action in which the
                              - 278 -

corporation was named.   The courts held that the corporation

could not deduct the costs because the claim originated not in

the corporation’s profit-making activities but in the nonbusiness

actions of the corporation undertaken for the benefit of its

controlling shareholder.   See O’Malley v. Commissioner, supra at

358-361; AMW Invs., Inc. v. Commissioner; T.C. Memo. 1996-235;

see also Jack’s Maint. Contractors, Inc. v. Commissioner, 703

F.2d 154, 156 (5th Cir. 1983) (holding that corporate taxpayer

could not deduct sole shareholder’s legal fees for tax evasion

because the fees were a “personal” and not business expense),

revg. T.C. Memo. 1981-349;68 Peters, Gamm, West & Vincent, Inc. v.

Commissioner, T.C. Memo. 1996-186 (holding that securities firm

corporation could not deduct criminal legal fees of principal

indicted for insider trading because the legal expenses were

incurred defending a claim which had its origin in a transaction

that was not part of the corporation’s business).

     C.   Whether HIE Incurred Any of the Disputed Expenses

     Respondent argues that HIE may not deduct many of the

professional fees at issue because it failed to establish that it



     68
      Following the reversal of this Court’s decision in Jack’s
Maint. Contractors, Inc. v. Commissioner, T.C. Memo. 1981-349,
revd. 703 F.2d 154 (5th Cir. 1983), we decided to adopt the logic
espoused by the U.S. Court of Appeals for the Fifth Circuit in
reversing us. See Hood v. Commissioner, 115 T.C. 172 (2000).
                               - 279 -

incurred these fees.    To that end, respondent asserts, Holdings

paid most of the fees and HIE has not shown that it was indebted

to Holdings as to any of those payments.    We disagree.   We are

satisfied on the record before us that Holdings and HIE had a

firm understanding that Holdings would pay the fees and then seek

reimbursement from HIE to the extent that the fees were paid on

behalf of HIE.   While Holdings may not have sought from HIE the

exact amount of professional fees that benefited HIE, we are

satisfied that the allocation method designed and employed by the

management of the corporations generally reached that end, and we

decline respondent’s invitation to second-guess or otherwise to

disturb that method.    See Boyd Gaming Corp. v. Commissioner,

177 F.3d 1096 (9th Cir. 1999); Californians Helping to Alleviate

Med. Problems, Inc. v. Commissioner, 128 T.C. 173, 185-186

(2007); Metrocorp, Inc. v. Commissioner, 116 T.C. 211, 224-225

(2001).   Thus, with the exception of the specific expenses that

we state infra were not incurred by HIE, we conclude that the

expenses that petitioners claim are deductible by HIE were in

fact incurred by HIE.

     In seeking a contrary conclusion, respondent stresses the

fact that each of the subject corporations is a distinct entity

that files a separate tax return.    Although such is so, the fact

of the matter is that the corporations were controlled by a
                                - 280 -

common shareholder and he and the rest of the management decided

from a business point of view that it was best to have Holdings

pay all of the costs and then seek reimbursement from HIE.   We

also note that respondent did not invoke his power under section

482 to reallocate such expenses, nor does he suggest an alternate

allocation that would more fairly apportion the expenses between

HIE and Holdings.   See Maxwell Hardware Co. v. Commissioner,

343 F.2d 713 (9th Cir. 1965), revg. Beckett v. Commissioner,

41 T.C. 386 (1963).

     D.   Whether All Expenses Were Substantiated

     Respondent also determined that some of the professional

fees were nondeductible because they were unsubstantiated.   For

the most part, we disagree.69   The record includes voluminous

documentary and testimonial evidence that substantiates to our

satisfaction most of the professional fees petitioners claimed as

deductible.   The documentary evidence includes invoices, ledgers,

and checks.   The testimonial evidence includes the testimony of

many of the professionals themselves.

     Moreover, both parties agree that the subject corporations

hired attorneys, accountants, and other professionals in



     69
      We agree with respondent that petitioners have failed to
substantiate certain fees included in the “other fees” category.
Those expenses are specifically identified infra p. 282.
                               - 281 -

connection with several ongoing and legitimate business matters

and that some of those expenses are “ordinary and necessary

business expenses by some entity”.   The services underlying those

expenses include the preparation of tax returns, lease issues,

tax advice and consultation (including HIE’s tobacco tax

liability), corporate resolutions and minutes, a corporate

reorganization, labor and employment issues, pension fund issues,

class action tobacco lawsuit filed by Hawaii, and general

business and corporate advice.   While respondent has reservations

as to which of the two corporate petitioners is entitled to be

treated as having incurred the specific portions of the expenses,

we do not have similar reservations.     As just mentioned, we

believe that the allocations advocated by petitioners are bona

fide and valid.

     E.   “Fees Accepted as Ordinary and Necessary” and “Other
          Fees”

     Given our disagreement with respondent’s arguments that HIE

failed to establish that it incurred any professional fees and

that petitioners failed to substantiate various professional

fees, we proceed to analyze further the deductibility of the

expenses listed in appendix C as “Fees Accepted as Ordinary and

Necessary” and “Other Fees”.   We conclude that all of the fees

listed in the former category are deductible as petitioners
                                 - 282 -

asserted.    As to the latter category, we conclude that

petitioners have failed to substantiate and otherwise establish

their entitlement to deduct any of the expenses for the following

professionals:    Accucopy, Case Bigelow, GMK Consulting, King

King, Laird Christianson, Robert Holland, Yoshida, Inc., Other

Legal, Lorin Kushiyama, Richard Kitagawa, TRI Pac, Vending

Consulting, and Watson Wyatt.70    On the other hand, we conclude

that the expenses in the “Other Fees” category for the following

professionals are deductible as petitioners asserted (and as

modified by statements infra note 71):     Amortization, Damon Key,

Foley Jones, Louis Wai, Michael McCarthy, Nathan Suzuki, Henry

Yokogawa, and Kobayashi Doi.71

     F.     Expenses of Michael Boulware’s Criminal Defense

            1.   Background

     With respect to the professional fees listed in appendix C

in the categories of “Criminal Investigation”, “Grand Jury


     70
      The subject corporations may not deduct the expenses
corresponding to GMK Consulting because we find that those
expenses are solely the personal expenses of Michael Boulware.
     71
      The subject corporations may not deduct $712.49 for Damon
Key because we find that this expense is solely the personal
expense of Michael Boulware. (The $712.49 related to the
personal estate planning services that Damon Key provided to
Michael Boulware.) The subject corporations may deduct
two-thirds of the expense for Louis Wai; the remaining one-third
is not deductible by those corporations because it is the
personal expense of Michael Boulware.
                              - 283 -

Proceedings” and “Criminal Trial”, respondent determined that

neither HIE nor Holdings may deduct those fees because the fees

were personal to Michael Boulware.   In support of this

determination, respondent asserts as a factual matter that

neither HIE nor Holdings was a target of the criminal

investigation or the grand jury proceedings.   We disagree with

this assertion.   The record persuades us, and we find as a fact,

that both corporations, through their management and counsel,

reasonably believed (and were so informed by the Government) that

while Michael Boulware (and not either subject corporation) was

the focus of the criminal and grand jury investigations, they

(HIE and Holdings) could eventually become targets of the

criminal investigation and grand jury proceedings.    Moreover, the

criminal investigation and grand jury proceedings entailed

examination and scrutiny of HIE’s tax returns, and in addition to

the risk of criminal liability, HIE faced civil tax exposure from

the investigations and criminal trial.   The possibility that HIE

or Holdings could become a target of those criminal

investigations even continued after the indictment of Michael

Boulware, e.g., the Government informed the U.S. District Court

hearing the criminal case that HIE could still be indicted in the

matter as a codefendant.
                              - 284 -

          2.   Expenses Stemmed From Personal Pursuits

     The fact that these fees may have benefited both Michael

Boulware and the corporations, however, does not mean that the

fees are deductible by the corporations.   To the contrary, we

find that petitioners have generally failed to establish that the

corporations paid the referenced legal expenses of Michael

Boulware for the primary benefit of the corporations.72   In fact,

we find that the subject corporations incurred most of the

professional fees deducted by the corporate petitioners for the

primary benefit of their controlling shareholder, Michael

Boulware, and that those fees were Michael Boulware’s personal

expenses.73


     72
      As we have indicated in our findings supra, the subject
corporations retained professionals in connection with collateral
matters attendant to Michael Boulware’s criminal proceedings as
they affected the corporations, e.g., responding to subpoenas and
moving to quash the subpoenas; representing and assisting
employees and directors of HIE who were called as witnesses; tax
advice concerning the implications of the criminal trial. As
discussed infra, we conclude that the subject corporations are
entitled to deduct those portions of the professional fees
attributable to Michael Boulware’s criminal proceedings.
     73
      Petitioners argue that respondent is judicially estopped
from asserting that none of the fees of Reinwald O’Connor are
business expenses of HIE. To that end, petitioners state,
respondent moved in Michael Boulware’s criminal case to
disqualify Reinwald O’Connor because it also represented HIE. We
disagree with petitioners’ argument. To say the least, Reinwald
O’Connor was disqualified in the criminal case because Dennis
O’Connor, as HIE’s attorney, represented Merwyn Manago, a key
Government witness.
                              - 285 -

     We consider the origin and character of the applicable claim

to be respondent’s investigation of crimes that Michael Boulware

may have committed with respect to his personal income taxes.

That investigation centered on whether Michael Boulware, as a

result of his failure to file timely personal Federal income tax

returns, failed to report and pay Federal income tax on large

amounts of gross income realized by and taxable to him.    The

professionals were hired primarily to serve Michael Boulware and

his personal interest in staying out of prison.   The origin of

the criminal investigation is thus traced most directly to the

personal pursuits of Michael Boulware, independent of HIE’s

operation of a trade or business.   In addition, HIE had no need

to pay Michael Boulware’s professional fees in order to stay in

its business.   On the basis of the record at hand, we find that

Michael Boulware could have paid those expenses himself.

      As stated supra, the subject corporations are entitled to

deduct expenses that are attributable to collateral matters

attendant to Michael Boulware’s criminal proceedings as they

affected the corporations.   We list those expenses as follows:

     1.   All of the $5,000 paid to Benjamin Cassidy in 199806.

     2.   One-half of the $331,653.46 for services in 199806 that

Shiotani Inouye (or its Kovel accountant Nathan Suzuki) provided
                                - 286 -

to Michael Boulware and HIE jointly in connection with the

criminal investigation.

     3.    One-half of the $3,986.95 for services in 199806 that

Wachi Watanabe provided to Michael Boulware and HIE jointly in

connection with the criminal investigation.

     4.    All of the $5,000 paid to Birney Bervar for 200106.

     5.    All of the   $13,049.23, $7,712.85, and $4,532.77 paid to

Brook Hart during 199806, 199906, and 200006, respectively.

     6.    All of the $2,806.88 paid to Kevin Chee and Chee Markham

for their services in 200006.

     7.    All of the $1,492.09 for services in 199806 that Damon

Key provided to HIE in connection with the grand jury

proceedings.

     8.    One-half of the $56,848.50 and $65,403.96 for services

in 199806 and 199906 that Graham James provided to Michael

Boulware and HIE jointly in connection with the grand jury

proceedings.

     9.    All of the $13,579.50 for services in 200006 that Lopeti

Foliaki provided to Nathan Suzuki in connection with the grand

jury proceedings.

     10.    One-half of the $44,480.01 for services in 200006 that

Perkin Hosoda provided to Michael Boulware and HIE jointly in

connection with the grand jury proceedings.
                              - 287 -

     11.   One-half of the $353,348.98 and $307,988.61 for

services in 199806 and 199906 that Reinwald O’Connor provided to

Michael Boulware and HIE jointly in connection with the grand

jury proceedings.

     12.   One-half of the $224,581.69 for services in 199906 that

Shiotani Inouye (or its Kovel accountant Nathan Suzuki) provided

to Michael Boulware and HIE jointly in connection with the grand

jury proceedings.

     13.   All of the $15,117.06, $8,111.50, and $24,749.15 for

services in 199806, 199906, and 200006, respectively, that

Stephen Pingree provided to Nathan Suzuki in connection with the

grand jury proceedings.

     14.   One-half of the $17,486.87 for services in 199806 that

Wachi Watanabe provided to Michael Boulware and HIE jointly in

connection with the grand jury proceedings.

     15.   All of the $4,864.74 for services in 200206 that Brook

Hart provided to Merwyn Manago in connection with Michael

Boulware’s first criminal trial.

     16.   All of the $25,154.47 and $9,343.61 for services in

200106 and 200206, respectively, that McCorriston Miller provided

to Nathan Suzuki in connection with his criminal prosecution by

the United States.
                                - 288 -

     17.    One-half of the $17,500 for services performed by

Nathan Suzuki as a Kovel accountant.

     18.    One-half of the $102,672.10 for services in 200006 that

Shiotani Inouye (or its Kovel accountant Nathan Suzuki) provided

to Michael Boulware and HIE jointly in connection with Michael

Boulware’s first criminal trial.

     19.    One-half of the $82,103.66 for services in 200106 that

Shiotani Inouye provided to Michael Boulware and HIE jointly in

connection with Michael Boulware’s first criminal trial.

     20.    One-half of the $12,604.03 for services in 200206 that

Shiotani Inouye provided to Michael Boulware and HIE jointly in

connection with Michael Boulware’s first criminal trial.

     G.     Professional Fees Related to Civil Litigation Initiated
            by Jin Sook Lee

             1.   Overview

     In the NOD issued to HIE, respondent determined that a

portion of the professional fees relating to the civil litigation

initiated by Jin Sook Lee was nondeductible capital expenditures

because that portion of the fees was incurred to recover certain

assets from Jin Sook Lee’s bankruptcy estate.     Those assets were

identified as the Punahou condominium, the Atkinson condominium,

an interest in the Makaiwa house, a Rolls Royce, and jewelry and

furs.     Respondent also determined in that NOD that HIE could
                                  - 289 -

deduct 50 percent of the substantiated, noncapital professional

fees as valid business expenses but could not deduct the

remaining 50 percent of these expenditures in that they were the

personal expenses of Michael Boulware.       Respondent argues that

the latter 50 percent of professional fees were the personal

expenses of Michael Boulware because they primarily benefited

him.

       We disagree with respondent that the professional fees

determined to be capital expenditures are in fact nondeductible

capital expenditures.       We agree with respondent, however, that

the fees benefited Michael Boulware to the extent of 50-percent

and to that extent are nondeductible by HIE.

            2.   Analysis

                  a.   Fees Determined To Be Capital Expenditures

       The cost of defending or perfecting title to property is a

capital expenditure that is not deductible as an ordinary and

necessary business expense under section 162(a).       See sec.

1.263(a)-2(c), Income Tax Regs.       Respondent determined that the

subject fees fall within this category because they were incurred

in connection with recovering the referenced assets from Jin Sook

Lee’s bankruptcy estate.       We disagree with this determination.

From a factual point of view, we find that HIE incurred these

fees not to defend or perfect HIE’s title in the referenced
                                - 290 -

assets but to collect the monetary judgment that the State court

had awarded to HIE in the JSL litigation.    To be sure, the jury

in the JSL litigation found that the Atkinson condominium, the

Punahou condominium, and the Makaiwa house were not in fact owned

by HIE.    On the basis of our finding, we conclude that the

referenced fees are deductible as the ordinary and necessary

expenses of HIE’s business.    See MacMillan v. Commissioner,

14 B.T.A. 1367 (1929); see also Vincent v. Commissioner, 219 F.2d

228, 231 (9th Cir. 1955) (legal expenses incurred to recover

assets from faithless fiduciary are deductible), revg. 18 T.C.

339 (1952); Nelson v. Commissioner, T.C. Memo. 2000-212

(taxpayer’s raising issue over his ostensible title to assets to

leverage settlement with true owners thereof did not render the

litigation fees a capital expenditure).

                 b.   Fees Determined To Be Michael Boulware’s
                      Personal Expenses

       The usual and expected response of a corporate taxpayer that

is sued or otherwise comes under legal attack is to hire legal

counsel to defend corporate assets and interests.    Thus, such

expenses of representation are generally characterized as

ordinary and necessary business expenses deductible under section

162.    Where as here, however, the expenses are incurred for the

equal benefit of a corporation and its sole shareholder, the
                               - 291 -

expenses are not deductible entirely by the corporate payor but

must be apportioned between the corporation and its shareholder

to reflect the reality of the situation.

     Respondent determined that the expenses related to the

litigation initiated by Jin Sook Lee benefited HIE and Michael

Boulware in equal amounts.    We agree that an equal allocation of

those expenses to HIE and Michael Boulware is appropriate under

the facts of these cases.    As to HIE, Jin Sook Lee was seeking

through that litigation to obtain a monetary judgment against

HIE, the removal of members of HIE’s board of directors, and the

appointment of a receiver to operate HIE.    As to Michael

Boulware, Jin Sook Lee was seeking an award of 50 percent of the

stock in HIE and a judgment ordering him to repay personally to

her the $1.2 million reflected in the note that he had given her;

she also alleged that he alone stole the cash and Koloa house

from her.   In addition, Jin Sook Lee commenced the JSL litigation

against both Michael Boulware and HIE, she sought an award

against each of them jointly, and both Michael Boulware and HIE

joined in the countercomplaint filed against her.    While HIE’s

board of directors formally decided that HIE should pay for the

legal expenses associated with the trust case (including Michael

Boulware’s counterpetition therein) and the shareholder

derivative case (to the extent of the defense of Michael
                                - 292 -

Boulware, Sidney Boulware, Merwyn Manago, and Mal Sun Boulware),

any such decision does not change the fact that the expenses

related to the litigation commenced by Jin Sook Lee were incurred

for the benefit of HIE and Michael Boulware alike.     Nor does it

make those expenses deductible entirely by HIE.    In fact, HIE did

not even perceive Jin Sook Lee as posing an actual threat to it

through her filing and prosecution of any of the civil

litigation.     We find that HIE is entitled to deduct no more than

50 percent of these expenses.

     H.   Applicability of Indemnification Agreement

           1.    Overview

     The general practice and policy of each subject corporation

was to pay for the professional representation of current or

former employees who were named, targeted, subpoenaed, or

otherwise involved in legal proceedings by reason of their

position with the company.    Each subject corporation also had

included in its incorporation documents indemnification

provisions to that effect.    Although the indemnity provisions in

HIE’s (but not Holdings’) incorporation documents were limited to

directors and officers, petitioners extended indemnity rights to

all employees.
                               - 293 -

          2.    Arrangements Under Section 62(a)(2)(A)

     Petitioners argue that the corporate petitioners’ indemnity

policy is an “employee reimbursement or other expense allowance

arrangement” under section 62(a)(2)(A).      We decide this argument

(and petitioners’ other indemnification arguments discussed

infra) with respect to the still disputed professional fees.74       A

plan is an employee reimbursement or other expense allowance

arrangement if expenses under the plan are substantiated, the

employee is not permitted to keep excess funds, and there is the

requisite connection to the employee’s employment.     See Shotgun

Delivery, Inc. v. United States, 269 F.3d 969, 972 (9th Cir.

2001); Trucks, Inc. v. United States, 234 F.3d 1340, 1342 (3d

Cir. 2000).    The just-mentioned third requirement mandates that

an expenses be “paid or incurred by the employee in connection

with the performance of services as an employee of the employer.”

Sec. 1.62-2(d)(1), Income Tax Regs.      The costs of a plan that

meets all three requirements are deductible by the employer and

excludable from the employee’s gross income as an above-the-line

adjustment.




     74
      We use the term “still-disputed professional fees” to
refer to those fees which we hold herein are not deductible by
the subject corporations.
                               - 294 -

     Petitioners argue that all three requirements were met in

these cases.   To this end, petitioners state, substantiation is

present because legal fees were not paid, or if paid were booked

as a loan to Michael Boulware, until an invoice was provided to

HIE; employees could not keep excess funds because the invoices

were paid directly to the attorneys; and the indemnity

arrangement assured a business connection because indemnity

occurred only with respect to legal proceedings that the employee

became involved in “by reason of” his or her current or former

status as an employee, officer, or director of the corporation.

We disagree with petitioners’ argument that they have satisfied

all three requirements with respect to the professional fees

related to Michael Boulware.   Petitioners have not established

the requisite connection between the performance of services by

Michael Boulware as an employee of either HIE or Holdings and the

payment of the fees by one or both of those corporations.

Indeed, the record leads us to find to the contrary,

specifically, that the fees were incurred for the primary benefit

of Michael Boulware to defend him against criminal income tax

charges investigated and brought against him personally; tax and

civil suits resulting from his diverting money from HIE to

himself and Jin Sook Lee; and charges of conspiracy to defraud a

lending institution.   None of those actions, we find, was “in
                                 - 295 -

connection with” his employment.      See Biehl v. Commissioner,

118 T.C. 467 (2002), affd. 351 F.3d 982 (9th Cir. 2003).

           3.   Mandatory Indemnity

                 a.   Overview

     Petitioners argue that the relevant incorporation documents

provided Michael Boulware with mandatory indemnification as to

certain of the professional fees that were paid on his behalf.

Petitioners also argue that two State statutes, specifically Haw.

Rev. Stat. sec. 416-35(d) (1985 & Supp. 1992), and its successor

Haw. Rev. Stat. 415-5 (1985 and Supp. 1992), also provided

Michael Boulware with mandatory indemnification as to those

fees.75   In connection with these arguments, petitioners assert


     75
      Haw. Rev. Stat. sec. 416-35 (Supp. 1982) was enacted in
1977 as a part of Act 71. See 1977 Hawaii Sess. Laws 121; see
also Lussier v. Mau-Van Development, Inc., 667 P.2d 830, 833 (Hi.
Ct. App. 1983). Haw. Rev. Stat. sec. 416-35(d), supra, provides:
“To the extent that an agent has been successful on the merits or
otherwise in defense of any * * * [derivative action or
nonderivative action], or in defense of any claim, issue or
matter therein, the agent shall be indemnified by the corporation
against expenses actually and reasonably incurred by the agent in
connection therewith.” See also Haw. Rev. Stat. sec.
416-35(a)(1) and (2), supra (providing that an “agent” includes
“a director, officer, employee or other agent of the corporation”
and that “expenses” include “attorneys’ fees”); Lussier v.
Mau-Van Development, Inc., supra at 832. In 1987, Haw. Rev.
Stat. sec. 416-35(d), supra, was replaced by Haw. Rev. Stat. sec.
415-5(d) (1985 and Supp. 1992), the text of which was similar to
that of its predecessor. While Haw. Rev. Stat. sec. 416-35(d),
supra, was then replaced by Haw. Rev. Stat. sec. 414-243
(LexisNexis 2008), effective July 1, 2001, see Haw. Rev. Stat.
                                                    (continued...)
                               - 296 -

that Michael Boulware was acquitted of the substantive bank fraud

counts; he was investigated and referred to a grand jury for

filing false corporate tax returns as the president of HIE, but

that count was not the subject of an indictment; Jin Sook Lee’s

shareholder derivative suit against HIE’s board of directors was

dismissed; and Michael Boulware defeated Jin Sook Lee’s claims as

to the owner of the Koloa house and the $840,000 in the safe.

Petitioners conclude that the referenced documents and State

statute obligated HIE to indemnify Michael Boulware with respect

to those actions and that HIE will be further obligated under the

statute to indemnify Michael Boulware as to all actions if he

eventually prevails on the charges underlying his criminal

convictions.

               b.   Analysis

     We disagree with petitioners that the so-called mandatory

indemnification provisions in the incorporation documents and

Hawaiian statute make any of the still disputed professional fees

deductible under section 162(a).   First, even if Michael Boulware

was entitled to the claimed mandatory indemnification, the

compulsory character of a payment does not ensure that it is


     75
      (...continued)
sec. 414-483, supra, petitioners limit their arguments to the
earlier two provisions stating that the latest provision does not
govern these cases.
                               - 297 -

deductible under section 162(a).    See Commissioner v. Lincoln

Sav. & Loan Association, 403 U.S. 345, 359 (1971); Dolese v.

United States, 605 F.2d 1146 (10th Cir. 1979).    Second, from a

factual point of view, we disagree with petitioners’ assertion

that Michael Boulware was entitled to mandatory indemnification

under those provisions as to any of the still-disputed

professional fees.    In the setting of the incorporation

documents, the criminal investigation of Michael Boulware and

related trials were not “by reason of his being or having been a

director or officer” of HIE; they grew out of his personal

liability to pay Federal income taxes and allegations that he

diverted money from HIE.

       Nor do we believe that Michael Boulware was acting as an

agent of one or both of the subject corporations in connection

with the subject matter underlying the professional fees that

were paid for his benefit.    An agent has a fiduciary duty to “act

solely for the benefit of the principal in all matters connected

with his agency”, 2 Restatement, Agency 2d sec. 387 (1958), and

we decline to find that the criminal proceedings against Michael

Boulware, in which he is accused of diverting funds from HIE and

delivering those funds to his mistress Jin Sook Lee, arose from

conduct undertaken by him for the benefit of or as an agent of

HIE.    See Commissioner v. Bollinger, 485 U.S. 340, 349 (1988).
                                - 298 -

            4.   Permissive Indemnity

     Petitioners also argue that even if the subject corporations

were not required to indemnify Michael Boulware as to his

professional representation, the subject corporations were

permitted to do so (and in no way precluded from doing so) as an

ordinary and necessary expense of their businesses.   Petitioners

add that the boards of HIE and Holdings decided to indemnify

Michael Boulware and other current or former employees of the

corporations as a matter of business judgment and conclude that

the professional fees are therefore deductible by the subject

corporations as ordinary and necessary business expenses.

     We disagree with petitioners’ conclusion as to the

deductibility of the professional fees.   As we find supra, the

subject corporations did not pay those fees primarily to benefit

their business but did so primarily to benefit Michael Boulware.

In addition, the mere fact that a corporate taxpayer pays an

expense on the basis of business judgment does not necessarily

mean that it is deductible as an ordinary and necessary expense

under section 162(a).    See, e.g., Inland Asphalt Co. v.

Commissioner, 756 F.2d 1425 (9th Cir. 1985), affg. T.C. Memo.

1982-463.
                              - 299 -

          5.   Repayment Obligation

     Petitioners assert that HIE has been paying Michael

Boulware’s legal expenses with an understanding (between HIE and

Michael Boulware) that he will repay HIE the amount of any of

those expenses that are proven not to have been required to be

paid by HIE.   Petitioners argue that the deductions therefore

should stand as claimed even if HIE was not required to make the

payment and that HIE will be required to include in its income

any repayment made in future years.     See Kanne v. Am. Factors,

Ltd., 190 F.2d 155, 161 (9th Cir. 1951); cf. O’Malley v.

Commissioner, 91 T.C. at 363 (allowing a taxpayer’s sec. 162(a)

deduction after this Court ruled that trust’s payment of the

taxpayer’s legal expenses constituted income to him).

     We disagree with this argument.    HIE’s payments of the

professional fees are most properly viewed as distributions to

Michael Boulware rather than as payments of business expenses

under section 162.   Therefore, those payments are nondeductible

by HIE irrespective of whether Michael Boulware transfers cash or

other assets of his to HIE to reimburse those payments.    In

addition, as noted infra, we do not find that HIE (or for that

matter Holdings) intended its payments of the professional fees

to be reimbursed by Michael Boulware.
                                - 300 -

VI.    Constructive Dividends

      A.   Overview

      Respondent determined that the professional fees, to the

extent nondeductible by either subject corporation, are taxable

to Michael Boulware as constructive dividends.      To that end,

respondent determined, the payment of those fees by the subject

corporations primarily benefited Michael Boulware.      We agree with

respondent that the amounts of these fees paid by the subject

corporations are considered to be cash distributions to Michael

Boulware.76   We hold that the total amount of the distributions in

each subject year is taxable to Michael Boulware as dividend

income to the extent that the amount does not exceed the relevant

amounts of E&P for that year.    We hold that any remaining amount

of each year’s total distribution is taxable to Michael Boulware

as a long-term capital gain to the extent that the distribution

exceeds Michael Boulware’s corresponding adjusted basis.      For

purposes of entering decisions in these cases, we shall order the

parties to prepare the requisite computations under Rule 155 in

accordance with our opinion herein.       The parties shall address in



      76
      Petitioners assert that Michael Boulware during each
subject year returned to HIE more money than he received from
HIE. The credible evidence in the record does not support that
assertion as to any of the subject years, and we decline to find
it as a fact.
                               - 301 -

those computations the applicable amounts of E&P and the portions

of the distributions that are treated as dividend income and

long-term capital gain.

     B.    Rules Applicable to Distributions

     Under section 301, funds (or other property) distributed by

a corporation to a shareholder with respect to its stock are

taxed under section 301(c).    Under sections 301(c) and 316, a

constructive distribution is taxable to the shareholder as a

dividend to the extent of the corporation’s E&P.    Any excess is

considered to be a nontaxable return of capital to the extent of

the shareholder’s basis in the corporation, and any remaining

amount is then taxable to the shareholder as a gain from the sale

or exchange of property.    See sec. 301(c)(2) and (3); Truesdell

v. Commissioner, 89 T.C. 1280, 1295-1298 (1987).    Section 301

characterizes a distribution as a dividend regardless of whether

the distribution is formally declared to be a dividend.    See

Truesdell v. Commissoner, supra at 1295; see also Noble v.

Commissioner, 368 F.2d 439, 442 (9th Cir. 1966), affg. T.C. Memo.

1965-84.

     A corporation’s payment of its shareholder’s expense is a

constructive distribution to the shareholder if the payment

primarily benefits the shareholder and was made without

expectation of repayment.    See Hood v. Commissioner, 115 T.C. at
                               - 302 -

180; see also Noble v. Commissioner, supra at 443.      The subject

corporations’ payments of Michael Boulware’s legal expenses

primarily benefited him, and we are not persuaded by the record

before us that either subject corporation (or Michael Boulware

for that matter) intended at the time of the payment that Michael

Boulware was to repay those amounts to the corporations.     We

conclude that the amount of the legal and professional fees of

Michael Boulware paid by the corporations are corporate

distributions to him for purposes of sections 301(c) and 316.

     C.   E&P

           1.   Background

     As discussed supra, the distributions to Michael Boulware

are deemed to be dividends to him to the extent of each

distributor’s E&P.   Respondent determined that each corporation

had enough E&P to characterize all of the distributions by that

corporation to Michael Boulware as dividends.      That determination

is presumed to be correct.   See DiLeo v. Commissioner, 96 T.C.

858, 884 (1991), affd. 959 F.2d 16 (2d Cir. 1992); see also Rule

142(a)(1).

           2.   Lack of Comprehensive Definition

     In the setting of these cases, Congress has not defined the

meaning of the statutory term “earnings and profit”, see sec.

312, and the meaning of the term does not equate exactly to the
                                    - 303 -

tax definition of the term “taxable income” (or to the accounting

definition of the term “retained earnings”).       See Commissioner v.

Wheeler, 324 U.S. 542, 546 (1945); Stark v. Commissioner, 29 T.C.

122, 128 (1957).       While Congress designed taxable income as a

measure of the income tax and related taxes which are assessed

against a taxpayer, Congress designed E&P differently as a

broader measure of economic income that reflects a corporation’s

capacity to pass along tax consequences to its shareholders

through distributions in excess of their investments in the

corporation.    See GPD, Inc. v. Commissioner, 508 F.2d 1076,

1082-1083 (6th Cir. 1974), revg. and remanding on another issue

60 T.C. 480 (1973).

           3.    Calculation

                  a.    Overview

     In general, a corporate taxpayer calculates its E&P for each

taxable year by making various adjustments to its taxable income

for that year.    See DiLeo v. Commissioner, supra at 888; see also

sec. 1.312-6, Income Tax Regs.        We summarize these adjustments as

follows.

                         i.   ATI

     The taxpayer must first adjust its reported taxable income

by any administrative and/or judicial adjustments to arrive at

its adjusted taxable income (ATI).        Initially, the taxpayer’s ATI
                                  - 304 -

equals the amount of its reported taxable income, plus or minus

(as the case may be) each adjustment to that reported income

subsequently made or allowed by the Commissioner.       If the taxable

year in question then becomes subject to litigation, the

taxpayer’s ATI would further reflect any additional adjustments

to its income resulting from that litigation.

                       ii.    Increases and Decreases to ATI

     The taxpayer’s ATI must be adjusted further by certain items

that increase or decrease E&P.       These items generally fall within

one of five categories.       See generally Bittker & Eustice, Federal

Income Taxation of Corporations and Shareholders, par. 8.03, at

8-18 (7th ed. 2006).    The first category consists of certain

items that are excluded from the computation of taxable income

but are included in the computation of E&P.       See generally id.

par. 8.03[3], at 8-22.       The second category consists of certain

items that are deducted in the computation of taxable income but

are not deducted in the computation of E&P.       See generally id.

par. 8.03[4], at 8-26.       The third category consists of certain

items that are not deducted in the computation of taxable income

but are deducted in the computation of E&P.       See generally id.

par. 8.03[6], at 8-29.       The fourth category consists of certain

items that create timing differences, e.g., on account of

deferred income or an accelerated deduction.       See generally id.
                              - 305 -

par. 8.03[5], at 8-27.   The fifth category consists of certain

items related to corporate distributions or changes in corporate

structure.   See generally id. par. 8.03[7], at 8-32.

     Examples of adjustments that fall within one of these five

categories and that increase E&P are the current year’s

deductions under sections 179, 179B, 179C, and 179D (to the

extent of 80 percent of the deductions); certain intangible

drilling costs deducted under section 263(c); certain mineral

exploration and development costs deducted under section 616(a)

or 617; a charitable contribution carryover deducted in the

current year; circulation expenditures; construction period

carrying charges; the dividends received deduction; the domestic

production activities deduction; the excess of accelerated

depreciation over straight-line depreciation; the excess of

percentage-of-completion profits over completed-contract profits;

the excess of percentage depletion deducted over cost depletion;

the excess of realized gains on installment sales over the

currently recognized gains; Federal income tax refunds; income

from tax-exempt bonds; the increase in a LIFO recapture amount;

life insurance proceeds in excess of the policy’s cash surrender

value; the NOL carryover deducted in the current year;

organizational expenditures; and tax-free income from other than

from tax-exempt bonds.
                              - 306 -

     Examples of adjustments that fall within one of the five

categories and that decrease E&P are 12 months’ amortization for

prior years’ intangible drilling costs; 12 months’ amortization

for prior years’ mineral exploration and development costs;

20 percent of prior years’ deductions under sections 179, 179A,

179B, and 179C; charitable contributions paid in excess of the

10-percent limit; the current-year net capital loss; a decrease

in the LIFO recapture amount; the excess of completed-contract

profits over percentage-of-completion profits; the excess of E&P

depreciation over tax depreciation; the excess of taxable gains

over E&P gains on depreciable and depletable property; expenses

and losses in transactions with related taxpayers; Federal income

tax payments; life insurance premiums in excess of current

increase in cash surrender value (including term life insurance);

nondeductible interest paid to carry tax-exempt bonds; penalties;

and the recognized gain from prior years’ installment sales.

               b.   Current E&P

     Initially, a corporate taxpayer’s current E&P for a taxable

year equals the amount of its ATI as adjusted by the increases

and decreases listed above (and similar items not listed above).

The total amount of any distributions that the corporation makes

during that year are then subtracted from and to the extent of

the initial current E&P.
                               - 307 -

                c.   Accumulated E&P

     The amount of the total distributions that exceeds the

amount of the initial current E&P is then compared with the

amount of the taxpayer’s accumulated E&P as of the beginning of

the year.   That beginning balance may have to be adjusted in

certain situations, such as where, as here, there was a change in

corporate structure; i.e., HIE’s nontaxable spinoff of Holdings.

The taxpayer’s ending accumulated E&P for a taxable year then

equals the accumulated E&P (as adjusted) as of the beginning of

that year, plus that year’s current E&P (as reduced by any

distributions out of current E&P for that year), less any

distributions out of accumulated E&P for that year.

                d.   Summary of Calculation

     We summarize the computation of E&P as follows:

     Taxable income as reported
         Administrative and/or judicial adjustments
           Adjusted taxable income (ATI)

     Increases to ATI:
         80-percent of current year’s deductions under sections
           179, 179B, 179C, and 179D
         Certain intangible drilling costs deducted under section
           263(c)
         Certain mineral exploration and development costs
           deducted under section 616(a) or 617
         Charitable contribution carryover deducted in current
           year
         Circulation expenditures
         Construction period carrying charges
         Dividends received deduction
         Domestic production activities deduction
                      - 308 -

 Excess of accelerated depreciation over straight-line
   depreciation
 Excess of percentage-of-completion profits over
   completed-contract profits
 Excess of percentage depletion deducted over cost
   depletion
 Excess of realized gains on installment sales over
   currently recognized gains
 Federal income tax refunds
 Income from tax-exempt bonds
 Increase in LIFO recapture amount
 Life insurance proceeds in excess of cash surrender
   value
 NOL carryover deducted in current year
 Organizational expenditures
 Tax-free income other than from tax-exempt bonds
 Other unspecified items
   Total increases to ATI

Decreases to ATI:
  12-months’ amortization for prior years’ IDC
  12-months’ amortization for prior years’ mineral
    exploration and development costs
  20 percent of prior years’ deductions under sections
    179, 179A, 179B, and 179C
  Charitable contributions paid in excess of the
    10-percent limit
  Current-year net capital loss
  Decrease in LIFO recapture amount
  Excess of completed-contract profits over percentage-of-
    completion profits
  Excess of E&P depreciation over tax depreciation
  Excess of taxable gains over E&P gains on depreciable
    and depletable property
  Expenses and losses in transactions with related
    taxpayers
  Federal income tax payments
  Life insurance premiums in excess of current increase in
    cash surrender value (including term life insurance
  Nondeductible interest paid to carry tax-exempt bonds
  Penalties
                                - 309 -

          Recognized gain from prior years’ installment sales
          Other unspecified items
            Total decreases to ATI

                Current E&P

     Distributions
     Distributions from current E&P
     Remaining current E&P after distributions
     Distributions in excess of current E&P

     Accumulated E&P at beginning of year
     Adjustments to beginning accumulated E&P; e.g., spinoff
       Adjusted beginning E&P
     Taxable distributions from accumulated E&P
     Ending accumulated E&P

     D.   Adjustments Applicable to These Cases

           1.    Overview

     At least five of these adjustments are relevant to the cases

at hand and deserve further explanation.

           2.    First Adjustment

     The E&P of each subject corporation must be adjusted to take

into account each adjustment to reported taxable income resulting

from these cases, e.g., E&P must be increased for unreported

income and disallowed deductions.    See sec. 1.312-6, Income Tax

Regs.; see also sec. 6214(b).

           3.    Second Adjustment

     Each subject corporation’s unpaid taxes, whether contested

or not, will reduce its E&P in the year for which the tax is due.

See DiLeo v. Commissioner, supra at 888; Estate of Stein v.
                               - 310 -

Commissioner, 25 T.C. 940, 965-966 (1956), affd. sub nom. Levine

v. Commissioner, 250 F.2d 798 (2d Cir. 1958).     Such is so

regardless of whether the corporation is aware of, or agrees to

its liability for those taxes.      See DiLeo v. Commissioner, supra

at 888; Estate of Stein v. Commissioner, supra at 965-966.

          4.    Third Adjustment

     The interest that applies to the unpaid taxes will reduce

E&P each year as the interest accrues; i.e., E&P is reduced for

interest accrued on unpaid tax, beginning in the year the

interest first arises, and accrued over the years the tax remains

unpaid.   See Stark v. Commissioner, supra at 127-128; Group

Admin. Premium Servs., Inc. v. Commissioner, T.C. Memo. 1996-451;

Kenner v. Commissioner, T.C. Memo. 1975-118; Fairmount Park

Raceway, Inc. v. Commissioner, T.C. Memo. 1962-14, affd. 327 F.2d

780 (7th Cir. 1964).   Because interest on a tax deficiency begins

to accrue on the date the tax return was due, the interest does

not reduce E&P until the year after the taxable year of the

deficiency.    See Group Admin. Premium Servs., Inc. v.

Commissioner, supra (citing Stark v. Commissioner, supra at 128).

          5.    Fourth Adjustment

     In the case of HIE, which is an accrual basis taxpayer that

we state infra is liable for the addition to tax respondent

determined under section 6651(a), the amount of that addition to
                                  - 311 -

tax is accrued and deducted from HIE’s taxable income to arrive

at its E&P in the year in which the return to which the addition

to tax relates was due to be filed.         See Kenner v. Commissioner,

supra (citing Estate of Stein v. Commissioner, supra at 965-967).

              6.   Fifth Adjustment

      In order to reflect HIE’s nontaxable spinoff of Holdings at

the beginning of 199706, the E&P of the distributing corporation

immediately before the transaction must be allocated between the

distributing corporation and the controlled corporation.        See

sec. 1.312-10, Income Tax Regs.        The Treasury regulations allow

that allocation to be made on the basis of one of three methods

set forth in the regulations.         See sec. 1.312-10(a), Income Tax

Regs.      Those methods in the order of preference as stated in the

regulations are:      (1) In proportion to the fair market value of

the business retained and the business that was spun off; (2) in

proportion to the net basis of the assets retained and the assets

that were spun off; or (3) by such other method as may be

appropriate under the facts and circumstances of the case.        See

id.

      E.     Conclusion

      As stated supra pp. 300-301, we otherwise leave it to the

parties to address in their Rule 155 computations the applicable
                               - 312 -

amounts of E&P and the portions of the distributions that are

treated as dividend income and long-term capital gain.

VII.   Addition to Tax

       Respondent determined that HIE is liable for an addition to

tax under section 6651(a)(1) for 199806.    Section 6651(a)(1)

imposes an addition to tax for failure to file a return timely

unless the taxpayer shows that the failure was due to reasonable

cause and not to willful neglect.    See Kotmair v. Commissioner,

86 T.C. 1253, 1263 (1986).    A failure to file a return timely is

due to reasonable cause if the taxpayer exercised ordinary

business care and prudence and, nevertheless, was unable to file

the return within the prescribed time.    See sec.

301.6651-1(c)(1), Proced. & Admin. Regs.    Willful neglect means a

conscious, intentional failure or reckless indifference.    See

United States v. Boyle, 469 U.S. 241, 245 (1985).

       HIE did not timely file its Federal income tax return for

199806, and petitioners have not argued (let alone established)

that HIE had reasonable cause for this untimely filing.    We

sustain respondent’s determination on this issue.
                                - 313 -

VIII.    Epilog

        We have considered all arguments made by the parties in this

proceeding and find that those arguments not discussed herein

lack merit or need not be reached.    To reflect the foregoing,


                                      Decisions will be entered

                                 under Rule 155.
                               - 314 -

                             APPENDIX A

     For the relevant period before July 1, 1993, Haw. Rev. Stat.

(1985 & Supp. 1992) provided in relevant part as follows:

     § 245-3 Tax; limitations. Every wholesaler or dealer
     shall, in addition to any other taxes provided by law,
     pay an excise tax, which is hereby imposed upon the
     sale or use of tobacco products, equal to forty per
     cent of the wholesale price of each article or item of
     tobacco products sold by the wholesaler or dealer,
     whether or not sold at wholesale, or if not sold then
     at the same rate upon the use by the wholesaler or
     dealer. The tax, however, is subject to the following
     limitations:

          (1) It shall not   apply to any tobacco products
     exempted, and so long   as the same are exempted, from
     the imposition of the   tax by the Constitution or laws
     of the United States,   and

          (2) The tax shall be paid only once upon the same
     tobacco product.

     § 245-4 Wholesaler or dealer to state tax separately;
     collection of tax from purchaser; penalty. Upon each
     sale of tobacco products by a wholesaler or dealer the
     tax collectible in respect to such sale shall be stated
     and charged separately from the sales price and shown
     separately on the record thereof kept by the wholesaler
     or dealer, and he shall deliver a duplicate of the
     record of such transaction, showing the sale price and
     tax, to the purchaser, and shall be liable for the
     payment of the tax. The wholesaler or dealer or any
     other person who acquires tobacco products upon which
     the tobacco tax has been paid shall have the same right
     in respect to collecting the tax and thereby
     reimbursing himself for the same from any purchaser
     from him, as if the tax were a part of the purchase
     price. Every wholesaler or dealer who fails to state
     and charge the tax to be collected, separately from the
     sales price as provided in this section, shall be fined
     not less than $10 nor more than $50 for each offense.
                        - 315 -

§ 245-5 Returns. Every licensee shall, on or before the
last day of each month, file with the department of
taxation a return of the tobacco products sold or used
by the licensee during the preceding calendar month and
of the tax payable thereon. The form of the return
shall be prescribed by the department and shall contain
such information as it may deem necessary for the
proper administration of this chapter.

§ 245-6 Payment of taxes; penalties. At the time of the
filing of the return required under section 245-5 and
within the time prescribed therefor, each licensee
shall pay to the department of taxation the tax imposed
by this chapter, required to be shown by the return.

     Penalties and interest shall be added to and
become a part of the tax, when and as provided by
section 231-39.

§ 245-7 Determination of tax; additional assessments,
credits, and refunds. (a) As soon as practicable after
each return shall have been filed, the department of
taxation shall cause it to be examined and shall
compute and determine the amount of the tax payable
thereon.

     (b) If it should appear upon such examination or
thereafter within five years after the filing of the
return, or at any time if no return has been filed, as
a result of such examination or as a result of any
examination of the records of the licensee or of any
other inquiry or investigation, that the correct amount
of the tax is greater than that shown on the return, or
that any tax imposed by this chapter has not been paid,
an assessment of such tax may be made, in the manner
provided in section 235-108(b). The amount of the tax
for the period covered by the assessment shall not be
reduced below the amount determined by an assessment so
made, except upon appeal or in a proceeding brought
pursuant to section 40-35.

     (c) If the licensee has paid or returned with
respect to any month more than the amount determined to
be the correct amount of tax for such month, the amount
of the tax so returned and any assessment of tax made
                        - 316 -

pursuant to the return may be reduced, and any
overpayment of tax may be credited upon the tax imposed
by this chapter, or at the election of the licensee,
the licensee not being delinquent in the payment of any
taxes owing to the State, may be refunded in the manner
provided in section 231-23(d), provided that no
reduction of tax may be made when forbidden by
subsection (b), or more than five years after the
filing of the return.

§ 245-8 Records to be kept. (a) Every wholesaler and
dealer shall keep a record of every sale or use of
tobacco products by the wholesaler or dealer, and of
the tax payable thereon, if any, in such form as the
department of taxation may prescribe. The records
shall be offered for inspection and examination at any
time upon demand by the department and shall be
preserved for a period of five years, except that the
department may, in writing, consent to their
destruction within such period or may require that they
be kept longer. The department may by regulation
require the licensee to keep such other records as it
may deem necessary for the proper enforcement of this
chapter.

     (b) If any wholesaler or dealer fails to keep
records from which a proper determination of the tax
due under this chapter may be made, the department may
fix the amount of the tax for any period from the best
information obtainable by it and assess the tax as
hereinbefore provided.

§ 245-9 Inspection. The department of taxation may
examine all records required to be kept under this
chapter, and books, papers, and records of any person
engaged in the sale of tobacco products, to verify the
accuracy of the payment of the tax imposed by this
chapter. Every person in possession of such books,
papers, and records, and the person’s agents and
employees, are hereby directed and required to give to
the department the means, facilities, and opportunities
for such examinations.

§ 245-10 Appeals. Any person aggrieved by any
assessment of the tax imposed by this chapter may
                             - 317 -

     appeal from the assessment in the manner and within the
     time and in all other respects as provided in the case
     of income tax appeals by section 235-114, provided the
     tax so assessed shall have been paid. The hearing and
     disposition of such appeal, including the distribution
     of costs and of taxes paid pending the appeal shall be
     as provided in chapter 232.

     Effective July 1, 1993, Haw. Rev. Stat. secs. 245-3, 245-5,

and 245-7 provide:

     § 245-3 Taxes; limitations. (a) Every wholesaler or
     dealer, in addition to any other taxes provided by law,
     shall pay for the privilege of conducting business and
     other activities in the State an:

          (1) Excise tax equal to 3.00 cents for each
     cigarette sold by the wholesaler or dealer, after June
     30, 1993, whether or not sold at wholesale, or if not
     sold then at the same rate upon the use by the
     wholesaler or dealer; such excise tax to increase to
     3.50 cents per cigarette on the first day of the month
     one hundred eighty days after a United States
     congressional act is signed into law which requires
     military installations to purchase cigarettes in Hawaii
     in a manner similar to that required of alcoholic
     beverages under 10 United States Code, section 2488
     (nonappropriated fund instrumentalities, purchase of
     alcoholic beverages); and

          (2) Excise tax equal to forty per cent of the
     wholesale price of each article or item of tobacco
     products sold by the wholesaler or dealer, whether or
     not sold at wholesale, or if not sold then at the same
     rate upon the use by the wholesaler or dealer.

          (b) The taxes, however, are subject to the
     following limitations:

          (1) The measure of the taxes shall not include any
     cigarettes or tobacco products exempted, and so long as
     the same are exempted, from the imposition of taxes by
     the Constitution or laws of the United States; and
                        - 318 -

     (2) The taxes shall be paid only once in respect
of the same cigarettes or tobacco product. This
limitation shall not prohibit the imposition of the
excise tax on receipts from sales of tobacco products
under subsection (a)(2); provided that the amount
subject to the tax on each sale shall not include
amounts previously taxed under this chapter.

§ 245-5 Returns. Every licensee, on or before the last
day of each month, shall file with the department of
taxation a return showing the cigarettes and tobacco
products sold or used by the licensee during the
preceding calendar month and of the taxes chargeable
against the taxpayer in accordance with this chapter.
The form of the return shall be prescribed by the
department and shall contain such information,
including a separate statement of the number and
wholesale price of cigarettes, and the wholesale price
of tobacco products, sold or used, as it may deem
necessary for the proper administration of this
chapter.

§ 245-7 Determination of taxes; additional assessments,
credits, and refunds. (a) As soon as practicable after
each return shall have been filed, the department of
taxation shall cause it to be examined and shall
compute and determine the amount of the taxes payable
thereon.

     (b) If it should appear upon such examination or
thereafter within five years after the filing of the
return, or at any time if no return has been filed, as
a result of the examination or as a result of any
examination of the records of the licensee or of any
other inquiry or investigation, that the correct amount
of the taxes is greater than that shown on the return,
or that any taxes imposed by this chapter have not been
paid, an assessment of such taxes may be made, in the
manner provided in section 235-108(b). The amount of
the taxes for the period covered by the assessment
shall not be reduced below the amount determined by an
assessment so made, except upon appeal or in a
proceeding brought pursuant to section 40-35.
                              - 319 -

          (c) If the licensee has paid or returned with
     respect to any month more than the amount determined to
     be the correct amount of taxes for the month, the
     amount of the taxes so returned and any assessment of
     taxes made pursuant to the return may be reduced, and
     any overpayment of taxes may be credited upon the taxes
     imposed by this chapter, or at the election of the
     licensee, the licensee not being delinquent in the
     payment of any taxes owing to the State, may be
     refunded in the manner provided in section 231-23(d);
     provided that no reduction of taxes may be made when
     forbidden by subsection (b) or more than five years
     after the filing of the return.

1993 Haw. Sess. Laws ch. 220, secs. 9, 10, 12; see also id. sec.
19 (effective date provision).

     Haw. Rev. Stat. sec. 245-7, as effective June 19, 2000,

through June 30, 2006, provides:77

     § 245-7. Determination of taxes; additional
     assessments, credits, and refunds

          (a) As soon as practicable after each return shall
     have been filed, the department of taxation shall cause
     it to be examined and shall compute and determine the
     amount of the taxes payable thereon.

          (b) If it should appear upon the examination or
     within five years after the filing of the return, or at
     any time if no return has been filed, as a result of
     the examination, or as a result of any examination of
     the records of the wholesaler or dealer, or of any
     other inquiry or investigation, that the correct amount
     of the taxes is greater than that shown on the return,
     or that any taxes imposed by this chapter have not been
     paid, an assessment of the taxes may be made in the
     manner provided in section 235-108(b). The amount of
     the taxes for the period covered by the assessment
     shall not be reduced below the amount determined by an


     77
      As of June 30, 2006, the predecessor statute again became
effective. See 2000 Haw. Sess. Laws ch. 249, secs. 7, 20(2).
                             - 320 -

    assessment so made, except upon appeal or in a
    proceeding brought pursuant to section 40-35.

         (c) If the wholesaler or dealer has paid or
    returned with respect to any month more than the amount
    determined to be the correct amount of taxes for the
    month, the amount of the taxes so returned and any
    assessment of taxes made pursuant to the return may be
    reduced, and any overpayment of taxes may be credited
    upon the taxes imposed by this chapter, or at the
    election of the wholesaler or dealer, the wholesaler or
    dealer not being delinquent in the payment of any taxes
    owing to the State, may be refunded in the manner
    provided in section 231-23(c); provided that no
    reduction of taxes may be made when forbidden by
    subsection (b) or more than five years after the filing
    of the return.

  2000 Haw. Sess. Laws ch. 249, secs. 7, 20(2); see also id. sec.
20.
                                                                 - 321 -

                                                               APPENDIX B

                                             Tobacco Tax Liability Adjustments

Taxable Year     July    August   September October   November December January   February   March   April   May     June      Totals

   198906         -0-      -0-      -0-        -0-      -0-       -0-      -0- $280,000 $280,000 $280,000 $280,000 $280,000   $1,400,000
   199006      $280,000 $280,000 $280,000   $280,000 $280,000 $280,000 $280,000 280,000 280,000 280,000 280,000 240,000        3,320,000
   199106       200,000 200,000 200,000      160,000 200,000 160,000 160,000 120,000 120,000 120,000 120,000 200,000           1,960,000
   199206       120,000 120,000 120,000      160,000 200,000 200,000 240,000 240,000 240,000 240,000 240,000 300,000           2,420,000
   199306       300,000 300,000 400,000      400,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000           4,280,000
   199406       360,000 360,000 360,000      360,000 360,000 360,000 360,000 360,000 430,000 400,000 400,000 400,000           4,510,000
   199506       400,000 400,000 200,000      200,000 250,000 250,000 200,000 250,000 350,000 350,000 350,000 350,000           3,550,000
                                                                                                                              21,440,000
                                                               - 322 -

                                                          APPENDIX C
                                                                                   Fees Re:    Fees Accepted
                                      Criminal       Grand Jury        Criminal     Jin Sook    As Ordinary      Other
                        Total       Investigation    Proceedings         Trial        Lee       and Necessary    Fees

Legal Fees
 Accucopy, Inc.
   200006                9,558.62         -0-            -0-           8,665.37       -0-             -0-       893.25
   200106                5,000.58         -0-            -0-           5,000.58       -0-             -0-         -0-
   200206                7,016.57         -0-            -0-           7,016.57       -0-             -0-         -0-
 Ayabe Chong
   200006             201,741.42          -0-            -0-         201,741.42       -0-             -0-         -0-
   200106              61,982.97          -0-            -0-          61,982.97       -0-             -0-         -0-
   200206              93,953.20          -0-            -0-          93,953.20       -0-             -0-         -0-
 Benjamin Cassidy
   199806                5,000.00     5,000.00           -0-               -0-        -0-             -0-         -0-
 Bird Marella
   200006             101,842.85          -0-            -0-         101,842.85       -0-             -0-         -0-
   200106           1,018,262.37          -0-            -0-       1,018,262.37       -0-             -0-         -0-
   200206           1,170,735.31          -0-            -0-       1,170,735.31       -0-             -0-         -0-
 Birney Bervar
   200106                5,000.00         -0-        5,000.00              -0-        -0-             -0-         -0-
 Bowen Hunsaker
   200006             100,887.28          -0-            -0-         100,887.28       -0-             -0-         -0-
 Brook Hart
   199806              13,049.23          -0-       13,049.23              -0-        -0-             -0-         -0-
   199906                7,712.85         -0-        7,712.85              -0-        -0-             -0-         -0-
   200006                4,532.77         -0-        4,532.77              -0-        -0-             -0-         -0-
   200206                4,864.74         -0-            -0-           4,864.74       -0-             -0-         -0-
 Candon Consulting/
   John Candon
   200006                8,615.00         -0-            -0-           8,615.00       -0-             -0-         -0-
   200106                5,002.28         -0-            -0-           5,002.28       -0-             -0-         -0-
   200206              11,761.55          -0-            -0-          11,761.55       -0-             -0-         -0-
 Carlsmith Ball
   199806              14,258.83          -0-            -0-               -0-        -0-        14,258.83        -0-
   199906                8,401.97         -0-            -0-               -0-        -0-         8,401.97        -0-
   200006              14,272.77          -0-            -0-               -0-        -0-        14,272.77        -0-
   200106                2,478.22         -0-            -0-               -0-        -0-         2,478.22        -0-
                        1
   200206                5,026.03         -0-            -0-               -0-        -0-         5,026.03        -0-
 Case Bigelow
   200006                  736.31         -0-            -0-               -0-        -0-             -0-       736.31
 Chee Markham
   199806                2,207.94         -0-            -0-               -0-    2,207.94            -0-         -0-
   199906                2,046.86         -0-            -0-               -0-    2,046.86            -0-         -0-
   200006                2,806.88         -0-        2,806.88              -0-        -0-             -0-         -0-
                                                              - 323 -
                                                                                   Fees Re:    Fees Accepted
                                        Criminal      Grand Jury     Criminal      Jin Sook    As Ordinary        Other
                            Total     Investigation   Proceedings      Trial         Lee       and Necessary      Fees

Chicoine Hallet
  200206                34,784.24            -0-            -0-      34,784.24          -0-          -0-            -0-
Corniel
  199806                18,559.93            -0-            -0-      18,559.93          -0-          -0-            -0-
Damon Key
  199806               378,261.40       13,874.12     122,706.28          -0-     227,005.66     2,831.89      11,843.45
  199906               312,735.35            -0-      173,275.20     25,864.59     55,025.96         -0-       58,569.60
  200006               423,692.50            -0-            -0-     373,737.84      5,762.90    40,913.91       3,277.85
  200106                63,890.75            -0-            -0-      47,055.32        438.25     6,792.73       9,604.45
  200206                23,062.32            -0-            -0-       4,486.71          -0-      1,977.36      16,598.25
Foley Jones
  200006                   1,459.50          -0-            -0-           -0-           -0-          -0-        1,459.50
Gaims Weil
  199806                65,234.68            -0-            -0-           -0-      65,234.68         -0-            -0-
  199906                11,558.00            -0-            -0-           -0-      11,558.00         -0-            -0-
  200006                36,927.34            -0-            -0-      36,927.34          -0-          -0-            -0-
  200106                   548.64            -0-            -0-         548.64          -0-          -0-            -0-
  200206                   395.00            -0-            -0-         395.00          -0-          -0-            -0-
Glenn Lee Boulware
  Trust
  199906                35,000.00            -0-            -0-           -0-      35,000.00         -0-            -0-
GMK Consulting
  200206                18,854.05            -0-            -0-           -0-           -0-          -0-       18,854.05
Goodenow
   199806               35,351.94            -0-            -0-       35,351.94         -0-          -0-            -0-
Graham James
   199806               56,848.50                      56,848.50          -0-           -0-          -0-            -0-
   199906               65,403.96            -0-       41,371.59     24,032.37          -0-          -0-            -0-
   200006               53,977.76            -0-            -0-      53,977.76          -0-          -0-            -0-
Hawaii National Bank
   200106               31,227.39            -0-            -0-      31,227.39          -0-          -0-            -0-
   200206               29,146.04            -0-            -0-      29,146.04          -0-          -0-            -0-
Hochman Salkin
   199806               48,590.23            -0-       48,590.23          -0-           -0-          -0-            -0-
   199906                3,475.70            -0-        3,475.70          -0-           -0-          -0-            -0-
   200006              (10,000.00)           -0-      (10,000.00)         -0-           -0-          -0-            -0-
 Howard Chang
                       2
   199806               42,853.42            -0-      42,853.42           -0-           -0-          -0-            -0-
   199906               20,638.78            -0-      20,638.78           -0-           -0-          -0-            -0-
   200006               16,837.64            -0-      16,837.64           -0-           -0-          -0-            -0-
Irell Manella
   199806               44,401.14       15,279.94     29,121.20           -0-           -0-          -0-            -0-
                                                           - 324 -
                                                                              Fees Re:   Fees Accepted
                                     Criminal      Grand Jury      Criminal   Jin Sook   As Ordinary       Other
                        Total      Investigation   Proceedings       Trial      Lee      and Necessary     Fees


King King
    200006              2,500.00           -0-           -0-           -0-        -0-           -0-      2,500.00
Laird Christianson
    200006                252.20           -0-           -0-           -0-        -0-           -0-        252.20
    200106                252.20           -0-           -0-           -0-        -0-           -0-        252.20
Leonard Sharenow
    200006           758,111.97            -0-           -0-     758,111.97       -0-           -0-          -0-
Lopeti Foliaki
    200006             13,579.50           -0-      13,579.50          -0-        -0-           -0-          -0-
Louis Wai
    200006              5,000.00           -0-           -0-           -0-        -0-           -0-       5,000.00
Lyle Hosoda Associates
    200106                665.29           -0-           -0-         665.29       -0-           -0-          -0-
    200206             15,667.22           -0-           -0-      15,667.22       -0-           -0-          -0-
Marr Hipp
    199806                825.26           -0-           -0-           -0-        -0-         825.26         -0-
    199906                293.39           -0-           -0-           -0-        -0-         293.39         -0-
    200006                771.14           -0-           -0-           -0-        -0-         771.14         -0-
    200106                465.10           -0-           -0-           -0-        -0-         465.10         -0-
    200206                469.79           -0-           -0-           -0-        -0-         469.79         -0-
McCorriston Miller
  200106               25,154.47           -0-           -0-      25,154.47       -0-           -0-          -0-
  200206                9,343.61           -0-           -0-       9,343.61       -0-           -0-          -0-
Michael McCarthy
  199806               21,747.02           -0-           -0-           -0-        -0-           -0-      21,747.02
  199906               18,193.49           -0-           -0-           -0-        -0-           -0-      18,193.49
  200006               14,914.59           -0-           -0-           -0-        -0-           -0-      14,914.59
  200106                2,019.44           -0-           -0-           -0-        -0-           -0-       2,019.44
  200206               15,266.02           -0-           -0-       3,646.54       -0-           -0-      11,619.48
Nathan Suzuki
  200006                1,118.00           -0-           -0-           -0-        -0-           -0-       1,118.00
  200106               17,500.00           -0-           -0-      17,500.00       -0-           -0-           -0-
Perkin Hosoda
  200006               44,480.01           -0-      44,480.01          -0-        -0-           -0-           -0-
  200106                  136.55           -0-           -0-         136.55       -0-           -0-           -0-
PWC
  200006               60,225.24           -0-           -0-      60,225.24       -0-           -0-           -0-
  200106               56,023.89           -0-           -0-      56,023.89       -0-           -0-           -0-
  200206               69,436.14           -0-           -0-      69,436.14       -0-           -0-           -0-
Professional Image
  200006                5,763.36           -0-           -0-       5,763.36       -0-           -0-           -0-
                                                            - 325 -
                                                                                  Fees Re:         Fees Accepted
                                      Criminal      Grand Jury      Criminal      Jin Sook         As Ordinary     Other
                          Total     Investigation   Proceedings       Trial         Lee            and Necessary   Fees

Reinwald O’Connor
  199806               533,491.70          -0-         353,348.98          -0-      180,142.72             -0-       -0-
  199906               321,845.65          -0-         307,988.61          -0-       13,857.04             -0-       -0-
  200006               260,264.45          -0-               -0-     259,730.35         534.10             -0-       -0-
  200206                23,543.49          -0-               -0-      23,090.85         452.64             -0-       -0-
Robert Waters
  200206               158,073.00          -0-               -0-     158,073.00              -0-           -0-       -0-
Robert Holland
  199806                   925.00          -0-               -0-           -0-               -0-           -0-     925.00
Saranow Pagani
  200006                31,345.34          -0-               -0-      31,345.34              -0-           -0-       -0-
  200106               292,282.61          -0-               -0-     292,282.61              -0-           -0-       -0-
  200206               192,644.18          -0-               -0-     192,644.18              -0-           -0-       -0-
Seyfarth Shaw
  199806                   122.50          -0-               -0-           -0-               -0-         122.50      -0-
Sherman Sherman
  200206                91,179.04          -0-               -0-      91,179.04              -0-           -0-       -0-
Sheila Balkan
   200206               32,430.00          -0-               -0-      32,430.00              -0-           -0-       -0-
Shiotani Inouye
   199806              356,826.59   356,826.59               -0-           -0-               -0-           -0-       -0-
   199906              285,228.94          -0-        285,228.94           -0-               -0-           -0-       -0-
   200006              199,130.37          -0-               -0-     199,130.37              -0-           -0-       -0-
   200106              124,213.60          -0-               -0-     124,213.60              -0-           -0-       -0-
   200206               56,266.17          -0-               -0-      56,266.17              -0-           -0-       -0-
Squire Sanders
   200106                3,888.10          -0-               -0-       3,888.10              -0-           -0-        -0-
Stephen Platt
   200206               13,102.18          -0-               -0-      13,102.18              -0-           -0-        -0-
Stephen Pingree
   199806               15,117.06          -0-          15,117.06          -0-               -0-           -0-        -0-
   199906                8,111.50          -0-           8,111.50          -0-               -0-           -0-        -0-
   200006               24,749.15          -0-          24,749.15          -0-               -0-           -0-        -0-
Wachi Watanabe
   199806               21,473.82      3,986.95         17,486.87          -0-               -0-           -0-        -0-
   199906               10,000.00          -0-               -0-      10,000.00              -0-           -0-        -0-
   200006                7,298.13          -0-               -0-       7,298.13              -0-           -0-        -0-
   200206                3,776.02          -0-               -0-       3,776.02              -0-           -0-        -0-
Wilmington Institute
   200106               67,225.00          -0-               -0-      67,225.00              -0-           -0-        -0-
   200206               26,853.00          -0-               -0-      26,853.00              -0-           -0-        -0-
                                                             - 326 -
                                                                                    Fees Re:     Fees Accepted
                                         Criminal      Grand Jury       Criminal    Jin Sook      As Ordinary     Other
                             Total     Investigation   Proceedings         Trial       Lee        and Necessary   Fees


 Yoshida, Inc.
    199906                 1,894.04          -0-             -0-             -0-        -0-            -0-        1,894.04
 Other Legal
    199806                      .23          -0-             -0-             -0-        -0-            .23            -0-
    199906                     (.16)         -0-             -0-             -0-        -0-           (.16)           -0-
    200006                   290.34          -0-             -0-             -0-        -0-            -0-          290.34
    200106                   298.77          -0-             -0-             -0-        -0-            -0-          298.77
    200206                   270.51          -0-             -0-             -0-        -0-            -0-          270.51

 Total Legal Fees
    199806          1,675,146.42        394,967.60      699,121.77      53,911.87   474,591.00     18,038.71       34,515.47
    199906          1,112,540.32              -0-       847,803.17      59,896.96   117,487.86      8,695.20       78,657.13
    200006          2,397,682.43              -0-        96,985.95   2,207,999.62     6,297.00     55,957.82       30,442.04
    200106          1,783,518.22              -0-         5,000.00   1,756,169.06       438.25      9,736.05       12,174.86
    200206          2,107,919.42              -0-            -0-     2,052,651.31       452.64      7,473.18       47,342.29

Other Professional Fees

 Antoneita DeWang-Seo
    199806                 7,000.00          -0-             -0-             -0-        -0-        7.000.00           -0-
 Applied Computer
    199806                   405.00          -0-             -0-             -0-        -0-          405.00           -0-
    200206                 1,025.00          -0-             -0-             -0-        -0-        1,025.00           -0-
 ASI Food Safety
    199906                   150.00          -0-             -0-             -0-        -0-          150.00           -0-
 Back to Basics Plus
    200206                 1,074.00          -0-             -0-             -0-        -0-        1,074.00           -0-
 Brewer Environmental
    199806                   145.83          -0-             -0-             -0-        -0-          145.83           -0-
    199906                 2,004.15          -0-             -0-             -0-        -0-        2,004.15           -0-
    200006                 1,899.98          -0-             -0-             -0-        -0-        1,899.98           -0-
    200106                 2,158.32          -0-             -0-             -0-        -0-        2,158.32           -0-
    200206                 1,999.98          -0-             -0-             -0-        -0-        1,999.98           -0-
 Business Consulting
    199806                19,999.93          -0-             -0-             -0-        -0-       19,999.93           -0-
    199906                 4,999.98          -0-             -0-             -0-        -0-        4,999.98           -0-
 Ceridian Employer
    200006                   520.00          -0-             -0-             -0-        -0-          520.00           -0-
 Charles Abraham
    200206                   675.00          -0-             -0-             -0-        -0-          675.00           -0-
                                                              - 327 -
                                                                                    Fees Re:        Fees Accepted
                                      Criminal      Grand Jury      Criminal         Jin Sook        As Ordinary       Other
                         Total      Investigation   Proceedings       Trial            Lee           and Necessary      Fees

Commercial Plumbing
   200006                 125.00          -0-                 -0-             -0-             -0-          125.00         -0-
Communications--Pacific
   200206                 979.16         -0-            -0-             -0-             -0-               979.16         -0-
COLIFORM
   199906                 145.83         -0-            -0-             -0-             -0-               145.83         -0-
Datahouse
   199806               1,588.53         -0-            -0-             -0-             -0-             1,588.53         -0-
   199906               8,234.22         -0-            -0-             -0-             -0-             8,234.22         -0-
   200106               6,054.64         -0-            -0-             -0-             -0-             6,054.64         -0-
Dataprofit Corp.
   200006             53,532.46          -0-            -0-             -0-             -0-            53,532.46         -0-
   200106               5,400.00         -0-            -0-             -0-             -0-             5,400.00         -0-
Dunn Bradstreet
   199806                 158.22         -0-            -0-             -0-             -0-               158.22         -0-
Electra Form
   199906             10,302.58          -0-            -0-             -0-             -0-            10,302.58         -0-
EMS Solutions
   199806                 (90.00)         -0-                 -0-             -0-             -0-          (90.00)        -0-
   199906               2,045.00          -0-                 -0-             -0-             -0-        2,045.00         -0-
   200006             21,970.00           -0-                 -0-             -0-             -0-       21,970.00         -0-
Fidelity Investments
   200006               7,017.53         -0-            -0-             -0-             -0-             7,017.53         -0-
Foley Jones
   199906                 741.00         -0-            -0-             -0-             -0-               741.00         -0-
Food Products
   199806               2,345.00         -0-            -0-             -0-             -0-             2,345.00         -0-
   199906               2,860.00         -0-            -0-             -0-             -0-             2,860.00         -0-
   200006               2,860.00         -0-            -0-             -0-             -0-             2,860.00         -0-
   200106               2,660.00         -0-            -0-             -0-             -0-             2,660.00         -0-
GEM Comm
   200006               5,841.12         -0-            -0-             -0-             -0-             5,841.12         -0-
GT Service
   200006               1,080.00         -0-            -0-             -0-             -0-             1,080.00         -0-
Hawaiian Hardware
   200006                 324.76         -0-            -0-             -0-             -0-               324.76         -0-
Henry Yokogawa
   200106             26,500.00          -0-            -0-             -0-             -0-                 -0-      26,500.00
   200206             63,600.00          -0-            -0-             -0-             -0-                 -0-      63,600.00
Intrastate Comm
   200006                  86.46         -0-            -0-             -0-             -0-                86.46         -0-
IW dba Italia Wang
   199906             32,000.00          -0-            -0-             -0-             -0-            32,000.00         -0-
                                                              - 328 -
                                                                              Fees Re:   Fees Accepted
                                      Criminal      Grand Jury    Criminal    Jin Sook   As Ordinary       Other
                          Total     Investigation   Proceedings     Trial       Lee      and Necessary     Fees
John Ching
  200006                1,075.00         -0-            -0-             -0-      -0-        1,075.00         -0-
Kimura International
  200106               19,428.68         -0-            -0-             -0-      -0-       19,428.68         -0-
  200206               11,562.42         -0-            -0-             -0-      -0-       11,562.42         -0-
Kobayashi Doi
  199806               65,837.29         -0-            -0-           -0-        -0-            -0-      65,837.29
  199906               61,140.22         -0-            -0-           -0-        -0-            -0-      61,140.22
  200006               57,966.64         -0-            -0-           -0-        -0-            -0-      57,966.64
  200106               67,758.54         -0-            -0-           -0-        -0-            -0-      67,758.54
  200206               76,116.85         -0-            -0-       2,195.28       -0-                     73,921.57
KPMG
  199806               17,291.00         -0-            -0-             -0-      -0-       17,291.00          -0-
  200006                8,854.11         -0-            -0-             -0-      -0-        8,854.11          -0-
L.C. Financial
  199806                  451.00         -0-            -0-             -0-      -0-          451.00          -0-
Leung Pang
  200006                1,800.00         -0-            -0-             -0-      -0-        1,800.00          -0-
Lorin Kushiyama
  199906               20,000.00         -0-            -0-             -0-      -0-                     20,000.00
Melvin Kam
  199806                  760.50         -0-            -0-             -0-      -0-          760.50          -0-
Michael Toigo
  199806                  246.75         -0-            -0-             -0-      -0-          246.75          -0-
  200006                1,291.60         -0-            -0-             -0-      -0-        1,291.60          -0-
Pension Services
  200006                  781.20         -0-            -0-             -0-      -0-          781.20          -0-
Procomm
   200006                 751.60         -0-            -0-             -0-      -0-          751.60          -0-
   200106               1,734.92         -0-            -0-             -0-      -0-        1,734.92          -0-
Professional Image
   200206                 125.68         -0-            -0-             -0-      -0-          125.68          -0-
Profit Concepts
   200006                 360.00         -0-            -0-             -0-      -0-          360.00          -0-
   200106               7,400.00         -0-            -0-             -0-      -0-        7,400.00          -0-
Quadrel Labeling
   199806              14,142.33         -0-            -0-             -0-      -0-       14,142.33          -0-
Rhanda Kim
   200106               7,127.56         -0-            -0-             -0-      -0-        7,127.56          -0-
   200206               7,658.81         -0-            -0-             -0-      -0-        7,658.81          -0-
Richard Kitagawa
   200006               4,500.00         -0-            -0-             -0-      -0-                      4,500.00
   200106                 500.00         -0-            -0-             -0-      -0-          500.00          -0-
   200206              (1,000.00)        -0-            -0-             -0-      -0-       (1,000.00)         -0-
                                                                 - 329 -
                                                                                   Fees Re:     Fees Accepted
                                       Criminal       Grand Jury       Criminal    Jin Sook     As Ordinary        Other
                            Total    Investigation    Proceedings        Trial       Lee        and Necessary       Fees

RJR Packaging
   200206                   745.00        -0-             -0-              -0-        -0-            745.00           -0-
Servend of Hawaii
   199906                 2,500.00        -0-             -0-              -0-        -0-          2,500.00           -0-
Stewart Engineering
   199906                 8,853.60          -0-            -0-             -0-          -0-        8,853.60           -0-
   200006                 2,197.78          -0-            -0-             -0-          -0-        2,197.78           -0-
Tricia Young
   200006                   613.60          -0-            -0-             -0-          -0-          613.60           -0-
TRI Pac
   199906                10,000.00          -0-            -0-             -0-          -0-            -0-       10,000.00
Vending Consulting
   200006                60,000.00          -0-            -0-             -0-          -0-            -0-       60,000.00
   200106                15,000.00          -0-            -0-             -0-          -0-            -0-       15,000.00
Watson Wyatt
   199906                15,857.00          -0-            -0-             -0-          -0-            -0-       15,857.00
Wayne Arakaki
   200106                   353.60          -0-            -0-             -0-          -0-          353.60           -0-
Amortization
   199806                30,643.54          -0-            -0-             -0-          -0-            -0-       30,643.54
   199906               116,176.10          -0-            -0-             -0-          -0-            -0-      116,176.10
   200006                38,387.03          -0-            -0-             -0-          -0-            -0-       38,387.03
   200106                45,080.13          -0-            -0-             -0-          -0-            -0-       45,080.13
   200206                40,570.67          -0-            -0-             -0-          -0-            -0-       40,570.67

  Total Other
    Professional
    Fees
   199806               160,924.92          -0-           -0-               -0-         -0-       64,444.09      96,480.83
   199906               298,009.68          -0-           -0-               -0-         -0-       74,836.36     223,173.32
   200006               273,835.87          -0-           -0-               -0-         -0-      112,982.20     160,853.67
   200106               207,156.39          -0-           -0-               -0-         -0-       52,817.72     154,338.67
   200206               205,132.57          -0-        2,195.28             -0-         -0-       24,845.05     178,092.24

  Total Legal and
    Other
    Professional
    Fees
   199806             1,836,071.34    394,967.60     699,081.77        53,911.87   474,591.00     82,482.80     130,996.30
   199906             1,410,550.00         -0-       847,803.17        59,896.96   117,487.86     83,531.56     301,830.45
   200006             2,671,518.30         -0-        96,985.95     2,207,999.62     6,297.00    168,940.02     191,295.71
   200106             1,990,674.61         -0-         5,000.00     1,756,169.06       438.25     62,553.77     166,513.53
   200206             2,313,051.99         -0-         2,195.28     2,052,651.31       452.64     32,318.23     225,434.53
                                                              - 330 -

        1
         In at least one of petitioners’ submissions to the Court, petitioners erroneously include this amount a second time in other
professional fees paid by Carlsmith Ball for 200206.

        2
         In at least one of their submissions to the Court, petitioners erroneously list Howard Chang’s total charges for 199806 as
$39,027.63. The correct total charges is $42,853.42, or in other words $3,825.79 greater than that reported by petitioners ($42,853.42
- $39,027.63 = $3,825.79).
