By John Cheves | Lexington Herald-Leader

Two investment firms that have handled hundreds of millions of dollars for Kentucky Retirement Systems sued the state pension agency this week for breach of contract, accusing it of betraying them by backing a lawsuit that asserts they swindled KRS on hedge funds.

Prisma Capital Partners and Blackstone Alternative Asset Management filed similar lawsuits in Delaware’s Court of Chancery to demand that the cash-strapped KRS reimburse them for their mounting legal expenses from the hedge fund suit and — if they lose that case — any court-ordered damages they are required to pay.

KRS executive director David Eager said the agency does not comment on pending litigation.

Jeff Mayberry, Don Coomer and Jason Lainhart are three of the eight public employees suing several major investment firms in Franklin Circuit Court, alleging that the firms cheated Kentucky Retirement Systems on $1.5 billion in hedge funds. | John Cheves, Lexington Herald-Leader

In their suits, Prisma and Blackstone protest a third lawsuit, this one filed in late 2017 by eight public employees whose pensions are held by KRS. The employees assert that several major investment firms, including Prisma and Blackstone, cheated KRS on $1.5 billion in hedge fund investments starting in 2011, with blame to be shared by some of KRS’ current and former trustees and officials.

The hedge funds produced “excessive fees … poor returns and ultimately losses,” saddling Kentucky with a crippling debt that should be repaid by the investment firms and their wealthy individual owners, the suit alleged. The hedge funds were “extremely high-risk, secretive, opaque, high-fee and illiquid vehicles,” carrying risks not adequately disclosed to KRS, the suit said.

The legal team behind the suit includes Michelle Ciccarelli Lerach, a Kentucky native who now practices law in San Diego, and Louisville attorney Ann Oldfather. They are working with Lerach’s husband, Bill, a disbarred California class-action lawyer who is identified in the case as a “pension consultant.”

Dissatisfied with the return on hedge fund investments, KRS opted several years ago to shrink its overall hedge fund allocation from 10 percent of assets to 3 percent. Presently, KRS faces an unfunded pension liability of $23.6 billion, and its primary pension fund for state employees has only 12.9 percent of the assets it’s expected to need for future payments.

After the public employees filed their suit, the KRS Board of Trustees debated whether to join as plaintiffs. KRS ultimately decided not to join, but it pledged to cooperate with the suit and issued a statement expressing support for its “potentially valuable claims for the benefit of KRS.”

That declaration of support upset Prisma and Blackstone, especially as the case continued in Franklin Circuit Court over the next year and survived the firms’ motions to dismiss.

The investment firms argued in court this week that KRS voluntarily entered into written contracts with them nearly a decade ago for hedge fund investments, that it claimed to understand how fees would be paid, and that the firms upheld their ends of the deals. Prisma managed the Daniel Boone Fund for KRS; Blackstone managed the Henry Clay Fund.

The Daniel Boone Fund generated $139 million in net returns, Prisma said. For the Henry Clay Fund, it was $158 million, Blackstone said.

It’s unfair for anyone to blame hedge fund investments for Kentucky’s public pension shortfall, which is actually due to “decades of underfunding of the pension system by the Kentucky legislature, incorrect actuarial assumptions and changes in the composition of Kentucky’s workforce and the life expectancy of its retirees,” Blackstone said in its suit.

Blackstone describes the public employees’ lawsuit as “the Mayberry action,” referring to lead plaintiff Jeff Mayberry, a retired Kentucky State Police trooper.

“KRS’ active support of the Mayberry action constitutes a breach of the representations to which KRS — advised by sophisticated internal investment professionals, outside advisers and counsel — agreed in the subscription agreement and on which (Blackstone) relied in structuring the Clay Fund,” Blackstone said.

“Those representations were intended to protect (Blackstone) against this very circumstance: an investor chasing potential financial rewards by repudiating everything to which it had previously agreed that it had understood in entering into the investment,” the firm said. “Here, the investor has done so by coordinating with rapacious, contingency-fee counsel to maintain a merit-less suit that has caused — and will continue to cause — (Blackstone) to incur massive legal fees and other expenses and to face the prospect of being named jointly liable for the entire deficit of a state’s pension system.”

Prisma made much the same arguments in its own suit. In a statement issued Friday, the firm said that it and partner PAAMCO, which merged with Prisma in 2017, are entitled to recover legal expenses when “the two firms are forced to defend baseless claims even though they managed their respective funds in good faith, profitably, and in accordance with the operative contracts.”