A major lawsuit was filed Wednesday against several private equity companies and the current and former advisers, trustees and officers of the Kentucky Retirement Systems, alleging that the pension plans’ assets were heavily depleted through a civil conspiracy of disastrous investments in risky “black box” hedge funds and breaches of fiduciary duties.
The 146-page complaint was filed in Franklin Circuit Court by eight current and retired government workers covered by a pension plan within KRS, on behalf of the taxpayers of Kentucky and derivatively on behalf of KRS. The plaintiffs would not be directly paid damages in the lawsuit, but they are seeking billions of dollars in damages that would be deposited back into KRS, along with a court-appointed special fiduciary who would supervise such funds to make sure they are not misused again.
The fate of KRS assets has been well-documented in recent years, as the public pension plans of 350,000 current and former government workers that had a surplus as late as 2001 are now among the worst-funded in the country. The second-largest plan within KRS — the Kentucky Employees Retirement System Non-Hazardous plan — is now the single worst-funded public pension plan in the country and near insolvency, with an asset-to-liability funding ratio of just 13.6 percent.
The complaint filed Wednesday largely focuses on the controversial $1.2 billion investment by KRS on a single day in August of 2011, when three international hedge fund sellers sold three different “black box” hedge fund vehicles — in which the investor knows little if anything about its content. The complaint states that these “risky, toxic” investments had poor returns that depleted the system’s assets, alleging how the private equity firm behind the worst performing hedge fund vehicle — the “Daniel Boone Fund” — used its influence to convince KRS to invest $300 million more into it in 2016.
The giant hedge fund sellers listed as defendants in the complaint are KKR & Co., Prisma Capital Partners, Blackstone and Pacific Alternative Asset Management Company (PAAMCO), in addition to six top executives at these firms. The complaint accuses the companies of targeting the underfunded KRS with risky hedge fund vehicles while charging massive fees, which eventually reaped poor returns that hastened the collapse of KRS assets.
Also listed as defendants in the complaint are several financial advisers to KRS, who are accused of breaching their fiduciary duties to the pension plan. KRS investment adviser R.V. Kuhns LLC is alleged to have used outdated, inaccurate and false actuarial assumptions on investment returns for many years — with actual returns falling well short each year — with two of its top executives also named as defendants.
Actuarial adviser Cavanaugh Macdonald Consulting and three of its top executives were also named as defendants, as well as fiduciary counsel Ice Miller LLP. Government Finance Officers Association, which certified the annual reports of KRS, is also listed as a defendant.
Four former trustees of the KRS board, three current trustees and four former KRS administrators were also named as defendants for breach of fiduciary duties, with the complaint alleging that they conspired with the financial advisers and hedge fund sellers “to cover up the true extent of the KRS financial/actuarial shortfalls and take longshot imprudent risks with KRS Funds to try to catch up for the Funds’ prior losses and deceptions.”
The four former trustees listed as defendants are Randy Overstreet, Bobbie Henson, Jennifer Elliott and Timothy Longmeyer — the latter being the former Beshear administration official who is currently serving in federal prison after his conviction for a bribery and kickback scheme. The current trustees named are Investment Committee members William Cook and Vince Lang, as well as former board chairman Tommy Elliot, who was removed by Gov. Matt Bevin in 2016 but restored as a non-voting member by a court ruling.
Cook, who was appointed to the KRS board by Bevin in 2016, was previously the executive director of Prisma when the firm created and sold the “Daniel Boone Fund” to KRS — retaining a multimillion-dollar interest in that company, according to the complaint.
The complaint also alleges that Cook “arranged for a KKR/Prisma executive to work inside KRS, while still being paid by KKR/Prisma,” and that his “presence on the KRS Board and the presence of KKR/Prisma executives inside KRS, and certain other transactions in which he participated, violated and continue to violate the conflict of interest provisions of the Kentucky Pension Law.”
The complaints also lists former KRS chief investment officer T.J. Carlson and David Peden as defendants, as well as former alternative investments manager Brent Aldridge. The lawsuit also names as a defendant former KRS executive director Bill Thielen, who Bevin recently said “should be in jail” for his actions in that position.
The complaint states that Peden formerly worked with Cook at Prisma, adding that “while Cook and Peden and the KKR/Prisma executive were working inside KRS, KKR/Prisma sold $300 million more in Black Box vehicles to KRS despite that KRS was then selling off over $800 million in other hedge funds because of poor performance, losses, and excessive fees and the KKR/Prisma Black Box was the worst performing of the three. This very large sale to KRS was a significant benefit to KKR/Prisma, which was then suffering outflows due to customer dissatisfaction over poor results and excessive fees.”
The complaint seeks damages for the losses incurred by KRS due to the alleged breaches of fiduciary duty and poor investments, the refund of fees given to financial advisers and hedge fund sellers, and the “greatly increased costs to the taxpayers” of restoring the public pension plans to a properly funded status “after years of concealment of the true financial condition of KRS and the waste of its funds.”
The complaint highlights a 2015 study from the Roosevelt Institute, which reported that hedge funds had aggressively pursued public pension dollars across the country, at great cost to the assets of those plans that would have been better off with normal investments. Examining 11 pension plans that invested in hedge funds, the report found that this cost those funds an estimated $8 billion in lost investment revenue, while hedge fund managers collected an estimated $7.1 billion in fees from those funds in that same time period.
Former KRS trustee Chris Tobe — a whistleblower who drew attention to many issues detailed in the complaint in his 2012 book “Kentucky Fried Pensions” — told IL that he was not involved in the lawsuit but is very supportive of it, “as it reinforces one of the top recommendations in my book to enforce state fiduciary law based on CFA codes and standards, through litigation if necessary. It also goes after directly the Wall Street firms that have taken Kentucky taxpayer money via excessive fees in secret no-bid contracts.”
The plaintiffs are represented by Louisville attorneys Ann Oldfather and Vanessa Cantley, as well as Michelle Ciccarelli Lerach of La Jolla, Calif., and Washington, D.C., attorney Jon Cuneo. Pensions Forensics LLC was hired by the plaintiffs as a consultant for the litigation.
In a press release from Oldfather announcing the litigation, plaintiff Jeff Mayberry — a retired captain with the Kentucky State Police — stated that the defendants should be forced to pay as the state struggles with budget shortfalls resulting from the pension crisis.
“I’m not one for litigation, but this suit needed to be brought,” said Mayberry. “Even if we don’t get a dime for the funds to help replenish what was lost – though I certainly hope we will — we might get some reform at the [KRS] board in how our money is managed. Most of (us) can’t afford to start over.”
The lawsuit filed in Franklin Circuit Court on Wednesday only presents the plaintiffs’ side of the legal argument.
The spokespersons for Gov. Bevin did not immediately return an email seeking the administration’s reaction to the lawsuit. Bevin had promised to call a special session of the Kentucky General Assembly before the end of this year to take up his public pension bill — which shifted most government workers from defined benefit plans to 401(k)-style defined contribution plans — but there was a lack of consensus among Republican legislators. Legislators are expected to devote the early weeks of the regular session that begins next to pension legislation.
Terry Sebastian, the spokesman for Kentucky Attorney General Andy Beshear, told IL in a statement that “because of our current action in Franklin Circuit Court involving the Kentucky Retirement Systems Board of Trustees, we are unable to consider the claims in this (Mayberry) lawsuit at this time.” In the case in question, Tommy Elliott sued the governor for illegally removing him from the KRS board, with Beshear intervening to also challenge this as an illegal reorganization of an independent board.
In a 2014 lawsuit filed by a Louisville teacher against the Kentucky Teachers’ Retirement System, KKR was represented by Stites & Harbison, where Beshear worked at the time before taking office as the attorney general in December of 2015.
KRS interim executive director David Eager told IL that “by policy, we have no comment on pending litigation.”
A spokesman for Blackstone told IL in an emailed statement that the claims in the lawsuit are “baseless,” as “the Blackstone fund referenced in the complaint delivered to the Kentucky Employees Retirement System positive returns outperforming relevant benchmarks.”
Likewise, a spokeswoman for KKR stated in an email to IL that “We take our fiduciary duty very seriously and believe that the allegations about our firm are meritless, misplaced and misleading.”
A PAAMCO representative told IL that the firm has not yet seen the complaint. Prisma did not immediately return a request for comment.
The full complaint can be read below:
This story will be updated.