Current Kentucky Retirement Systems Trustees Considering Throwing Predecessors Under the Bus to Get Blackstone and KKR

At the beginning of this year, we discussed Mayberry v. KKR, a lawsuit on behalf of the beneficiaries of the all but bankrupt Kentucky Retirement Systems at length. This case appeared to be a long-overdue corrective for the way pension fund trustees and boards, either due to laziness, gullibillity, desperation, and/or outright corruption, have put too much money and faith in high-risk, high fee investment strategies like hedge funds and private equity funds that don’t deliver the returns needed to compensate for their extra risks.

Our judgment was confirmed at the just-concluded spring Council of Institutional Investors conference in Washington, DC, as well as by some new developments in the case.

First, to the Council of Institutional Investors conference. It included a full-day session on fiduciary duty. That briefing started with and discussed at some length the very same Kentucky Retirement Systems case.

As we explained in our January post, this suit not only targeted some very deep pockets, namely Blackstone, KKR Prisma, and PAAMCO for successfully targeting Kentucky Retirement Systems along with other particularly clueless public pension funds for untested hedge fund strategies that proceeded to enrich the fund managers while delivering poor returns to KRS, but it also hit all sorts of arguable culpable parties with solid-looking legal theories. No one before had bothered going after fund trustees, the execs, or key advisers because there wasn’t enough money among them to make it worth the fuss. But include them as part of a bigger story involving the people who walked off with the real money, their inclusion fills out the story for the purpose of a jury trial. It also has the very salutary effect of being a wake-up call to cronyistic public pension fund boards and executives that their belief that no one would bother to sue them over anything that might stick is a self-serving delusion.

I am told that the experts on the fiduciary duty panel recommended against a long-standing procedure among public pension funds, that of having the same fiduciary attorney represent both the board and the staff. It was treated as obvious that the fiduciary counsel would be inclined to favor staff as the party that paid its bills and would also likely generate more legal work than the board, and the board could therefore not rely on a fiduciary counsel in a role with inherent conflicts to put the board’s interest first. It was treated as obvious that the staff and board would regularly have interests that were not aligned and therefore the board needed independent representation. Someone needs to tell Matt Jacobs, who is now on the board of the CII, that CalPERS is out of compliance with what CII recommends as prudent practice.

The fiduciary duty panel also endorsed the idea of individual board members having their own representation. This is a repudiation of a bogus legal argument that has been deployed against dissident board members, who are almost alway pro-reform or pro-transparency. Fiduciary counsels for years have been promoting “co-fiduciary duty” which is a way of saying that minority board members, even if they see evidence of wrongdoing, must shut up and go along with what the majority decides.:

Cotrustees are jointly and severally liable for a breach of trust if there was joint participation in the breach. Joint and several liability also is imposed on a nonparticipating cotrustee who, as provided in Section 703(g), failed to exercise reasonable care (1) to prevent a cotrustee from committing a serious breach of trust, or (2) to compel a cotrustee to redress a serious breach of trust.

Now, to the news as far as the Kentucky Retirement Systems case proper is concerned. The latest wrinkle is that the Kentucky Retirement Systems is considering joining the case. How can that be when it is being sued???

The interesting wrinkle is that there has been so much turnover at the board and staff level that the group in charge is almost entirely new faces. They can thus go after the old incumbents.

This is yet another liability wrinkle that should scare the bejeezus out of public pension boards and staffs. The statute of limitations is long enough that senior staff and board members may have retired before class action lawyers representing broke beneficiaries show up. The Kentucky Retirement System suit notes in passing the the directors and officers’ insurance policy looks awfully thin in light of the exposure the fund was taking on. This may not be true at other funds, but if the lawyers who are representing the Kentucky Retirement Systems beneficiaries score a win, they will also have had the opportunity to hone their arguments (the lead attorney has a history of going to trial rather than settling). This will make them more effective when (not if) they go after other targets.

By way of background, the overview from our January post:

The suit, which we’ve embedded at the end of this post, was filed on behalf of the beneficiaries of Kentucky Retirement Systems (KRS), the state’s public pension fund and its taxpayers, against Blackstone, KKR/Prisma, and PAAMCO for engaging in a civil conspiracy and violating its fiduciary duties under Kentucky law by misrepresenting what it calls “Black Box” hedge fund products. One of the eight plaintiffs is a sitting district court judge.

In addition to suing the top executives at these funds, including Henry Kravis and George Roberts of KKR and Steve Schwarzamn of Blackstone, the filing also targets four former and three current KRS board members, four former KRS administrators for breach of fiduciary duties, along with KRS’ fiduciary counsel, several financial advisers, its actuarial adviser, and a firm that certified its Comprehensive Annual Financial Report.

The fund managers allegedly focused on KRS and other desperate and clueless public pension funds who were unsuitable investors, particularly at the risk levels they were taking. KRS made what was a huge investment for a pension fund of its size. $1.2 billion across three funds all at once, in 2011, roughly 10% of its total assets at the time. They all had troublingly cute names. The KKR/Prisma funds was “Daniel Boone,” the Blackstone fund was “Henry Clay” and the PAAMCO fund, “Colonels”.

In the case of KKR/Prisma, the fund had installed an employee at KRS as well as having a KKR/Prisma executive sitting as a non-voting member of the KRS board. The filing argues that that contributed to KRS investing an additional $300 million into the worst performing hedge fund even as it was exiting other hedge funds. 1

The suit seeks damages for losses, recovery of fees paid to the hedge funds and other advisers, and punitive damages. The damages would go to KRS and the suit also asks that the court appoint a special monitor to make sure the funds are invested properly.

Some observers may be inclined to see this litigation as having only narrow implications, since KRS is fabulously underfunded, at a mere 13.6% funding level with only $1.9 billion in assets, and famously corrupt. KRS not only saw its executive director and chief investment officer fired over a 2009 pay to play scandal, but more recently, it had the astonishing spectacle of having the governor call in state troopers to prevent the KRS chairman, Tommy Elliot, from being seated. 2

Charming, no? But with so much bad conduct out in the open, it’s not hard to see why analysts might assume that Kentucky is so sordid that a suit there, even if it proves to be highly entertaining, is relevant only to Kentucky.

That may prove to be a mistake. As one former public pension trustee said,

This is the equivalent of going from a confrontation between the public pension industry and some people throwing rocks to a confrontation against the Soviet Army. Bill Lerach, the guy behind this is as serious as they come. Don’t let the fact that he was disbarred in any way fool you.

Lerach’s wife is a Kentucky native and one of the lawyers representing KRS. Her husband’s firm, Pensions Forensics, is an advisor to this case.

Lerach has a net worth estimated at $900 million, which is plenty of firepower to fund expenses on a case like this. Two different readers in Kentucky (neither of them Chris Tobe) separately informed me that the Kentucky attorneys pleading the case are formidable. As one said by e-mail:

Anne Oldfather is a local lawyer with a fearsome reputation and not to be taken lightly and not prone to settlement of any cases.

The case has also been assigned to the most progressive judge in the state.

The stakes for the defendants are high. The giant fund managers do not want to be found liable for misrepresenting their products, since a loss in this case would expose them to many other suits. But the plaintiffs appear not inclined to settle, a settlement with a state entity may not be secret (they aren’t in California). That would reduce the defendants’ incentive to agree to anything bigger than what they could argue was a token payoff

But as we discuss below, this case also has serious implications for pension trustees and advisers all over the US.

The filing makes persuasive arguments about how all-too-common practices, like the overstatement of expected returns, which in turn leads pension actuaries, trustees, and legislatures to seek too little in the way of current contributions, is a breach of fiduciary duty. If the court were to rule in favor of the plaintiffs on the overstatement argument, it would send a shock wave across the pension world. Many supposedly well-run public pension funds like CalPERS engage the behaviors that this case credibly depicts as violations of fiduciary duty.

The legal team on this case would like to conduct a Sherman’s march through the many parties that have sat pat or benefitted from public pension fund grifting.

The Lexington Herald-Ledger provided . Anyone with a strong interest in this case should read the article in full. Key points:

The is debating whether to join on up to $1.5 billion in hedge fund investments by several wealthy corporations, with blame to be shared by some of its own current and former trustees and officials….

“All of the actions discussed in the lawsuit happened before I joined the board and before most of the current members of the board joined,” [John] Farris [KRS board chairman ] said. “So we’re having to go back and recreate a time-line and decide what the board was doing when it invested in these funds. So far, we’re looking at 37,000 pages of documents.”…

Among the 30 defendants named in the suit are the hedge fund dealers that sold investments to KRS and some of the nation’s wealthiest investors, including Henry Kravis, co-founder of KKR & Co., and Stephen Schwarzman, chairman and chief executive office of The Blackstone Group. The estimated net worth of just those two men is about $15 billion. The suit also targets KRS’ fiduciary and actuarial advisers….

Focusing on those who allegedly had a direct hand at KRS in investment decisions, the suits’ defendants include current trustees William Cook and Vince Lang; former trustees Randy Overstreet, Timothy Longmeyer, Bobbie Henson, Thomas Elliott and Jennifer Elliott; former chief investment officers David Peden and T.J. Carlson, former executive director William Thielen; and former director of alternative investments Brent Aldridge.

The suit also alleges certain conflicts of interest in the hedge fund deals.

For example, in June 2016, retired a year earlier as a senior portfolio manager at Prisma and continued to have a financial interest in the company and a “close personal” friendship with Prisma CEO Girish Reddy, the suit alleges.

While Cook was still at Prisma, the company created and sold the Daniel Boone Fund as an investment for KRS, the suit alleges. As the $500 million fund started to lose money, Cook and others helped arrange for a Prisma executive to work inside the KRS offices in Frankfort for two weeks every month, helping with the system’s investment portfolio, the suit alleges. In 2016, even as , citing their weak performances, it put an additional $300 million into Prisma’s Daniel Boone Fund, the suit alleges.

KRS’ chief investment officer at the time was Peden, who worked at Prisma himself a decade earlier, the suit alleges…

The defendants have filed individual responses to the lawsuit denying wrongdoing and asking Judge Phillip Shepherd to dismiss the case.

The implication is obvious: if Kentucky Retirement Systems joins the case. the plaintiffs have much greater odds of a win. They will get ready access to records, which greatly speed the progress to trial, since jousting over the discovery process is meant to throw sand in the gears. The longer a case is dragged out, the lower the odds of a plaintiff win, since the memory of key participants fades. And of course, the optics of the fund itself going after the fund managers and its own advisers, something that historically has been seen as a huge no-no for fear of alienating the oh-so-powerful fund kingpins, would represent a sea change.

Stay tuned. At a minimum, this litigation will be highly entertaining and it could even do a world of good.

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19 comments

  1. Chris Tobe

    For more on the history of this KY corruption see my new books
    is 550 pages and focuses on Kentucky funding issues as well

    is derived from the larger book with a focus on investments and adds more examples from others states but is only 222 pages and probably most appropriate for NK

  2. Larry

    When you read how ham-fisted manner in which Prisma went about plundering KRS it enrages you and makes you wonder how the plaintiffs can possibly lose? Financial professionals are clearly in the sole business of plundering these days.

    1. cnchal

      May I remind you of the financial professional’s duty?

      Bernie Sanders: The business of Wall Street is fraud and greed.

      What are those retirement commercials all about? Hand over money to fraudsters so they can take care of it for you and “make it grow”. Of course the disclaimer is only a couple of pixels high, but taken at face value means you’re a sucker for trusting us.

      1. Arizona Slim

        Yup, they’ll make it grow, all right. Especially when the “it” is the commission they earn from churning your account.

  3. Samuel Conner

    Is it uncharitable of me to think that it’s a shame that Pete Peterson could not also have been named as a defendant?

  4. Tom Anderson

    I’m in 10 supposedly top quartile funds that have posted mediocre returns at best. How do I someone about class action lawsuits. These guys are culpable!

  5. UserFriendly

    KY just slipped a 200+ Pension reform bill as an amendment to a sewage bill. Teachers in at least 9 counties are striking.

    According to a summary, the bill would place teachers hired after Jan. 1, 2019, in a hybrid cash-balance plan at Teachers’ Retirement System of Kentucky rather than a traditional pension, but it would not reduce the annual 1.5 percent cost-of-living adjustments for retired teachers, which was a controversial part of Senate Bill 1. Retired teachers in Kentucky do not get Social Security benefits, so any freeze in their pensions affects their total retirement income.

    Retirement eligibility for future teachers would increase to age 65 with five years of service or the “rule of 87” (when the employees’ combined age and years of service equal 87). The “inviolable contract” that protects reduction in future employee benefits would be limited to account balances in the cash-balance plan. Cash-balance plans are less generous than a traditional defined-benefits pension but offer more retirement security than a 401(k)-style defined-contribution account.

    Contribution rates would be 9.105 percent of salaries for teachers, with the state kicking in 6 percent and school districts providing another 2 percent. For educators at state universities who participate in the pension system, the employee contribution rate would be 7.625 percent, with a 4 percent employer contribution.

    Current teachers could not count payments for sick leave days accumulated after Dec. 31, 2018 toward their retirement benefits.

    For state workers who are enrolled at Kentucky Retirement Systems — and who who have been placed in hybrid cash-balance plans since 2014 — sick leave could not be used for the purposes of retirement eligibility “or to reduce applicable actuarial penalties for retirements occurring on or after July 1, 2023.” A state employee who retires after Jan. 1, 2019, and returns to a state job would not get a second retirement account at KRS.

    State retirees also would lose a $5,000 death benefit, payable to a designated beneficiary, state Rep. James Kay, D-Versailles, said in the House floor debate.

    As lawmakers debated in the House, a vocal group of about 70 teachers shouted protests outside the chamber.

    “Vote them out,” they cried.

    “We’re madder than hornets,” said retired teacher Claudette Green of Lexington, who taught in Elliott and Carter counties.

  6. hemeantwell

    Thanks for the tie-in with the developing teacher’s strike.

    The Kentucky legislature should be up on charges for political arson. Flim-flamming in full view of a mobilized public has an FU, incendiary quality.

  7. Allegorio

    This has been the pattern, loot social insurance programs, from pension plans, social security, student loans, Medicare, housing mortgage guarantees. When are these masters of corruption going to be rounded up along with their political enablers and join Bernie Madoff in prison for life. The statute of limitations needs to be rolled back and all and sundry prosecuted for crimes against humanity.

    Corrupt insiders are placed on the staffs of pension funds and the like by corrupt politicians funded by corrupt financial firms which also control the state prosecutors. When are Kamala Harris, Eric Holder and a host of other corrupt prosecutors going to held accountable for obstruction of justice.

    Just as Medicare for All is the only solution to the health care crisis, Social Security for All is the solution to the retirement crisis. Roll all private pensions into Social Security. No more opportunities for corruption, no more politically connected public employee unions getting Cadillac pensions, no more CEO golden parachutes.

    Flushing the Stygian Stables of corruption is indeed a Herculean task, but it must be done, now! The Age of Privilege based on phony meritocracies needs to come to an end and a new age of social solidarity begun. Equal opportunity indeed!

  8. Rosario

    For all KY people on this site please support the teachers fighting this bullshit. I’ll be at the Frankfort capital building Monday (4/2) with other JCPS teachers to challenge this. We are leaving Louisville around noon from Atherton High School. Sorry I do not have Facebook or Twitter to update. Will come back to this thread if anyone wants follow up information.

    1. Rosario

      To anyone returning to the thread.

      KFTC meeting at the capital:

      KY teachers are planning to join with other public workers.

  9. Synoia

    First they came for Pensions, and I did not speak out—
    Because I was on my Employer’s 401k plan—

    Then they came for the College Fees and I did not speak out—
    Because I was in a had already graduated—

    Then they came for Medial Copays, and I did not speak out—
    Because I was on an Insurance Plan—

    Then they came for my income—and there was none left for me.

  10. schmoe

    But what if KRS takes over the case, and then rolls over? Not saying it’s likely, but I assume that the plaintiff’s lawyers will have a right to return the case to its current posture if they believe that KRS is actually trying to hinder the case.
    Also, I wonder if this could nullify any insurance coverage for KRS since most insurance policies will not cover an insured suing itself (former directors might be fair game if they left several years ago). If the insurance is immaterial to the potential benefit of KRS joining, this will not matter.

    1. Yves Smith Post author

      KRS is not “taking over the case”. This is a class action lawsuit on behalf of the beneficiaries. There are eight lead plaintiffs. One is a retired judge. The attorneys are serious actors and they smell blood. Lerach is worth over $900 million, so he does not need KRS to fund expenses on the case, and KRS is too broke to do that anyhow to any meaningful degree.

  11. Randall Stephens

    The pension reform in KY, enacted just yesterday according to the link provided by UserFriendly above, appears to be unconstitutional pursuant to the Kentucky Constitution at Section 51:

    “No law enacted by the General Assembly shall relate to more than one subject, and that shall be expressed in the title, and no law shall be revised, amended, or the provisions thereof extended or conferred by reference to its title only, but so much thereof as is revised, amended, extended or conferred, shall be reenacted and published at length.”

    The bill was titled “Wastewater Sewage.”

    I sh*t you not.

  12. Norb

    -The estimated net worth of just those two men is about $15 billion-

    This statement is staggering. And still, Kravis, Schwarzman, and their ilk spend their working day figuring out how to increase this obscene number.

    The trouble is that the term “investment” has reverted to its archaic meaning- the surrounding of a place by a hostile force in order to besiege or blockade it. In our time, the besieging is looting plain and simple. Investment has moved from a positive, society building force, to one of social destruction. Investment morphing into speculation. Speculation morphing into outright corruption and looting.

    Speculation and pornography go hand in hand. Fine if restrained to small, discrete undertakings, but disastrous if allowed to flourish unchecked.

    So this is what Sodom and Gomorrah looked like…

    A large cleansing fire is well overdue.

    And then, once again, people will have to determine what will arise out of the ashes.

  13. KYrocky

    Also being overlooked, KY’s governor, Matt Bevin, is a former hedge funder guy himself. He knows how the looting works and is smart enough to expect that the hedges stripped KRS of several hundreds of millions of dollars in fees, at a minimum. Yet Bevin placed the blame of the entirety of the pension fund’s shortfalls on just one person: his immediate Democratic predecessor in the Governor’s office, Steve Beshear.

    With respect to the sewage bill, what has so far been missing is any discussion of who, exactly, it was that wrote the bill. Its language, substituted in its entirety into the sewage bill, was never disclosed prior to its filing, was voted on without any of those voting having had time to read it, and yet no one in office has addressed its divine birth. Speculation is that ALEC, Heritage and other Koch funded groups did the heavy lifting in drafting the bill. Only Bevin knows for sure. Republicans in the legislator did what they were told to do; we just don’t know who told them to do it.

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