FRANKFORT — Kentucky's big public pension systems fall "drastically short" of complying with a two-year-old law that requires them to disclose how they invest their money and how much they pay money managers, a state audit has found.

A 2017 law known as Senate Bill 2 required greater transparency from Kentucky's retirement plans, but a report from Kentucky Auditor Mike Harmon on Tuesday concluded both Kentucky Retirement Systems and Teachers' Retirement System have fallen far short of meeting the law's requirements.

"With the tremendous amount of attention that has been given in recent years to our public retirement systems, stakeholders and taxpayers have a right to know how funds are being invested, and who is investing them," Harmon said in a news release. "... Yet KRS and TRS have failed to fully keep with the spirit of SB2."

Harmon said at a news conference, "KRS and TRS have fallen drastically short of what is required by the law" regarding its requirement that investment contracts be posted on the websites of the retirement systems.

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Auditors found that 243 of the Kentucky Retirement Systems' 281 investment contracts are not posted on its website. But auditors said they could not be absolutely certain of those numbers because "KRS provided inconsistent data that made it impossible to calculate the exact percentage of unposted contracts."

Likewise, the audit reports that TRS has failed to post on its website 136 of 167 contracts. "According to TRS, the investment manager contracts not posted to the TRS website ... pertain to private equity investments, which TRS considers proprietary as a whole," the audit says.

Moreover, auditors questioned large tracts of information that have been blacked out within the pension investment contracts that are available.

The report is particularly critical of KRS, saying that KRS allows the money managers to do their own redacting.

"KRS has abdicated its responsibility to abide by the Open Records Act," says the audit's first finding. It says it has done so by delegating "its responsibility to redact confidential and proprietary information for those contracts to external investment managers."

Harmon said at the news conference that this "would be much like a baseball player going up to bat and being allowed to call his own balls and his own strikes."

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While certain proprietary information can be withheld from public disclosure under the Open Records Act, auditors said their review of contracts shows there are "clearly unnecessary redactions" from some KRS contracts of basic information such as the date of the contract and its table of contents.

The audit says TRS has a process to handle redaction requests in writing from money managers, but also redacts other information without requests.

And both KRS and TRS failed to post documents called "side letters" that contain information relating to the agreement with their vendors.

Auditors also criticized TRS regarding a key provision of the law that required any complicated profit sharing, carried interest or other incentives offered to money managers be clearly disclosed. While TRS has technically complied with the provision, the audit says the system has not reported this information "in a manner to allow the public to easily identify the amount earned."

SB2 was a priority of the 2017 General Assembly, and it passed without a dissenting vote as a necessary reform during a time when lawmakers were approving Gov. Matt Bevin's proposed massive increases in state funding to keep the financially troubled plans afloat.

KRS Executive Director David Eager said in an interview later Tuesday that he takes "great exception" to the finding that KRS has abdicated its responsibility to abide by the open records act.

Eager wrote in his response to auditors that KRS is under no legal obligation to disclose contract information that is exempt, such as a proprietary secret, or information that would "detrimentally impact KRS' ability to invest."

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He said in the interview that KRS has an attorney general's opinion from 2016 "that says the managers have the right to determine what is proprietary, secretive, and could be detrimental to them by giving competitors information."

He said KRS is not in a legal position to determine what type of information investment managers can redact from contracts, noting a legal process by which an aggrieved party can appeal a dispute over a redaction to the attorney general or the courts.

"If we decide what they can redact and not redact, it puts us in a potentially liable situation. If we chose to do the redactions and didn't catch something that subsequently became a problem and the manager is sued, potentially by one of the other investors in one of these limited partnerships, it comes back," Eager said. "... We are fiduciaries for the plan, the system, and we can't do that because it puts us in legal jeopardy."

As for contracts that were not posted in their entirety, Eager wrote that KRS was "contractually obligated to maintain the confidentiality of managers" brought on before the passage of SB2, the posting of which could open the system up to litigation.

Harmon's response to the KRS reply reiterated that the posting of the names of vendors, dates of contracts, table of contents headers and fee terms in contracts "are clearly not trade secrets" that are exempt from disclosure requirements.

In a statement reacting to the audit, TRS general counsel Beau Barnes countered that it is following the letter and spirit of the law.

"Releasing all contract information is contradictory to protections for sensitive details provided by current law," Barnes stated. "This hurts taxpayers by precluding partnerships as an investment, taking teachers out of funds that averaged a compounded 13.41% return the last 10 years."

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While the vast part of the audit deals with failure to comply with SB 2, the audit also found that KRS has $16.1 million in delinquent balances from state agencies.

Kentucky State Police has the highest unpaid balance — owing KRS $6.1 million.

Harmon's report contains many recommendations aimed at forcing more disclosure by KRS and TRS. One of them is to ask for a new attorney general's opinion to clarify exactly what sort of information can be legally redacted as proprietary and withheld from public disclosure.

Harmon is seeking reelection in November as the Republican nominee for state auditor. He is opposed by Democrat Sheri Donahue, of Frankfort, and Libertarian Kyle Hugenberg, of Louisville.

Harmon stressed Tuesday that nothing in the audit finds any state retirement plan has mismanaged any funds. But he said that "it is clear to me" that KRS and TRS are not complying with the 2017 law and he urged executives and board members of the two systems to follow the audit's recommendations.

Bevin told reporters later Tuesday at the Capitol that he had not seen the audit, "but I'm in full agreement of the fact that the more transparency the better."

Bevin said, "We should know exactly who's managing the money, who's getting paid, who got paid finder's fees for bringing managers on board. We should find out exactly how much every pension retiree is making. Anything that the taxpayers are funding — which is almost everything associated with the pension system — should be disclosed, fully disclosed, to the public."

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Former Sen. Joe Bowen, the lead sponsor of SB 2 in 2017, told the Courier Journal he was not surprised by the findings of Harmon's audit and hopes KRS and TRS leaders begin providing the type of transparency on contracts that is required under the law.

“I think his audit is very revealing and should be of some concern to everybody —legislators and taxpayers and people that are actually in the systems — that they’re not complying with the legislation,” Bowen said.

According to records on the KRS website, investment firms managed $16.8 billion of its pension and insurance fund assets in the 2017-18 fiscal year ending last summer, receiving $121.5 million in management and performance fees.

Through the first nine months of the 2018-19 fiscal year, investment firms managed nearly the same amount of KRS assets, but had been paid $78.2 million in fees.

Records on the TRS website show that investment firms managed nearly $21 billion in its assets in that same nine-month period, with those managers receiving $34.2 million in fees.

Reporter Tom Loftus can be reached at 502-875-5136 or tloftus@courier-journal.com. Twitter: @TomLoftus_CJ. Support strong local journalism by subscribing today: courier-journal.com/toml.