Lawsuit: Retirement systems gambled on hedge funds, concealed its financial mess

FRANKFORT, Ky. – Struggling with a growing financial crisis in 2011, officials of Kentucky Retirement Systems gambled with a $1.2 billion investment in risky hedge funds and for years masked the severity of the crisis with false assumptions of its future investment returns, a lawsuit filed Wednesday alleges.

The 143-page lawsuit charges that certain KRS officials, its consultants, selected board members, three hedge fund firms and their top executives played roles in a “civil conspiracy” that involved hedge fund investments that eventually went sour and actions that obscured the systems’ financial woes.

The suit was filed by eight current and former Kentucky public employees in Franklin County Circuit Court.

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It charges that international hedge fund sellers – KKR/Prisma Capital Partners, Blackstone Group and Pacific Alternative Asset Management – breached their fiduciary duty by luring the Kentucky systems to make investments without fully disclosing the high risks, massive fees and lack of transparency.

But also named as defendants are major KRS consultants, several former or current KRS board members and administrators for allegedly also violating their fiduciary duty in decisions about the hedge fund investments and approving allegedly faulty assumptions.

The eight plaintiffs are seeking to recover losses resulting from the allegedly irresponsible actions for the Kentucky Retirement Systems, not for themselves. While the suit does not ask for a specific dollar amount in damages, it does say that KRS is "billions of dollars” worse off today because of the defendants' actions.

"The claims are baseless," Matthew Anderson, a spokesman for Blackstone, said in response to the suit. "The Blackstone fund referenced in the complaint delivered to the Kentucky Employees Retirement System positive returns outperforming relevant benchmarks."

KKR released a statement that said, "We take our fiduciary duty very seriously and believe that the allegations about our firm are meritless, misplaced and misleading."

A Pacific Alternative Asset Management spokeswoman said the lawsuit was still being reviewed and had no immediate comment.

The suit was filed six days before the convening of the 2018 Kentucky General Assembly where lawmakers are preparing to address a pension reform plan that Gov. Matt Bevin had hoped to pass during a special legislative session this year.

But the reform plan Bevin unveiled in October – which called for transitioning Kentucky’s traditional “defined benefit” pension plans to 401(k)-like savings plans and cut some benefits – was met with considerable opposition and the special session was never called.

Now leaders of the legislature’s Republican majorities are working privately to develop a revised bill they hope to unveil next week and pass later in January.

The goal is to gain control over one of the worst-funded pension systems in the country with more than $40 billion in unfunded liabilities when the liabilities of KRS are combined with those of the separate Kentucky Teachers’ Retirement System.

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The lawsuit was filed by four attorneys: Ann Oldfather and Vanessa Cantley, of Louisville; Michelle Ciccarelli Lerach, of La Jolla, California; and Jonathan Cuneo, of Washington.

Kentucky Retirement Systems, which oversees five retirement plans for about 360,000 current and former state and local government workers, was more than fully funded in 2000 but suffered massive losses during economic recessions of 2001-02 and 2008-09.

With KRS officials and its consultants caught in a financial “vise,” the suit alleges they took a risky gamble with $1.2 billion in investments in hedge funds – an alternative investment that uses different strategies to try to beat the market.

The lawsuit calls the investments made by KRS “black boxes” – hedge funds it says are actually funds comprised of other hedge funds with limited transparency and exorbitant fees. And significantly, the lawsuit charges these investments generated sub-par returns and, later, large losses.

The lawsuit mostly criticizes actions of KRS during the administration of Democratic Gov. Steve Beshear, who was governor 2007-15.

And Bevin appointees who now control the KRS board this year have strongly criticized the prior board for optimistic assumptions and significantly dropped its assumptions for how much KRS will earn on investments and state government payroll growth.

Higher assumptions on how much the systems make on their investments resulted in KRS not asking for enough state taxpayer funding to support the systems.

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Still, the suit criticizes a decision made in 2016 to put about $300 million more into its worst-performing hedge fund even as it was selling off $800 million in the earlier investment it had made in other hedge funds.

One of the defendants, former KRS Executive Director Bill Thielen, said assumptions made for investment returns by KRS were consistent with assumptions made by other state pension systems. Thielen also said that even with assumptions that the lawsuit charges were too optimistic, the Kentucky General Assembly fell far short of funding requests made by KRS over more than a decade prior to 2015.

The lawsuit says Attorney General Andy Beshear was asked to file the action, but he declined. Beshear's spokesman said that because of a pending case Beshear's office has taken involving KRS, it was "unable to consider the claims in this lawsuit at this time."

Tom Loftus: 502-875-5136; tloftus@courierjournal.com; Twitter: @TomLoftus_CJ. Support strong local journalism by subscribing: www.courier-journal.com/toml