FRANKFORT — A "placement agent" profited from his questionable access to major investment deals at the Kentucky Retirement Systems in violation of disclosure rules, according to a report released Tuesday by state Auditor Crit Luallen.
Luallen's staff spent months examining the role of placement agents, the middlemen who help private investment companies sell their products to the $13 billion pension fund for state and local government retirees. Luallen found nearly $11.6 million in fees paid or committed to placement agents from 2007 to 2010.
Luallen said one placement agent in particular, Glen Sergeon of New York, enjoyed close access to KRS through his relationship with Adam Tosh, then KRS' chief investment officer. Tosh resigned in 2010, shortly after internal auditors at KRS's questioned him about nearly $6 million in fees paid to Sergeon in KRS deals.
No other placement agent won more deals from KRS than Sergeon, auditors wrote. Luallen said Tuesday that her office did not have access to Tosh's and Sergeon's personal financial records, so she could not determine whether money privately changed hands between them. But she is forwarding her report to the U.S. Securities and Exchange Commission for further review. The SEC has the authority to subpoena financial records.
"There are still questions about the relationship between these two individuals," Luallen said at a news conference.
Tosh, now a managing director at Rogerscasey investment firm in Darien, Conn., did not return a call seeking comment for this story. Sergeon could not be reached for comment. Both men refused to speak to state auditors, Luallen said.
Tosh arranged for Sergeon to attend a 2009 KRS investment committee meeting that led to a $200 million commitment to invest in the hedge fund Arrowhawk, a deal for which Sergeon would be paid placement agent fees, auditors wrote. Tosh did not introduce Sergeon to committee members or explain what Sergeon's interest was, auditors wrote.
Email messages show that Sergeon organized trips and business meetings for Tosh in New York, Dallas and San Francisco, which led to investment deals for which Sergeon was paid fees, auditors wrote. KRS officials were not informed of Sergeon's role in these trips, auditors wrote.
In some instances, Tosh did not submit all of the expense records for his out-of-state travel — for example, restaurant meals — raising the possibility that outside parties with an interest in KRS business might have treated him, auditors wrote.
"This may be in direct conflict with the best interests of KRS, as placement agents may be more inclined to bring KRS those (investment) managers that are willing to pay them the most advantageous fee," auditors wrote.
During an internal audit conducted by KRS last year, Tosh and Sergeon said they became acquainted several years earlier when they teamed up on market strategies in Pennsylvania. At the time, Tosh was employed by that state's pension fund, and Sergeon was with Merrill Lynch.
One of Sergeon's several firms, Diamond Edge, has been caught up in a controversy in New York over placement agents whose large political donations might give them unique access to state investment officials.
Diamond Edge partner Marvin Rosen — whom KRS records identify as sharing a $750,000 fee with Sergeon from a 2008 KRS deal — is a major national Democratic Party fund-raiser and a close ally of former Democratic President Bill Clinton. Sergeon, too, contributes to Democratic political campaigns, although none in Kentucky, according to campaign-finance records.
Auditors said they found no evidence of such "pay-to-play" corruption in Kentucky. They also said they saw no evidence that placement agents' fees led to higher management costs for KRS. Deals involving placement agents cost about the same as deals without them, auditors said.
Luallen said she found no reason to act on phone calls that aides to Gov. Steve Beshear made to KRS, suggesting meetings with two of the governor's Democratic political supporters who worked on behalf of private investment companies. The phone calls produced meetings but no deals, she said.
The Herald-Leader first reported on those calls in May.
"There was no evidence of pressure to use specific firms," Luallen said.
It remains to be seen whether the investments recommended to KRS by placement agents will produce good returns over the long term, auditors wrote.
Under KRS disclosure rules, Tosh was supposed to tell his superiors about Sergeon's role in investment proposals, but he repeatedly failed to do so, auditors wrote. Several times, auditors wrote, Tosh recommended investments linked to placement agents while bypassing KRS's outside investment consultants, who were paid nearly $300,000 a year to weigh in on such proposals.
Auditors made 92 recommendations to strengthen controls and oversight. In short, Luallen said, the nine-member KRS board of trustees — some of whom are elected by government employees, others of whom are appointed by the governor — must ask more questions about the agency's investments and administrative costs.
Although Tosh did not always volunteer information about how investment proposals were put together, board members should have known to ask for it, Luallen said. Until recently, she said, the board didn't even know the salaries of top KRS executives; it simply approved the agency's payroll budget in one lump sum.
"There is not another public agency in Kentucky that has such a significant fiduciary responsibility affecting as great a number of people as the Kentucky Retirement Systems board," Luallen said Tuesday. "To carry out this responsibility, these board trustees need to be highly qualified, adequately informed and fully engaged."
Luallen will present her audit Wednesday to the legislature's interim joint committee on state government. Lawmakers might want to consider legislative changes, Luallen said, such as requiring placement agents to register as lobbyists with the Executive Branch Ethics Commission.
In her response to the audit, KRS board chairwoman Jennifer Elliott wrote that most of the agency's leadership has been fired or replaced or has resigned in recent months, including the longtime board chairman, executive director and general counsel. The new leadership is committed to knowledge and transparency, Elliott wrote.
"We do not disagree with any of the findings and recommendations contained in your report," Elliott wrote.