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Court of Appeals dismisses suit alleging hedge fund fraud at Kentucky pension agency

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Kentucky is at the center of a PBS "Frontline" investigation of how state governments and Wall Street led America’s public pensions into a multi-trillion-dollar hole.

The Kentucky Court of Appeals has dismissed a fraud lawsuit against several major hedge fund dealers filed by public employees on behalf of Kentucky Retirement Systems, ruling that the employees lacked the right to sue because they could not show how they had been damaged.

The lawsuit, filed in Franklin Circuit Court two years ago, alleged that investment firms cheated KRS on $1.5 billion in hedge fund investments starting in 2011, with blame to be shared by some of KRS’ current and former trustees and officials. The firms sold funds that were “extremely high-risk, secretive, opaque, high-fee and illiquid vehicles,” leaving KRS in poor shape, according to the suit.

Jeff Mayberry, Don Coomer and Jason Lainhart are three of the eight public employees suing several major investment firms in Franklin Circuit Court, alleging that the firms cheated Kentucky Retirement Systems on $1.5 billion in hedge funds. John Cheves

The defendants — KKR & Co., Prisma Capital Partners, The Blackstone Group and Pacific Alternative Asset Management — denied wrongdoing. Last year, they filed a motion to dismiss the case that cited, among other things, the plaintiffs’ alleged lack of “standing,” or their inability to show how they’ve been harmed in order to justify their involvement in a lawsuit.

Judge Phillip Shepherd denied the defendants’ motion Nov. 30 and let the case proceed.

But the Court of Appeals overturned Shepherd on Tuesday and told him to vacate that denial, issuing a rare writ of prohibition, an order from a higher court telling a judge to cease proceedings because he does not have the jurisdiction to hear it.

Although the eight public employees who filed the lawsuit are Kentucky taxpayers and members of KRS, which oversees state and local government retirement benefits, they cannot show how the hedge fund dealers directly harmed them, Court of Appeals Judge Judge Pamela Goodwine wrote for a panel that also included judges James Lambert and Larry Thompson.

Judge Pamela Goodwine

“The individual members have not alleged their benefits have been or will be decreased,” Goodwine wrote.

“Rather, they assert only that KRS is currently in a budgetary shortfall due to improvident investments and the advice, mistakes and breach of fiduciary duty of the trustees and financial advisers. The individual members’ statutory rights do not extend to oversight of the process by which their pension is funded, such as by asserting claims against KRS’ financial advisers. The individual members’ right is only to the receipt of promised funds,” Goodwine wrote.

The investment firms praised the appellate court’s decision Thursday. The lead plaintiff in the case is Jeff Mayberry, a retired Kentucky State Police trooper.

“The Court of Appeals has now confirmed that the Mayberry lawsuit should never have been brought. Kentucky law does not allow private plaintiffs and their contingency-fee lawyers to usurp the powers of a state agency and assert claims for personal profit in the name of the commonwealth,” Prisma Capital Partners said in a prepared statement.

A lawyer for the public employees said Thursday they are asking the Kentucky Supreme Court to review their case.

“Judge Shepherd upheld the right of the Mayberry plaintiffs, on behalf of the Kentucky Retirement Systems and every Kentucky taxpayer, to recover damages from Wall Street hedge fund sellers and paid consultants and advisers for breaching their fiduciary duties and causing what may be the largest economic crisis in Kentucky’s history,” said Louisville attorney Vanessa Cantley.

“We are confident the Kentucky Supreme Court will, likewise, protect Kentucky citizens’ rights to recover from all wrongdoers by reinstating Judge Shepherd’s ruling in short order and allowing our case to proceed on the merits,” Cantley said.

Although discovery in the case had been stalled while several issues were appealed, lawyers for the public employees gathered enough documents to level accusations of “self-dealing” against the investment firm and KRS insiders.

For example, the plaintiffs alleged that Prisma gained improper control over the KRS hedge fund portfolio when the pension agency’s then-chief investment officer, who previously worked for Prisma, allowed a Prisma executive to be embedded at the KRS offices as an adviser, and later, when a Prisma retiree with financial interests in the company was named to the KRS Board of Trustees.

Prisma countered by saying that its Daniel Boone Fund generated $139 million in net returns for KRS, and that its various relationships with KRS were understood by the pension agency’s Board of Trustees and its investment committee. William Cook, the Prisma retiree on the KRS Board of Trustees, also named in the suit, said he abstains from voting on Prisma-related business.

KRS mostly stayed on the sidelines during the litigation, choosing not to join as a plaintiff. But it could get stuck with an enormous bill for dozens of lawyers and court fees because the hedge fund dealers are suing the pension agency in Delaware and California in order to pass along their costs from the lawsuit. They argue that they partnered with KRS under contract in good faith, and KRS should cover the expense of any litigation they now face for their work.

Kentucky faces a combined $37 billion public pension shortfall between KRS and the Teachers’ Retirement System of Kentucky, due to many years of inadequate state funding, inaccurate projections by the pension agencies of how much they would need and, in some cases, weak investment returns.