Politics & Government

Public workers sue hedge funds, allege pushing pension system into risky deals

Madison District Judge Brandy Oliver Brown listened as lawyers presented evidence during a preliminary hearing in Madison District Court on March 30, 2012.
Madison District Judge Brandy Oliver Brown listened as lawyers presented evidence during a preliminary hearing in Madison District Court on March 30, 2012. Herald-Leader file photo

Eight current and former public employees in Kentucky have filed a lawsuit against three hedge funds and their top executives for allegedly violating their fiduciary duty to the Kentucky Retirement Systems by creating a false sense of security about their risky investments.

The lawsuit, filed Wednesday in Franklin Circuit Court, seeks monetary damages from KKR/Prisma, Blackstone and PAAMCO investment groups for losses incurred by KRS in high-risk investments recommended by the groups.

In particular, the lawsuit questions $1.2 billion invested into three “black box” hedge funds, in which KRS knew little about how its money was being managed.

Had the trustees of KRS avoided these “exotic” hedge-fund investments and put that money into “prudent investments, like simple, no-frills, low-index funds, the KRS funds would be vastly better off,” according to a summary of the lawsuit filed by a team of lawyers from Kentucky, California and Washington D.C.

In 2001, KRS was fully funded, but a combination of poor investment returns, faulty actuarial assessments and underfunding from the legislature has made Kentucky’s pension system one of the worst-funded in the nation. As of June 30, KRS had $26.75 billion more in future pension liabilities than it held in anticipated assets. Its largest pension fund had only 13.6 percent of the money it is expected to need to pay future benefits.

The lawsuit alleges that the hedge funds promised high rates of returns and then failed to deliver, while charging high fees that are impossible for taxpayers to tally.

The hedge-fund investments that KRS made in August 2011 were the largest single investments ever made by the agency, which oversees the pensions of nearly 365,000 active and retired public employees.

“As remarkable as the size of these plunges was the fact that the trustees took them after having been badly burned in two hedge fund investments shortly before, losing millions when the funds quickly collapsed amidst allegations of impropriety, and later, exposure of ‘suspicious payments’ to ‘middlemen,’” the summary says.

The lawsuit also names as defendants several former or current KRS board members, a former KRS chief investment officer, and key consulting firms that helped advise KRS. It alleges that the board members and consultants breached their fiduciary duty when making decisions about the hedge fund investments and by approving financial calculations, such as the assumed rate of return on investments, that were allegedly faulty.

Any money won by the lawsuit would be used to shore up the pension system, which Gov. Matt Bevin has urged state lawmakers to overhaul when they convene Jan. 2.

“In lieu of, or to augment, whatever the state may do, hopefully we’ll be able to recover some funds to fill this hole,” said Jeffrey C. Mayberry, a retired state police officer and one of the plaintiffs in the case.

The other plaintiffs are Brandy O. Brown, Martha M. Miller, Steve Roberts, Don D. Conner, Jason Lainhart and Ben Wyman.

The plaintiffs approached Attorney General Andy Beshear about filing the suit but he declined, citing their lawsuit against Bevin for reorganizing the KRS Board of Trustees.

“Because of our current action in Franklin Circuit Court involving the Kentucky Retirement Systems Board of Trustees, we are unable to consider the claims in this lawsuit at this time,” said Terry Sebastian, a spokesman for Beshear.

Because of that, the suit is being filed as a derivative lawsuit, or a lawsuit brought by members on behalf of KRS.

In late 2016, the KRS board said it had agreed to a three-year plan to withdraw about $1.5 billion that it had invested in hedge funds in the previous six years.

State legislators, local governments and others have strongly criticized KRS for putting large sums into hedge funds despite their high fees, lack of transparency and lackluster returns.