The Kentucky Retirement Systems Board of Trustees voted unanimously Thursday to not join a lawsuit filed by eight public employees alleging that several major investment firms cheated it on up to $1.5 billion in hedge fund investments, with blame to be shared by some of its own current and former trustees and officials.
The public employees filed their suit in December in Franklin Circuit Court, seeking to represent the interests of others with retirement benefits paid by KRS as well as Kentucky taxpayers generally. KRS faces a $27 billion pension shortfall largely due to inadequate funding by the state government.
Judge Phillip Shepherd, presiding over the case, had asked KRS to decide whether it intended to join the suit as a co-plaintiff.
In response, several KRS board members studied thousands of pages of internal documents to determine what went into the agency's decision, nearly a decade ago, to invest in hedge funds. After meeting in closed session Thursday to discuss the litigation, the full KRS board emerged without comment to vote against active participation in the suit.
"The current board commends plaintiffs and their counsel for their diligent and significant legal and investigatory work that enabled them to present proper and potentially valuable claims for the benefit of KRS," the agency said in a statement issued later Thursday.
"Plaintiffs and the current board have agreed that it is in the best interests of KRS for the plaintiffs, through their experienced and capable counsel, to pursue the claims for the benefit of KRS and its member retirees and future retirees. A recovery in this litigation could go a long way in supporting the significantly underfunded retirement system," the agency said.
At stake in the suit is whether KRS can recover part of its pension shortfall from the investment firms and the out-of-state billionaires who own them, as compared to the state budget, which already is being squeezed at the expense of schools, social services and other programs. KRS is responsible for retirement benefits for about 365,000 past and present employees of state and local governments.
The suit alleges that KKR & Co., Prisma Capital Partners, The Blackstone Group and Pacific Alternative Asset Management sold KRS hedge funds that were “extremely high-risk, secretive, opaque, high-fee and illiquid vehicles.” The investment firms did not adequately disclose the risks to KRS, and KRS did not honestly reveal the extent of its subsequent losses to its members, the suit alleges.
From 2011 to 2016, the so-called "black box" investments that were sold to KRS "provided very poor absolute and relative returns. The absolute return portfolio returned a miserable 3.73 percent from inception and lost over 6 percent — almost $100 million — in 2015-16," the plaintiffs have alleged. Simultaneously, the firms charged management fees that KRS never fully understood, the suit alleges.
The legal team behind the suit includes Michelle Ciccarelli Lerach, a Kentucky native who now practices law in San Diego, and Louisville attorney Ann Oldfather.
They are working with Lerach's husband, Bill, a disbarred California class-action lawyer who is identified in the case as a "pension consultant." When Bill Lerach still practiced law, before a 2007 felony conviction for a client-kickback scheme that sent him to prison for two years, he reportedly earned hundreds of millions of dollars from suits targeting Enron, R.J. Reynolds and other high-profile corporate defendants.
The investment firms being sued by the public employees have denied the allegations. They are asking Shepherd to dismiss the case.
In its motion to dismiss, The Blackstone Group said KRS was suffering financial losses long before it ever did business with the firm, and that the fund Blackstone sold KRS outperformed its targets and its comparable industry benchmarks, with net annualized returns of 6.5 percent. Blackstone cannot fairly be blamed for KRS' troubles, the firm said.
"Plaintiffs' novel theory of breach of fiduciary duty — that (Blackstone) sold KRS a product that KRS requested but (Blackstone) shouldn't have permitted KRS to purchase — is both unsupported and unsupportable," New York attorney Brad Karp wrote for Blackstone. "Plaintiffs' theory has not been accepted, to our knowledge, by any court, in any jurisdiction, ever."
Apart from the investment firms and some of their executives, other defendants named in the suit include past and present KRS officials, including current trustees William Cook and Vince Lang; former trustees Randy Overstreet, Timothy Longmeyer, Bobbie Henson, Thomas Elliott and Jennifer Elliott; former chief investment officers David Peden and T.J. Carlson, former executive director William Thielen; and former director of alternative investments Brent Aldridge.
Those defendants also have denied any wrongdoing.