With many billions of taxpayer dollars at stake, Kentucky’s two largest public pension systems are violating transparency requirements passed in 2017 by the General Assembly, state Auditor Mike Harmon said Tuesday.
Auditors found that the Kentucky Retirement Systems and the Teachers’ Retirement System of Kentucky fail to post more than 80 percent of their investment contracts online for public review. Senate Bill 2, which the legislature passed unanimously two years ago, requires that all of the contracts be posted.
Even when they do post contracts, the pension systems allow private investment companies to redact basic information about their fees, expenses and conflicts of interest so the public cannot see them, Harmon said. The pension systems also fail to post “side letters” that contain more information about the terms of their contracts with investment companies, he said.
“While there are some things KRS and TRS have improved upon since the passage of Senate Bill 2, both systems have failed to follow the spirit of transparency that was intended by the General Assembly,” Harmon told reporters at a news conference.
KRS manages $17.5 billion in assets with the help of private financial advisers on behalf of state and local government retirees. TRS manages $21.3 billion for retired Kentucky educators, also by hiring outside advisers.
SB 2 requires the pension systems to publicly identify the investment companies they hire and disclose their fees and commissions, including profit sharing, carried interest and partnership interest. The law covers KRS, TRS and the Kentucky Judicial Form Retirement Systems, which provides benefits to retired state judges and legislators.
Officials at TRS and KRS said Tuesday that they disagree with Harmon’s findings.
Pension system leaders said investment companies expect a degree of privacy around their business deals, fearing they will forfeit their competitive edge if details of their fee structures are shared. KRS, for example, has lost some investment opportunities because hedge funds did not want to comply with the new transparency law.
“Releasing all contract information is contradictory to protections for sensitive details provided by current law. This hurts taxpayers by precluding partnerships as an investment, taking teachers out of funds that averaged a compounded 13.41 percent return the last 10 years,” said Beau Barnes, TRS general counsel.
The Kentucky Open Records Act allows certain kinds of information to be exempted from public disclosure if they would provide an unfair advantage to a state vendor’s competitors, such as proprietary trade secrets, Barnes said. SB 2 references that exemption even as it requires most other information about investments to be posted by the pension systems, Barnes said.
However, the pension systems have failed to ask the Office of the Attorney General for any legal guidance on what information can be redacted for proprietary reasons, Harmon said. Instead, they have erred entirely on the side of the investment companies, allowing the table of contents of one document to be blacked out, and letting a full contract be redacted in another, he said.
“Some investment managers have redacted fee terms from the investment contracts, and KRS has taken no action to disclose those fees to the public,” Harmon said. “Now, KRS claims they encourage surgical and not wholesale redactions in hopes that investment managers would only redact a line or a statement and not a full paragraph. But the data does not support that claim.”
In its written response Tuesday, KRS said it doesn’t have the legal authority to decide what an investment company can or cannot redact from documents. Anyone aggrieved by a lack of information provided through an Open Records Act request can appeal to the attorney general’s office, KRS said.
KRS also disputed the auditor’s report for saying it failed to post 86 percent of its 281 investment contracts. In fact, KRS said, it has 197 investment contracts that are not available on its website, but 189 of them were signed before SB 2 took effect, and therefore, KRS believes they are exempt from the law. And the auditor’s office misunderstood a spreadsheet provided by KRS showing multiple investment managers changing over time as well as one manager with multiple contracts between the KRS pension and health insurance funds, KRS said.
“The (auditor’s office) severely overstated the number of contracts not reported on the KRS website,” KRS said.
The legislature required greater transparency from the pension systems in part due to scandals at KRS involving “placement agents,” well-connected middlemen who collected nearly $15 million in fees during the 2000s for putting investment managers with proposed deals in the room with KRS officials.
State auditors in 2011 identified one placement agent in particular, Glen Sergeon of New York, who 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 questioned him about nearly $6 million in fees paid to Sergeon in KRS deals.
Another New York financier who stole millions of dollars from KRS through placement agent deals, Lawrence E. Penn III, was sent to prison in 2015. Penn managed Camelot Acquisitions: Secondary Opportunities LP, a $120 million private equity fund for which KRS was one of the earliest and biggest investors.
The U.S. Securities and Exchange Commission found that Penn improperly diverted about $9.3 million from the fund to support a lavish lifestyle. KRS officials wrote off half the system’s investment in Camelot as outside managers took control of the fund and tried to sort out its affairs.
SB 2 has no enforcement mechanism, so there are no penalties for breaking the transparency law, Harmon noted Tuesday.
However, Harmon said he’s urging the governing boards of KRS and TRS to take his audit report seriously and make more information about their systems’ finances public, as lawmakers intended.