Kentucky Sues Financial Firms, Advisers Over Handling of Retirement System Funds

(CN) — Kentucky is accusing hedge-fund sellers and retirement-fund overseers of sinking its public employees and retirees into a financial quagmire that will require an extra annual $1 billion “indefinitely” to remedy.

The commonwealth asserted claims of breach of fiduciary duty and civil conspiracy on Tuesday in a 133-page lawsuit in Franklin County Circuit Court. 

Kentucky is suing “sophisticated, high-powered financial firms” that sold the Kentucky Retirement System “unsuitable, high-risk, high-fee funds.”

The commonwealth also sought punitive damages and the restoration of its pension funds “after years of concealment of the true financial condition of KRS and the waste of its funds.”

Investment advisers were also named as defendants, along with individual KRS trustees and officers.

Entering the new millennium, the 350,000 former and present state and local employees had fully funded KRS, with a $2 billion surplus.

“Today, the KRS Plans are in danger of failing. They are among the worst-funded public pension plans in the United States,” the lawsuit states.

The retirement system lost $2.2 billion in 2000 and 2001, followed by a $4.4 billion loss in 2008 and 2009, according to the complaint. 

“The trustees had been utilizing outmoded, unrealistic and even false actuarial estimates and assumptions about the Pension Plans’ key demographics, i.e., retiree rates, longevity, new hires, wage increases and inflation,” the lawsuit states. 

At the same time, the plans were promising a 7.75% average annual rate of investment return, which Kentucky called “unrealistic and unachievable.”

Each of the two losses was spread over the following five-year period.

Retirees lived longer and their numbers increased, while government hiring slowed down. This led to fewer new employees contributing to the system. The commonwealth called this a “tightened financial/actuarial vise.”

The trustees responded by choosing “to cover up the true extent of the KRS financial/actuarial shortfalls and take longshot imprudent risks with KRS Funds to try to catch up for the Funds’ prior losses and deceptions,” the lawsuit states.

Their desire to climb out of the hole made them a target of hedge-fund sellers KKR & Co., Prisma Capital Partners, Pacific Alternative Asset Management Co. and The Blackstone Group, according to the commonwealth.

They allegedly sold the trustees “something far more exotic, risky, toxic and expensive than an ordinary hedge fund,” so-called “Black Box” hedge funds that invest in other hedge funds.

KRS trustees allegedly invested between $400 million and $500 million in each of three Black Boxes, which get their nickname from the inability to see what is being invested by the downstream funds.

The sellers allegedly called the Kentucky-specific investments “The Daniel Boone Fund,” “The Newport Colonels Fund” and “The Henry Clay Fund.”

Kentucky is not the only state to run into this problem, according to the lawsuit. A 2015 study by the Roosevelt Institute showed that 11 public pension funds lost $8 billion in investment funds while paying 57 cents in fees for every dollar earned.

By 2016 and 2017, journalists and an independent investigation revealed the funds’ losses and excessive fees, according to the lawsuit.

“Trustees and officers failed to follow legal mandates regarding the safeguarding and prudent investment of trust monies for which they were responsible, consisting of both pension funds and tax dollars, wasting billions of tax dollars and damaging the Commonwealth, KRS, its Pension Funds and the Kentucky taxpayers,” it states.

Many states have well-funded pension funds, according to the lawsuit, which drew a contrast to the alleged conduct of KRS officers and trustees.

“If they honestly and in good faith factored in these realistic assumptions and known demographics trends, the published underfunded status of the Funds would skyrocket by billions of dollars, their stewardship would be vigorously criticized and investigated, resulting in them being ousted or even sued, a situation they wanted to avoid,” the commonwealth states.

Instead, it added, taxpayers must pour another $1 billion each year into the pension pot indefinitely.

The commonwealth alleged that the KRS Trustees “created a mosaic of false and misleading statements and reassurances that were intended to and did give a false sense of security as to the Funds and the quality of their stewardship.”

In addition to the fiduciary duty, conspiracy and punitive damage claims, the state is also seeking an accounting and disgorgement of the defendants’ fees, compensation and profits.

Attorneys J. Christian Lewis, Victor Maddox, Justin Clark, Steve Humphress and Aaron Silletto of the Kentucky Attorney General’s Office filed the lawsuit on behalf of the commonwealth’s taxpayers.

KKR did not immediately respond to a request for comment. 

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