Landmark Kentucky Pension Case Against KKR, Blackstone, and PAAMCO to Move to Trial?

We’ve posted before on Mayberry v. KKR, a potentially trail-blazing case in which beneficiaries of the destitute Kentucky Retirement System are suing three major fund managers, KKR, Blackstone, and PAAMCO, over dedicated hedge funds they created that promised high returns at low risk only to perform worse than cash. As we will discuss shortly, the parties to the litigation had a hearing yesterday over the defendants’ motions to dismiss. The judge is expected to rule in two weeks. Former Kentucky Retirement Systems trustee Chris Tobe attended the hearing and based on that and his knowledge of the case, thought it was likely to proceed.

Background of Pathbreaking Breach of Fiduciary Case

The suit charges breach of fiduciary duty and names a whole load of parties in addition to the three big fund managers as defendants, including Kentucky Retirement System’s fiduciary counsel, Ice Miller, current and former directors, former senior employees, several financial advisers, its actuarial adviser, and even the firm that certified Kentucky Retirement System’s Comprehensive Annual Financial Report. Our recap of the suit from a January post (which includes the initial filing):

The fund managers allegedly focused on KRS and other desperate and clueless public pension funds who were unsuitable investors, particularly at the risk levels they were taking. KRS made what was a huge investment for a pension fund of its size. $1.2 billion across three funds all at once, in 2011, roughly 10% of its total assets at the time. They all had troublingly cute names. The KKR/Prisma funds was “Daniel Boone,” the Blackstone fund was “Henry Clay” and the PAAMCO fund, “Colonels”.

In the case of KKR/Prisma, the fund had installed an employee at KRS as well as having a KKR/Prisma executive sitting as a non-voting member of the KRS board. The filing argues that that contributed to KRS investing an additional $300 million into the worst performing hedge fund even as it was exiting other hedge funds. ¹

The suit seeks damages for losses, recovery of fees paid to the hedge funds and other advisers, and punitive damages. The damages would go to KRS and the suit also asks that the court appoint a special monitor to make sure the funds are invested properly.

Some observers may be inclined to see this litigation as having only narrow implications, since KRS is fabulously underfunded, at a mere 13.6% funding level with only $1.9 billion in assets, and famously corrupt. KRS not only saw its executive director and chief investment officer fired over a 2009 pay to play scandal, but more recently, it had the astonishing spectacle of having the governor call in state troopers to prevent the KRS chairman, Tommy Elliot, from being seated. ²

Charming, no? But with so much bad conduct out in the open, it’s not hard to see why analysts might assume that Kentucky is so sordid that a suit there, even if it proves to be highly entertaining, is relevant only to Kentucky.

That may prove to be a mistake. As one former public pension trustee said,

This is the equivalent of going from a confrontation between the public pension industry and some people throwing rocks to a confrontation against the Soviet Army. Bill Lerach, the guy behind this is as serious as they come. Don’t let the fact that he was disbarred in any way fool you.

Lerach’s wife is a Kentucky native and one of the lawyers representing KRS. Her husband’s firm, Pensions Forensics, is an advisor to this case.

Lerach has a net worth estimated at $900 million, which is plenty of firepower to fund expenses on a case like this. Two different readers in Kentucky (neither of them Chris Tobe) separately informed me that the Kentucky attorneys pleading the case are formidable.

This is the first time a deep-pocket plaintiffs’ firm has taken up a fiduciary duty case targeting major fund managers. As a result, it has caught the attention of public pension trustees. It was hotly discussed at the Council for Institutional Investors conference in January, for instance.

Progress So Far

The case made an important step forward earlier this year when Kentucky Retirement System decided not to join the case but made a supportive (and unusual) joint filing with the plaintiffs, embedded at the end of this post,, and indicated it reserved the right to take up the claims at a future date.

However, the plaintiffs have yet to surmount motions to dismiss from the many defendants. They made voluminous filings, totaling 658 pages of briefings and 1,122 pages of attachments, according to a memorandum by the plaintiffs. The various defendants were making factual arguments, which is improper at this stage of the process.

The hearing yesterday was to determine whether the complaint states a claim. It was not an evidentiary hearing.

When a trial court receives a Kentucky Rules of Civil Procedure (CR) 12.02 motion to dismiss, the court must take every well-pleaded allegation of the complaint as true and construe it in the light most favorable to the opposing party.

Nevertheless, despite the lengthy counter-factual narratives the defendants presented in their filings, Tobe reports that the arguments in the hearing hewed largely to legal issues like arguments on standing and the statute of limitations. The plaintiffs did present their overview of the case in a slide deck below (Tobe got an embargoed copy pre-hearing).

Although I have some quibbles with parts of the argument like the use of the S&P 500 versus the returns earned by KRS (any pension fund would have a meaningful allocation to bonds, which would lead to lower expected results), the discussion of Kentucky fiduciary law, which is very specific and places very strong, explicit obligations on fiduciaries, in combination with the action of the principals of the various fund managers while they were “advising” Kentucky and later selling them on the idea of these hedge fund vehicles, is very well done. Two parts are particularly compelling. One is where the defendants try arguing that KRS was sophisticated. Materials produced by one of the hedge fund managers shows them describing recently-installed executive as rubes in the world of hedge funds. Another section contrasts how the hedge fund products were described in the marketing materials as high return with low risk, and contrasts that with how they were depicted in SEC filings as high risk.

I hope Tobe is correct and the plaintiffs prevail. I’d also love to see a trial, or at least some serious discovery. However, the incentives of both parties will be to settle. So even if the judge gives the go-ahead for the case to proceed, the only way we are likely to see courtroom fireworks is if the defendants overplay their hand and aren’t willing to pay enough to make this go away.