The Kentucky Retirement System “Tier 3” plaintiffs have almost immediately filed their first major action after Judge Thomas Wingate approved of their standing to pursue claims against a cast of miscreants, including KKR, Blackstone, PAAMCO, as well as storied financiers like Henry Kravis and Steve Schwarzman personally. And it’s a doozy.
Due to the peculiar way pdf in recent years have been subject to size bloat, regularly exceeding WordPress upload limits, I am embedding only the critical sections of the 125 page filing at the end of the post.
The plaintiffs are seeking $771 million from KKR and its fellow travelers over withholding $137 million from its Kentucky Retirement System custom hedge fund, cutely named Daniel Boone, in 2019 when the hedge fund was supposed to be wound up. The KKR defendants invoked an indemnification provision in the their agreement with Kentucky Retirement System to retain these monies, purportedly to pay legal fees and damages resulting from the Mayberry v. KKR suit filed in 2017. Here is what the plaintiffs are seeking:
- return over $137,000,000 of misappropriated KRS trust funds, plus interest at 8% since April 2019,2 for a total of $192,713,333 as of April 30, 2024; and
- pay a civil penalty, authorized by Subsection (3) of KY. REV. STAT. § 61.685, of $578,139,999 (three times the amount of $192,713,333 (as of April 30, 2024)), to a special fiduciary appointed by the Court; and
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provide an accounting of all dealings with these KRS trust monies.
This $137 million compares to the total Kentucky Retirement Systems paid in capital of $768,728,901 and the meagre returns of $5,276,203. To add to the injury, the filing also points out (and shows the detail from the fund reports).
Oh but it is no longer $137 million! KKR has been looting the pot even though the indemnification was being challenged in court. Again from the filing:
Time is of the essence not only because KRS has been — for over five years — deprived of the use and value of the $137 million in withheld funds, but also because the withheld funds have inexplicably decreased by hundreds of thousands of dollars:
Note S. Prisma Daniel Boone Fund
The funds invested with Prisma Daniel Boone Fund continue to be held in a contingency reserve to cover potential obligations arising from the Mayberry Action (see Note O for details of Mayberry Case). The total reported in reserve as of June 30, 2023, is $97.7 million for the Pension Plans and $40.6 million for the Insurance Plan. This is based on the May 31, 2023, report because Absolute Return managers are reported on a one month lag.
Mind you, yours truly is charitably assuming that the reduction from $137 million was due to paying legal fees and expenses. But as Lambert warns, “It’s called a vehicle because it drives away with all your money.” Hence the demand for an accounting.
Back to KKR’s bogus justification. All of the three custom hedge fund agreements had indemnification language. As the Corporate Finance Institute explains, indemnification is, “A legal agreement by one party to hold another party blameless for potential losses or damages In the private equity and hedge fund world, those provisions are usually not just sweeping but egregious, as in often omitting the common “bad faith or gross negligence” carveouts.
So if the three hedge fund miscreants indeed had effective indemnification provisions, the Attorney General and Tier 3 plaintiff lawsuits would not just be pointless but even counterproductive. Even if they won, they would wind up reimbursing the hedge fund operators’ legal fees and any damages.
However, Kentucky courts have already determined that the indemnification provisions are in violation of the Kentucky constitution, which these very same hedge fund terms explicitly conceded was applicable in their contracts. You can see in the second embedded document below how Judge Philip Stephens worked through the issues in gory detail after the three big defendant groups presented Motions to Dismiss, invoking those indemnification provision plus claims that they were not subject to personal jurisdiction in Kentucky.
The short procedural history is that the trial court approved the Attorney General’s Motion to Intervene on behalf of the Commonwealth’s claims on December 28, 2020. (We are skipping over how in 2019 the major hedge fund groups also each tried suing Kentucky Retirement Systems for breach on contract, PAAMCO in California, the Blackstone and KKR perps in Delaware; these were invalid due to Kentucky Retirement Systems possessing sovereign immunity). The state then filed two actions against the hedge funds operators in 2021, and then a Motion for Summary Judgement in September 2021, which was quickly met by Motions to Dismiss.
In March 2022, Judge Philip Stephens issued an extremely detailed ruling addressing the points of contention: that the court lacked personal jurisdiction (this was quite a howler; Stephens went painstakingly through evidence like KKR having not only an office but even lobbyists in Kentucky). As you can see in the second embedded document, he gave a similarly exhaustive treatment of why the indemnification language in the relevant contracts did not trump Kentucky’s constitution. A Kentucky appeals court upheld Stephen’s ruling in December 2023.
One might ask, the Attorney General’s office finally having cleared the obstacles to asserting damages against the three hedge fund sellers, why there has apparently been no action since December on the earlier filings. One of the three orders by the new judge, Thomas Wingate, last Friday, was to deny yet more motions to dismiss against a Commonwealth case against KKR and a very long list of other defendants. Judge Stephens remarked that his March 2022 ruling that this the second time his court had considered whether it had had personal jurisdiction over the hedge fund sellers, and added: “In the near future, it will be provided with a third opportunity to conduct similar analysis in connection with the Underlying Action.” Why this sort of motions practice is not considered bad faith in beyond me.
In any event, by being so fast off the blocks, the Tier 3 plaintiffs have put the Attorney General in a very difficult position. It looks almost incontrovertible that Kentucky Retirement Systems is entitled to the return of the $137 million and interest; the only thing that would seem open to question is how much interest and whether punitive damages should be assessed. The presumed point of the Attorney General intervention was to achieve a quiet, lowball settlement. High nine figure potential recoveries from only one of the three perps will make it very hard for the Attorney General to operate against the interests of the state (which backstops the funds) and the funds themselves by settling for peanuts.
The first of the embedded filings argues that they are warranted by virtue among other things, of KKR having made flagrant misrepresentations to the court in connection with its effort to escape jurisdiction. From the filing:
In fact, KKR-Prisma’s withholding of KRS trust funds constitutes a “Misapplication of Entrusted Property” — a crime under the Kentucky Penal Code. The KKR Defendants acted in bad faith in litigating the declaratory-relief action, in which they submitted a false affidavit to contest personal jurisdiction. They also commenced retaliatory litigation in Delaware in an attempt to evade Kentucky’s justice system. The KKR Defendants’ bad-faith conduct warrants the imposition of a three-time civil penalty.
Another reason for the demand for the punitive damages is the afore-mentioned looting of the withheld funds, which looks highly improper since the indemnification which could have allowed the use of those monies was being contested.
Obviously KKR will contest this filing. It is over my pay grade to know what they will argue. They will surely try to say that at most only certain not well capitalized subsidiaries can be targets of this action (the legal speak is that the Tier 3 Plaintiffs cannot be allowed to pierce certain corporate veils). Judge Shepherd already pre-rebutted some of this argument, saying effectively that legal entities created primarily to achieve tax benefits can’t be treated as substantive for liability purposes. I also doubt that claim could be adequately supported, given many statements in KKR press releases and SEC filings about how KKR itself provides various services and benefits from the activities of these subs, without discovery, which is what the defendants have been so keen to avoid. Mind you, the court has already received sort of evidence in earlier filings.
The KKR lot could also try contending that the Tier 3 Plaintiffs lack standing. That would be one basis for appealing the Wingate Tier 3 rulings of last Friday. I don’t see that having great odds of succeeding but it will further push out the timetable.
Assuming that fails, the defendants could try arguing that the Tier 3 plaintiffs are entitled to only an itty bit of the $137 million. I’m not sure where that position leads, but even if it has some juice, the counter is that the Tier 3 Plaintiffs, as defined contribution plan members, are effectively in a first loss position.
Regardless, we can expect a pitched battle over this claim, and the plaintiffs are set to be opening more fronts soon.
00 Plaintiffs' Motion for Order Directing Return of Trust Funds 1-2200 Plaintiffs' Motion for Order Directing Return of Trust Funds 70-98
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I am a little surprised at the lack of similar public pension lawsuits against other HF or PE sponsors. but performance since the credit crisis as generally been favorable and the funds at issue here were laggards and allegedly misrepresented in the PPM process.
Kentucky has very strong fiduciary duty laws. That is the distinctive feature.
Wow! Again wow. This opening sentence reminded me of something.
“The plaintiffs are seeking $771 million from KKR and its fellow travelers over withholding $137 million from its Kentucky Retirement System custom hedge fund, cutely named Daniel Boone, in 2019 when the hedge fund was supposed to be wound up.”
It reminded me of the way some landlords will withhold security deposits when renters move out even though the apartment is left in near spotless condition. This KKR withholding is so far above – or below that landlord practice and so much more egregious, imo.
With the deep pockets involved, here’s hoping this doesn’t turn into a Jarndyce and Jarndyce case.
Thanks for this post.
adding: Thanks for staying on this story. Its legal arguments and outcome could prove to be very important. Very important.
I’m curious, with the much reduced size of the group of plaintiffs (just tier 3), how is this a profitable case for the lawyers? This has taken a lot of expensive hours from a lot of people for 7 years and counting with no payout. Have they really been putting in all this effort for a hoped-for payout years down the road?
They are representative plaintiffs for the entire Tier 3 beneficiaries. They are not the entire affected group.
‘How dare you suggest we haven’t been acting in your best interests! We’ve been selflessly acting for your benefit all along, and our lawyers will prove it – after we help ourselves to this nine-figure sum of your own money to pay for them.’
An entity of any state is barred as a matter of law and public policy from entering into agreements that purport to indemnify hedge and PE funds from liability for malfeasance and fraud. Captured fund managers whining that “They won’t take our money otherwise!” is ludicrous on its face.
The more bad faith foot-dragging, the more likely it becomes that treble damages will be imposed (as they indeed should be). Discovery will doubtless show that the misrepresentation of returns and outright looting of funds invested on behalf of the public is even worse than has already been shown.
In what moral universe does the victim of a crime have to pay for the legal defense of the perpetrators?