State of Kentucky Sues KKR, Blackstone, RVK and Others Over Hedge Fund Investments

Posted on 07/22/2020

The State of Kentucky has filed a lawsuit against KKR, The Blackstone Group, PAAMCO, investment consultant RVK (R.V. Kuhns), Cavanaugh MacDonald Consulting, LLC, T. J. Carlson c/o Texas Municipal Retirement System, and other individuals. Kentucky Retirement Systems (KRS) invests the assets of insurance benefit plans for each of the KRS Pension Plans. The Commonwealth of Kentucky is Plaintiff in this action. Pursuant to KRS 15.020, the Attorney General is the chief law officer of the Commonwealth and may commence actions on behalf of the Commonwealth. T. J. Carlson was an Officer of KRS from February 2011, through November 2013, during which time he served as the Chief Investment Officer. Carlson was CIO of KRS when the hedge fund sellers sold the “black box” hedge fund products to KRS.

Big Losses During Down Turns

In 2000-2001, KRS posted a US$ 2.2 billion loss in investments, which at the time was 20% of KRS’ assets. During 2008-2009, KRS lost over US$ 4.4 billion, which at the time was over 30% of KRS’ assets. After these investment losses, the trustees were given studies that showed the financial condition and liquidity of the Funds were seriously threatened and far worse than was publicly known.

Part of the complaint states, “This action is brought on behalf of the Commonwealth of Kentucky by the Office of the Attorney General seeking compensatory and punitive damages and equitable and states as follows. The relief sought includes (i) damages for the losses incurred by the Commonwealth as a result of breaches of fiduciary and other duties, including unsuitable investments, the loss of trust assets, the loss of prudent investment opportunities and positive investment returns; (ii) disgorgement of fees from the sellers of unsuitable hedge fund products, investment, actuarial and fiduciary advisors and the annual report certifier; and (iii) the greatly increased costs to the taxpayers of restoring KRS and its Pension Plans to properly funded status, after years of concealment of the true financial condition of KRS and the waste of its funds. The action alleges Defendants’ individual breaches of duty, their participation in a joint enterprise and their knowing aiding and abetting of one another while participating in a scheme, civil conspiracy, and concerted course of conduct in violation of Kentucky law. Because of the wanton nature of the misconduct of certain defendants, punitive damages are sought from them.

Defendants are (i) the Hedge Fund Sellers (defined below) who created and sold unsuitable, high-risk, high-fee funds of hedge funds to KRS; (ii) KRS’ investment, actuarial and fiduciary advisors; (iii) the KRS annual report certifier; and (iv) certain KRS Trustees and Officers who oversaw the KRS Funds. Defendants (i) directly participated in the transactions, actions and omissions complained of; (ii) aided and abetted one another; and (iii) pursued a conspiracy and concerted common course of conduct and joint enterprise damaging KRS, its Funds and Kentucky taxpayers. The claims made are based solely on Kentucky pension law, trust law, common law and other Kentucky statutory laws. There are no federal claims asserted.”

Staff Turnover

In 2009-2010, KRS was suffering from serious Board turmoil and staff turnover. A special audit had uncovered $12-15 million in “suspicious payments” (now statutorily illegal payments) to mysterious placement agents, much of it in connection with KRS’ first ever “investment” of over US$ 100 million in two exotic hedge fund-like vehicles sold to KRS by financial firms in 2010 ,in which KRS suffered large losses. The KRS Chief Investment Officer and Executive Director were both fired.

In August 2011, Trustees of KRS were sold US$ 1.2 to US$ 1.5 billion in three extremely large commitments, each between US$ 400 and US$ 500 million, hedge fund vehicles. These were sold as absolute return strategies aimed at reducing volatility and to help get KRS to an expected rate of return of 7.75%, according to the complaint. The complaint says, “According to KRS’ investment advisor RVK, Trustees had decided on the “most effective asset allocation strategies for each pension and insurance plan … in order to lower risk, control the level of illiquidity in the portfolios and generate a return expected to exceed the actuarial assumed rate of return 7.75%” [and] “with new allocations to the … absolute return buckets … going forward the portfolio is more diversified than ever.””

These hedge funds were sold by KKR, KKR/Prisma, Blackstone Group and PAAMCO. The complaint alleges that these Wall Street hedge funds, ” targeted underfunded public pension funds like KRS. To them, KRS was a potential buyer of the exotic, high-fee and high profithedge fund vehicles they sold. The Hedge Fund Sellers nicknamed these vehicles the “Daniel Boone Fund,” “Henry Clay Fund,” and “Newport Colonels Fund” (“Colonels Fund”) because they were specially designed and created for Kentucky.”

Board Conflict

William S. Cook is a defendant in the complaint. Cook was a Trustee of KRS and member of KRS’ Investment Committee. He served as Chair of the Investment Committee from October 14, 2016 through August 22, 2017. The complaint states, “for over seventeen years, Cook was an executive with Aegon USA, a Kentucky-based company owned by Prisma, where he specialized in selling hedge funds. In 2004, Cook joined Prisma Capital Partners, L.P. (“Prisma”) as it was being formed in New York City by Aegon and three former Goldman Sachs partners, and Defendant Girish Reddy. Cook became an executive director of Prisma, had a multi-million-dollar financial interest in Prisma and was a member of the Prisma Investment Committee, which included the other four top officers of Prisma. Cook retired from Prisma in 2015. Cook was at Prisma when it created and sold the “Daniel Boone Fund” to KRS. Cook retains a multi-million-dollar financial interest in KKR/Prisma, the combined firm formed in 2012 when KKR & Co. L.P. (“KKR”) acquired Prisma (the combined firm is referred to as KKR/Prisma). 44. Cook is close personal friends with current or former KKR/Prisma top officials including Girish Reddy. Cook helped arrange for KKR/Prisma to act as an investment advisor to, and manager for, KRS with respect to the investment of its overall hedge fund “investments.” Cook arranged for a KKR/Prisma executive to work inside KRS, while still being paid by KKR/Prisma. Cook’s presence on the KRS Board and the presence of KKR/Prisma executives inside other transactions in which he participated, violated the conflict of interest provisions of the Kentucky Pension Law.”

Case: 20-CI-00590

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