New Kentucky Lawsuit Takes Aim at Risk in Public Pension Investments

The state of Kentucky revived and expanded a lawsuit that claims former officials of the state pension system and hedge fund firms violated their fiduciary duty by choosing risky investments. The state is demanding compensation from hedge funds for their excessive fees and underperformance. 

Kentucky’s pension system remains one of the worst-funded in the nation, hovering around a 32.8% funding level. Lawmakers have discussed cost-saving measures such as cutting agencies’ spending and reevaluating employee contribution caps, but little progress has been made towards revitalizing the fund. Recent accusations may explain, in part, Kentucky’s lack of funding.

A case, which was originally filed in 2017 by eight state pension recipients, accused Kentucky Retirement System employees and a number of prominent hedge funds of mismanaging pension investments. Earlier this month, the Kentucky Supreme Court dismissed the case, asserting that the plaintiffs lacked legal standing to bring the lawsuit. Kentucky Attorney General Daniel Cameron, however, recently joined as a new plaintiff along with additional allegations concerning the Kentucky Teachers Retirement System (KTRS). 

Between 2000 and 2009, the Kentucky Retirement System (KRS) lost half of its assets. Cameron’s complaint alleges that, given the massive losses KRS sustained in 2009, the fund managers sought a quick fix by gambling with “alternative investments.” According to Cameron, KRS employees bought risky investments from hedge funds in a last-ditch effort to rapidly fund the system, which had already been failing for years. When the funds’ performance didn’t meet their expectations, they allegedly attempted to cover up any indication of wrongdoing. 

Along with accusing KRS employees of misconduct, the plaintiffs claimed that the CEOs of Blackstone and KKR benefited from significant financial gain from a relationship with KTRS, while selling the system faulty funds. These “alternative investments” were marketed by KKR & Co. and Blackstone Group, among others, to underfunded pension systems across the country. They referred to the strategy as an “absolute return strategy,” promising annual returns of 7.75 percent in addition to reduced risk. The funds were generally hedge funds that invest in other hedge funds and, although they promised higher returns, studies have shown these “alternative investments” fail to perform and include large management fees which reduce any existing profits.

Last week, an attorney representing the Blackstone Group responded to accusations, indicating that the fund’s shortfalls existed long before their collaboration with the Blackstone Group and stating, “As we’ve demonstrated repeatedly, these claims have absolutely no merit… We delivered more than $150 million in net profits to Kentucky pensioners and exceeded by nearly three times the benchmark set by KRS itself.” Kelly also expressed his surprise in learning that the attorney general’s office would actively pursue a case already addressed by the state’s supreme court. 

Meanwhile, Krista Locke, deputy communications director for the attorney general’s office promised that their “goals in pursuing this litigation are straightforward: to protect the pensions of hardworking government employees and to safeguard taxpayer dollars”. 

Although the case remains in its early stages, the question remains whether KRS employees violated their fiduciary duties by choosing risky investments. The case’s outcome will also determine whether Blackstone Group and KKR are forced to spend millions in payouts, a decision that will undoubtedly be hotly contested.