Kentucky Court Greenlights Pension Plan Lawsuit Challenging Questionable Hedge Fund Investments

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In a recent decision, Mayberry v. KKR & Co., L.P., No. 17-CI-01348 (Ky. Cir. Ct., Nov. 30, 2018), a Kentucky state court sustained claims brought by several government employees who sued derivatively on behalf of the Kentucky Retirement Systems. The suit alleges that the retirement systems over-invested their pension assets in risky and expensive hedge fund-managed accounts, resulting in billions of dollars of financial losses.  The plaintiffs brought claims for breach of fiduciary duties and conspiring to breach these duties against:  KKR & Co., L.P. and the Blackstone Group L.P., two well-known investment companies that manage hedge funds, and who had contracted with the retirement systems; the systems’ trustees and officers; Cavanaugh MacDonald LLC, the actuarial firm retained by the systems; and the systems’ law firm, Ice Miller LLP, which the plaintiffs alleged served as a “fiduciary advisor” for the systems on conflict of interest and investment matters.

The Court’s opinion denying the motion to dismiss is noteworthy for a few reasons:

First, in light of the Court’s order, the case will now proceed to the discovery phase, in which the parties gather evidence to support their claims and defenses.  What this means is that the nature of the financial arrangements between the retirement systems and the hedge fund managers—sometimes kept so secret that they are described as “black boxes”—will be uncovered, and possibly even disclosed to the public.  As Bloomberg noted, hedge funds and private equity firms “have long battled to remain exempt from open-records requirements that apply to other government contractors and to keep the details of their relationships with public pensions confidential.”

Second, the Court found unconvincing the defendants’ argument that the plaintiff-pensioners lacked standing to prosecute an action on behalf of the retirement systems, as any monetary award would be paid directly to the state.  Notwithstanding that the General Assembly could, at its discretion, determine whether to allocate any of the money awarded from the litigation to the retirement systems, the Court forcefully rejected the notion that “simply because the funds might be paid to the Commonwealth, . . . there is no way to ever redress a financial loss suffered by a state agency or public entity.”  The Court also found that the plaintiffs, in any event, had standing as Kentucky taxpayers to ensure that pension funds were invested prudently.

Third, this decision should remind trustees and officers of pension funds—often full-time government employees like firefighters and teachers who serve as fiduciaries in their spare time—that their service, while immensely valuable to workers and the public at large, comes with its own risks.  The Kentucky trustees and officers had argued that, as public servants, they were immune from suit. The Court found, however, that the plaintiffs sufficiently alleged at the early stage of the litigation that these defendants labored under conflicts of interest, acquiesced to a 7.75% return rate, which the plaintiffs described as “reckless,” and concealed from pensioners the true financial condition of the retirement systems.  Such charges, in the Court’s view, raised an inference of “bad faith,” which, by law, cannot be immunized. 

Thus, while it remains to be seen if the plaintiffs will prove their allegations at trial, the Court’s decision should serve as a cautionary tale: that individuals overseeing an underperforming or underfunded pension plan will invariably invite public scrutiny, and possibly even costly litigation from unhappy plan participants, which, in turn, could expose these individuals to paying damages from their own pockets. In the first instance, trustees and officers should confirm that they have adequate fiduciary liability insurance (although, if the fiduciaries were ultimately found to have acted in bad faith, it is unlikely that the insurance carrier would pay out any money under the insurance policy). More broadly, trustees and officers should ensure that documentation exists that explicitly enumerates the responsibilities they may owe to the fund and its intended beneficiaries, as well as the steps they took to ensure that they acted in good faith and in compliance with their fiduciary duties, such as by hiring competent and independent advisors, and relying upon their advice when making investment decisions.