Brawl Over Mayberry v. KKR: Big Hearing Monday Over One Contested Issue, Whether Attorney General Can Intervene in Kentucky Retirement Systems Case

As many reader know, the Mayberry v. KKR, Kentucky public pension suit over alleged abuses by hedge fund managers KKR/Prisma, Blackstone, and Prisma, was rescued from the dead.

Mayberry v. KKR looked dead parrot level dead when the Kentucky Supreme Court ruled that its eight plaintiffs did not have standing to act as plaintiffs even in a derivative suit because they had not suffered an “injury in fact,” as required by “Article III” standing rules. Kentucky, unlike most states, has adopted Federal “Article III” standing provisions.

The US Supreme Court had just ruled in an ERISA case, Thole v. US Bank, that the plaintiffs did not have standing because they had not suffered a loss, which is what the Supremes decided was the basis for determining injury. Note that ironically, the Trump Solicitor General had submitted an amicus brief in favor of the plaintiffs, arguing that a loss did not necessarily have to be realized to meet the Article III threshold, so the Supreme Court decision was hardly a given.

Even though anyone with an operating brain cell knows that the Kentucky Retirement System beneficiaries have pension haircuts in their future thanks to the 13% funded status of the system, the Kentucky Supreme Court ruled they had to pound sand because they had not yet suffered any losses. Oh, and the state, which has yet to show any seriousness about plugging this monster hole, was legally obligated to Do Something, so the plaintiffs should not worry about not getting paid. That check surely will be in the mail.

The Kentucky Supreme Court ordered that the original complaint be dismissed for lack of standing based on Thole, and that the claims made by the beneficiaries as taxpayers be dismissed because only the Attorney General could sue when the state was the real party at interest. The Supreme Court spilled some ink on the fact that the Attorney General was aware of Mayberry v. KKR and had done nothing.

KKR and Blackstone, who presumably thought they were in the clear, have suffered a serious reversal of fortune. As we discussed, the Attorney General filed a Motion to Intervene, an unprecedented move.

Then Michelle Lerach, one of the two original co-counsels, filed a Second Amended Complaint on behalf of a reconstituted “Mayberry Eight”. Three of the original plaintiffs were replaced by three new plaintiffs, all hired after January 2014 and hence “Tier 3” beneficiaries in the Kentucky Retirement Systems plans. As we explained late last month:

….the Supreme Court ruling instructed the trial court to dismiss the case, which by implication was without prejudice. The loss on standing issues was based entirely on court decisions made after the initial complaint was filed and amended.

Parties to litigation are permitted to re-file their cases; as the filing below notes, for instance, “….ample federal authority exists for the proposition that a plaintiff is entitled to amend his complaint to comply with intervening change in the law.”…

The Supreme Court did not hear new arguments from the plaintiffs; it made its ruling based on their so-called First Amended Complaint. It didn’t consider supplemental filings and evidence submitted at the trial court even though those were part of the record. The filing stays just short of grumbling that an argument presented in supplemental filings cited by the trial court judge, Philip Shepherd in his favorable ruling on standing, were not considered by the Kentucky Supreme Court by virtue of considering only the First Amended Complaint

The filing below describes how the plaintiffs were harmed in tangible ways. It also differentiates between the initial plaintiffs, all hired before 2014, who were “Tier 1” or “Tier 2” beneficiaries and together represent roughly 80% of all KRS beneficiaries and later “Tier 3” beneficiaries.

Tier 1 and Tier 2 beneficiaries were stripped of their Cost of Living Adjustments (COLAs) in 2013 which were never part of the state’s “inviolate contract” yet were a benefit the employees were supposed to receive when they had 5% to 9% deducted from their pay. The filing contends that theses individual plaintiffs each lost between $2,000 and $40,000 and collectively, the Tier 1 and Tier 2 beneficiaries, using conservative estimates, have lost over $200 million.

The new filing also removed some of the original plaintiffs (only five of the original Mayberry eight remain) and added three, all of whom are “Tier 3 beneficiaries” hired after January 1, 2014. They do not have a defined benefit pension and their pensions are not backed by the state (they are a hybrid “cash balance” plan where individuals make contributions as in a defined contribution plan, but eventual payouts are based on how the pooled monies perform). The Second Amended Complaint contends they were harmed because even though the plan did show positive returns from 2014 to present, they were diminished due to the high fees and misrepresented performance of the defendant’s products and that more specifically, KRS added to rather than exited hedge funds, as most of its peers did, due to self-serving actions of a KKR staffer who was tasked to work at KRS and deliberately not supervised (juicy new details include an “earn out” contract).

Finally, all beneficiaries were damaged by the fact that their annual deductions also fund health and life insurance plans that are not state backed, are deeply underfunded, and were invested in part in the dodgy hedge fund vehicles.

The Second Amended Complaint also argued that the plaintiffs have standing to pursue a derivative case against the defendants, a topic the Kentucky Supreme Court appears not to have addressed squarely.

Needless to say, these filings elicited outraged responses, which has in turn engendered more legal submissions (you can see the documents here).

We’ve embedded the Attorney General’s terse reply at the end of this post, which gives you an idea of the ratio of puffery to substance in some of the filings. For instance, the objection by the Blackstone defendants banged on about how the Attorney General’s motion was untimely. In addition to discussing the various legal reasons why that wasn’t so, the Attorney General noted (emphasis original):

While the Defendants argue that the Commonwealth’s motion is untimely because they have been litigating this case for two and a half years, the duration of this litigation to date is not the only factor to be considered. There has been a great deal of procedural posturing concerning motions for protective orders, but it appears from the Court’s record in this action that there has been little substantive discovery taken to date beyond some initial document requests. No depositions have been taken. The long, arduous path this litigation has taken has all been a result ofthe Plaintiffs’ novel theory of standing (which the Supreme Court has rejected) and the Defendants’ motions to dismiss attacking the Plaintiffs’ debunked theory. To date, as far as the Commonwealth can tell from the record, there havebeen no summary judgment motions directed to the merits of the claims asserted by the Plaintiffs, and now, by the Commonwealth. Despite the longevity of this case, it has not advanced so far on the substance of the claims that the Defendants would be prejudiced by the Commonwealth’s intervention.

The sniping at the plaintiffs’ attorneys may seem odd since the Attorney General’s Motion to Intervene made no attempt to hide being completely depending on their filings. It not only hoisted and closely replicated their arguments, but it even copied their framing, for instance, calling KKR/Prisma, Blackstone and PAAMCO the “Hedge Fund Sellers.”

The Attorney General’s original filing made clear that he intends to pursue fiduciary duty claims as well as taxpayer claims:

The Commonwealth of Kentucky, as the Intervenening Plainitff, brings this action, seeking compensatory and punitive damages 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 otherduties, 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 violationof Kentucky law. Because of the wanton nature of the misconduct of certain defendants, punitive damages are sought from them.

That is less straightforward than it might appear.

Plaintiffs’ co-lead counsel Michelle Lerach filed a motion for the plaintiffs supporting the Attorney General and also asking that the court permit the Attorney General to proceed with his claims for the state, along with the claims made by the Mayberry plaintiffs on behalf of the pension beneficiaries, and derivatively, for the Kentucky Retirement System.

Normally, a layperson would assume that an Attorney General would trump any private plaintiffs. However, there are complicating considerations. As both the Lerach group and even some of the defendants have argued, the claims about losses to Kentucky Retirement Systems are contingent assets of the System. The Attorney General cannot properly represent the beneficiaries or Kentucky Retirement Systems derivatively because any judgment he wins goes into the Kentucky general fund, which creates a conflict of interest. He cannot contribute any recovery or damages to the Kentucky Retirement Systems. Any monies garnered by the Attorney General are distributed by the legislature in its budgeting process.

Another wee problem is that the Attorney General (admittedly in the prior regime) said it lacked the expertise to pursue the case, as you can see in the second embedded document at the end of this post. Of course, they could hire an outside firm and cut a deal for a contingent recovery, but the expense and hours outlay on a case like this would be very large and any winnings would be well down the road. There are perilously few firms that have the skills, the risk appetite, and the staying power.

Lerach then filed a “Motion for Appointment of Lead Plaintiff, Lead Counsel and Liaison Counsel” to the effect that the Lerach group be put in charge of the plaintiff’s actions, since former lead counsel Anne Oldfather had been missing from action in the heavy lifting to revive the case, and was also not representing the three new “Tier 3” plaintiffs who helped bolster the new standing arguments. The “Oldfather group” responded, and observes are unsure as to whether she is acting on her own behalf or as a stalking horse for the Attorney General.

An even later Lerach filing points out that five of the original eight Mayberry clients have dismissed Oldfather as their counsel. It also provides a blistering, detailed account of how Oldfather has not only been a free rider on the heavy lifting done by the Learch group (particularly Michelle Lerach’s husband, the formidable if disbarred Bill Lerach, who is still phenomenally effective as an investigator and strategist) but also actively tried to sandbag avenues of research that exposed an additional big ticket, damaging claim: that KKR had schemed, and had a considerable amount of success, in trying to take over the investment decisions of Kentucky Retirement Systems. This charge is troublingly similar to the way Mike Milken took over the investment of zombie thrifts, faxing them the daily lists of the junk bonds Drexel bought for them with no formal approval or participation on the thrift side.

In other words, a big power struggle is underway as to who get to represent the various plaintiffs on what matters. And if I understand the law correctly, the court makes that determination.

Judge Philip Stephens is hearing the case tomorrow and is limiting the scope to the Attorney General intervention. The media alert also stated:

Judge Shepherd has also requested that the parties responding to the Attorney General’s Motion to attempt to coordinate your responses and decided amongst yourselves who will present, and to notify the Court after deciding who is planning to speak during the Zoom session.

The hearing is public via Zoom and I intend to listen in, but I’m a terrible typist and really rely on reading transcripts, so I am not sure my impressions will be post worthy, even before you get the fact that judges don’t always rule the way one would guess given their line of questioning.

The part that is not clear about the scope of Monday’s hearing is if it will simply be about whether the court will allow the Attorney General’s intervention to proceed (which seems very likely) or whether it will also consider arguments on the scope of his intervention (as in does he take over the entire case or not)

Let the fireworks begin!

00 AG-reply-in-support-mot-to-intervene
00 Attorney General letter
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  1. orlbucfan

    Thank you, Yves. I so hate legalese/lawyer gobbledygook language. It would be a long overdue, and very welcomed change to see a few white collar criminals in a genuine prison. Stay well.

  2. Susan the other

    Yes, thanks again. I’m just wondering why the Atty General would not have standing because of on his ties to Kentucky state government. If the funds he might recover would be mingled with state revenues that seems like the proper place for them to be processed because it will ultimately be (I assume) the state of Kentucky that makes KRS beneficiaries whole again. (There should be an insurance fund.) Using some portion of state taxes as well. So what’s the alternative? It sounds like the plaintiffs are making the argument that KRS is an entirely private operation that is somehow above the law, fraud or not. How can that fly?

    1. Yves Smith Post author

      Public pension funds (and pension funds generally) are separate entities. There is a huge body of very well settled law that enshrines their status as separate legal entities, with the highest duty of care under the law for their beneficiaries, far higher than that of corporate officers and boards. Kentucky also clearly and explicitly set up KRS as an independent entity from the state with independent obligations.

      As for the plaintiffs’ attorneys, you seem to misconstrue the issue. First is that the non-taxpayer claims of KRS are assets of the trust (as in KRS), yet the AG is constitutionally set up so as not to be able to recover for KRS, which means that there is a solid argument that he cannot properly represent the plaintiffs. He has a conflict of interest because his role as collection agent for the state conflicts with the requirement that counsel be able to represent the plaintiffs’ interests, which includes above all securing recoveries on their behalf, and not unrelated constituencies that he is constitutionally required to prefer.

      There is zero assurance that any money the AG would recover ex the taxpayer claims. which are rightfully his to pursue, would ever go to KRS. So far, the state has show no interest in addressing the severe underfunding, which would require big tax hikes. KRS is projected to stop paying beneficiaries in 2027. There is no assurance that the state won’t try to evade its obligations by filing for bankruptcy or simply not stepping up, and forcing broke beneficiaries to sue a broke state.

      Second is that (per the legal argument listened to this AM), while the AG can clearly sue, it isn’t clear he can participate in the original KRS case, given the big pushback as to what the Supreme Court dismissal for standing means. He might be limited to filing a new case which means he might have statute of limitation issues.

      Third is that the AG is rife with conflicts, although they are not the usual legal conflicts that a judge can consider. The case that the AG in his letter used as an excuse not to intervene was rendered moot by new law passed in January 2018, so he had no legal impediment to joining the plaintiffs’ case then or filing his own case. The reason he didn’t was 100% political: the Beshars are a Democratic political dynasty in KY, and the most powerful individual actors in KY on the Dem side. The AG’s suit against the reorg pitted the Beshars against Bevin, the head of the biggest Republican faction in the state.

      By contrast, the plaintiffs’ suit would expose how deeply involved the Beshars were in the looting of KRS. No way would the old AG ever go there.

      Now there is the question of why the new AG is interested given that the heads of the two big hedge funds, KKR and Blackstone, are not just big Republican donors but also big donors to Mitch McConnell, who is AG Cameron’s mentor and responsible for him becoming AG at such a tender age.

      The best theory I have heard is that the AG might regard this suit as an opportunity to do such damage to the Dems in KY that it will make them toxic for a generation, and he may believe he can do enough discovery to really mark them up and yet not claw anything more than a “cost of doing business” settlement out of KKR and Blackstone.

      There are two problems which the AG may not have recognized. One is that he needs to do discovery to score those political points, yet what KKR and Blackstone fear most is exposure of their agreements and records, as well as being forced to testify under oath, since that could gin up legislation in other jurisdictions. Two is if the Lerachs get to pursue the amended case, they won’t let KKR and Blackstone settle the non-taxpayer claims on the cheap.

      1. Susan the other

        Thank you – this is so complex you’d think it would be impossible to ever settle. We need a way to cut bait on egregious stuff like this and start fresh – who did what to whom? When something this wrong cannot be prosecuted it is not the fault of the KRS beneficiaries – it is the fault of the law itself and the people who skillfully use it. Clearly one thing that should come of this, regardless of which judge decides which case can go forward, is that the laws should be changed asap.

    2. rd

      Info on a state-by-state basis on state consitutional protections for pension plans:

      Here is some funding info for the 50 states. It is one of the few bipartisan things out there as the funding status is essentialyl randomly distributed among Democratic and Republican run states.

      They are typically inviolable contracts where the benefits cannot be impinged or reduced.

      A pension fund is a mechansim for funding the pension at the time the benefit is accrued while the future benefit recipient is working.Basically, the state is the guarantor of the state and local pension funds (not private pension funds).

      However, I don’t believe the state constitutions typically say that the pension fund itself must be funded in advance, just the benefits need to be not violated. Presumably, they could go into a pay-as-you-go mode where each year the state government would just pay the benefits out of general revenue. so even a badly funded pension fund like Kentucky still has a few years left before the state legislature would need to take that step. That is a lifetime in politics.

  3. Di Modica's Dumb Steer

    Thanks, Yves, for the post. It always takes me a bit to read through these, since they’re so dense and filled with pitfalls, but there was one particularly worrying bit that stood out:

    Another wee problem is that the Attorney General (admittedly in the prior regime) said it lacked the expertise to pursue the case, as you can see in the second embedded document at the end of this post. Of course, they could hire an outside firm and cut a deal for a contingent recovery, but the expense and hours outlay on a case like this would be very large and any winnings would be well down the road. There are perilously few firms that have the skills, the risk appetite, and the staying power.

    So essentially, all these big hedge fund managers have to do with their predatory behavior is target smaller, underfunded states (anything even remotely rural will work) which don’t have as much experience in arcane financial instruments, and possibly get their people (or a few sympathetic lackeys) into positions of power within? Then, after they get the state embroiled in some investing scam du jour, the state is out of luck because they can barely understand the way they got scammed out of their citizens’ retirements, and getting them back would be too costly and time-consuming? Sounds like this line of reasoning is even stronger incentive for the big fish to eat the little ones. Almost like a damn business model.

    …that KKR had schemed, and had a considerable amount of success, in trying to take over the investment decisions of Kentucky Retirement Systems.

    Oh, wait. There it is. These are truly vile people.

    1. rd

      “Lack of expertise” is an easy out. Thurgood Marshall and Ruth Bader Ginsburg “lacked expertise” as well as budget and staff when they changed the United States with regards to civil rights. If the state wanted to develop expertise, they could.

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