In Response to Court Order, Kentucky Retirement Systems Releases 2,256 Page, Yet Incomplete, Investigation into Hedge Fund Shenanigans

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The latest Kentucky Retirement Systems expose of sorts has been the forced release of a pricey report it fought to keep secret. Prepared by law firm Calcaterra Pollock, in money terms it was presented to the public as $1.2 million but actual invoices suggest more like $1.6 million, but perhaps more impressive, in not a good way, is its heft:

I did download the report to my hard drive but it’s way too large to embed, even limiting the document to the 97 page main text.

Recall that the supposed reason for this report was to advise Kentucky Retirement Systems if there was gambling in Casablanca there was improper or illegal conduct by the parties involved in the hedge fund investment controversy which led to the Mayberry v. KKR lawsuit. If so, was there a basis for legal action by Kentucky Retirement Systems, and what would the costs and risks be?

These questions became important after that landmark Mayberry v. KKR suit was dismissed over standing by the Kentucky Supreme Court. Recall further that trial court judge Philip Stephens had ruled in favor of the plaintiffs on all substantive issues and even the Supreme Court remarked that there was evidence of serious misconduct. That meant it was conceivable that another party, like Kentucky Retirement Systems, could take up the claims in place of the Mayberry plaintiffs.

However, surprisingly, the Attorney General, whose office had ignored the case, suddenly showed up wanting to take up the claims. Since AG Daniel Cameron is a protege of Mitch McConnell, and the two biggest firms fingered, KKR and Blackstone, have firm heads who are major Republican donors, cynics thought Cameron was trying to get a settlement on the cheap so he could pretend to have scored a win for the state while getting rid of a lingering problem for the Wall Street kingpins.

One wonders if Cameron became the real client for the report, even though Kentucky Retirement Systems was paying for it. Cameron repeatedly asked for more time to submit his Amended Intervening Complaint because he’d only seen the draft Calcaterra report and argued he needed to review a final copy. Yet when Cameron finally did submit his much-delayed complaint, there was not a single reference to any material or information from the investigation.

When an advisor gives a report that way overdoes on the weight test, it means one of:

The preparer was unable to come to a conclusion but wanted to show it did a lot of work

The preparer wanted to take many positions and not have to reconcile them

The preparer wanted to confuse, overwhelm or terminally bore any readers

Remember how this pricey paperweight came into being: the Kentucky Retirement Systems had very suddenly made a big shift in allocation and moved over 10% of its portfolio in three customized hedge fund of funds. This already sounds sus since the total amount allocated was so large that there was no good reason to have dampened returns by paying a second layer of fees (hedge fund of fund on top of the underlying hedge fund fees). Not surprisingly, due to the fee load, the funds well underperformed the stock market despite being higher risk investment (as their sponsors told the SEC, contradicting their representations to Kentucky Retirement Systems).

This report already had a great deal of smoke around it because Kentucky Retirement Systems years ago had conducted a investigation. Why should a second one made years later be any better, particularly since memories would have faded and records might have conveniently disappeared? Kentucky Retirement Systems earlier had taken the unusual position of giving written approval for litigation against the hedge fund operators, former Kentucky Retirement Systems board members and executives and other advisors, without formally joining the suit.

On top of that, Regina Calcaterra, the lead in conducting this investigation, didn’t have any expertise in pension funds but did as a fixer. And she’d oddly pitched the report well before the Kentucky Supreme Court ruling that tossed the original case on the grounds of standing, reopening the question of whether Kentucky Retirement Systems should sue in its own name. How did Calcaterra know this question might become live again? And why was the RFP process designed to deter other submissions?

There are likely very informative tidbits in the over 2000 pages of exhibits, for those with the time and motivation to go through them. From a very cursory look at the text:

The report is garbage in, garbage out. Even though Calcaterra did get access to critical internal records, such as Investment Committee records and hedge fund marketing materials, the only people she interviewed was on a voluntary basis, and they were not under oath. Even worse, only the information that they consented to have included is incorporated. Moreover, Calcaterra also did not get access to documents that the hedge fund sellers had apparently deemed to be confidential, such as the investment agreements and likely detailed documents about fund performance and holdings.

The report engages in serious “the dog that didn’t bark” behavior. It does not consider why Kentucky Retirement Systems, which was supposedly desperate to get more return, went into super high fee hedge fund of funds which were guaranteed at best to do only so-so by virtue of managers sucking out a lot of any investment results? The document actually does raise the possibility that there were payoffs yet fails even to set down what would need to be done if Kentucky Retirement Systems wanted to explore the matter further.

In more choosing not to overturn important rocks, the investigation does not appear to have interviewed the newer trustees and state officials who had done their own deep dive into the pension mess. It’s a reasonable assumption that they would have been eager to have been interviewed.

So it’s hard to take the conclusion, that no one did anything wrong, seriously, particularly when the report describes numerous conflicts of interest that it didn’t or didn’t choose to run down adequately. Instead, the picture it paints is of desperate officials who then got their feelers hurt as the fund got more and more deserved bad press.

I’m hoping another shoe will drop on this front.

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  1. Amfortas the hippie

    as a newborn Pensioner(!), i hope the ire against such shenanigans has legs.
    i suppose a win, and some important heads rolling would be at least precedent for other states…but it would be better if it were dealt with in federal court.
    (not that i trust federal courts to be fair and honest, mind you)
    I’ve only run over the surface of the Texas Teacher Retirement System(TRS)…but wouldn’t be surprised if there were similar shenanigans somewhere under all that…it being Texas, and all.

    1. griffen

      I hope and do suspect your state is in somewhat better hands. Size does not always matter in the pension space, but it definitely is not a hindrance. I also believe Texas has plenty of legitimate finance people matriculating each year out of the likes of A&M, UT, TCU, Texas Tech. I worked with many of them over a 10 years span, mostly in the banking or credit union spaces.

      but in summary, It never hurts to ask questions, research and dig into what ever lies under the surface. Good luck !

      1. Amfortas the hippie

        i’d be pleased if they surprised me,lol…but, again, it is Texas…all that talk of “fiscal conservatism” is mainly about making sure poor and/or brown people can’t get healthcare and food and stuff.
        and again, i haven’t had the bandwidth available to even start to dig in to whatever they’re doing…likely won’t have it for some time(too much to do).
        to be perfectly fair, all 5 people ive talked to there were super helpful and very tolerant of my performative ignorance as well as my luddism(i dont have a credit card, checking account, dont use email, etc etc…when i said i wanted a paper check, sent in the mail, they only took two breaths to say “ok, sir”.)

        its the back of the house i’m interested in.
        like the kentucky thing…or any of a zillion examples of public/private partnerships and other assorted grift-holes built in to various systems…i’ve too much experience with texas gooberment,lol, to be sanguine.
        so long as my 5 years of pension checks flow, i’m cool…its more academic interest than anything.

    2. Dave in Austin

      The Texas Teacher Retirement System(TRS) is small beans compared to the Texas University Permanent Fund, made up of the revenue from oil and natural gas land the state accidentally owns, especially land in the Permian Basin. In theory the money is supposed to be used for bricks-and-mortar for the state U system. They’ve been “creative” in what constitutes brick-and- mortar, but not necessarily in a bad way.

      But what does smell bad is taking the Fund, which was open and public, and handing a big chunk of it to “advisors” who invest the money in secret, make no detailed reports including profit-and- loss and are not subject to disclosure laws. It seems that the funds are controlled by interests in Dallas/Fort Worth connected to the Bass family, who might thus be in a position to make money off access to this truly huge pool of cash.

      This is a generalized, second-hand description of the issue based on gossip I’ve heard in Austin. I’m not a forensic accountant and have chosen to not look at the situation in detail, but the above is my understanding of what is going on. I wonder if anyone (hint, hint) might invite leakers from the interests who now control this huge fund to send copies of documents in by non-elecronic (and therefore hard to trace) methods for publication?

      If nothing is wrong then public disclosure should cause no harm.

      1. griffen

        This may be a different fund that mentioned above, but back in my time at a retail bank I pulled research on state and local municipal bonds. Many state institutions will hold such local bonds as it is somewhat encouraged by varying tax status implication of doing so. That is all to say, my research included a review of the Texas Permanent School Fund. A healthy endowment to aid the more rural towns and cities in the state to issue school district bond funds. I won’t argue with what you said above about the Bass family; had heard similar rumblings before about the Hunt family too.

        Permanent School Fund used to have readily available annual reports as well. Not always the lightest of reading material.

  2. Stupendous Man - Defender of Liberty, Foe of Tyranny

    I always suspected AG Cameron stepped in to intentionally throw the case.

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