Game Finally On! Judge Denies Key Motions to Dismiss in Kentucky Retirement Systems Litigation, Subjecting KKR, Blackstone, PAAMCO, and Top Financiers Henry Kravis, George Roberts, Steve Schwarzman, and Tomlinson Hill to Discovery

It now seems like an eternity ago, but the latest big play in the long-running Kentucky Retirement Systems case, with the centerpiece a deeply underfunded pension fund reaching for return, was the Kentucky Attorney General Daniel Cameron rousing himself to enter the case on behalf of allegedly all potential plaintiffs. This was despite the previous AG having filed a motion supporting the effort by the legal team lead by Michelle Lerach, with her formidable and controversial husband, one-time top securities litigator Bill Lerach, and a cast of other able lawyers to obtain damages from some of the biggest names in finance, KKR, Blackstone, PAAMCO (a one-time affiliate of bond giant Pimco), their top execs (!!!) and many co-conspirators and enablers. The basis for action was over fiduciary duty breaches and other bad conduct in the sale and management of custom hedge funds.

This is a very hard won and important victory for the plaintiffs. As you may recall well from the financial crisis, individual executives are virtually never successfully targeted for their misconduct, let alone figures as prominent as these. Here, they are subject to punitive damages and their personal finances are discoverable. So expect more pitched battles to try to continue to keep this case from advancing.

Forgive me for skipping over the extensive legal and factual arguments to focus on the high points of the progress of the case; Footnote 1 presents some of the major evidence and arguments.

As we will discuss in detail below, after yet another long detour from the original case, Mayberry v. KKR, first filed in 2017 and now replaced by overlapping new actions, judge Thomas Wingate has finally completed what must have been the painful process of evaluating the merits of a very large number of motions to dismiss. We’ve embedded his orders at the end of the post. He deserves a lot of credit for patiently working through the different circumstances of the various defendants and delivering sound and clearly-explained rulings.

We and others saw the Cameron maneuver was as intended to displace this tenacious legal team and entering a lowball, quiet settlement with powerful Republican donors. Cameron is the protege of Mitch McConnell. The targets in the suit include heavyweights like KKR co-founder Henry Kravis and Blackstone’s current chief Steve Schwarzman.

For those of you following this saga, the case was originally Mayberry v. KKR. The legal team presented a derivate case on behalf of all beneficiaries, who nearly all are in defined benefit plans. A “derivative suit” is when plaintiffs step in to assert the legal rights of other parties, typically a corporation or other entity, who are supposed to be serving plaintiffs’ interests but have failed to do so (there are various tests for that).

The case was appealed before any trial court rulings had been made, a highly irregular development. The decision against the plaintiffs raised a lot of eyebrows; even one of the defendant’s attorneys privately said was a bad ruling.

Mayberry v. KKR then went to the Kentucky Supreme Court, which tossed it due to lack of standing as a result of an intervening Federal appeals court and a Supreme Court decisions that took place after the initial filing. The result was that beneficiaries in defined benefit plans could not sue for losses unless they had suffered reduction in or termination of their benefits (as in the plan had to be totally out of money). Even at an only 13% funding level at the time, Kentucky Retirement System was still satisfying all its current obligations.

In the case of intervening decisions, plaintiffs are usually allowed to replead their cases.

But then came another effort to throw a spanner. As it became clear that the plaintiffs were not going to go away easily even after their Kentucky Supreme Court defeat, Attorney General Daniel Cameron got out of bed. In July 2020, he intervened on behalf of the plaintiffs, shamelessly reworked the original plaintiffs’ filings (this was done with the cooperation of one of the original lead attorneys. Anne Oldfather, whose loyalties were seen as questionable from the outset). He later asserted he would fully occupy the field, as in represent the state (which is backstopping the funds), Kentucky Retirement Systems, and its beneficiaries. Kentucky Retirement Systems bleated, pointing out it was one of the state agencies that got to pick its own counsel and had not authorized Cameron to act on its behalf.

The core legal team sought to file a reconstituted case, which kept some of the original plaintiffs, the ones who had “hybrid” so-called “Tier 3” plans (both defined benefit and defined contribution components) and added other Tier 3 plaintiffs. Defined contribution plan members have a substantial body of precedent allowing them to sue over losses to their plan assets, even if they have not started withdrawing funds. That solved the earlier standing problem. Admittedly these beneficiaries represent a much smaller amount of total Kentucky Retirement System funds, but the fact of harm was presumably enough to get to discovery.

At the end of December 2020, the trial court court rejected nearly all efforts to replead the case except the above mentioned Tier 3 claims (now called Taylor v. KKR). Perhaps other close followers of this many chaptered saga will disagree, but Judge Philip Shepherd, considered to be one of the most progressive judges in the state, seemed to sour on the case after the appellate and Supreme Court reversed his initial rulings.

Judge Shepherd said he could not rule on whether the Tier 3 plaintiffs could proceed on their own until the Cameron articulated the “nature and scope of the claims that will be asserted by the OAG.” The Attorney General kept asking for extensions of time, even as Shepherd voiced frustration with the foot dragging. That was a pretty strong sign that Cameron’s presumed plan of negotiating a fast settlement had gone pear-shaped. So Cameron is looking like the dog that caught the car.

The defendants then successfully sued to have Shepherd removed from the case because he had touted his tough position on the Mayberry v. KKR cases in his re-election campaign (Shepherd recused himself in May 2022). The defendants no doubt believed a more conservative judge would prove to their advantage. It appears not to have occurred to them that a competent judge, regardless of his ideological bent, would not blindly accept what the coastal con artists financiers were selling out of deference to their status.

Judge Wingate has finally issued orders on the extremely large number of motions to dismiss, nearly all by differently-situated defendants. The magnitude of that task, plus getting his arms around the very very large body of past filings, presumably accounted for the substantial delay. The compact orders are well reasoned. They seem even more credible by rejecting the idea that the Attorney General could properly represent the Tier 3 plaintiffs, and denying the motions to dismiss of the hugely powerful defendants, KKR, Blackstone, PAAMCO, and private equity kingpins Henry Kravis, George Roberts, Steve Schwarzman, and Tomlinson Hill personally.

Needless to say, the fact that the Tier 3 plaintiffs have gotten a discovery green light further complicated the Attorney General’s life….who by the way is no longer Daniel Cameron, who left office earlier this year, leaving the hot mess of this not-completed gambit on his successor, Republican Russell Coleman’s desk. How can he enter into a lowball settlement, which will be subject to disclosure, if the Tier 3 plaintiffs keep fighting and eventually get a healthy number on what is certainly to be less monetary harm based on their smaller interest in total fund assets?

And finally keep in mind that everyone close to the case understands what the real leverage is. It’s exposing the chicanery of the big ticket, supposedly reputable private equity leaders and getting deeply into the economic and commercial relationship of their top leaders to their firms.

Pass the popcorn. The Lerach team has been so chomping at the bit that your humble blogger is behind their pace of action. They’ve already filed their first big motion/demand, which I will cover tomorrow. I thought it important to give an adequate recap of this tortured history before moving to the new battles.

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¹ From a 2021 post:

The 50,000 foot version of the plot thus far is that in late December 2017, attorneys filed a derivative lawsuit for eight Kentucky Retirement System beneficiaries against three fund managers, KKR/Prisma, Blackstone, and PAAMCO, that had sold customized hedge fund products that contrary to their sales pitch, had high risk and underwhelming performance.¹ The Kentucky Retirement System, at only 13% funded, is the most spectacularly underwater large pension fund in the US, despite Kentucky having some of the most stringent statutory fiduciary duty requirement in the US.

The fund managers allegedly focused on KRS and other desperate and clueless public pension funds who were unsuitable investors, particularly at the risk levels they were taking. KRS made what was a huge investment for a pension fund of its size. $1.2 billion across three funds all at once, in 2011, roughly 10% of its total assets at the time. They all had troublingly cute names. The KKR/Prisma funds was “Daniel Boone,” the Blackstone fund was “Henry Clay” and the PAAMCO fund, “Colonels”.

In the case of KKR/Prisma, the fund had installed an employee at KRS as well as having a KKR/Prisma executive sitting as a non-voting member of the KRS board. The filing argues that that contributed to KRS investing an additional $300 million into the worst performing hedge fund even as it was exiting other hedge funds.

The stakes here are much higher than the potentially meaty recoveries. Private equity and hedge funds fetishize secrecy because too often, their conduct will not stand up to scrutiny. The giant fund managers are almost certain to be most afraid of discovery, since they sharp practices they used with Kentucky Retirement Systems were very likely to have been replicated at other public pension funds. Even the limited discovery so far uncovered more misconduct and allowed the plaintiffs to add to their claims.

The initial case was appealed before discovery had gotten meaningfully underway, an unusual sequence of events. The plaintiffs lost on what most independent lawyers thought was an extremely strained ruling. The case then went to the Supreme Court, which dismissed the case without prejudice on standing due to intervening appellate and US Supreme Court decisions. The Supreme Court also got peculiarly snippy about private attorney pursuing these claims.

The Kentucky Attorney general, Mitch McConnell protege Daniel Cameron, filed a surprise Motion to Intervene on July 20. Bear in mind the attorney general’s office could have intervened at any time to support the case but oddly chose to now. Its filing was also clearly and wholly dependent on the earlier submissions by the private plaintiffs.

After a raft of oppositions, including multiple formulations by the somewhat reshuffled plaintiffs’ legal team (former lead counsel Anne Oldfather was replaced by her former co-counsel Michelle Lerach), Judge Shepherd issued an order on December 28. He rejected most of the plaintiffs’ reformulations to deal with the standing issues except having the so-called Tier 3 Plaintiffs effectively make their pitch. The reason the earlier case had been largely shot down was those intervening decision (such as Thole v. US Bank) required that the plaintiffs have suffered a “particularlized” loss. The Kentucky Retirement System beneficiaries hadn’t yet, since the fund has not yet missed a payment and arguably even if the system does, the State of Kentucky is also on the hook.

By contrast, the Tier 3 plaintiffs had mandatory deductions from their paychecks for a hybrid pension which is not state guaranteed. Even though public pension plans are not subject to ERISA, they are often managed in accordance with ERISA principles. The Kentucky Supreme Court in fact used ERISA cases to guide its decision. Unlike a defined benefits plan, which is what the Tier 1 and Tier 2 plaintiffs have, the Tier 3 plan is a defined contribution plan. Extensive case law backs the idea that under a defined contribution plan, the employee has suffered when his account balance is impaired. So the standard for loss is completely different than for the original “Mayberry Eight.”

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