Pathbreaking Public Pension Case Mayberry v. KKR Is Back From the Dead as Kentucky Attorney General Joins Case

A little birdie told me a secret plan was afoot to revive Mayberry v. KKR, a derivative suit by eight beneficiaries of the severely underfunded Kentucky Retirement System against fund managers KKR/Prisma, Blackstone, and PAAMCO as well as private equity barons Henry Kravis, George Roberts, Steve Schwarzman and J. Tomilson Hill personally. That little birdie was right.

In a surprise move yesterday, the Kentucky attorney general, Daniel Cameron, intervened in the case, joining the plaintiffs. We’ve embedded the Commonwealth of Kentucky’s filing at the end of the post. As we’ll discuss, the politics of this move are extremely perplexing. Cameron is a protege of Mitch McConnell, and two of the defendants in this suit, Steve Schwarzman and Henry Kravis, are not just Republican heavyweight donors; they are (or at least have been) specifically top McConnell funders. What gives?

Readers may recall that the case seemed dead after the Kentucky Supreme Court dismissed it earlier this month, relying on the recent the US Supreme Court ruling in Thole v. US Bank to find that the plaintiffs lacked standing.1 It would seem awfully unlikely that the courts would take the view that the Kentucky’s highest law enforcement officer lacked standing to pursue these allegations and seek a sizable recovery on behalf of the state.

This filing uses much of the language of the original case, including defined terms like “Hedge Fund Sellers” and “Black Box” and has updated versions of key exhibits charting the terrible performance of the Kentucky Retirement System portfolio. The Attorney General filing preserves the main argument, which we summarized in 2018:

The suit, which we’ve embedded at the end of this post, was filed on behalf of the beneficiaries of Kentucky Retirement Systems (KRS), the state’s public pension fund and its taxpayers, against Blackstone, KKR/Prisma, and PAAMCO for engaging in a civil conspiracy and violating its fiduciary duties under Kentucky law by misrepresenting what it calls “Black Box” hedge fund products. One of the eight plaintiffs is a sitting district court judge.

In addition to suing the top executives at these funds, including Henry Kravis and George Roberts of KKR and Steve Schwarzamn of Blackstone, the filing also targets four former and three current KRS board members, four former KRS administrators for breach of fiduciary duties, along with KRS’ fiduciary counsel, several financial advisers, its actuarial adviser, and a firm that certified its Comprehensive Annual Financial Report.

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 suit seeks damages for losses, recovery of fees paid to the hedge funds and other advisers, and punitive damages. The damages would go to KRS and the suit also asks that the court appoint a special monitor to make sure the funds are invested properly.

This iteration of the case has cleaned up some of the repetitions in the original filings but more important, firms up and extends its arguments on some key points. I imagine that some of this material was developed in the successful effort at trial court to surmount Motions to Dismiss (recall it was the appeals and Supreme Court that ruled against the original plaintiffs).

One issue that was questionable in the original filing but is compelling in the version below is the rationale for suing Henry Kravis, George Roberts and Steve Schwarzman personally. The filing has a lengthly discussion of the unusual governance arrangements that allow these executives to retain operating control of their respective companies, including appointing board members, despite both KKR and Blackstone having gone public. The document argues that KKR and Blackstone are the alter egos of their founder. One tidbit that exemplifies this relationship:

Privately owned jet planes of Kravis and Roberts in the case of KKR/Prisma and Schwarzman in the case of Blackstone were used by their respective companies to fly their agents to Kentucky, for which the companies were charged and for which Kravis, Roberts and Schwarzman were reimbursed, in amounts, on information and belief, often in excess of $5 million per year. Thus each of Kravis, Roberts and Schwarzman personally profited from Kentucky business.

In fact, this practice is no secret except of course to fund beneficiaries and other members of the great unwashed public. Private equity and hedge fund limited partnership agreements not only authorize the use of “private class” travel, some even extend it to family members of the fund’s principals. Blackstone’s 10-K further discloses that Blackstone used Schwarzman’s jet for firm travel and pays him normal commercial rates.

Nevertheless, having a publicly owned company should effectively guarantee the profits (by providing for full utilization) of a side venture of a top executive is not an arm’s length relationship. One of my private equity contacts volunteered that at prevailing rates, $5 million a year is an awful lot of flying to and from Kentucky (one wonders if Kentucky Derby partying was billed to Kentucky retirees).

In other words, the idea that a going-bust pension system of modestly-paid state workers is paying for the priciest airfare on offer is not a good look. Having the plaintiffs root around in the use of the planes and how Kravis and Schwarzman profited from them is chump change in terms of all of the damage done to Kentucky Retirement Systems beneficiaries, but it nevertheless serves to illustrate the way these Masters of the Universe feel entitled to take personal advantage of the funds they operate.

Another set of arguments that this iteration of the case fleshed out more fully was the misrepresentation of the founding of defendant Jane Buchan’s firm PAAMCO. Buchan presented PAAMCO as a majority woman-owned firm, which gave her great advantage in marketing. In fact, virtually all of the founding money came from convicted hedgie David Sussman, who also obtained a large percentage of the economics. Sussman and Buchan even created fake documents to depict his ownership stake as a loan. The arrangement came to light when Buchan cheated Sussman on his payout and he successfully sued her.

This filing also explains how KKR/Prisma and PAAMCO decided to combine their hedge fund operations as the industry started imploding due to lackluster performance and investor withdrawals. The filing drily points out that Kentucky Retirement System was instead plowing even more money in despite poor returns.

Nevertheless, the way private equity firm employees use private jets like taxis has remained under the radar. One top Wall Street Journal reporter has repeatedly pitched articles on private equity jet use and has repeatedly been told no (the excuse? The Journal does not want to look anti-capitalist).

Similarly, the media has chosen to ignore other accounts of private equity executives profiting personally from owning businesses that sold services to private equity portfolio companies. We wrote back in 2013 about how another Blackstone executive, Tony James, engaged in apparent self-dealing by gaining ownership of a software program, iLevel Solutions spun out of Blackstone, then selling the software to portfolio companies, including Blackstone’s.

As to process: the quick intervention of the Attorney General and the extent of updates and polishing of the filing strongly suggests considerable direct support of the plaintiff’s attorneys, Anne Oldfather and Michelle Ciccarelli Lerach. There’s even a nod in the text to the formidable, disbarred attorney Bill Lerach, who is a consultant on the case:

Other public pension funds have recouped billions of dollars through lawsuits against persons and firms which damaged those funds in violation of law – including Wall Street financial houses. Most notable are the suits arising out of the Enron, WorldCom and AOL Time Warner financial collapses by which public pension funds recovered billions of dollars

Those were all Bill Lerach cases.

Attorneys General often hire outside counsel on a contingent fee basis, and not just for their expertise. Even New York, which has one of the larger state AG offices, has only a dozen attorneys, so outside counsels also provide manpower.

In many states, these arrangements need to be approved by an independent party in the Administration, usually the Governor. As a lawyer who has been engaged by the Attorney General in another state opined, “In this situation, I would also guess that the Governor wouldn’t put up much of a complaint if the Attorney General wanted to hire the same crowd that started the case.”2Note that the plaintiffs had prevailed at trial court on the original case on all the Motions to Dismiss save the removal of a minor defendant from the case; you can review the issues previously adjudicated here. I assume the defendants will insist on repeating these fights; it is over my pay grade to know how a judge will respond if the case goes before a new jurist, as opposed to back to Judge Philip Shepherd.

Finally, I am not the only one having to wrap my mind around what is going on here. Attorney General Daniel Cameron is joined at the hip with Mitch McConnell. A Mitch McConnell scholarship helped fund his college tuition. After clerking for a Federal judge in Kentucky, he Cameron then became McConnell’s legal counsel before joining a Kentucky firm for two years as associate. At 34, he won the Attorney General election, the first Republican to hold the seat since 1944 and the first black, in no small measure due to McConnell’s backing. So there is no way for McConnell to act as if Cameron has gone off the reservation.

Not only are Henry Kravis and Steve Schwarzman long-standing, big ticket Republican donors, but Kentucky contacts maintain that they are McConnell’s largest donors. The Mayberry v. KKR case was dead; there is simply no way that reviving it is in any of the defendants’ interest. The case is very likely to get to the discovery phase and discovery would be very damaging to the plaintiffs, most of all Blackstone and KKR. Remember that anything that gets into the public record isn’t just a potential embarrassment; it can be included in other cases.

Should Cameron believe he can go through the motions on this litigation after November, it’s going to be hard to extricate himself, given the dire state of the Kentucky Retirement System finances and the visibility of his involvement to beneficiaries, without clawing a meaningful-appearing amount out of the deep pockets. Even a cost of doing business fine/disgorgement like the big private equity funds paid to settle SEC enforcement actions, on the order of $50 million each, is an expense they would not have faced absent Cameron mixing things up. And a settlement would not be secret; it’s a public record, subject to disclosure.

So what is the political play here? Does McConnell feel the need to bolster his bona fides with Kentucky cops? Recall Mayberry is an officer. Have the Republicans decided they need to bolster their populist credentials? Recall that the Trump Administration filed an amicus brief in favor of the plaintiffs, as in the lowly pension beneficiaries, in Thole v. US Bank.

Is this revenge? Has Schwarzman or Kravis crossed McConnell? Or has the famously sure-footed and ruthless McConnell miscalculated due to not adequately understanding the terrain? There’s some sort of dark matter exerting force on this equation. It will likely become evident in due course.


1 We pointed out that the plaintiffs in fact made three independent arguments regarding standing, and the Kentucky Supreme Court, relying on Thole, addressed only one, that the plaintiffs lacked Federal “Article III” standing because their losses had not yet actualized. Since Kentucky is one of the minority of states that uses Article III in state law matters, the Kentucky Supreme Court could have reached the same conclusion without Thole, but they risked with Thole in play that the US Supremes might reach the opposite conclusion, that what amounted to a mark to market loss might do. We pointed out that the Kentucky Supreme Court handwaved away the second standing argument and simply ignored the third.

2 In light of the oddity of Mitch McConnell’s protege going after some of McConnell’s biggest meal tickets, it does not appear that the Attorney General and the original plaintiffs have the same interests, although the legal pretense is the AG is above those considerations. Nevertheless, this does raise the question of whether the Attorney General is as motivated as the original plaintiffs to go the distance on this case. That means I wonder how the same legal team could represent both even if Kentucky were willing. Having said that, the key attorneys are not part of the same firm, so conceivably the original team could divide up the representation.

00 Mayberry + Commonwealth of KY v. KKR

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