Eight Kentucky government employees and retirees filed a lawsuit in the County of Franklin Circuit Court this week, seeking to recover losses from products three hedge fund managers sold to the Kentucky Retirement System.

The plaintiffs are seeking damages from Blackstone Group, KKR & Co./Prisma Capital Partners and Pacific Alternative Asset Management Co. for selling “custom-designed ‘black box’ funds of hedge funds they portrayed as capable of producing the high investment returns with safe diversification while providing downside protection.”

The Courier-Journal of Louisville first reported the lawsuit.

According to the lawsuit, KRS invested between $1.2 billion and $1.5 billion, or $400 million to $500 million each, in the three funds in August 2011. Based on the sales pitches, KRS trustees expected lower risk, increased liquidity and returns of 7.75% on an ongoing basis.

The investments delivered on none of these things, the lawsuit says, but “[T]hey did generate excessive fees for those hedge fund sellers, poor returns and ultimately losses for the funds, in the end damaging KRS and Kentucky taxpayers.”

The lawsuit also names several KRS board members, staff executives and consultants who, it alleges, breached their fiduciary duty in making the hedge fund allocations. In addition, it charges them with making decisions and projections that were “outmoded, unrealistic and even false actuarial estimates.”

State pensions’ shortfalls increased in fiscal 2016.

Kentucky’s pensions are in especially dire straits. As of June 30, KRS, which comprises five pension funds and nearly 500,000 workers who draw pensions or expect to do so upon retirement, had $26.8 billion more in future pension liabilities than it held in anticipated assets, according to the Lexington Herald-Leader.

KRS plans’ deteriorating status caught the attention of the hedge fund sellers, the lawsuit says, which offered them safe investments — “just what the desperate KRS Trustees were searching for” — but were actually “secretive, opaque, illiquid, impossible to properly monitor or accurately value, high-fee, high-risk gambles with no historical record of performance.”

As a result, “KRS was ‘locked in’ for years and[the] hedge fund sellers had complete discretion to pick the investments and then to value them.”

— Check out MetLife’s Failure to Pay Workers’ Pensions Is Under Scrutiny on ThinkAdvisor.