Suit Charges Milken, KKR With Siphoning Funds : Litigation: Two teachers file a class-action that contends hundreds of millions of dollars of state pension funds were misappropriated.

Two school teachers sued convicted junk bond king Michael Milken and the leveraged buyout firm of Kohlberg Kravis Roberts & Co. for $1 billion Wednesday, charging that they misappropriated hundreds of millions of dollars of state employee pension funds.

The class-action suit in U.S. District Court in Seattle alleges that KKR improperly siphoned investors’ money to Milken, who participated with the Wall Street firm in some of the biggest takeovers of the 1980s.

KKR, which became the largest leveraged buyout firm on Wall Street, used investors’ money and borrowings to buy public companies and take them private.

The borrowings in many cases consisted of junk bonds sold by Milken at Drexel Burnham Lambert Inc., which is now in bankruptcy.

The state retirement funds of Oregon and Washington invested money in many KKR buyouts, including Beatrice Foods Co., Motel 6 and Safeway Stores Inc.

The suit charges that KKR improperly gave Milken a bonus for selling the junk bonds that financed the buyouts, cutting into the return that should have gone back to the original investors.

The suit also alleges that KKR conspired with Milken and violated its fiduciary duties to contributors to the pension funds.

It also alleges violations of the Racketeer Influenced and Corrupt Organizations Act and charges that KKR violated the Investment Advisers Act by charging lofty fees.

Representatives for Milken and KKR said separately that the lawsuit was without merit.

“The allegations are ludicrous,” Alan Dershowitz, Milken’s lawyer, said in a statement. “Every investor, including the plaintiff’s pension funds, profited tremendously from these investments.”

KKR said in a statement that “we will vigorously defend ourselves against this baseless and frivolous lawsuit,” which it said was brought by “publicity-seeking individuals.”

The suit was brought by Hal Buttery, a Washington state teacher, and Linda Whitmore, a teacher in Gresham, Ore.

They were represented by Steve Berman and Jeffery Squire, two lawyers that have filed shareholder actions in the past.

The teachers’ suit contends that KKR used Milken as the exclusive underwriter for all its leveraged buyouts of companies and that it secretly agreed to give him stock warrants in them at a fraction of their value.

It alleges that KKR conspired to transfer to Milken nearly $1.34 billion of warrants related to five leveraged buyouts.

The suit claims that KKR told pension fund managers that the warrants were necessary to persuade bondholders to purchase the bonds needed for financing the buyouts.

Instead, Milken and his associates received them. In one example, the 1986 buyout of Beatrice, Milken bought a 23% equity stake in the company worth over $800 million for less than $50 million, Berman said.