Capitalism - McKinsey edition!

I have blogged repeatedly highlighting how iconic companies like McKinsey, Goldman Sachs, JP Morgan, Google, and so on have become exemplars of what is wrong with the American capitalism, the variant that others are trying desperately to emulate. Their unfortunate practices, which have amoralised and enfeebled capitalism, may also carry the sparks that, along with other growing trends (widening inequality, financialisation, business concentration etc), could contribute to burning the entire house down. And, in the long sweep of history, that may perhaps be a good thing. 

With McKinsey, from India and Ukraine, and Malaysia and Saudi Arabia, the skeletons have been tumbling out at an alarming pace.

Now comes more news about the conflicts of interest between McKinsey's consulting work and the hedge fund that manages the pensions and investments of about $12.3 bn on behalf of about 30,000 current and former McKinsey's employees, McKinsey Investment Office (MIO).

First it was Valeant, the notoriously price-gouging pharma company, in which MIO was one investor,

Four top Valeant officials, including Mr. Pearson (the CEO), were McKinsey veterans, and the firm was advising Valeant on drug prices and acquisitions. That web of relationships underscores the unusual nature of McKinsey’s hedge fund, and the potential for undisclosed conflicts of interest between the fund’s investments and the advice the firm sells to clients.

The relationship was very deep, almost defining and birthing, albeit indirectly, Valeant itself,

The Senate hearings on Valeant Pharmaceuticals examined how the company, under Mr. Pearson’s leadership, raised the price of Isuprel and Nitropress, decades-old heart medications commonly found on emergency-room crash carts. Mr. Pearson relied on an idea he had honed as head of McKinsey’s pharmaceutical practice: focusing on acquisitions of existing drugmakers instead of spending heavily to discover the next blockbuster drug. Before buying Isuprel and Nitropress from a competitor, Valeant consulted McKinsey, which reported that the drugs had “material pricing potential,” according to records obtained by the Senate. After the acquisition, Valeant raised Isuprel’s price by 720 percent, and Nitropress’s by 310 percent. As McKinsey consultants were advising Valeant in late 2014, two of MIO’s funds, Compass TPM and Compass Offshore TPM, acquired an indirect stake in Valeant, through Visium Asset Management, a fund soon to implode in an insider-trading scandal. Through another outside hedge fund, Aristeia Capital, two other MIO funds acquired shares in Valeant in early 2015, after the company agreed to buy Dendreon, a bankrupt drugmaker. The McKinsey funds were listed among the eight noteholders of Dendreon, entitled to a portion of the $495 million, in cash and Valeant shares, that Valeant paid for the company… Even if the McKinsey fund’s investments in Valeant were indirect, the firm’s partners stood to profit from their own advice. 

Then came the case of Alpha Natural Resources, a Virginia based firm, while filed for bankruptcy. A federal judge reopened the bankruptcy case recently after learning that McKinsey had cheated the court by advising the company without disclosing that through MIO, it was one of the company's secured creditors. And secured creditors had recovered the most most money. It is thought that McKinsey had improperly reaped a profit of $50 million because it helped determine the way secured creditors were compensated. The US Department of Justice (DoJ) has supported the reopening. The federal Judge Kevin R. Huennekens wrote,

“These are some of the most serious allegations that I have ever seen.”  

Another case, one involving Colorado's Westmoreland Coal, too is currently in a Federal Bankruptcy Court in Houston. An activist, Jay Alix, and the US DoJ, are accusing McKinsey of "pervasive disclosure deficiencies" and "incredibly inflammatory" wrong-doing. As the courtroom battle rages, McKinsey has been forced to return $1.2 million in fees to Westmoreland.

The courtroom fight hinges on whether McKinsey or its clients have hidden interests in a bankrupt coal company that the firm has been advising, a practice prohibited by federal laws meant to ensure that one insider can’t effectively cut itself or its friends a great deal at the expense of others... On Dec. 14, the department said in a court filing that McKinsey was fraught with “pervasive disclosure deficiencies” and should be dismissed from the Westmoreland case immediately and stripped of the fees it had earned so far.

Finally, there is the federal bankruptcy case of Puerto Rico, where McKinsey indirectly owns at least $20 m in bonds whose fate is inextricable from the advise the company is giving to the government,

McKinsey & Company is advising the Puerto Rican government on a financial overhaul to lighten its crippling debts — a process that will determine how much money the bankrupt territory’s creditors recoup on their investments. The giant consulting firm has millions of dollars riding on the outcome. The reason: McKinsey owns bonds issued by Puerto Rico. That creates a potential conflict of interest between McKinsey’s client, which wants to save as much money as possible, and McKinsey itself, which wants to make as much money as possible on the bonds... Affiliates of McKinsey revealed their investments in filings in federal court in Puerto Rico’s capital, San Juan. The filings were not made under McKinsey’s name, and were among nearly 165,000 bankruptcy claims. McKinsey so far has received $50 million in fees to advise Puerto Rico’s federal oversight board on drafting a blueprint for the island’s fiscal affairs over the next decade.

Lynn M. LoPucki, a law professor at the University of California, Los Angeles, and the founder of the school’s Bankruptcy Research Database, says,

“It’s a conflict of interest. They are making decisions that will determine how much money is given to themselves.”

The defence is that there are Chinese walls to limit conflicts of interests. But how meaningful are those walls? Sample this,

McKinsey’s main competitors, Bain & Company and Boston Consulting Group, have nothing like MIO. Regulatory filings show that an outside manager, Vanguard, manages their employees’ 401(k) retirement accounts. But investments for McKinsey’s 401(k) plan, which must be disclosed to the Department of Labor, make up only about half of MIO’s assets. The rest, about $6 billion, is the private wealth of McKinsey’s current and former partners... Those partners have access to a trove of inside knowledge about their clients. According to its website, McKinsey counts as clients 90 of the world’s 100 biggest companies. It advises two-thirds of the top mining companies, more than half of the top 25 airlines and 60 percent of the 100 largest banks. At the same time, the current or former McKinsey consultants who dominate MIO’s board include the leaders of the firm’s wealth and asset management and energy practices, according to an S.E.C. filing... an official with the Justice Department’s Office of the United States Trustee argued that the hedge fund was not a “blind trust,” as claimed. The Justice Department pointed out that the head of McKinsey’s bankruptcy practice, Jon Garcia, sat on the fund’s board. Until he stepped down in 2017, Mr. Garcia received regular reports on the fund’s investment decisions and ratified them, the official said.

For a company that promotes corporate best practices, the opacity of MIO’s investments is striking,

For someone who manages such a large and successful portfolio, there is surprisingly little public information about Mr. Todd Tibbetts, the fund’s longtime chief investment officer. So secretive is the fund under Mr. Tibbetts that its managers were discouraged from attending industry events and, even when they did, from talking to participants, one former fund executive said. One reason for the secrecy, another former executive said, is that McKinsey does not want people connecting any dots between what its consultants do and where its hedge fund invests... McKinsey does not disclose the identity of its clients — the chief executives, prime ministers and princes who seek its counsel on management best practices. And even as the firm is privy to market-moving corporate maneuvers and confidential government information, its hedge fund’s investments are often secret, with a large part of its approximately $12.3 billion in holdings concealed behind a tangle of shell companies in an island tax haven in the English Channel. 

Even in this world of utilitarian excesses, this MIO investment structure in a dubious Chinese entity, in particular, is very hard to rationalise,

And despite all this, from just the past six months, sample this for cheekiness,

McKinsey says the way the fund is structured and operated ensures that its employee investors do not stand to benefit from the firm’s inside knowledge and consulting advice. Hedge fund managers do not coordinate with McKinsey consultants, the firm says, and about 90 percent of MIO’s capital is managed by outside funds. “MIO and McKinsey employ separate staffs. MIO staff have no nonpublic knowledge of McKinsey clients,” the company said in a statement. “For the vast majority of assets under management, decisions about specific investments are made by third-party managers.”

Actually the Times investigation is extremely generous in so far as it does not go the full distance with interpreting a whole series of potentially criminally indicting corroborative circumstances. For example, it stops short of highlighting the coincidence between McKinsey's consulting role and MIO's investments in these relatively obscure four contexts. Given that MIO's portfolio is $12.3 bn and not $12.3 trillion, it is intriguing as to why should MIO ever even have considered investing in these odd assets? It is difficult to believe that when the MIO fund managers scanned the global investment opportunities landscape, these four obscure assets would have stood up as standout investment opportunities. The coincidence raises the question of whether MIO got the consulting business for McKinsey or did the consulting business open up the investment opportunity? Either ways, it is a striking illustration of the corrosive business practices that exemplars of capitalism follow. 

One is perhaps an inadvertent omission, to be condoned. Two, three, and four (and more waiting to tumble) is perhaps more than enough to attribute a conscious pattern for criminal indictment.

But such is the regulatory and political capture that it is futile to even expect heads to roll internally, much less criminal prosecution. Most likely those partners and executives would get even bigger bonuses and promotions. 

Update 1 (29.12.2020)

Daniel Markowitz has an article in The Atlantic which examines how McKinsey's technocratic management work undermined the society and the middle class. 

Fundamentally, management consulting, with efficiency maximisation being the preeminent consideration, elevates one particular value or attribute, at the cost of many others like fairness, empathy, loyalty, and so on.