How Trust Was Eroded

In 2009, it emerged that two McKinsey consultants, one very senior executive, Anil Kumar, and the other the then recently retired ex-global CEO of the firm, Rajat Gupta (no relation to the Saxonwold brothers), had deliberately leaked inside information to Raj Rajaratnam, the CEO of a hedge fund called Galleon, for the purpose of making a quick profit. It was at this point that the inherent assumption of trust in the high-wattage management consulting business model, was first publicly exposed.

 A raft of books had already been written documenting the indomitable rise of management consulting and its omnipresence across all of industry and government. As early as 1997, John Micklethwait and Adrian Wooldridge had published their best-selling chronicle on the topic, titled The Witch Doctors. At the time, the public sentiment had not yet turned against the consulting business, nor for that matter against investment banks.

Recall: this was the heady nineties, the time when despite Alan Greenspan’s own analysis that the market was overly buoyant – famously introducing the phrase “irrational exuberance” – he and his peers kept interest rates low, and watched the Dow Jones reach all-time highs. The sub-title of Micklethwait and Wooldridge’s   book, What the Management Gurus are Saying, Why It Matters and How to Make Sense of It, is an example of the somewhat crooning reverence even seasoned journalists held for the profession.

In fact, the entire profession of management consulting grew exponentially in tandem with the Milton Friedman school of thinking in which the liberal capitalist agenda of free markets was pushed by Harvard Business School and others as being the only option for market structure.

As chronicled in Duff McDonald’s biography of McKinsey, titled The Firm, it was during this period that McKinsey grew substantially and more than tripled in size from the 2500-person organisation they had grown into over their first sixty years of business. It was only after the Nasdaq crash in 2000, and the deflating of the Y2K bubble – followed only six years later by the failure of the entire financial system in general and investment banks in particular – that the tone of sentiment turned against management consultants. 

One of the less complimentary books to cast its eye on the profession was called The Lords of Strategy published in 2010, written by Walter Kiechel, former editorial director of the Harvard Business Review. It was not particularly praising of McKinsey. Walter Kiechel was quoted in a lengthy 2011 Financial Times “Long Read” piece, written after the criminal convictions of both Anil Kumar and Rajat Gupta were confirmed, that “the Firm’s ability to insinuate itself into local elites drives its competitors slightly berserk with envy”.

The Financial Times piece also quoted a strategy professor from UCLA, Richard Rumelt, who stated – in reference to the internal contradiction hard-wired into the management consulting value proposition – that “ideally, companies want inside knowledge of their industry without spying on their competitors”.

Following the arrests and convictions of Kumar and Gupta, McKinsey faced enormous criticism and apparently entered a period of self-reflection, their new global managing director, Dominic Barton, commissioning a detailed internal history of the firm so that executive management would possibly look inward and return to their roots. Naturally, at the time, there were many critics who pointed out that Jeffrey Skilling, the CEO of Enron when it collapsed and the architect of Enron’s enormous fraud and malfeasance, was an ex-partner of McKinsey.

Nevertheless, despite McKinsey’s ex global managing director, Rajat Gupta, leaking inside information to a hedge fund, the firm made it through the media storm and maintained its status. It continued, post 2010, to attract the best talent, Rhodes scholars included, and remained one of the most desirable companies to work for. In the firm’s self-aggrandisement at the time, they decided at an executive level to focus on their values and principles, those that had been engendered by Marvin Bower, their CEO and their most beloved leader in the company’s history, who had held the global managing director post between 1950 and 1967.

Of particular relevance, and quoted also in the Financial Times 2011 piece on McKinsey was his 1967 farewell memo to the London Office. In the memo he pleads for senior members of McKinsey to “shout out whenever they feel we’re doing anything that might impair the enduring values of the professional approach, or just letting those values erode through inattention”. He had a phrase for it in fact, a phrase that encases the idea that a firm cannot be misled by its leaders, because good men and women would stand up against them. He called it the “obligation to dissent” – meaning that consultants at all levels should feel compelled to confront any activity or behaviour, no matter the seniority of the perpetrator.

This idea of being obliged to dissent, irrespective of level, was inculcated into McKinsey’s culture and was specifically re-invigorated by Dominic Barton after the arrest and conviction of Rajat Gupta. This idea – as it was envisaged as an active call to maintain and uphold the firm’s values, rather than a passive injunction – rejects entirely the notion that rogue elements could exist at a senior level within the firm perpetrating random illegal or criminal activities, without there being consequences. This would be the antidote to the Rajat Gupta disease, the insider-trading crime for which he was convicted, but more so an antidote to the rot of doubt that had crept into the organisation and that could eat away at the trust upon which the organisation so heavily depends.

To clarify the obvious problems of conflict of interest that would frequently arise within a firm that consults to 90 percent of the top 100 companies in the world, the firm issued an edict that consultants should not trade in the stocks of companies to which McKinsey consults. It is worth noting that of Marvin Bower’s fifteen principles, the fourteenth is to uphold the obligation to dissent. The first four are the following: put client interests ahead of the firm’s, observe high ethical standards, preserve client confidences, and maintain an independent perspective.

When, in June of 2016, it was revealed through leaked documents from McKinsey’s own offices that McKinsey runs a specialised hedge fund called MIO Partners – the MIO standing for McKinsey Investment Office – with investments valued at USD 9.5 billion, the genie was out of the bottle. This fund, it turns out, has been in existence for over thirty years, has a staff of eighty personnel running it, and was specifically created and continues to benefit, McKinsey partners and McKinsey ex-partner alumni. The fund, according to its own documentation, is not restricted in any way in terms of the investments it can make.

The Financial Times went to extreme lengths to remain carefully neutral when it sub-titled its lengthy front-page expose of the fund with the following: “McKinsey quietly runs an investment arm for partners but experts warn of conflicts of interest”. To be clear, there are several examples of investments that the fund has made that clearly overlap the work McKinsey has performed in its consulting practice. Even McKinsey recognises that there is potential for conflict of interest.

In Securities and Exchange Commission (SEC) filings by MIO Partners, fund documentation states that they have created essentially a Chinese wall – what they call an “information barrier” between consulting and investing. The documentation recognises that MIO Partners funds “are not required to refrain from investing in such issuers” – this is in reference to debt or equity instruments issued by clients of McKinsey. These clients are referred to with the following language: the firm has “a variety of business engagements with numerous issuers of securities”. This seems vague and somewhat disingenuous, given McKinsey’s client base, but the detailed requirements of SEC filings are not set in stone in terms of their content.

To be fair, investment banks have always had precisely the same problem. It has always been necessary to have Chinese walls in place, since the primary business of investment banking is to assist corporations in raising debt and equity capital, and providing advice in the structuring and sales of these securities; whilst at the same time investment banks would have had extensive trading floors full of teams of traders as part of their proprietary trading operations. These traders, were they to be privy to information leaked from the Corporate Finance or Debt Capital Markets departments, would have had possession of material non-public information prior to public announcements of corporate action, and would have had the opportunity to take unfair profits.

This happened. A lot. The SEC has spent enormous amounts of time and resources on this specific problem, but the investment banking business model persisted for decades, perennially arguing that Chinese walls were sufficient discouragement to insider trading.

The investment banking model however differs from the conflict of interest problem at McKinsey in certain critical ways. Firstly, investment banking, following the 2008 financial crisis, virtually ended in the form that it had existed structurally before the crisis. Mostly the bigger investment banks were absorbed into global retail banking giants, some went bust – Lehman Brothers  being the prime example – and others, like Goldman Sachs, were forced to become Bank Holdings Companies, and would therefore fall under the control of the laws of banking, including under the international banking rules issued by the Basel Committee for Bank Supervision (BCBS). This is the second critical difference: banks are heavily governed and regulated, both internally and externally – their compliance departments now comprising a sizable proportion of their costs.

McKinsey, as is true of all management consulting firms, does not have to comply with any of these banking rules, nor does there exist even a regulator for the consulting industry. KPMG, as an example, needs to comply with auditing regulations and the rules of IRBA in respect of its audit business; no such rules exist pertaining to its advisory business. Of course, as a registered hedge fund, MIO Partners does have to comply with SEC rules, and with the regulations pertaining, but there are no specific rules pertaining to hedge funds whose main beneficiaries are the partners of a management consulting firm – in McKinsey’s case a management consulting firm with substantial reach into corporations worldwide, and usually conducting engagements of a strategic nature that could materially impact these corporations.

The third critical difference is that – even if one buys into the argument that Chinese walls are effective – there is still the problem that MIO Partners is governed by a board of 12 current and former partners of McKinsey, all of whom are beneficiaries of the fund itself, and all of whom either work or worked on client engagements. In any case, by definition, it is their job to know what their consultants are up to – certainly in the case of current McKinsey partners. There is no record ever of an investment bank whose entire proprietary trading operation is governed by a board of their Corporate Finance advisory executives. They would long ago have been shut down by the Department of Justice.

McKinsey’s response to the Financial Times piece – which emanated from the leaking of documents rather than from open dialogue – was typically brusque, not dissimilar to their initial response in respect of the Eskom turnaround engagement. A McKinsey spokesperson stated that MIO Partners is “managed independently, and all its activities are separate from McKinsey’s consulting operations, for example having separate offices and IT systems”. Not to be disingenuous, but it takes more than an IT infrastructure firewall to discourage malfeasance. McKinsey’s own ex global managing director, Rajat Gupta, proved this beyond reasonable doubt.