Opinion

Felix Salmon

McKinsey’s corrupted culture

By Felix Salmon
March 10, 2011

John Gapper makes a good point: management consultants in general, and McKinsey consultants in particular, have made their entire business out of exploiting the moral grey zone surrounding confidential information.

The reason you hire McKinsey is that its consultants have seen strategic business issues like yours before, and therefore might have developed good insights into how to approach them. But the reason they’re familiar with those issues is that they’ve been given highly confidential information about your competitors. So when you hire McKinsey you’re essentially trying to acquire, for a very high hourly fee, the kind of corporate intelligence that can only be built up through long exposure to highly-sensitive commercial information.

Here’s Gapper on McKinsey:

The accumulation and sharing of privileged knowledge is integral to how it works…

The calculation every client makes is, in the words of Christopher McKenna, a professor at the Oxford university’s Saïd Business School who studies professional services firms, that “consultants will carry information in and information out. The client has to decide which of those flows is worth more.”

Indeed, one of the main reasons companies hire consultants is to make sure they do not fall behind what their competitors are doing – in return for parting with their own secrets, they gain access to their rivals’ suitably disguised “best practices”. The consultant is a broker who attempts to amass so much knowledge that each company has to hire him, no matter how uncomfortable that feels.

In this sense, a management consultant is a bit like an art dealer, or anybody else who traffics in valuable information asymmetries. The consultant knows more than the client, when it comes to strategic issues within the industry in question. If the client wants access to that knowledge, he has to open his own kimono to get it, thereby putting the consultant at yet more of an information advantage.

For pretty much Rajat Gupta’s entire career, then, he was trading in information that he obtained in confidence by dint of his position. When it comes to corporate intelligence, management consultants are pretty much unique in this regard: while other professionals like lawyers and accountants certainly encounter a great deal of confidential corporate information, they don’t trade in it in the same way — no one ever feels the need to hire Ernst & Young just because they audit a major competitor. The only profession which might come close to consultants, in this regard, is M&A bankers, and maybe a handful of extremely senior lawyers like Rodge Cohen.

None of this remotely explains or excuses what Gupta is accused of doing, of course. But as Gapper notes, there’s a long history of management consultants violating the spirit of the confidentiality agreements they enter into — he tells the tale of Booz Allen Hamilton’s John Burns taking lots of IBM knowledge with him when he took a job as president of the computer maker’s fiercest rival.

In any case, McKinsey can and should find itself in serious reputational jeopardy here. Gapper concludes his column portentiously, saying that “McKinsey must devoutly hope that there is no third man” in addition to Gupta and Anil Kumar, the McKinsey partner who has already admitted giving confidential information to Raj Rajaratnam.

And, predictably, it now looks as though there is just such a third man after all. Three McKinsey consultants all channeling confidential information to a single hedge-fund manager who wasn’t even a client? That’s not bad apples, it’s a culture of corruption. At this point it’s unimaginable that it wasn’t happening elsewhere as well.

Comments
18 comments so far | RSS Comments RSS

I’ve long wondered why do giant, multi-billion dollar corporations, who sometimes pay their execs tens of millions of dollars per year, need to hire consultants? Shouldn’t they have experts in their organization for the amount of compensation their managers are receiving? But what you are saying is that consultants have nothing to do with advice, but really they are just sanctioned spies.

Posted by KenG_CA | Report as abusive
 

It indeed is a culture of corruption. And on and on it goes…

Another take on consultants and exec compensation
http://www.bnet.com/blog/business-resear ch/how-ceos-jack-up-their-pay/1001

Posted by hsvkitty | Report as abusive
 

So 0.03% of the company **might*** be indicted is a sign of a culture of corruption? Note the SEC specifically chose a court with a far lower burden of proof to prosecute one of the indictees.

So when Reuters gets regularly caught mistranslating and photoshopping pictures from the Middle East what is that a culture of? Lying?

Posted by Danny_Black | Report as abusive
 

Actually, Felix, people do hire Ernst & Young or one of their Big 4 brethren because they also audit a competitor. It’s called industry knowledge and it’s also a proxy for competitive intelligence about how others in your industry – your competitors – are interpreting accounting standards and policies. Accounting manipulation is big money and being able to do it by claiming your auditor blessed it is worth its weight in gold. Of course there are some companies that are highly sensitive to this. If you audit Coca-Cola you can not audit Pepsi and some tech companies and airlines are also sensitive.

The banks, on the other hand, are not sensitive to this because it provides them a competitive advantage. Neither are the regulators. With only four firms it’s hard to limit how many banks and government entities each one cadvises. PwC made out the best during the crisis in this regard. They audit AIG, bigger and denser BAC andJPM, GS, FRE, the Federal Home Loan Banks and are supporting the Treasury as TARPS biggest contractor next to FNM and FRE. If you don’t think this concentration is useful to those entities in terms of the information sharing opportunities, you’ve not been paying attention.

Posted by FrancineMcKenna | Report as abusive
 

Good post. This distinction also explains why accountants who, as you say, don’t trade in the confidential information they acquire, seem inexorably drawn to consulting, where they may.

Posted by Eric_H | Report as abusive
 

Well, in the legal profession, clients clearly do value knowledge about how others have handled a difficult compliance or legal issue, and even if you know, you have to preserve confidentiality. It has happened at least once, however, that someone called me for advice on something and became exasperated and actually said, “I know you represent X, and they do it this way so how are they getting away with it?” I was seriously taken aback, but it wouldn’t do to say “against our advice,” or, “they have a plan in place to gradually come into compliance.”

On the other hand, we also have clients who very clearly will not allow us to represent any other “leaders” in their industry, and that’s baked right into the retention agreement.

So businesses do appreciate this problem and they try to navigate it based on what they perceive their best interests are. But providing specific, timely, sensitive competitive information to a competitor or a hedge fund manager? That’s NOT part of any model.

Posted by rb6 | Report as abusive
 

This is a horribly written article with limited knowledge of McKinsey. As an alum the firm is very strict about an individual consultant NOT serving competitors and not even discussing your client information with other consultants, let alone a consultant serving a competitor. Saying the firm borrows for one client for another just shows an ignorance of how the firm works. Though you can never stop bad apples, the culture is very self-governing.

Posted by pearljamfan | Report as abusive
 

@Danny_Black, the burden of proof is not lower. And I’m talking about what every McK consultant does, not just the ones who get indicted.

Posted by FelixSalmon | Report as abusive
 

Mr Salmon, got it from here:

http://dealbook.nytimes.com/2011/03/07/c urious-accusations-in-s-e-c-s-insider-ca se/

“”“It’s a little easier from an evidentiary perspective,” Mr. Weissman said, for the S.E.C. to bring the case in front of an administrative judge. “The evidentiary standard is lower,” he explained.”

Care to back up the claim that every McK consultant is violating client confidentiality?

Posted by Danny_Black | Report as abusive
 

Danny Black- you’re confusing evidentiary standards for introducing evidence with burden of proof. Evidentiary standards has to do with how evidence is introduced at Court and burden of proof is how certain the factfinder is of the defendant’s guilt. SEC cases, whether before federal judge or magistrate, must be proven by a preponderance of the evidence.

Posted by AdamJ23 | Report as abusive
 

Danny Black- you’re confusing evidentiary standards for introducing evidence with burden of proof. Evidentiary standards has to do with how evidence is introduced at Court and burden of proof is how certain the factfinder is of the defendant’s guilt. SEC cases, whether before federal judge or magistrate, must be proven by a preponderance of the evidence.

Posted by AdamJ23 | Report as abusive
 

@pearljamfan: We’ve all seen how well “self-governing” cultures have worked out in other situations.

Posted by marcnyc | Report as abusive
 

I must say, I’m appalled to see that Reuters lets this kind of “journalism” to be published. You didn’t even bother to investigate or hear the part you are accusing!

As a McKinsey alum, I never saw anything of the sorts of what you accuse the Firm of doing happen. On the contrary, McKinsey maintains a very strict code of confidentiality that stops consultants from working for competitors or sharing confidential client information outside group of consultants that have been authorized by the client to receive that information. All information held by individual consultants is destroyed at the end of the engagement.

Rajat Gupta’s actions DO NOT reflect the common practice or the culture in McKinsey. The actions of a single consultant or a very small group of them are no indication of the very high ethical standards the firm abides to.

Posted by fpalha | Report as abusive
 

AdamJ23, maybe i am… Again in the UK a civil case is tried on balance of probabilities. A criminal case requires guilt beyond reasonable doubt. My understanding is that the SEC decided to go for a civil case in a court with lower evidentiary standards solely in this guy’s case.

Not a lawyer, let alone a US one.

Posted by Danny_Black | Report as abusive
 

Danny- Your understanding is wrong- every case the SEC brings is a civil case (or quasi-criminal if you like). Criminal cases are only brought the DOJ, not the SEC.
And the likely reason Gupta is the first to use this provision(if he truly is the first- which I’m far from certain of) was to gain a procedural advantage- who wouldn’t want an edge when they’re up against a multi-million dollar defense team?

My understanding is that in Federal Court there’s plenty of room for gamesmanship through filing discovery requests and motions- something that would likely happen when you have a defense team eager to justify their fees. But I can’t see how the venue decision has anything to do with having a weak case- it looks like they’ve caught him pretty much caught him red-handed.

Also, its not like any old McKinsey associate was caught- didn’t this guy run the company for 9 years?

Posted by AdamJ23 | Report as abusive
 

AdamJ23, I stand corrected.

Posted by Danny_Black | Report as abusive
 

hmm, i have worked for one of the top consultancies, and while i do think the model is limited and may have peaked in its usefulness, the gapper article and your post seem to be pretty poorly informed about the industry you are pontificating about.

Firms do recycle solution recommendations/”best practices” for different clients, but it’s more driven by intellectual lazyness/ lack of imagination on the part of the particular consultant (if he was doing his job he would develop something ad hoc – assuming the problem faced isn’t completely generic) than blatantly sharing any secret sauce gleaned at a competitor (firms aren’t stupid btw, they don’t show consultants the passcode to the family safe…)

As for confidential info itself, consultants would show sometimes benchmarking data (more or less thinly disguised or averaged so as not to blatantly disclose confidential information) to clients and I guess clients to a certain extent hire consultants because they are expected to have a broad view of the industry and are vectors of trends/gossip, but it is really a very small portion of both the real and perceived value add of a consultant. Any company that wants info on a competitor can just hire away an employee of the opposition, at a cost a fraction of what a Mckinsey team costs for a week, and get the full download, and of course they do it all the time.

Never in a million years would a consultant reveal to a mere client tradeable and current information on a competitor – first of all teams are firewalled so he is very unlikely to speak to both sides at the same time (unlike investment bankers who tend to be a lot more promiscuous), and second there is so little upside/ so much downside it’s just not worth it. Now, do some individuals trade on the information for personal account or pass info to friends (as Gupta did)? i would bet so. Just like lots of corporate execs do. Just like apparently lots of congress reps/senators do. Just like journalists no doubt do. Throw the first stone, or propose a solution that actually works, or shut up.

Posted by jwu1217 | Report as abusive
 

First, FrancineMcKenna is most definitely correct, regarding the concentration of available audit firms, and the consequences both good and bad.

More recently, jwu217′s comments are consistent with my impressions. I worked as a consultant, not quite a “management” consultant, rather, as an engineering consultant for several years, after earning a specialized degree. The era of management consultancy seems to have passed, other than for the big firms like McKinsey, who were the first in the field to begin with.

My recollection of my consulting work was of producing very specifically designed models for our client, under terms of strict confidentiality and non-compete agreements. The models could not be easily adapted for other companies in the same industry anyway. I recall that the group of us, as consultants, were kept sequestered in our own work area, with strictly enforced security protocols. Our access to online data was limited to need-to-know, and the same was true for access to client work areas and interactions. It was rather dreary, difficult work, and once our engagement was completed, I did wonder how well the regular staff were able to maintain our deliverables (production software).

This was utterly different from my later experience in finance, often investment bankers and corporate counsel. I worked with the same people on many deals, with broad access to all sorts of potentially valuable information. But that didn’t mean that fraud and abuse was rampant. The small upside gain of acting unethically wasn’t even worth considering, when balanced the certainty of a good job, done honestly.

Additional research would have been a good idea for the journalist who wrote this post.

Posted by EllieK | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •