The top U.S. congressman in charge of overseeing Puerto Rico’s bankruptcy recently announced that the island’s “ongoing lack of transparency’ is one of their biggest problems.”
So why is a firm with a track record of secrecy and non-disclosure a lead consultant on the bankruptcy?
In a May 9th statement, House Committee on Natural Resources Chairman Rob Bishop (R-Utah) pointed to “the systematic financial malpractice of the Puerto Rico government over the past half-century” and the need for “structural and financial reformation.”
“The government of Puerto Rico must fulfill its responsibility to provide all requested information and commit to working with the Oversight Board on the path to economic recovery,” Bishop said.
“Providing all information,” however, is not the modus operandi of McKinsey & Company. They’re the powerful, politically-connected firm chosen by the Financial Oversight and Management Board for Puerto Rico as the strategic consultant for the Puerto Rico bankruptcy at a cost of $2 million a month.
The $2 million, by the way, is modest compared to McKinsey’s overall portfolio (they reported some $10 billion in revenue last year) and to the other actors involved in the nuts and bolts of the Puerto Rico bankruptcy process. Less than a year in, total billing for professional services like lawyers and consultants has already hit $135 million, with years of work still to come.
As a Bloomberg Business headline put it: “Puerto Rico Finds Going Bust Isn’t Cheap.” In response to these rising costs, Chairman Bishop sent the Board a letter complaining about the “triple representation within restructuring cases” and the need to control costs by avoiding litigation.
But while the Committee on Natural Resources overseeing the Puerto Rico project is focused on billable hours, the real “resource” at stake is the island’s $72 billion in debt. Given Puerto Rico’s recent record of corruption and mismanagement, making sure the bankruptcy process is as transparent as possible would seem to be a priority.
Enter McKinsey & Company.
McKinsey is the world’s largest management consulting firm with offices in more than 60 countries. They’ve done about a billion dollars worth of business with the U.S. government over the past decade alone, according to information at USASpending.gov.
But they are a relatively new player in the specialized field of bankruptcy management. And in that short time, they’ve already managed themselves into a reputation of less-than-stellar levels of transparency.
For example, in June the Wall Street Journal reported that McKinsey failed to disclose that their retirement fund “held investments that gave it a financial interest in the outcome of six bankruptcy cases in which the company also was serving as an adviser.” McKinsey’s failure to make these disclosures appears to be a violation of Chapter 11 bankruptcy law.
A lawsuit filed by a former competitor accuses McKinsey of “intentionally concealing its clients’ identities and that it was conducting the ‘pay to play’ scheme.”
And in 2016 the U.S. Justice Department objected to bids by McKinsey to work two Chapter 11 cases due to their refusal to name current clients who might have presented conflict of interest questions.
None of this is evidence of wrongdoing, and McKinsey claims that the bankruptcy disclosures of their restructuring unit (McKinsey RTS) “meet all legal requirements and have been consistently approved by the courts.”
Nevertheless, there are questions swirling around McKinsey’s conduct in the bankruptcy arena that are both unlike those of other similar players in the industry, and particularly problematic for a firm working as a strategic consultant on the Puerto Rico bankruptcy.
In April, the WSJ wrote a deep-dive piece on McKinsey’s entrance into the bankruptcy market with the headline “McKinsey is Big in Bankruptcy—And Highly Secretive.” The coverage reveals a standard of practice that hardly inspires confidence in a firm asking for $2 million a month in consulting fees for the Puerto Rico project. And the largest area concern is conflicts of interest.
In large-scale bankruptcy cases, it’s hardly surprising when big consulting firms who work with large and influential companies and investors have potential conflicts. The odds of a large consulting firm like McKinsey having no clients with any interest whatsoever in the outcome of a bankruptcy involving institutional investors and billions of dollars are virtually zero. Which is why, when the Wall Street Journal reviewed 13 bankruptcy cases involving McKinsey and other consulting firms, the average number of pre-existing relationships disclosed by those other firms was 171. Per case.
McKinsey’s average number disclosed? Five.
McKinsey—the biggest consulting firm on the planet—is likely to have the most overlap of client interests. Yet they report far fewer.
According to Jay Alix, that’s not a McKinsey bug. It’s a feature. Alix founded AlixPartners, a major consulting firm in the bankruptcy field who was eclipsed by the rise of McKinsey. In a lawsuit filed under the federal Racketeering Influenced and Corrupt Organizations (RICO) Act, Alix accused McKinsey of “knowingly and intentionally submitted false and materially misleading declarations under oath,” declarations that he says allowed the firm to hide conflicts of interest. If the extent of the conflicts had been known, Alix claims, McKinsey would not have been allowed to take those cases.
“By engaging in its unlawful scheme, McKinsey has profited by receiving tens of millions of dollars in bankruptcy fees that it would not have otherwise earned had it disclosed its numerous connections to interested parties,” Alix says in his complaint.
Once again, McKinsey denies all wrongdoing. And it is entirely possible that they haven’t broken any laws or done anything unethical. A lawsuit by a disgruntled competitor is hardly definitive proof of bad behavior.
However, it is also true that McKinsey has been forced to repeatedly amend its potential conflict disclosure filings. In the Get On Energy bankruptcy case, McKinsey originally reported 36 potential conflicts, then added another 19 more a few months later. But the Wall Street Journal reported that the updated information was still incomplete. “The list still omitted 24 firms involved in the GenOn matter that McKinsey had identified in other cases as potential conflicts,” the paper said.
Or take the 2012 Edison Mission Energy bankruptcy, in which the law firm Akin Gump Strauss Hauer & Feld listed 368 potential connections—a large number but, given the size of the firm and the case, an unsurprising one.
No, the surprise came when, in that same case, McKinsey claimed to have no potential conflicts. Zero.
And even if McKinsey reported a conflict, it likely wouldn’t matter. Their agreement with the Oversight Board explicitly allows McKinsey to do business with other clients who have conflicts of interest regarding the Puerto Rico bankruptcy.
The outcome of the island’s bankruptcy is vitally important to people far beyond the borders. Billions of retirement dollars have been invested in Puerto Rico’s tax-exempt bonds. U.S. mutual funds hold around $8 billion in Puerto Rico debt. Every dollar lost—to exorbitant consultancy fees, legal costs, or the influence of undisclosed conflicts of interest—is potentially taken from a U.S. retiree, or a pension fund that must be made whole.
It could be the case that the conflict-of-interest-friendly bankruptcy newcomers of McKinsey & Company are the perfect people to protect the interests of all parties in this high-stakes, complex case. It could be that no other firm has the influence and expertise to bring about the ideal outcome.
But it wouldn’t hurt for the Committee on Natural Resources to have a hearing or two on the subject, just to make sure.