Company hasn’t followed its own disclosure rules
Consultant has paid millions in penalties
McKinsey & Co. has spent months fighting in court over how it should disclose potential conflicts of interest when it advises bankrupt companies. The powerful consulting company has defended itself by arguing that federal disclosure rules are so vague and confusing that almost no one can agree on how to comply.
But for years, McKinsey has had a 57-page primer — titled “Bankruptcy 101” — that lays out how to identify possible conflicts and make proper disclosures. The only problem: McKinsey hasn’t been following its own instruction manual.
“It is critical that the disclosure rules and guidelines in these materials be followed,” the document says. It adds, “Failure to adequately disclose material connections may result in severe penalties and fines.”
That’s precisely the situation McKinsey finds itself in. The court battles have already cost it millions of dollars in penalties and risk costing it millions more.
The disclosure rules are intended to protect the integrity of the bankruptcy courts, where valuable corporate assets and vast sums of cash regularly change hands, by safeguarding against secret deals. They allow regulators to make sure that the advisers retained by bankrupt companies are not improperly favoring one creditor or bidder over others.
The rules are also at the heart of a multijurisdictional court fight involving McKinsey, a retired turnaround expert named Jay Alix and the Justice Department over what, exactly, the company must disclose.
Gary Pinkus, McKinsey’s chairman for North America, said in a statement that “Bankruptcy 101” was a “confidential and proprietary internal training document that provides a high-level overview of the entire arc of a typical Chapter 11 retention, for those unfamiliar with the bankruptcy process.”
Pinkus added that the manual demonstrated that McKinsey “has always been concerned about compliance with respect to its Chapter 11 work and, as we have consistently said, takes its obligations under the bankruptcy rules seriously.”
He also challenged the assertion that McKinsey had not adhered to the disclosure rules of bankruptcy, saying, “No court has ever made such a finding.”
Since reaching a $15 million settlement with the Justice Department in February over what the government called its “pervasive disclosure deficiencies,” McKinsey has promised to improve its procedures. It has even told a federal judge that it should be permitted to write a new disclosure protocol for the entire advisory community, to help clarify rules that McKinsey argues are ambiguous.
Robust disclosures are important because bankruptcy advisers such as McKinsey have a substantial say in how a case turns out. They help determine how much the various creditors are paid and how a bankrupt business is broken apart, sold off or reorganized. A key requirement for such advisers is that they be “disinterested” in the cases they work on.
The manual’s authors defined the term much the way the law does: Advisers can’t be a creditor, shareholder or insider of the bankrupt company. Nor can they “have an interest materially adverse to the interest of the estate,” meaning the court-controlled assets that will be used to repay creditors.
Truthful disclosures are supposed to give the courts, the parties and the government an understanding of the connections each professional brings to a case. Merely having connections is not disqualifying. But the connections have to be disclosed in enough detail to permit the Justice Department to determine if they are relevant. McKinsey’s handbook said that includes both “direct” and “indirect” interests in the bankrupt company and its creditors.
McKinsey has a number of such interests. Its $25 billion hedge fund, MIO Partners, manages money for thousands of McKinsey employees, retirees and alumni. McKinsey has said the fund is independently managed and has no conflicts of interest, but nine of its 11 board members, who oversee the investments, are current or past McKinsey partners. According to government filings, the fund often invests in distressed debt — the same market the bankruptcy advisory unit serves.
In announcing its settlement with McKinsey in February, the Office of the U.S. Trustee specifically mentioned McKinsey’s investments, saying the company “lacked candor regarding its investments in entities that could create a conflict of interest.” It warned of “more far-reaching remedies” if McKinsey continued to provide inadequate disclosures.
McKinsey’s disclosure practices had not been a major issue until Alix decided to raise them in a number of bankruptcies — including Westmoreland Coal in Houston, Alpha Natural Resources in Virginia, Standard Register in Delaware and SunEdison in New York. He has accused McKinsey of not only failing to follow the law, but perhaps using its lack of disclosures to hide nefarious activities, and he filed a complaint under the Racketeer Influenced and Corrupt Organizations Act.
McKinsey has said Alix is trying to undercut the firm’s competitive position in order to help AlixPartners, the restructuring firm he founded in 1981. Alix is retired, but he sits on the firm’s board and holds about a third of its stock.