Table of Contents
Introduction & Description.
Background and Analysis.
Optimal Go-Forward Strategy.
Implementation Considerations & Conclusion.
The white paper aims at discussing the issue of conflict of issues at Mckinsey and its wholly owned subsidiary MIO Partners. The paper will be identifying various reasons of potential COI and the primary and alternative measures to manage and mitigate the COI situations. The paper has from time to time discussed various real life examples of financial industry to establish the importance of ethical conductance and consequences of violating standards of ethics. The paper has also make recommendation to choose the best method to manage the COI.
McKinsey & Company is a global management consulting firm and companies like these including the Big 4 and MBBs (of which McKinsey is a part of) have a history conflicts and scandals, where they misuse their domination in the global financial markets and provide unauthorized services or services without proper disclosures that create conflicts of interest. For example an auditing firm is not allowed to provide other than auditing services to its clients, but in the case of Big-4, there are proofs that a large portion of their annual revenues have been generated from other than auditing services from their auditing clients. Similarly, when firms like McKinsey provides financial consultancy about making investment in a particular security, item or product in which they have substantial interest, then they are indulging in unethical activities and establishing situations of conflicts of interest (McKinsey 2020).
A conflict of interest (COI) is a situation that occur when the reliability of an individual or an organization decreases due to clash between professional responsibilities or duties and personal (or self-serving) interests. The conflict of interests occurs when these individuals or organizations has a vested interest, including money, information, relationships, reputation or status, which creates biasness in their actions, decision-making or judgments.
McKinsey & Company is getting scrutinized on the basis of evidences that company’s retirement fund held investments might have conducted conflict of interests in various bankruptcy cases (six to be specific as per evidences) where Mckinsey provided advisory services. The bankruptcy consultancy services are included in the core business operations at McKinsey & Company. And MCkinsey Investment Office or (MIO Partners) held large investments in these six companies (the clients of Mckinsey). It is interesting to know that MIO is a wholly owned indirect subsidiary of Mckinsey but it never revealed or disclosed any direct or internal relationship of itself with the Mckinsey. It is further interesting to note that the managing members and executives at MIO Partners are all former employees & veterans of Mckinsey (NY Times 2020).
In the financial industry, where legislations are easily manipulated, there is a high importance of ethical standards that establishes a moral course of action that aims at benefiting all the stakeholders and putting the interest of all the stakeholders (including clients, employer, regulators, etc.) before their personal or self interest. But large firms like McKinsey usually aims at putting their own interests firsts, benefits themselves with large monies and violates the ethical standard against conflict of interest.
The ignorance of such ethical standards looks relatively small when making discussions about a particular firm’s scandals, but it can cause systemic effects and has the capacity to drown an overall economic structure of a financially strong nation like USA. Before the global financial crisis (GFC) of 2007 – 08, all the reputed credit rating agencies in USA started selling credit ratings for various Mortgaged Backed Securities (MBS) trading in the market without any due diligence and for money. This was a classic example of COI, which resulted in the fall of the overall real-estate and mortgage sector in USA that eventually led to the financial crisis all around the world. If those agencies performed their professional duties while complying the ethical standards like due diligence, transparency, independence and most importantly conflict of interest, then such crisis might have been avoided (Bley, Saad, & Samet 2019).
Mckinsey as a bankruptcy advisor needed to disclose all its investments in the client companies, but it did not disclose neither of those potential investments to the court of law while applying as a bankruptcy adviser, moreover the information that had been disclosed were very few and not sufficient. As per the bankruptcy law, it is required that advisers remain the “disinterested persons,” and should not own the equity or debt of the company in debt (the debtor company), indirectly or directly. Moreover, some specific bankruptcy rule needs the advisors to make disclosures about potential conflicts (conflicts of interest) to avoid the adulteration of the overall process.
MIO, which stands for McKinsey Investment Office, a wholly owned subsidiary and unique internal hedge fund of funds of powerful global consultancy McKinsey & Co. initially, came under scrutiny because it held investments in the corporate clients of McKinsey as firm’s bankruptcy consultancy work. McKinsey never disclosed this information about investments through MIO to the court while submitting applications as a bankruptcy adviser. It still argues that there are no direct relation between McKinsey and MIO (Chang 2017).
However apart from MIO to be a McKinsey subsidiary, it only allows the money of McKinsey employees, former partners, partners, family, etc to be invested in the related funds.
The NY Times report the relation of Mcinsey with Valeant Pharmaceuticals that bought out other drug makers instead of spending in R&D of new drugs. Later it increases the prices of various lifesaving drugs by as much as 5,785 %. McKinsey was the official advisor of Valeant for pricing of drugs and acquisitions of other drug makers. Also top four officials at Valeant Pharma were McKinney veterans. Such web of relationships and an opaque structure of operations at McKinsey have a huge potential for undisclosed conflicts of interest between the investments in company’s funds and the consultancy the firm sells to its clients (DeZoort & Harrison 2018).
Political: Large consultancy firms like McKinsey have high level political connections as their client lists includes people and institutions that influences the political and law making structure of a country. McKinsey never disclose its client’s identities that include chief executives, princes, and prime ministers who seek firm’s counsel on best practices of management. These firms have large access, pools and sources of insider and confidential information that can create potential conflicts of interests
Economical: Conflicts of interests at institutional level have a history of creating crisis for the economies of the country and the whole world. The Global Financial Crisis is a classic example where the whole financial infrastructure was opaque including commercial and retail banks than lent money to common man, the institutional investors that created securities like MBS and made them more complex, the credit rating agencies, the regulators, all were culprits because they keep their self interest ahead of all others.
Social: An "interest" (in COI) is an obligation, commitment, or duty associated with a particular social practice. When individuals and institutions (with reputation) are found of practicing unethical conducts and non compliance of their duties, then there is a breach of trusts and security in the society. Under legislations, financial professionals owe undivided loyalty to their client. In its absence, it may cause irreparable damages to client’s sense of security and trust (Drogalas, Pazarskis, Anagnostopoulou & Papachristou 2017).
Technological: Technological reforms and advancements can play a major role in managing and mitigating the situations of conflicts of interests. A proper infrastructure and policy for ethical conduct will not only decrease such circumstances to occur but also tracks if there is any misconduct happens. The collapse of Barings Bank is a classic example where a rogue trader (Nick Lesson) had conflicts of interest for name, fame and money. He incurred huge losses but showed them as profits, Barings (a top level institution) was unable to track Nick’s actions and resulted in bankruptcy.
Legal: Conflicts of interest is more ethical and less legislative, in various cases, there are no legal claims for conducting conflicts of interest, for example a whistle blower may conduct actions against the interest of its clients or employer. However, in the case of McKinsey, there is a breach in compliance of ethical standards as well as of bankruptcy act, for which the company paid penalties to court of law.
The primary stakeholders includes in the case of McKinsey and MIO Partners includes the government and the regulating agencies including Securities and Exchange Commission (SEC), FINRA, OCC and others because they have the capacity and responsibility to track the unethical or illegal activities conducted by large auditing and consultancy firms to earn additional money. The investors and the clients are the people that are mostly affected as they have invested their hard earned money. The employees and the management of McKinsey including the company’s veterans and former employees are important stakeholders because they eventually manage the funds of funds at MIO Partners (Ferguson, Pinnuck, & Skinner 2018).
The management of the company and its employees are the stakeholders that are at potential default. Their perspective is to violate the laws (the bankruptcy law to be specific) and avoid the ethical standards, prioritizing self interest against other stakeholder’s interest and breach of trust.
The court ordered McKinsey to disclose its MIO connections for investigations for possible conflicts of interests. Also the U.S. Trustee found that McKinsey failed in satisfying the disclosures related compliances of bankruptcy law. McKinsey for such violations of law had to pay a sum of $ 15 million for settling three cases: Westmoreland Coal Co., SunEdison and Alpha Natural Resources with the U.S. Fed. However, McKinsey never accepted its direct relation with MIO and disagreed with the accusations of noncompliance of bankruptcy law (Grossmann, Mooney, & Dugan 2019).
• Personal Greed
• Susceptible personality
• Metrics of academic or professional performances
• Absence of performance appraisals,
• Unconstructiveness or weakness
• Weak or absent policies of conflict of interest or codes of conduct
• Inefficient corporate governance
• Organizational greed: maximization of profit
• Poor ethical environment and infrastructure
• Rigid and complex hierarchies
• High power-distance relationships
• Role models normalization are poor
• Payments to employing institution
• Direct payments and gifts
• Travel or accommodation
• Equity ownership
• Positions held (personal, research funding bodies, academic, professional, societies, journals)
• Competing research interests
• Family members or friend at influential posts
• Blind beliefs
• Lack of trust
• Wrong treatments
• Expensive products and services
• Poor investing and purchasing decisions
• Misappropriation of funds
• Ghost or gift authorship
• Deliberate research fraud
• Biased peer review
• Reputational damage
• Money Laundering
• Systemic failure of financial institutions
• Organizational Bankruptcy
• Collapse of overall economies
Conflict of interests are unavoidable circumstances that are likely to occur but their frequency and potential impacts can be reduced by implementing various ethical and regulatory components at personal, organizational and regulatory (government) levels. The main factors towards managing and mitigating conflicts of interest can be:
These approaches are required to be supplemented through:
In order to eliminate the conflict of interest going forward, the three valid courses of action could be as follows:
The individuals that may be perceived of having potential conflict of interests can practice resignation from their respective position or sell their substantial interest (shareholding) in a venture, in situations of troubles, for eliminating the conflict of interest going forward.
Pros: Lord Evans held the position of non-executive director at National Crime Agency (UK) and at HSBC. When HSBC was accused for a tax-avoidance-related controversy, then he resigned from his influential post at National Crime Agency (Laux, & Stocken 2018).
Cons: However removal is not practical solution and should be practiced in extreme conditions of as in the above case when serious COI are not able to be resolved in any alternative workable way.
Such methods are usually utilized in political scenarios, where a person gain or have access to highly confidential information like governmental policies. In a blind trust, the trustees have full discretion over the assets, and the trust beneficiaries theoretically have no knowledge of the holdings of the trust.
Pros: A politician holding shares in a company that is going to be affected by upcoming governmental policy, in such event, he/she can put these shares in a “blind trust” where the family including themselves becomes the beneficiary.
Cons: It is a matter of dispute and debate that whether blind trusts actually removes the COI or not, however it is illegal in UK to fund any political party through blind trusts if the donor’s is not disclosed.
Third-party evaluations can be used to testify with proofs that conducted actions were fair and in compliance or were false and violating (Melé, Rosanas, & Fontrodona 2017).
Pros: For example, MOI funds invested in clients of McKinsey, now company’s management argues to have no direct relation of the two companies and there is no breach of ethics or violation of law. In this case an external agency, governmental or otherwise, can investigate for the potential conflict of interests that exists between McKinsey and MOI.
Cons: The third-party evaluations like audits are based on the information provided by the individual or organization on which the investigation is being conducted, hence there are possibilities that a fair representation is made every time (Spalding, & Lawrie 2019).
The report has discussed three alternatives to eliminate the conflict of interest going forward, and have evaluated on the basis of potential pros and cons. Based on the analysis, the optimal go forward strategy should be third party evaluation because of the following reasons:
It is recommended to implement a third party evaluation (TPE) mechanism within the company to manage and mitigate the possibilities and impacts of potential conflicts of interests. As recommended, it will be in the most benefit of the client that the implementation is made on a continuous periodical basis, which can be monthly, quarterly, semiannually or at least once in a year. However, with such TPE implementation, the client might face the following risks and challenges:-
Time consuming: To identify a potential, efficient, fair and independent professional for TPE is not an easy tasks and might consume a lot of important working hours of the client. Filtering various responses, set up of interviews and reaching a final decision can take a month or more to complete (Whittle, Mueller & Carter 2016).
Learning Curve: When an external professional is hired, then the client need to acquaint him with the company, its business, company’s financial and accounting procedures, etc. which might be highly complex. This is a substantial disadvantage to the client because if such external evaluator doesn’t take enough time to learn about client’s business, then the overall evaluation process might become unsuccessful.
Confidentiality: The client might requires to provide such external third person access to private and confidential information, like data relate to internal employee salary, billing records of customers, etc. The client most likely requires providing login information to access internal financial database and records, which can put the confidential information of the client at risk. However, client can make the third party evaluator to sign a confidentiality agreement, although then also the risks mitigate but not eliminate (Bley, Saad, & Samet 2019).
Bley, J., Saad, M., & Samet, A. (2019). Auditor choice and bank risk taking. International Review of Financial Analysis, 61, 37-52.
Chang, K. H. V. (2017). Internal audit quality and its association with financial distress: An Australian context (Doctoral dissertation, Curtin University).
DeZoort, F. T., & Harrison, P. D. (2018). Understanding auditors’ sense of responsibility for detecting fraud within organizations. Journal of Business Ethics, 149(4), 857-874.
Drogalas, G., Pazarskis, M., Anagnostopoulou, E., & Papachristou, A. (2017). The effect of internal audit effectiveness, auditor responsibility and training in fraud detection. Accounting and Management Information Systems, 16(4), 434-454.
Ferguson, C., Pinnuck, M., & Skinner, D. J. (2018). Lucky or good? Audit market concentration and the emergence of the Big 4 in Australia. Audit Market Concentration And The Emergence of The Big, 4, 14-13.
Grossmann, A., Mooney, L., & Dugan, M. (2019). Inclusion fairness in accounting, finance, and management: An investigation of A-star publications on the ABDC journal list. Journal of Business Research, 95, 232-241.
Krishnan, J., Krishnan, J., & Song, H. (2017). PCAOB international inspections and audit quality. The Accounting Review, 92(5), 143-166.
Laux, V., & Stocken, P. C. (2018). Accounting standards, regulatory enforcement, and innovation. Journal of Accounting and Economics, 65(2-3), 221-236.
McKinsey. (2020). About us. Retrieved from https://www.mckinsey.com/about-us/overview
Melé, D., Rosanas, J. M., & Fontrodona, J. (2017). Ethics in finance and accounting: Editorial introduction. Journal of Business Ethics, 140(4), 609-613.
Niemi, L., Knechel, W. R., Ojala, H., & Collis, J. (2018). Responsiveness of auditors to the audit risk standards: Unique evidence from Big 4 audit firms. Accounting in Europe, 15(1), 33-54.
NY Times. (2020). As McKinsey Sells Advice, Its Hedge Fund May Have a Stake in the Outcome. Retrieved from https://www.nytimes.com/2019/02/19/business/mckinsey-hedge-fund.html
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Spalding, A. D., & Lawrie, G. R. (2019). A critical examination of the AICPA’s new “conceptual framework” ethics protocol. Journal of Business Ethics, 155(4), 1135-1152.
Whittle, A., Mueller, F., & Carter, C. (2016). The ‘Big Four’in the spotlight: Accountability and professional legitimacy in the UK audit market. Journal of Professions and Organization, 3(2), 119-141.
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