The failure of global consulting firm McKinsey to disclose information about the managed accounts of its internal investment fund, MIO Partners, took center stage Wednesday morning in a Houston federal bankruptcy trial.
The trial could finally end the dispute between McKinsey and Jay Alix, the retired turnaround pioneer who founded AlixPartners, a competitor to McKinsey in the bankruptcy advisory business.
For years, Alix, through his investment partnership Mar-Bow Value Partners, has argued that McKinsey has failed to disclose its connections with debtors that it has sought to represent in bankruptcy proceedings, as required by law. As a result, it has hidden serious conflicts of interests that are disqualifying, according to Alix.
In this case, both Alix and the U.S. Trustee, a Department of Justice entity that has oversight responsibility for bankruptcy cases, have asked Houston Judge David Jones to disqualify McKinsey as the advisor for Westmoreland Coal, which filed for bankruptcy in 2018.
Even though McKinsey is on its third attempt to make adequate disclosures in this case, it still hasn’t done enough, both Mar-Bow and the U.S. Trustee allege.
In its latest effort, McKinsey “searched less than half the firm’s global database,” said Sean O’Shea, lawyer for Mar-Bow, in his opening statement, who referred to McKinsey’s posture as “catch me if you can.”
Many of McKinsey’s undisclosed connections are in the investment fund, specifically the separately managed accounts that MIO has with hedge funds.
“That type of information should have been disclosed,” said U.S. Trustee attorney Hugh Bernstein. “It’s not a game of cat and mouse.”
McKinsey has long claimed that 90 percent of MIO’s investments are made with third-party hedge funds, and MIO has no knowledge or control over those funds’ investments.
But, as Institutional Investor previously reported, some 30 to 40 percent of these are in managed accounts — which comes to about half of MIO’s $26 billion in assets under management. Institutional investors often choose to invest in a separately managed account, instead of a commingled hedge fund, so they can have more control over the investment. II previously exclusively documented evidence of such control at MIO.
[II Deep Dive: The Story McKinsey Didn’t Want Written]
It now appears that more information on the managed accounts will be coming out in the trial, as MIO chief investment officer Todd Tibbetts is scheduled to testify Thursday.
In the past, “McKinsey has specifically told us we can’t find out what is in that 90 percent,” said the U.S. Trustee’s Bernstein.
But he said that depositions of executives have shown that 30 to 40 percent is invested in managed accounts, and “they know exactly what those are invested in, and they could have looked them up. They have it in their records, they chose not to disclose that.”
Bernstein joined O’Shea in arguing that the global consulting firm should not be hired as a result of these deficiencies.
“MIO has a ledger for every security in their managed accounts,” said O’Shea, but those investment accounts were excluded when McKinsey conducted its search for connections that could have been a conflict with its role as Westmoreland’s s advisor.
“They admit that MIO portfolio managers talk to third party managers about investments,” he said. “Those were not searched.”
McKinsey settled with the US Trustee in 2019 regarding alleged deficiencies in its first two declarations of connections with Westmoreland, as well as in two other bankruptcies. McKinsey made another extensive declaration in the Westmoreland case in July after adopting a “protocol” it commissioned in order to help it determine what it needed to disclose to comply with bankruptcy rules.
But the separately managed accounts of MIO were one place where the firm held back.
McKinsey has argued that MIO is run separately from McKinsey, is additionally separated from the consultants by an “information barrier” and that neither McKinsey nor MIO have insight into the third party managers’ investments.
“MIO is limited as an investment manager,” said Faith Gay, the attorney representing McKinsey. “It’s not in the business of stock picking.”
She added that “Mar-Bow, whether talking about MIO or anything else, has never given us concrete facts about some concrete connections that create this adverse connection.”
A number of high-profile McKinsey partners are slated to testify during the trial, which is expected to stretch into next week. In addition to Tibbetts, MIO’s general counsel Casey Lipscomb and McKinsey senior partner Robert Sternfels will be on the stand.
Former global managing partner Dominic Barton, who is now Canada’s ambassador to China, will testify via his video deposition.
Alix first approached Barton about his concerns regarding McKinsey’s lack of disclosures in 2014, and the two men had 11 meetings in which Alix tried to convince him to change McKinsey’s practices. When McKinsey did not do so, Alix created Mar-Bow to file his objections in court.
“Barton will say that his emails are missing,” O’Shea told the court, saying they were “destroyed.” McKinsey has, however, “been able to produce emails all the way back to 2014 for other employees,” he noted.
McKinsey has already completed its work for Westmoreland, and if they don't win this trial, they will be out several million dollars for work already performed. Attorney Gay said the firm is spending “tens of millions of dollars” in legal fees on this case. Despite the high cost, she said McKinsey wants to clear its name.
“We take the long view and we will do whatever it takes,” she added.
“Whoever is right or wrong….it’s incredibly expensive,” Judge Jones said, adding that most of the parties engaged in bankruptcy cases can’t afford such efforts.
Jones called for the trial to get to the bottom of the issue.
“I don’t want to ever do this again,” he said during opening statements.