Memo to McKinsey: Avoiding Arthur Andersen’s fate

NEW YORK, May 14 (Reuters Breakingviews) - McKinsey could use some of its own advice. After guiding the strategies of some of the world’s largest companies for nearly a century, the elite consulting firm finds itself under criminal investigation, opens new tab related to its recommendations to drugmakers on how to “turbocharge” sales of opioids, according to the Wall Street Journal. An indictment against Arthur Andersen more than two decades ago proved to be a death knell for the auditing giant, and it is an instructive example for what happens next.

Similarities between the two firms extend beyond the superficial. Both were started by accountants in Chicago early in the 20th century and before its collapse Arthur Andersen was generating roughly the same $16 billion of annual revenue, adjusted for inflation, as McKinsey did last year. At the same time, McKinsey’s legal predicament is somewhat different than Arthur Andersen’s, which involved charges of obstructing justice over its work for the bankrupt energy giant Enron. Prosecutors also have changed their approach since that case was filed more than 20 years ago. Despite the discrepancies, however, the potential threat is sufficiently existential to be taken seriously.

McKinsey, whose blue-chip clients have ranged from Citigroup to General Motors, has been on the defensive since its role working with Purdue Pharma, a maker of the addictive painkillers, and its controlling Sackler family first surfaced, opens new tab in a February 2019 lawsuit. More than 200,000 Americans died, opens new tab from prescription opioid overdoses alone in the two decades leading up to the case, according to U.S. government data.

The firm has avowed not to advise any clients on opioid-related business anywhere in the world. It also did some soul searching, opens new tab about how to assess client risks, adding the unintended consequences of any proposed assignments to its list of criteria. This exercise, which included $700 million of investment in governance and risk management processes since 2018, should help ease concerns created by a string of ethical lapses.

McKinsey also has suffered further financial fallout. The firm, which received $86 million from Purdue over 15 years and undisclosed sums from fellow bankrupt opioid makers Endo International and Mallinckrodt, agreed to cough up nearly $1 billion to resolve separate lawsuits involving state attorneys general, local governments and schools, Native American tribes, and healthcare insurers and benefit plans. It expressed regret for failing to “adequately acknowledge the tragic consequences” of the epidemic. A more full-throated apology from Global Managing Partner Bob Sternfels in Congress was another important step. Yet the firm did not admit wrongdoing in its legal settlements and maintains that its work was lawful even if it “fell short of the high standards we set for ourselves.”

Criminal charges over the advice McKinsey provided, or for obstructing justice, would potentially expose the firm to more damaging repercussions. Arthur Andersen offers a worst-case scenario. When the U.S. Department of Justice unveiled its accusations, opens new tab in March 2002, the firm’s clients and accountants defected in droves. By the time it was found guilty a few months later of shredding paperwork related to its audit work for Enron, it was already effectively defunct. And when the U.S. Supreme Court vindicated Arthur Andersen three years later by reversing the verdict because of a judge’s vague jury instructions on how to consider the document destruction, only 200 of 28,000 staff members remained.

McKinsey’s woes are the latest in a succession of scandals that could cost the firm some of its roughly 1,000 clients and 45,000 employees. Its former leader, Rajat Gupta, spent two years in prison after he was convicted in 2012 of insider trading. Advice it gave to U.S. Immigration and Customs Enforcement came under scrutiny, opens new tab, prompting McKinsey to sever ties with the government agency in 2018. The firm later remade its South Africa business and agreed to pay back about $100 million for its role in a corruption scandal involving the country’s state-owned power company.

Nevertheless, there are notable differences between the McKinsey and Arthur Andersen cases. For one, senior auditors need certification to practice and are vital for companies to publish credible accounts. Consultants, by comparison, largely provide strategic advice while leaving final decisions to their clients. Moreover, questionable or unsavory guidance offered by a McKinsey team in one industry in one part of the world is less likely to rattle customers in other businesses operating elsewhere.

The circumstances surrounding Arthur Andersen’s collapse also were distinct. The government filed its lawsuit, opens new tab mere months after Enron’s accounting fraud was uncovered and weeks before many of Arthur Andersen’s audit clients were due to finalize their annual financial statements. By contrast, federal prosecutors started looking into Purdue around 2002 and the state of Kentucky sued the company in 2007. McKinsey’s role has been under investigation for years, allowing more time to weigh up the impact of any additional charges.

The Arthur Andersen example also has been blamed for making U.S. prosecutors more cautious about criminally targeting corporate wrongdoers. It’s a big reason no big bank faced criminal charges following the financial crisis, as journalist Jesse Eisinger noted in his 2017 book, opens new tab “The Chickenshit Club.” The DOJ probably wants to avoid a trial almost as much as McKinsey does.

Even so, McKinsey would be ill-advised to be complacent. Instead, it’s worth girding for the possibility of having to make additional concessions if U.S. legal authorities decide they can make a case. The firm might need to write another hefty check, as Purdue and the Sackler family did to resolve criminal and civil DOJ investigations. Purdue also pleaded guilty to three federal felonies related to marketing and distributing OxyContin. None of McKinsey’s previous legal agreements preclude it from handing over more cash.

Any admission of wrongdoing would be a significant step, and not just for McKinsey, because it would draw a closer link between a consultant’s advice and its client’s actions. Another form of punishment might restrict the way McKinsey conducts business. It already agreed, opens new tab to court-ordered document retention policies and to stop advising companies on some dangerous narcotics. Prosecutors could, however, impose further limitations on the types of clients or work it can pursue, handing an edge to rivals. Even that scenario, however, would be preferable to taking a chance of becoming another Arthur Andersen.

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CONTEXT NEWS

Consulting firm McKinsey is under criminal investigation by the U.S. Department of Justice for its role in advising Purdue Pharma and other opioid manufacturers and possible obstruction of justice, according to an April 24 report by the Wall Street Journal, citing unnamed sources.

A federal grand jury has been empaneled in Virginia, and U.S. attorney’s offices in Virginia and Massachusetts are jointly conducting the probe, the newspaper added.

McKinsey, which provided recommendations to Purdue on how to boost sales of its OxyContin painkiller, previously agreed to pay nearly $1 billion in separate settlements with states, Native American tribes, public schools, healthcare insurance companies and others, without admitting any wrongdoing.

Opioid makers Purdue, Endo International and Mallinckrodt, all of whom were McKinsey clients, filed for bankruptcy protection following costly legal charges and settlements.