As McKinsey Sells Advice, Its Hedge Fund May Have a Stake in the Outcome

Eh? A few dropped words during a social dinner, or even a knowing glance, you call that a huge risk? And a hedge fund getting (even only 1 bit of) information from some well-informed people, allowing them to adjust their position on a firm, can lead to substantial gains, obviously.

> Most consultants won’t even know what other people on their team is working on, and most are in and out after 2 years.

This is not about junior guys.

> Hedge fund managers don’t coordinate with consultants.

Well, yeah, officially, of course. But that's precisely what the article is about.

Interesting data science exercise...visualize all the MIO LinkedIn connections to McKinsey people.

I doubt there is an on record scheme with company memos and other communication discussing inside info. It's probably much closer to work friendships and casual partnerships that pass much of this information along.

As long as you can build a reasonable model to line up with the information you get, it's pretty difficult without a smoking gun to get caught.

There's no smoking gun and the Times did seem to be fishing around for one in this piece. It's a bit of a lurcher.

On the other hand:

> Internal documents examined by The Times show that from 2000 to 2010, MIO’s flagship fund, the Compass Special Situations Fund, had an average annual return above 9 percent, compared with a 1.6 percent loss in the S&P 500 Index. In 2008, when the broader United States stock market fell more than 36 percent, the Special Situations Fund lost about half that amount.

It's possible to get that kind of return with nothing but public information. But it's a lot easier if you have miraculous hunches every now and then.

Let's not kid ourselves, people have been caught in stuff like insider trading for peanuts before.

I don’t see how McKinsey would not be an “access person” held to the same insider restrictions as their client company’s executives.

Either way this snippet from Bloomberg seems to completely miss the point.

You are an adviser? Good. Here's your consulting fee and that should do it.

The problems would be:

1) McKinsey learns about non-public good things on the inside, and so buys even more stock than they otherwise would (pretty much the definition of insider trading) and/or sells competitors' stock

2) McKinsey learns about non-public bad things on the inside, and so sells stock they otherwise would have held and/or buys competitors' stock

I don't see how Matt Levine can possibly just brush that aside?

That's a lot of words to say "sketchy-ass shit."

Then if things ever go wrong, you always have the out of "I hired the best, what did you want me to do?"

Here's the delicious summary from Matt Levine's "Money Stuff" Bloomberg column:

> Incentives

All else equal, would you rather hire an evil investment bank to underwrite your stock offering, or a good investment bank? I think there are good arguments both ways. An evil investment bank might do evil things to you, which you won’t like. On the other hand, it might do evil things to investors on your behalf, which you might like; if there is evil in the world, you might as well hire it so it’s on your side. Also an evil investment bank might hang out with all the evil investors, who have a lot of money and will buy your stock, while a good investment bank will only hang out with good investors, who have less money.

Or whatever, I don’t know, it’s a model. More generally, if your model is “the whole financial system is evil,” then evil investment banks should be preferable and more successful, because they will be better plugged in to the (evil) networks of the financial system.

Here’s a fun paper from Thomas Roulet of Cambridge’s Judge Business School, whose model really is kind of “the whole financial system is evil”; as the school’s blog summarizes it:

The study concludes that negative coverage actually helped banks gain IPO business from corporate customers, as those corporates view certain banking practices widely criticised after the financial crisis (such as appetite for risk, short-termism and big bonuses) as consistent with industry norms, thus suggesting quality of service.

“This study shows how divergence in audiences’ perception of typical industry behaviours can make wrongdoing beneficial,” says the paper authored by Dr Thomas Roulet, University Senior Lecturer in Organisation Theory at Cambridge Judge Business School. “Most audiences tend to disapprove of wrongdoings, but specific stakeholders may interpret this disapproval as an indication of the focal organisation’s level of adherence to professional norms.”

The model is roughly that “professional norms,” in business, are evil, and so businesses looking to hire qualified professional investment banks tend to look for the ones who are most evil. And so winning IPO mandates is correlated with negative press coverage. What kind of negative press coverage? These delightfully specific kinds:

The media coverage was evaluated based on a list of 204 words built on a qualitative analysis of a sample of opinion articles. The articles were then coded on the basis of how those words were associated with the banks. The words were grouped into four factors that have been heavily criticised since the financial crisis:

Greed: words such as “obscene”, “excess”, “selfish”, and “shameless”. Violence as in a battleground: “assault”, “frenzy”, “vicious”, “fierce”. Opacity as in fostering secrecy: “covert”, “cryptic”, “dubious”, “hazy”. Risk-taking behaviours: “casino,” “tempt”, “daring”, and “gamble”.

“This study suggests that the coverage of misconduct can actually act as a positive signal providing banks with incentives to engage in what is broadly perceived as professional misconduct.” It is broadly perceived as professional misconduct, but it is narrowly perceived—within the profession, and its target audience of businesses—as proper professional conduct.

Obviously you can tell this story without using the word “evil,” and I am joking at least a little bit when I use it. The work of finance is esoteric, and its norms are specific and contextual; in many cases, those norms look bad to outsiders but are sensible and useful in their context. Trading ahead of a client order for a foreign-exchange fixing can be perfectly appropriate hedging, but looks like bad bad front-running when it is exposed as an FX scandal. Taking large risky positions in derivatives can be a perfectly appropriate way to facilitate clients’ hedges, but looks like bad scary prop trading when it loses money. Pricing and allocating an IPO so it is likely to trade up probably serves the goals of banks and investors and issuers, even though outside commentators regularly describe it as “leaving money on the table” for issuers. Sophisticated clients tend to understand what banks are doing and why, and not to take the criticisms too seriously, although I still find it a bit counterintuitive that they’d think more criticisms would be good.

I used to work at Goldman Sachs Group Inc., including during a period when it was heavily criticized for being, um, “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” We did fine. There was a distinct sense that clients thought we were evil but smart, and that they’d rather have us on their side than against them. Also I would sometimes go pitch oil companies, and they would welcome us warmly and thank us for being so widely hated, because it made them look good by comparison. I suppose this is evidence for the “the whole financial system is evil” view.

[1] https://journals.sagepub.com/doi/abs/10.1177/001872671879940...

Goldman has a history of doing terrifically by their clients. They aren’t the best counterparty to trade against, however, in the same way that one would rather play poker against a bad player than a great one. (McKinsey, on the other hand, is a consistent dumpster fire.)

It may very well have simply done research on drugs for Valiant as requested. Valiant was making ultra-risky moves in buying up things it shouldn't have.

Even if there were 'insider moves' in the McKinsey fund (which I doubt but maybe it's true in some indirect way), it's easy to see independant investors somewhere else seeing that Valiant is doing some dumb things.

Goldman was involved in helping the Greek government clean up it's balance sheet in order to get into the Euro. It'd seem that in this case, it was the Greek government that likely hired Goldman due to their very prowess in 'doing whatever it takes' to get the job done. In this particular scenario, my hunch is that Goldman probably told Greek officials that the presentation of the information in such and such a way would likely cause problems, but 'the client' did it anyhow.

Also note that McKinsey in particular is not a highly centralized entity, it's almost like a 'franchise brand' with a lot of fairly independant entities that operate differently. Not exactly Subway sandwiches but it's not like Amazon either.

I'm not really defending GS or McKinsey, it's just that these things aren't black and white.

Maybe it's better to think of them as 'consiglieres' for the powers that be.

https://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_legisla...

https://www.bloomberg.com/opinion/articles/2015-04-01/anothe...

- It's based almost entirely on self-reporting. If a MIO employee has access to material non-public information (whether from a McKinsey consultant or elsewhere) MIO's compliance department has virtually no way of knowing that investment needs to be restricted unless the employee tells them.

- Insider Trading is one of the most difficult allegations to defend against. You're innocent until you can prove otherwise. How do you prove you didn't do something? Typically through records outlining the rationale for your investment decision. The quality of the notes, and investment decisions for that matter, of Portfolio Managers varies significantly from PM to PM.

Rather than simply rely on policies and procedures it seems MIO has contracted most of the investment responsibilities out to sub-advisers and/or has some sort of fund-of-funds structure to their investments. Whether that's to make sure the transactions are actually untainted by inside information or whether that's to obscure transactions that are tainted by inside information is anyone's guess. It seems most of the issues outlined in the article stem from McKinsey failing to disclose their ultimate beneficial ownership of securities (by looking through to the fund's holdings) rather than anyone being able to demonstrate (yet) MIO has acted on insider information.

I also did a brief stint as an accountant at a big four firm. There's a reason accountants aren't permitted to invest in their corporate clients. Not only is there potential for insider trading but it could cloud their professional judgment. As the lines between the big accounting firms, law firms, and consulting firms blur it no longer makes sense that they operate under vastly different regulatory and ethical obligations.

Edit: Others might also be interested to know that while McKinsey's setup is apparently unusual for the consulting world, there are many large law firms who are also SEC-Registered Investment Advisers and deal with the same conflicts of interest. The potential for insider trading in those cases might be even higher as the law firms are often filing disclosure documents with the SEC on their clients' behalf.

The Times actually ran an article today about the McKinsey investigation:

https://www.nytimes.com/2019/02/19/reader-center/mckinsey-he...

> We were intrigued by a company that seemed to be everywhere — and nowhere at the same time. As a private company, it had no obligation to report information to the public. And as a consulting company, it wasn’t regulated. Other types of companies, especially accounting firms and investment banks, have similar client rosters, but they are overseen by government agencies. This lack of accountability, particularly for a firm as influential as McKinsey, beckoned us to dig deeply into its conduct around the world.

> The most basic question we set out to answer was this: Did McKinsey’s pristine reputation as the foremost purveyor of “best practices” match its record? After nearly a year of reporting, we found that the answer was often no.

> That point was driven home in startling fashion when we recently reported that the Massachusetts attorney general had accused McKinsey of fanning the flames of the opioid epidemic. In legal papers, the attorney general alleged that McKinsey had instructed the maker of a powerful opioid on how to “turbocharge sales” of the drug, how to counter efforts by drug enforcement agents to reduce opioid use and how to “counter the emotional messages from mothers with teenagers that overdosed” on the drug.

“The job of the newspaper is to comfort the afflicted and afflict the comfortable.”

This guys suggestion is to put our data in redis b/c it's fast and in memory. Looking up hosted REDIS solutions, (redislabs, we use for other smaller cache redis things). To put 1 TB of data in standard redis server would be ~50k/month :p

Not to mention that if your standard for impropriety is the investment bank, you're lost already.

> A Chinese wall is an ethical barrier that prevents communication between members of an organization that might lead to conflicts of interest. For example, a Chinese wall could exist between departments where the exchange of information could unfairly influence trades. The "wall" is figuratively erected to safeguard insider information and protect private data that could create negative implications and legal consequences if improperly shared.

BREAKING DOWN Chinese Wall > Protecting client data and confidential information is critical to any business but is especially important to companies with diversified services, such as insurance companies, banks, and other financial services firms.

> The Gramm-Leach-Bliley Act (GLBA) of 1999 repealed the Glass-Steagall Act that prohibited banks, insurance companies, and financial services companies from acting as combined firms, such as banks offering insurance products. The Gramm-Leach-Bliley Act resulted in a surge of mergers and increased diversification of services, as well as an increase in fears and public scrutiny. One concern was the protection and sharing of confidential information and personal consumer data with those of contrary interests. In response to growing concerns, many companies adopted the Chinese Wall concept.

(https://www.investopedia.com/terms/c/chinesewall.asp)

Ugly news reports about what senior partners at a highly selective professional services company did != meaningful career repercussions for its alumni, most of whom were there as junior grinders rather than decision makers.

I'm not a McK alum but would definitely still recommend a talented young person with a job offer there to take it.

I get that it wasn't run well but that doesn't really mean the folks working there aren't good at what they do / didn't do interesting things.

https://news.ycombinator.com/newsguidelines.html