• An Honest Services Crisis: Professional Poison and a Chicago Connection

    By • Mar 30th, 2011 • Category: Latest, Pure Content, The Big 4 And Consulting


    “Where do bad folks go when they die?  They don’t go to heaven where the angels fly.”

    This guest post is by Mark O’Connor, CEO and Cofounder of Monadnock Research.

    Phyllobates Terribilis, the golden poison dart frog (not to be confused with, or metaphorically associated with Nectophrynoides Deloittei), is the second most toxic creature on earth. Hold him in your hand and you’ll barely feel he’s there. But touch him and your heart will stop within minutes. This little guy normally sports a coat of batrachotoxin, an alkaloid neurotoxin, sufficient to quickly kill up to 10 mature adults. But take him out of his element and he’s just a cute harmless yellow frog – a frog with a latent capability to process poisonous plants and insects, and secrete deadly neurotoxins.

    Things are not always as they appear.

    Every time I hear allegations of professional services misconduct involving a Chicago accountant, consultant, or lawyer, I send Francine McKenna an email. The title of my first missive on the subject in August 2009 was, “Are You Living at Ground Zero for Criminals in Suits?”

    It appears to be a worry that Francine and I share. There also appears to be no other metro area on earth with such a high concentration of associated indictments and lawsuits in the last 10 years. We can only hope it’s an aberration. In Chicago’s defense, the city is also within an hour’s flight of a corporate headquarters concentration that has few rivals. Professional services is big business in Chicago. I would expect it to be one of the profession’s most active news hubs. I just wish it was better news for clients and the consulting profession.

    Our interest at Monadnock Research is primarily consulting and advisory services. The Big Four, off and on, have had some of the largest global consulting practices across most categories. Later I’ll share our view of the unique operational and strategic levers of the Big Four firms. But first I’d like to provide some background on the numbers from a recent piece of our research (Vol IV, No 9), and what I would characterize as today’s “honest services crisis.”

    Fiscal 2010 Big Four Consulting and Advisory Services Revenues

    Global non-audit advisory services reported by the Big Four firms, including tax, again broke the $50 billion (USD) mark in fiscal 2010 after retreating briefly in 2009, a 3.23 percent increase. Total non-tax advisory services of Deloitte, KPMG, PwC, and E&Y were $27.8 billion, an increase of 8.1 percent over ’09. Deloitte tops the rankings as the largest global provider of advisory, including tax, with $14.9 billion, edging out PwC’s at a little under $13.3 billion. E&Y was third with $11.19 billion and KPMG finished its fiscal year with $10.72 billion.

    PwC led the group in Tax advisory with $7.09 billion, or close to one-third (31.78 percent) of total Big Four Tax. Ernst & Young ranks second, with $5.671 billion, or 25.42 percent of client revenues. Deloitte ranked third with $5.4 billion and a 24.2 percent share, with  KPMG fourth at $4.15 billion globally and an 18.6 percent share. Excluding tax advisory, Deloitte leads the consulting and advisory services segment among the Big Four with $9.5 billion, followed by KPMG at $6.57 billion, PwC at $6.2 billion, and E&Y at $5.52 billion.

    Big Four audit services were around $44.84 billion in Fiscal 2010. So with advisory services now a little more than $50 billion, how much advisory is too much? I will address that later. But first, I’d like to explore the risk posed to clients and firms by the crimes of wayward professionals, including bribes, kickbacks, fraud, and undisclosed self-dealing, and conflicts of interest, our present-day honest services crisis.

    Chicago: A Culture Predisposed Toward Corruption?

    Readers of re: The Auditors would likely agree that firms providing public accounting services are at most risk. This is why the topic of auditor-provided advisory services is relevant and so important. But it’s also important for management consulting pure-plays like McKinsey.

    Whether it’s a Big Four firm or McKinsey, isn’t it really about the professionals providing clients with those services, and their leaders? Here is a sampling of the latest in a string of professional services sector embarrassments in the nine years since Chicago-based Arthur Andersen surrendered its licenses to practice as an auditor in 2002.

    • The SEC charged Deloitte’s former vice chair Thomas P. Flanagan with insider trading, and violating auditor independence rules in August 2010, and simultaneously settled. Deloitte itself sued Flanagan and received a summary judgment in January 2010 on charges of breach of fiduciary duty, breach of contract, common law fraud, and equitable fraud after filing suit in November 2008.
    • Former McKinsey Senior Partner and capital markets practice lead, Anil Kumar, was the first McKinsey principal in its history to be criminally indicted. Kumar pled guilty to fraud and conspiracy in Manhattan Federal Court in January 2010, admitting to selling confidential client information to Raj Rajaratnam, of the now- defunct hedge fund, Galleon Management (wiretap recording here).
    • Even more disturbing, 3-term McKinsey Managing Director Rajat Gupta, has also been civilly charged in the scandal, and there is at least one wiretap of Gupta sharing confidential information about Goldman Sachs where he served as a board member, after leaving McKinsey. Gupta was the Chicago office leader at the time of his appointment to lead McKinsey in March seventeen years ago. McKinsey itself was founded in Chicago in 1926 by James McKinsey. Another former affiliate, McKinsey Kearney and Company, was later renamed A.T. Kearney and continues to be based there.
    • Chicago-based Huron’s CEO, CFO, and Chief Accountant were forced out after financial improprieties were disclosed in August 2010. One of Galleon’s largest investments at the time the Hedge fund was shut-down was Huron.
    • Canopy Financial in Chicago used fraudulent audit reports, purportedly from KPMG. That scheme was orchestrated by two of the company’s Chicago-based co-founders.
    • Chicago’s International Profit Associates and its CEO John R. Burgess were sued by the Illinois Attorney General in April 2009 for alleged deceptive practices affecting hundreds of small-business clients, where fraudulent claims were alleged for failing to deliver on promises to boost client profits.
    • A number of senior leaders from BDO Seidman and Jenkins & Gilcrist (J&G) in Chicago were indicted in 2009 on charges of conspiracy to defraud the IRS, tax evasion, and perjury related to fraudulent tax shelter schemes offered to clients. Those charged from BDO included Denis Field, former CEO and Chairman and tax partner Robert Greisman and Paul M. Daugerdas, the former head J&G’s Chicago office and tax practice, and Partners Erwin Mayer and Donna Guerin. Those that pled guilty included Vice Chairman and board member Charles W. Bee Jr.; Michael Kerekes, a principal and former member of the Tax Opinion Committee; and Adrian Dicker, also a former Vice Chairman.

    There are scores of cases globally over the same period where providers of professional services have been charged civilly or criminally. There does, however, appear to be a disproportionately large share of U.S. and global cases involving allegations of misconduct with a Chicago connection, according to our research on consulting sector litigation.

    The Audit/Advisory Conundrum: How Much is Too Much Consulting?

    What does any of this have to do with the Big Four? I would argue that it’s all about risk, and mitigating that risk. And the Big Four, among professional services firms, have more risk than anyone.

    What Warren Buffet said in his July 2010 biennial letter to Berkshire Hathaway CEOs on reputation and ethics, republished in its 2010 Annual Report, is even more relevant to each of the Big Four. I include the relevant excerpt below for context.

    Warren Buffet on ethics and protecting reputation, from pages 105 and 106 of the 2010 Berkshire Hathaway Annual Report:

    The priority is that all of us continue to zealously guard Berkshire’s reputation. We can’t be perfect but we can try to be. As I’ve said in these memos for more than 25 years: ‘We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation.’ We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.

    Sometimes your associates will say “Everybody else is doing it.” This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody offers that phrase as a rationale, in effect they are saying that they can’t come up with a good reason. If anyone gives this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.

    If you see anything whose propriety or legality causes you to hesitate, be sure to give me a call. However, it’s very likely that if a given course of action evokes such hesitation, it’s too close to the line and should be abandoned. There’s plenty of money to be made in the center of the court. If it’s questionable whether some action is close to the line, just assume it is outside and forget it.

    As a corollary, let me know promptly if there’s any significant bad news. I can handle bad news but I don’t like to deal with it after it has festered for awhile. A reluctance to face up immediately to bad news is what turned a problem at Salomon from one that could have easily been disposed of into one that almost caused the demise of a firm with 8,000 employees.

    Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That’s inevitable: We now employ more than 250,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. Culture, more than rule books, determines how an organization behaves.

    It’s one thing to make a bold and inspiring statement like that. But it’s another to back it up. With Warren Buffett, I believe he would stand behind that message. And I think it’s a safe bet his operating company CEOs and their employees believe it too. How many companies can make that statement, with confidence that employees will believe that it’s genuine? I bet it’s less than 50 percent. And likely a lot less than that.

    Unlike firms that provide other categories of services, firms that also provide audit services encounter a unique set of marketplace dynamics. I would argue that the Big Four, like insurance carriers, face a dilemma of trading risk for cash flow. In the insurance business it’s called cash flow underwriting vs. underwriting for a profit. The prudent long-term decision for insurers is to maintain a focus on underwriting profit, even in a soft market, and not trade increases in claims tomorrow for today’s premiums on an increasingly risky book of business.

    This may seem obvious but, without fail in competitive times, insurance carriers are drawn into competing for business where they must either cede share to imprudent carriers, or maintain share at the expense of profitability. This type of inappropriate decision is the source of many historical insurance industry failures, where management did not understand the delicate balance, or chose to ignore it with tragic consequences.

    Firms that provide audit and non-audit advisory services are faced with similar dilemmas. As with the insurer, a firm providing audit services can relax its standards for accepting new non-audit business that might be demanded by clients. But doing so may ultimately compromise the firm’s auditor independence. The risks are both real and perceived and must be acknowledged.

    The Big Four maintain systems for tracking and navigating conflicts posed at the firm and professional levels throughout their networks of firms, within a complex labyrinth of global legal and regulatory environments. The audit committee and client signatories, under Sarbanes Oxley, have the responsibility to assess auditor independence annually. But, realistically, clients look to their auditor to bring conflicts and potential conflicts to their attention, so the client can make its own assessment of auditor independence and the associated risks.

    Hiring a Big Four firm to provide advisory services has additional value (real and perceived), outside the obvious scope of an engagement, in terms of quality, integrity, and competence. If a trusted relationship already exists with a firm as auditor or advisor, channeling more work to it reduces project failure risk, brings projects to completion more quickly, and decreases cost.

    Similar quality services are available from other firms that have strong reputations and may not be one of the Big Four, and may not even provide audit services. Working with a Big Four firm, however, also carries weight with a client’s investors, regulators, customers, employees, board members, and virtually every client stakeholder. So, increasing the volume of client work directed to one or more Big Four firms may appear to make business and financial sense, especially for the world’s largest publicly traded entities. But there are many risks and opportunities that need to be properly assessed by the firm and the client prior to engaging one of the Big Four, and many of these risks involve subjects not easily broached.

    Big Four firms stand alone in many ways, and play a unique role in the marketplace for advisory work. Their services are so highly demanded that they are often in the enviable position of assessing whether they are able to (or should) accept work that may be presented. The rigorous controls maintained by the Big Four increases their cost of providing services. That cost, however, is largely offset by lower business development expenses associated with the engagement opportunities presented to them simply because they are a Big Four firm.

    Same “Shtick,” Different Century

    Last week there was a meeting to discuss U.S. auditor reporting changes being considered by the U.S. Public Company Accounting Oversight Board (PCAOB) in Washington DC. This would affect public companies trading on the $15 trillion U.S. capital market. To put this in perspective, China, the next largest single market, is just $5 trillion. Reporting standards for companies trading on U.S. capital markets, however, have been largely unchanged for more than 50 years.

    James Doty, PCAOB Chairman, noted (recording) that within this market, we must address the largest number of disbursed owners of public companies and institutions trading with broad participation among individual investors. This will require a clarity and consistency of reporting that assures auditor statements are not only transparent, but when compared to those of other companies by different auditors, the reports themselves must consistently and accurately portray what is real, and not simply differences of auditor standards of quality, interpretation, and detail.

    PCAOB Board Member Steven B. Harris commented on investor concerns:

    “Most investors responding to [our] survey found that the current auditor’s report does not provide valuable information that is integral to understanding the financial statements. Investors want auditors to discuss their estimates and judgments, and how the auditors arrive at that assessment. And the majority of investors would like more information on audit risk, unusual transactions, the quality of an issues’ announcing procedures and processors.”

    Balancing the dual auditor/consultant role, and the overall impact on the mix of advisory business to audit and attest work, is a challenge that firms have struggled with for decades, and has been the subject of much debate. James Kennedy, who launched the Consultants News (CN) publication in 1970, was among the first to criticize the large accounting firms about their inherent conflicts of interest.

    Kennedy was also not shy about criticizing management consultants with conflicts. His first issue of Consultants News in August 1970, led with another McKinsey scandal. At that time McKinsey Principal Carter Bales was moonlighting as a New York City Assistant Budget Director, while the firm was being awarded contracts worth at least $1.5 million, without competitive bidding.

    A quote from Kennedy at the time:

    “Mostly everyone ranks McKinsey as No. 1 in the profession, and its high-level ‘positioning’ via contact with leading business schools, its Foundation and other awards, etc. … all of its ‘non-selling’ selling has been superb … but continued vigilance is the price of such leadership. Whether proved factual or not, the charges have not only hurt McKinsey, but all of consulting.”

    Another quote from that same 1970 issue, from an unnamed McKinsey consultant:

    “Consultants are entirely client oriented. They are not oriented toward solving the problem but toward pleasing the client. When a political executive retains a consultant, he can be pretty sure they’re not going to do anything to upset him and if they do upset him they can change it. The work that we do is helping the executive maintain and consolidate his position, not help solve the problem.”

    Kennedy’s response:

    “Even the most junior junior would not even think such thoughts, much less express them to an outsider!”

    Consultant conflicts are clearly nothing new. We have not, however, made much progress toward addressing conflicts in the last 40 years. In fact, with the admissions of McKinsey’s Kumar, where I applaud his candor and only wish Gupta would provide more of the same, we have taken a big ethical step backward, in my view.

    James Kennedy passed away in 2006. At that time, I was running Kennedy’s consulting research group and co-wrote his obituary in CN with the assistance of his daughter, the firm’s former Executive Vice President, Kathleen Kennedy Burke. She shared that her father was particularly critical of conflicts of interest posed by auditor work in the area of financial systems over the years.

    The number of public accounting firms was then much larger in number, and the regulatory environment had fewer controls. But the problem is no less urgent today. With only four firms doing most audits of public entities, it is significantly harder for firms and their professionals to avoid conflicts, and to identify high-risk staffers that may even view conflicts as opportunities for personal financial gain.

    Audit: Advisory Ratios

    Given the issues and the circumstances faced by the Big Four, their clients, and stakeholders of those clients and firms, it appears reasonable to contrast the full range of each firm’s professional services practices to one another. The exhibit below illustrates this for Big Four firms across five categories of metrics. The first measures the firms’ audit revenues as a percentage of all fiscal 2010 non-audit work. The second compares audit revenues to non-tax advisory work. The third combines audit and tax, and draws a ratio between that and all other advisory work. The fourth category contrasts audit and tax. And the fifth compares advisory to tax.

    PwC has the largest audit practice in relative proportion to its advisory groups. Since PwC also has the largest proportion of the Big Four audit market at 29.53 percent, it has more areas of potential conflict to police. So we would expect its advisory practice to be smaller in relative size, and it is. PwC also has the largest global tax practice at $7.09 billion, compared to the second largest practice, Ernst & Young, at $5.67 billion. Deloitte follows close behind E&Y in tax at $5.4 billion, followed by KPMG with $4.15 billion.

    A comparison of the advisory categories to the median and mean across all ratios and firms shows that that Deloitte, who never sold its consulting business as the others did, has the largest proportion of non-tax advisory business to audit relative to its peers at $9.5 billion. KPMG is a distant second at $6.57 billion, followed by PwC at $6.206 billion, and E&Y at $5.523 billion.

    I present these statistics, not to propose a correlation or causal link between specific independence or objectivity conflicts and a particular firm. There is simply not enough insight into the actual conflicts, or frankly agreement among experts on what actually constitutes a conflict. But it is clear that conflicts increase for auditors when they do non-audit work for clients, and these ratios highlight the relative risk that certain firms face.

    Deloitte has the second largest audit practice among the Big Four at $11.7 billion, a little over 26 percent of the group’s $44.94 billion in global fiscal 2010 audit revenues. Deloitte also has the largest advisory business at $9.5 billion excluding tax. We propose that tax advisory presents the least of all risks to an auditor’s real or perceived independence, so we treat it separately, as each of the firms does.

    Deloitte has the lowest ratios among its peers for Audit: Advisory at 1.232 and Audit+Tax: Advisory at 1.8. So Deloitte has the most exposure to conflict risk in its current client relationships across the service categories presenting the most risk. In our assessment, PwC, who is essentially the same size as Deloitte, has the lowest apparent overall level of conflict risk, with an Audit: Advisory metric of 2.139 and an Audit+Tax: Advisory ratio of 3.281.

    This is not to say that Deloitte does not have the capability to mitigate its larger risk more effectively than other firms. Deloitte clearly has more years of uninterrupted experience than the other three in managing that risk. And it has one of the best histories of not being sanctioned for conflicts. Deloitte, however, has had some very public embarrassments at the Partner-level in 2010, including Flanagan, that highlight it has far to go in policing its compliance at the professional-level. This is particularly challenging for acquired companies.

    We also highlight that while PwC finished its fiscal 2010 with the most favorable ratios of the group, its stated strategy is to aggressively expand the very advisory practice areas with more acquisitions that, like Diamond, raise conflict risk. So PwC’s status may be in transition depending on how aggressively the firm carries out its strategy. KPMG’s recent acquisition of Equaterra is another example.

    Back-Door Compliance Issues

    Even the best-intentioned firms can find themselves conflicted. The issue of what I will term “back-door compliance issues” presents latent risk, even when a Big Four firm does everything by the book. With more than 610,000 staff among them, the sheer size of each firm and aggregated percentage of the total global audit revenues controlled by such a small number of firms presents risk. Mergers, acquisitions, and failures of client organizations, create conflict in and of themselves.

    PwC, for example, has such a high concentration of clients in financial services, it is very difficult for any industry event to not affect the firm. Deloitte has an historically high concentration of work in financial and ERP system implementations. If nothing changed, how could a stringent regulatory standard be imposed limiting involvement of firms with accounting system implementations from participating in audits for firms where they were involved in the financial system development work? Most financial systems remain in-use at companies for more than 10 years, and often much longer than that.

    There is also the issue of firms growing their advisory and accounting businesses, and the conflict risks posed by integrating those acquisitions and on-boarding acquired talent in a way that conflict is minimized. These professionals must become proficient with honoring regulatory standards that can be complex and are likely foreign to most. We may now be at the point where these four firms are so large that one could not be allowed to fail, as many have argued. Many regulatory actions of late appear to bear that out, including the 2005 KPMG Deferred Prosecution Agreement.

    Simply keeping track of these potential conflicts is a monumental task. While enforcement of legal compliance has been lax, building a business and network of relationships that is predicated upon a lack of compliance within the spirit and letter of the law is imprudent, at best.

    Again, it is our intent to introduce these metrics to raise awareness of the practice levers that create and reduce conflict exposure, and we strongly urge clients and firms to innovate in this important risk mitigation domain. The consequences, as with insurers, for not doing so in a single instance, can have dramatic implications fiscally and from a reputation perspective for both the client and the firm.

    Professional Poison

    The larger an organization gets, the more its staff takes on the average characteristics of individuals within the markets it serves. So, it makes sense that to maintain rigorous standards for competence and ethics, firms find themselves working disproportionately harder, the larger they become, to mitigate the increased risk posed by not maintaining those standards.

    And on the issue of maintaining ethical standards, a common myth is that unethical behavior is the exception and not the rule in business. Not only is this not true, it has never been true. Two recent studies from Harvard Business School and from Deloitte itself explore the reality of questionable preferences and how individuals that otherwise appear to be pillars of business and society are often the moist egregious violators.

    The Harvard study, Justifying and Rationalizing Questionable Preferences, cites research going back decades that indicates this is nothing new, and little has changed. That paper examines numerous studies that found people behave in ways that are selfish, prejudiced, or perverted, and tend to engage in a host of strategies designed to justify these questionable preferences with rational excuses.

    The Deloitte study, Managing the Bad Apples and Protecting the Barrel, profiles the behavior of professional services firm executives, and identifies the conditions under which inappropriate behavior takes root and thrives. According to Deloitte, organizations need to guard against the segment of habitual amoral actors. But that action, while necessary, is insufficient. Evidence indicates that the vast majority of people aspire to do the right thing, but they too can slip into behavior that they know is wrong, becoming occasional immoral actors. Organizations need to anticipate and manage the risk posed by both hazards.

    OK, It’s a Problem. But What Can I Do About It?

    Chances are, if you’re reading this, you agree we have a problem. The moral hazards presented to professional services practitioners and the professionals they serve, and those they serve with, are enormous. And make no mistake, the attractant they pose to dormant and seasoned criminals is a professional poison that can take them down, and take the honorable among us down in the process.

    I suggest these 7 recommendations would be a good start:

    1. Take a step in the right direction. We need to take the right steps by sponsoring organizations, individuals, and legislation that will do the right thing. But just as importantly, we need to block actions that, essentially, grease the skids for people like Anil Kumar and organizations that stand in the way of providing honest services, or that shield them from liability when they get caught. By creating a system with great rewards for inappropriate behavior, lax enforcement, and virtually non-existent penalties for non compliance, what do you think you’ll end up with? Hint, look around. You have it today.
    2. Trade secrecy for transparency. It’s amazing what affect the truth has on strangers to it. To them, disinformation is king, or information known only to them. When you listen to the recorded conversations between the McKinsey and Galleon executives, its not simply a question of whether or not confidential client information is being disclosed. It’s being disclosed as a form of currency, and the ability to control its selective disclosure is most valuable. We will always have the Anil Kumars that somehow penetrate our defenses, and the Raj Rajaratnams that seek them out, no matter what we do. Vigilance in combination with transparency is the answer.
    3. Turn them in. It’s obvious to say, don’t stand idly by and watch it happen, but we all know that’s easier said than done. Show me a whistleblower and I’ll show you someone with professional scars for doing the right thing. Even organizations that claim to have programs where such inappropriate actions can be reported, often fail to meet the standard claimed by their existence. Organizations that truly want to root out inappropriate conduct should institutionalize examples of what Warren Buffett describes as his policy, on reputation and ethics featured earlier, on page 106 of Berkshire Hathaway’s 2010 annual report.
    4. Shun them. Stop working for the bad guys and stop associating with them. Just being connected with them is poison. For Anil Kumar’s charade to have gone on as long as it did, he needed to be associated with perceived good guys with integrity, which transferred to him by association. McKinsey was his mark. Now he has the honor of being the first McKinsey Director to ever be criminally charged for his actions as a consultant since the firm’s formation in 1926. And McKinsey’s professionals now need to deal with the consequences of being guilty by association.
    5. Stop feeding them. Stop doing business with them. Bad guys don’t patronize providers of honest services, so why should honest people and organizations support them? It’s better to support an organization that will always tell you the truth, than one that will tell you what you want to hear for the right price. Feed that beast, and you’ll be feeding it forever. Money is the oxygen in business and life. Shut it off, walk away, and don’t look back.
    6. Trust, but verify. As America’s 40th President, Ronald Reagan, once said in speaking of relations with the Soviet Union near the end of the Cold War, we must trust, but verify. Don’t accept the status quo of an auditor’s sworn attestations to a company’s financial results, or those of the client in SEC filings. Urge the adoption of standards and legislation that requires those statements be verified using the latest deception detection technologies for the entire team doing the audit. If we can admit as evidence secret recordings of conversations between parties because of their importance to the stability of the world’s largest securities market, we can certainly require that the entire audit engagement team have verified sworn confirmation of audit opinions, along with the client’s senior management team for their assertions about what has been presented to auditors. This one simple change would likely address most of the disclosure problems, since comprehensive voluntary disclosure would become an outcome of that process. In the U.S., verification may even fall within existing regulatory guidelines, given the potential financial impact on markets and individual investors of not requiring it.
    7. Just say no. Don’t play any role in their schemes. And if you know, or should have known, and do nothing, you are likely complicit and can be charged civilly or criminally. There can be no agreement that binds you to commit a crime, or to maintain information about a crime because it’s supposedly confidential. As you can see in the wiretaps of Rengan Rajaratnam, it’s the strategy of these sleaze bags to make you “a little dirty.” When you do that, they own you. Then you’re stuck in their world, and your only relief will be when it’s time to bare your soul to investigators, as McKinsey’s Kumar ultimately did. Picture the effect of that on you, your family, and every relationship you’ve ever had. That should be sufficient motivation to make the other recommendations sound like a walk on the beach.

    Recognition of Good and Bad Behavior

    A case study of good behavior is Willis Group Holdings. This firm has done more than any other organization during 2010, in my view, to advance the cause of providing clients with associated honest services. Despite the actions of its chief competitors, MMC and Aon, to reverse course on government-mandated actions that reduced potential for conflict in the area of insurer contingent commissions, Willis has held its course.

    Willis did this even after relaxation of regulatory restrictions in New York, which were likely the most restrictive in the world related to this alternative fee remuneration category. Granted, Willis has less at stake in terms of potential forgone profit by refusing to accept contingent commissions. This is a type of alternative fee arrangement that is tied to recommending specific insurance products to clients that may carry higher compensation tied to client premium volume increases and lower client loss ratios. But what is lost to Willis by taking the ethical high-road is proportionately equivalent in relative terms to that of its competitors.

    According to Willis CEO, Joe Plumeri, “A regulatory arrangement built around minimum disclosure requirements tends to result in just that: minimum disclosure.”

    Willis stands apart in recognizing its advisory duty to the client, which is “to provide independent objective advice.” Monadnock Research recognizes Willis for these efforts and choices. Clients should keep Willis in mind when considering recommendation 5 above.

    We will also recognize three professionals that exemplify the “Professional Poison” that has impacted the credibility of consultants and firms in profoundly negative ways during 2010. Allegations do not make it so, but each of these three individuals has been recognized by his organization as an example of what not to do. We concur.

    So we would like to recognize the behavior of these three consulting and advisory services industry leaders as the Professional Poison that must be addressed.

    1. Former McKinsey Director, Anil Kumar, has probably done more harm to the profession than any individual in its history. Kumar’s unethical trifecta has simultaneously brought shame and disrepute to himself, his colleagues at McKinsey, and to every consultant in the world. Kumar’s escapades are so well known I won’t repeat them.
    2. Thomas Flanagan comes in a close second. Flanagan’s actions as an advisory services senior Partner and former Vice Chairman of Deloitte, while trading on information he learned while serving on client boards, show Deloitte has far to go in policing internal conflicts. Deloitte’s high levels of risk for potential conflicts presented above show that it needs to be particularly vigilant to identify and deal with its own bad apples, and before regulators give them a heads-up.
    3. Former EDS CRM practice Managing Director, Joe Galloway, is in a category of his own. Galloway was found by a court in January 2010 to have lied to win an IT consulting project from the U.K.’s Sky Broadcasting. Like a bad seed Galloway moved from SHL Systemshouse to EDS, and later to HP, all though acquisitions. He lied about his credentials, claiming even to have an MBA. Galloway was then caught committing perjury at trial, which finally gave HP cause to fire him. HP ultimately settled with Sky in June 2010 for £318 million in damages.

    To Him that Will, Wais are Not Wanting

    The stakes are high and there is much riding on a solution to this honest services crisis. There are those among us that sit on a house of cards and have much invested in the status quo. It’s a mess of our own making that we’ve allowed to fester far too long. Sometimes it’s just easier to push problems along, rather than deal with them. This approach is particularly vexing within the consulting and advisory services marketplace, since its services are essentially discretionary and a loss of confidence can be devastating.

    My examples may have been focused geographically for presentation. But this is a global problem, and remains an opportunity for the Joes, Toms, and Anils among us. Perhaps what I believe is a well-reasoned argument may just wind up with all the past arguments of this ilk, as whispers in the wilderness.

    As Welsh poet George Herbert said centuries ago, “To him that will, wais are not wanting.”

    There may or may not be a will today. But my sense is the timing is right, and that a well-connected group of like minded passionate people could set a will on its way.

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    7 Responses »

    1. This is a very interesting and worthwhile article. I congratulate the author for being willing to call a spade a spade.

      Yesterday evening I had the opportunity to listen to a lecture at the Baker Institue at Rice University. The speaker was Jeffrey Immelt the chairman of GE and also Chariman of the President’s Committee on Competiveness.

      I called to the speaker’s attention the major problem we have with dishonesty among the Big Four. He agreed that it was a problem; however, he stated that his committee did not have the time to handle it. I pointed out that this is a major problem affecting the nation’s ability to be competitive.

      I suggest that we should review the members of the committee and determine who their auditors are. Then we should contact them and advise them of the frauds their auditors participated in.

      This is a major problem that no one high up in business or government is willing to face up to.

    2. You could have gone with “Criminal Accounting: a Who’s Who” as the title…sad.

    3. […] Managing Partner: “We look forward to elevating our presence in Philadelphia, as well as entering the Chicago market, which is one of the most important financial centers in the […]

    4. Chicago connection is a surprising insight.

    5. But . . . didn’t the Supremes obviate the requirement that folks (above a certain station) provide honest services? Something about the law being too broad, as I recall it.

    6. @EdwardEricsonJr. I was presenting a more broad interpretation of what is codified in US law with regard to “honest services.” But I’m not sure the current interpretation obviates the requirement that people above a certain station provide honest services. The US Supreme Court ruled a year ago in SKILLING v. US (USSC 08-1394 ) that “the intangible right of honest services” covers only bribery and kickback schemes. It had been more broadly interpreted in many cases, including against Enron’s Skilling. (more detail here: http://en.wikipedia.org/wiki/Honest_services_fraud)

    7. […] re: The Auditors » Blog Archive » An Honest Services Crisis: Professional Poison and a Chicago Con…. This entry was posted in Uncategorized. Bookmark the permalink. ← Managing Major Corporate Initiatives […]

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