January 17, 2002

McKinsey's Close Relationship With Enron Raises Question of Consultancy's Liability


Back in the heady days of October 2000, at a sumptuous hotel ballroom in Palm Beach, the finance committee of Enron Corp.'s board heard then-Chief Financial Officer Andrew Fastow describe Enron's need for outside private partnerships to help drive the company's explosive growth -- partnerships that would sow the seeds of Enron's current woes.

According to internal company documents, one outsider also attended that meeting: Richard N. Foster, a senior partner with McKinsey & Co.

Mr. Foster was an advisor to Enron's board, according to a McKinsey spokesman, and attended about six board meetings between October 2000 to October 2001. Indeed, the celebrated consulting firm was a major force at Enron almost from the company's birth in the mid-'80s. McKinsey was where former Enron CEO Jeff Skilling worked before jumping to Enron, and McKinsey was instrumental in advising Enron during its decade-long transformation from a natural-gas-pipeline company into a massively complex trading operation with far-flung interests in water, timber, and high-speed Internet. McKinsey typically stationed its own personnel at Enron's offices, and dispatched about five to 15 consultants to the Houston headquarters to advise on strategy and operations, according to former Enron executives.

At a time when Enron's collapse is churning up thorny ethical and legal problems for its accountants, lawyers and executives, the question arises: How accountable should McKinsey, its strategy advisor, be? Though courts generally haven't found consultants liable for their advice, McKinsey's long and close relationship to Enron inevitably raises questions about how much the company knew about financial irregularities that only surfaced last summer.

A McKinsey spokesman said: "In serving Enron, McKinsey was not retained to provide advice to Enron or any Enron-affiliated entity with respect to the company's financial reporting strategy, methods of financing, methods of disclosure, investment partnerships or off-balance-sheet financing vehicles."

In exchange for its strategic advice to Enron, McKinsey received millions of dollars in consulting fees. When Enron's stock began to soar, the consulting firm made the Enron success story a cornerstone of the management gospel it preaches in part to woo other clients.

In an article published in the March 22, 1997, edition of its academic publication, McKinsey Quarterly, the authors celebrated Enron's "new breed of tightly focused and vertically specialized 'petropreneurs.' " Later in that same article, McKinsey writers extolled how Enron had created a trading, finance and risk management business worth more than $250 million in five years, and how "its deployment of off-balance-sheet funds using institutional investment money fostered its securitization skills and granted it access to capital at below the hurdle rates of major oil companies."

Though such writings suggest McKinsey knew about Enron's extensive use of off-balance sheet funds, there is no indication that anyone at the consulting firm knew fully how Enron was using those partnerships. Late last year, Enron had to restate four years of earnings because of improper accounting for some of those entities.

A McKinsey spokesman said it was a 75-year old policy of the firm not to comment specifically on client matters.

Enron also played a featured role in McKinsey-partner Mr. Foster's recent book "Creative Destruction," published last year. "How do the concepts of control, permission and risk fit together?" asked authors Mr. Foster and Sarah Kaplan, a former McKinsey employee. "Enron offers one good example of managing these elements to a favorable outcome."

Speaking on behalf of Mr. Foster, a McKinsey spokesman said "the main thesis of Creative Destruction is that in the long run markets outperform companies because companies have not yet found a way to change at the pace and scale of the markets without losing control." Enron didn't return calls seeking comment about McKinsey's relationship with Enron.

McKinsey has seen rocky times of late. The slowing economy has hit the firm hard, forcing McKinsey to trim its work force last year. McKinsey was embroiled in a public display of finger-pointing with a Chinese computer firm last year, and the firm parted ways with Swissair after an ambitious plan it devised was blamed for the airline's collapse. McKinsey declined to comment on those relationships as well.

Enron could represent more than just an embarrassing client for McKinsey. Its plunge into bankruptcy has sparked numerous investigations, as congressional leaders and others search to understand what drove its collapse, which jolted financial markets and left thousands of its current and former employees with little or no retirement savings. McKinsey says it has not been contacted by government investigators regarding Enron.

Though there is no indication that McKinsey may itself become a subject of investigation, it could be caught up as a third party in the investigation of its client. Legal experts say McKinsey, unlike Enron's lawyers and accountants, has no privilege of confidentiality that would shield it from disclosing information to government investigators.

For decades, McKinsey has been revered -- even feared -- for its influence in boardrooms and its extensive and powerful old-boy network among major corporations. Its alumni list reads like a who's who of the Fortune 500, including the likes of IBM Corp. Chief Executive Lou Gerstner. In recent years, that network has helped privately held McKinsey win lucrative consulting contracts from companies run by its former partners.

Mr. Skilling, a vital bridge between McKinsey and Enron, described McKinsey's approach in an interview with this newspaper in 1993, three years after joining Enron: "In the old days, we'd do one project and go away," he said of his days at McKinsey. But over time, "the relationships got closer and bigger."

McKinsey was central to Enron's "asset-light" strategy, the notion of building an industrial powerhouse with few hard assets; McKinsey also advised Enron as it considered entering new businesses, according to former Enron executives. In one McKinsey Quarterly article in 1999, the consultants praised Enron's water-industry investment, "despite a lack of obvious linkages to energy," they wrote, "as a chance to leverage intangibles such as project management, network operations, and infrastructure development skills." The water foray ended in disaster last October, when Enron took a $287 million write-off to exit the business.

One former executive who developed and managed power projects said he was ordered to check with McKinsey when he wanted to make an arcane type of gas-transmission investment. A team of McKinsey experts was sent to Enron's offices to check out the deal. "They were all over the place," he says.

Suggestions that McKinsey was a "decision maker or a necessary review body on Enron's asset investments are flat-out wrong," McKinsey says.

Write to Suein Hwang at suein.hwang@wsj.com2 and Rachel Emma Silverman at rachel.silverman@wsj.com3

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Updated January 17, 2002 12:01 a.m. EST

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