An Issue of Trust

[This piece first appeared in News Items, a newsletter that covers four “subjects” — a world in disarray, the financialization of everything, advances in science and technology, and politics, global and domestic.]

We’ve heard a lot this summer about what Donald Trump thinks of America’s courts and the officials in them. They’re “very biased,” “unfair,” “corrupt and highly partisan,” “rabid,” and so on. Millions of followers seem to agree.

But there’s someone else who believes he’s seen real corruption in America’s courts, and instead of calling people names on social media, decided to pursue reform. Jay Alix, a retired corporate turnaround man and certified fraud examiner, has spent the last seven years ricocheting from courtroom to courtroom, arguing that McKinsey, the elite global consulting firm, has been breaking the law, improperly enriching itself, and rigging cases in the bankruptcy courts, where it’s required to act as a fiduciary. Not just once, but again and again.

“If somebody’s doing this across multiple cases, across billions of dollars of transactions, they’ve corrupted the system,” Alix told me.

I had called him because in August, a federal judge in Manhattan ruled that Alix’s core arguments about McKinsey were “plausible,” and gave him a green light to move forward with a RICO lawsuit that he filed in 2018. (Yes, RICO, the Racketeering Influenced and Corrupt Organizations Act–the federal version of the law Fani Willis is using to go after Trump and 18 others for election tampering in Georgia.)

The ruling surprised me, because civil RICO suits are always long shots, and after seven years, this one seemed to be Alix’s last chance. He’s spent most of those seven years fighting McKinsey in the bankruptcy courts, winning some rounds but never landing a knockout punch. Bankruptcy courts are busy with bankruptcies, and they’ve turned out to be a tough venue for proving systemic corruption. Federal district court seemed like it might be inhospitable too; Alix’s case was dismissed the first time around. He appealed and in August he finally got traction.

I wanted to know what McKinsey thought about it, too, but a spokesman said the firm would have no comment.

I’d have liked to ask whether McKinsey now regrets branching out from its high-end management consulting work 22 years ago and going after bankruptcy gigs. Yes, bankruptcy pays very well, but it’s rough, and it happens in a special realm, governed by special rules that you don’t run into anywhere else. The rules can seem picayune. Skirt them once and it might not seem to matter. Skirt them again and you may start to feel like you’ve been given a free pass. And so it goes, until one day you’re accused in public court of racketeering.

A lot of wealth changes hands in America’s bankruptcy courts–more, in fact, than in any other court system in the world. And where there’s that much money, there’s bound to be the temptation to cheat.

Congress anticipated this and provided for those who work on big bankruptcy cases to be well-paid, so they’d be less tempted to do side deals. They’re also required to serve as fiduciaries, putting the creditors’ interests ahead of their own. (“Creditors,” by the way, can be anything from hedge funds to truck drivers to retirees with unfunded pensions.)

You have to get court approval before you can be hired on a case, and to get court approval, you must swear that you’re “disinterested.” To back it up, you must also provide an affidavit, sworn under penalty of perjury, listing all of your connections, by name, to the other parties to the case.

That’s what tripped up McKinsey. Everybody else working on big bankruptcy cases files long, tedious lists of names. You’d expect the world’s biggest consulting firm to have longer lists of names than anybody else, but McKinsey didn’t provide any at all. If asked about it, McKinsey would say it had promised strict confidentiality to its clients and couldn’t name them. Until Alix came along, no one pressed that hard. The Chapter 11 bankruptcy business is clubby, and it was understood that challenging McKinsey could cost you referrals.

Alix wasn’t a member of the club. He had made a fortune on corporate turnarounds in the 1980s and 1990s, but stepped back from the business in 2000, at 45, after his wife died and left him to raise their two young children. He stopped going out and pitching restructurings, but he kept a minority stake in his old firm, AlixPartners, and sat on its board.

It didn’t ring true to him that McKinsey was concealing its connections because of confidentiality agreements. He thought McKinsey had something to hide: multiple connections running all through the bankruptcies it worked on–longstanding relationships with the bankers, investors, lawyers, major customers, bidders at auction and others that might want McKinsey’s consulting services more than ever, now that it had good information about the bankrupt company. If McKinsey provided services to them, it would make a mockery of its pledge to remain “disinterested,” but Alix thought that was what was going on. You could make a lot of money in bankruptcy, he thought, but you’d make a lot more if you worked both sides of the case.

He hired lawyers and formed a small investment firm that bought the distressed debts of several bankrupt companies that McKinsey was advising. That gave him standing to file motions in the bankruptcy courts, asking the judges to compel McKinsey to disclose its connections.

First was the Richmond, Va., bankruptcy court, where Alpha Natural Resources, a coal company, was reorganizing. McKinsey said its connections were all confidential, and portrayed Alix as a kook, obsessively demanding paperwork when there was a failing company to be saved. One lawyer called his legal challenge “the vanity project of a narcissistic billionaire.” Alix persisted, and eventually showed that McKinsey itself was a secured creditor of ANR.

That blew a hole in McKinsey’s sworn statement of disinterestedness. In bankruptcy, a disinterested party cannot own the debt or equity of the bankrupt company, not even indirectly. Worse, in the reorganization ANR was split into two companies, including a new one called Contura that got ANR’s best mines. The secured creditors, including McKinsey, then got stock in Contura to settle their claims. Other creditors, like a coal miners’ pension fund, got pennies on the dollar. A McKinsey partner testified under oath that the deal was in the best interests of all classes of creditors, without mentioning that his own firm was among the creditors that got the best deals.

“These are some of the most serious allegations that I have ever seen,” said ANR’s bankruptcy judge, Kevin R. Huennekens, when he learned what had happened. But he couldn’t do anything about it because the reorganization was by then finished, and bankruptcy won’t let you unscramble the eggs.

McKinsey’s lawyers told Judge Huennekens that the firm’s failure to disclose its ANR stake was not intentional, and said Alix was using an innocent mistake to make “wild accusations.”

Alix next went to the bankruptcy court in Houston, where McKinsey was working on the case of Westmoreland Coal. The firm’s involvement in the case had not yet been approved by the court.

The bankruptcy judge, David R. Jones, had recently closed the bankruptcy of an energy company, GenOn. McKinsey had worked on that case, too. Alix had followed the case and knew that GenOn’s creditors believed it had been looted by its parent company, NRG Energy. McKinsey, as a fiduciary, was paid to investigate the creditors’ allegations, which it did–without telling Judge Jones that NRG was a McKinsey client. The undisclosed conflict tainted McKinsey as a fiduciary and raised doubts about whether the creditors’ recoveries were fair.

Alix and his lawyers filed a 163-page objection, telling Judge Jones that McKinsey had worked both sides of the GenOn case, and warning that the same thing might happen in the Westmoreland case, too, because McKinsey was fraudulently claiming to be disinterested while concealing its connections.

Judge Jones immediately called a hearing and arrived in court looking shaken. “I’m worried to death that I made a mistake in GenOn,” he said.

Westmoreland wanted a speedy resolution and asked the judge to overrule Alix’s objection. Judge Jones said he could not ignore someone who had stood up in his court and accused a professional of a crime. He allowed work to continue on the reorganization, while opening a separate inquiry into McKinsey’s disclosures and lack of disinterestedness.

McKinsey’s lawyers said they were confident that Alix could not prove fraud. “We stand behind our disclosures, which have always complied with the law, and are confident that the court will find that Alix’s allegations of fraud were reckless, without basis, and should never have been made,” one said.

The long legal proceedings that followed went very badly for McKinsey. The firm filed a series of disclosure statements, each of which showed that the previous ones had been false. Its lawyers said Alix was misconstruing the disclosure rules, and offered to bring in an expert, on McKinsey’s nickel, to write a new protocol for disclosure. Judge Jones let the expert try, but rejected the resulting protocol. He ordered mediation. That led to a $15 million settlement with the Justice Department, which said that McKinsey had “failed to satisfy its obligations under bankruptcy law.” McKinsey did not acknowledge any wrongdoing. Alix pulled the plug on mediating his claims. Meanwhile, Westmoreland’s bankruptcy case ended and the company went back to its coal mines.

In the bankruptcy court, a trial began. When McKinsey’s side was making its case, a McKinsey practice leader, Mark Hojnacki, testified that, without approval, he had removed $1.5 million from the bankruptcy’s “trust estate,” the pot that’s held under the absolute control of the court for eventual use in paying the creditors. Judge Jones wondered aloud about whether to call the U.S. Attorney.

“If it isn’t obvious, Mr. Hojnacki and this Court have a trust issue, and I am trying to deal with that the best way I know how,” he said. As the trial continued, seats in the courtroom began to fill up with criminal defense lawyers. Later, when McKinsey’s current CEO, Robert Sternfels, was on the stand, Judge Jones said he couldn’t understand why McKinsey kept claiming that its disclosures were perfect, only to correct them.

“Is it just that I’m dealing with a group of people who are so educated, so arrogant, that they just can’t admit that they’re wrong?” he asked.

As soon as McKinsey’s team had finished presenting its evidence, it withdrew its application to be hired for Westmoreland’s long-gone bankruptcy, cutting short the trial and preventing Alix’s side from making its case. That left Judge Jones with no ruling to make on whether McKinsey was “disinterested.” McKinsey had not been approved by the court, which meant that it couldn’t be paid. Hojnacki and the rest of the McKinsey team had done about $8 million worth of work on Westmoreland and simply walked away from it. Judge Jones apparently decided that was a suitable penalty–that and an admonition.

“The only thing that I want to tell you all is the bankruptcy process itself is extremely, extremely fragile,” he said in confirming McKinsey’s withdrawal. “It depends upon a level of trust between the Bench and Bar, and the Bench and the professionals, that doesn’t exist in any other court system. If I can’t trust the professionals that appear before me, then the process won’t work. It can’t work. The cases are too big. The cases are too complex.”

Alix had been hoping for a full-blown trial, ending in a conclusive ruling that McKinsey had filed false statements, in violation of the U.S. Criminal Code. He didn’t think McKinsey took the judge’s message to heart. Judge Jones may not have thought so either. But someone else was apparently listening: the Second Circuit Court of Appeals, which heard Alix’s appeal after his RICO case in New York was dismissed. A three-judge panel ruled that his case was sui generis — a unique case that couldn’t be handled like a garden-variety RICO case.

What made it unique, wrote Barrington D. Parker for the panel: “McKinsey’s alleged misconduct targeted the federal judiciary.”

He went on to say that the circuit courts had a responsibility to supervise the bankruptcy courts and ensure their integrity: “Litigants in all of our courts are entitled to expect that the rules will be followed.”

The panel told Judge Furman to reinstate Alix’s lawsuit, which he did in August. It also told him that a more detailed court record was needed, “one that will disclose more about who did what, when, and with what reasonably likely consequences.” It said Alix should investigate, effectively pinning a sheriff’s badge on his shirt.

Proof that the system works? It seems to be working for Alix now, but only after seven years of hammer-and-tongs litigation and millions of dollars in legal expenses. And the RICO case isn’t done. Alix could still lose, if it ever goes to trial. This is America, and of course, every accused is innocent until proven guilty.

As Trump has been reminding us, we need our courts to be fair. Alix is showing us what an effort that can take.