How a revered global adviser blundered into a corrupt bargain

In late 2015, over objections from at least three influential McKinsey partners, the firm decided the risk was worth taking and signed on to what would become its biggest contract ever in Africa, with a potential value of $700 million.

It was also the biggest mistake in McKinsey’s nine-decade history.

The contract turned out to be illegal, a violation of South African contracting law, with some of the payments channeled to an associate of an Indian-born family, the Guptas, at the center of a swirling corruption scandal. Then there was the lavish size of that payout. It did not take a Harvard Business School graduate to explain why South Africans might get angry seeing a wealthy U.S. firm cart away so much public money in a country with the worst income inequality in the world and a youth unemployment rate of more than 50 percent.

And a bitter irony: While McKinsey’s pay was supposed to be based entirely on its results, it is far from clear that the flailing power company is much better off than it was before.

The Eskom affair is now part of an expansive investigation by South African authorities into how the Guptas used their friendships with Jacob Zuma, then the country’s president, and his son to manipulate and control state-owned enterprises for personal gain. International corruption watchdogs call it a case of “state capture.” Lawmakers here call it a silent coup. It has already led to Zuma’s ouster and a moment of reckoning for post-apartheid South Africa.

Yet despite extensive coverage of the scandal by the local news media, one question has remained largely unanswered: How did McKinsey, with its vast influence, impeccable research credentials and record of advising companies and governments on best practices, become entangled in such an untoward affair?

McKinsey admits errors in judgment while denying illegality. Two senior partners, the firm says, bear most of the blame for what went wrong. But an investigation by The New York Times, including interviews with 16 current and former partners, found that the roots of the problem go deeper — to a changing corporate culture that opened the way for an aggressive push into more government consulting, as well as new methods of compensation.

The firm also missed warning signs about the possible involvement of the Guptas and only belatedly realized the insufficiency of its risk management for state-owned companies. Supervisors who might have vetoed or modified the contract were not South African and lacked the local knowledge to sense trouble ahead. And having poorly vetted its subcontractor, McKinsey was less than forthcoming when asked to explain its role in the emerging scandal.

“I take responsibility,” McKinsey’s managing director, Dominic Barton, said in a recent interview. “This isn’t who we are. It isn’t what we do.”

Since the Eskom disclosures, much of McKinsey’s business in South Africa has evaporated. Barton has made six trips there to assess the damage and make amends, and McKinsey has asked its 2,000 global partners to repay South Africa, where it is under investigation.

McKinsey had worked with the state-owned rail and port agency, Transnet, since 2005. Still, Transnet remained an underachiever, its ports inadequate, its freight rail system moribund.

Then, in February 2011, Transnet got a new chief executive, Brian Molefe, who had been running the country’s public pension fund.

His tenure began with controversy. The South African media had already linked him to the Guptas, a family led by three brothers who arrived in South Africa a quarter-century ago and became ostentatiously wealthy through a web of businesses, once commandeering an air force base to fly in wedding guests from India.

McKinsey and Molefe set out to revitalize the agency by buying as many as 1,064 new locomotives in what would be the biggest government procurement in South African history. But McKinsey would have to take on a subcontractor, under a South African law requiring companies that worked with state-owned enterprises to have black-owned partners.

According to prosecutors, the Guptas saw these black-empowerment companies as a way to empower themselves, and state-owned companies like Transnet became willing accomplices. Transnet steered McKinsey toward working with a company, Regiments, owned in part by a businessman linked to the Guptas.

But weeks before the winning bidders were announced, McKinsey bowed out, saying the process was moving too quickly.

As it turned out, Transet agreed to pay about $1 billion more than the agreed-upon price for the locomotives. And, as leaked documents published last year in the local media revealed, one of the winning bidders, a state-owned Chinese company, paid more than $100 million to shell companies tied to another Gupta associate, Salim Essa.

Although it is unclear what, if anything, Molefe knew about those payments, he left Transnet to search for a new challenge. He found it in 2015 as the chief executive at Eskom.

The power company had long been the public’s favorite punching bag, notorious for its high rates, sputtering from one crisis to the next. Officials worried about getting enough coal, about delaying maintenance to keep electricity flowing. During the World Cup in 2010, Eskom feared that the lights might go out at any moment.

To address Eskom’s financial troubles, McKinsey and Eskom drew up an audacious reorganization plan.

McKinsey’s team leader on the project was a popular partner, Vikas Sagar, a stylish, Porsche-driving fitness buff in his 40s, known for hugging colleagues when the spirit moved him and fiercely charting his own course. He was assisted by Alexander Weiss, a serious reverse image of Sagar, who thought little of commuting between his home in Germany and Johannesburg.

McKinsey’s proposal appeared perfect for a company in desperate financial straits. Eskom would pay only if the plan produced savings. Then the consultancy would get a percentage. All the risk, ostensibly, would be McKinsey’s, since it might spend heavily but get nothing in the end.

Yet for all the upside, the proposal had a Trojan-horse quality: Eskom would hire McKinsey not knowing what the final bill would be.

The plan left several McKinsey partners uneasy. Could Eskom absorb and apply McKinsey’s recommendations? And how would a contract with an anticipated payout in the hundreds of millions of dollars be received by South Africans? Also troubling was the fact that McKinsey had won the contract without competitive bidding.

In situations like these, risk managers are supposed to serve as corporate lifeguards, ready to whistle back dealmakers if they expose the company to unnecessary legal and reputational peril. Yet the Eskom contract was approved with less scrutiny than regular public contracts. That was because state-owned enterprises were treated as private corporations, where reviews focused on commercial viability, not political risk.

Had McKinsey vetted the Eskom contract properly, it might have spared itself some of the grief to come. The contract, it turned out, was illegal: The power company had failed to get a government waiver from the standard fee-for-service payment, despite assuring McKinsey that it had done so.

“For the scale of the fee, they were prepared to throw caution to the wind, and maybe because they thought they couldn’t be touched,” said David Lewis, executive director of Corruption Watch, a local advocacy group.

If McKinsey fell short in vetting the Eskom contract, the same could be said about the scrutiny of its minority partner, a company called Trillian Management Consulting.

During the internal debate over the Eskom deal, several partners had questioned whether McKinsey knew enough about who precisely was behind Trillian. Now rumors began reaching the McKinsey office that Trillian Management and its parent company, Trillian Capital, might have ties to the Gupta family.

McKinsey knew little about Trillian — a new company, with no track record, that had broken off from McKinsey’s previous minority partner, Regiments, after a business dispute. What’s more, Trillian had refused McKinsey’s requests to divulge its ownership.

An influential senior partner in Johannesburg, David Fine, had grown increasingly uneasy about Trillian, according to his testimony to Parliament. One source of concern: Over the objections of two senior partners, McKinsey’s team leader, Sagar, had been meeting with Eskom and Trillian without any other McKinsey officials present.

Eventually McKinsey hired a private investigative firm to dig into Trillian’s background. When that did not produce any definitive leads, Fine began running internet searches on companies named Trillian and found the name “S. Essa” listed as a director. Weeks later, the South African media revealed the majority owner of Trillian as none other than Salim Essa, the Gupta associate whose shell companies had received more than $100 million in the locomotive deal.

On March 30, 2016, McKinsey told Eskom in writing that it was severing its ties to Trillian. But while McKinsey had finally taken a stand, it quietly undercut that decision by continuing to work alongside Trillian — independently, rather than as a subcontractor.

To the consternation of some McKinsey partners, that arrangement continued until the end of June 2016. With the local media revealing ever more of the Gupta family’s influence, Eskom — not McKinsey — prematurely terminated the contract. Molefe resigned that November. Molefe did not respond to requests for comment for this article; a lawyer for the Guptas declined to comment.

The abbreviated tab for barely eight months of work: nearly $100 million, with close to 40 percent going to Trillian.

Late the next year, South Africa’s National Prosecuting Authority would deliver a stinging summation of the Eskom case. McKinsey, the prosecutors would allege, had been instrumental “in creating a veil of legitimacy to what was otherwise a nonexistent, unlawful arrangement.” That arrangement, in turn, allowed a company controlled by the Gupta associate, Essa, to profit.

The advocacy group Corruption Watch referred the firm’s conduct to the U.S. Justice Department for possible violations of the Foreign Corrupt Practices Act. McKinsey declined to say whether federal investigators had contacted the firm; the Justice Department declined to comment. The National Prosecuting Authority in South Africa has frozen the proceeds of the Eskom contract, pending the completion of the government’s investigation. And several banks and corporations, including the South African arm of Coca-Cola, have said they will not do business with McKinsey until investigations are concluded.

McKinsey vehemently denies breaking any laws and says that this view has been validated by a monthslong internal inquiry involving more than 50 lawyers reviewing millions of documents and emails.

The firm does admit mistakes. McKinsey will now give state-owned companies the same scrutiny it would government agencies or ministries. That policy may have a major impact in China, where McKinsey has advised at least 19 of the biggest state-owned companies as well as the country’s powerful planning agency.

In a statement, McKinsey said, “We are embarrassed by these failings, and we apologize to the people of South Africa, our clients, our colleagues and our alumni, who rightly expect more of our firm.”

This article originally appeared in The New York Times.