The world’s most prestigious consultancy prides itself on its intellectual prowess and ethical standards. But this year, an insider trading scandal surrounding former McKinsey luminaries has left staff and alumni reeling.

When 1,200 partners of McKinsey&Company – the elite of global consulting – arrived at the Gaylord National Hotel & Convention Center, outside Washington DC, early on the morning of March 15 this year, they found themselves where they least wanted to be: at the centre of a media firestorm.

Up the east coast, in a Manhattan courtroom, an insider trading case was focusing attention on the links between key former employees of the world’s best-known, most prestigious, most self-consciously high-minded consulting firm and a corrupt hedge fund boss. For outsiders, intrigued by and suspicious of the McKinsey mystique, it was an irresistible combination. For partners, most of whom had flown into Washington from their offices around the globe for the scheduled annual meeting, it was a public embarrassment, a private outrage – and even a potential threat to the future of “the Firm”, as McKinseyites call their employer. “You can’t underestimate the shock, the disbelief and anger there,” recalls one McKinsey veteran. As Dominic Barton, the Firm’s personable global managing director, brought the opening plenary session to order, the older partners were “completely ashen-faced”, the same person recalls.

The cause of concern was the New York trial of Raj Rajaratnam, founder of the Galleon hedge fund group. He was accused of insider dealing, allegedly using tips passed to him by former McKinsey partner Anil Kumar, and the once-unimpeachable Rajat Gupta, who had served three successive three-year terms as global managing director of the Firm up to 2003. Kumar had pleaded guilty to passing confidential information to Rajaratnam and was under cross-examination in New York. Gupta, who had retired from McKinsey in 2007, was fighting an administrative order from the Securities and Exchange Commission, made only two weeks earlier. (The SEC later dropped its case, but federal prosecutors pursued it.) The allegation? That he had shared tips with the hedge fund boss, following board meetings at Procter & Gamble and Goldman Sachs, where he was a director.

Barton shared the platform that day with Jean Molino, the firm’s general counsel. Partners who were present say there was a lot of “pushback” from the audience, though little finger-pointing. Over the course of about 90 minutes, Molino described the legal situation, while Barton explained what the Firm was doing to allay the concerns of clients and alumni about the alleged breaches of confidentiality and McKinsey’s all-important principles. The partners’ principal anxiety was summed up in one recurring question: “Why didn’t we pick up on it?”

If Barton and Molino thought they had soothed that concern, they were mistaken. Later that day, the New York court heard tapes of conversations between Gupta and Rajaratnam in July 2008. Though Gupta had left McKinsey in 2007, as an ex-managing director he was a carrier of the McKinsey flame. Yet the recording appeared to McKinsey partners to show that Gupta had known that Rajaratnam was paying Kumar for information. As shocking to them was the fact that they had not previously been made aware of any such activities. Until then, says one partner, the senior consultants had been ready to debate the rights and wrongs of Gupta’s position. But the recording put an end to that. It appeared, according to the same partner, that he was “acting in total breach of what everyone expected of him”.

Barton and his management team of eight partners were in conclave in a private room on the evening of March 15 when the news of the tapes filtered through. “We’ve got to go out there again,” he told those present. With partners seething, the team decided to recast the first session the next day to tackle a new round of questions about the biggest public crisis in this very private partnership’s 85-year history.

When James Kondo, now head of Twitter Japan and a visiting professor at Hitotsubashi University ICS, joined McKinsey, he says insiders offered two analogies to help him understand the Firm: the Jesuits, and the tailors of Savile Row, who “unlike fashion houses and designers … are always in the background”.

Yet McKinsey is arguably better known than either the Catholic religious order or the London suit makers. Founded in 1926 by James O. McKinsey, who originally styled its consultants as “management engineers”, McKinsey is to consulting what Goldman Sachs is to banking: it supplies the most prestigious – and perhaps the most expensive – advice that top corporate and government clients can buy.

In 1937, after James McKinsey died unexpectedly, the Firm nearly disintegrated, but it came through this early crisis, was refounded in 1939 and grew in the 1950s and 1960s into an increasingly global consultancy, with revenues that had swelled tenfold to $20m by 1967. Periodically since then, the partnership has castigated itself for growing too far, too fast – but grown it has. As a private body it releases no figures, but Forbes estimates its current overall annual revenues at $7bn. It boasts 9,000 consultants worldwide out of a total staff of 17,000.

Since the 1970s, the consulting industry has burgeoned. For a company to shun consultants altogether is now rare, even eccentric. Walter Kiechel, author of The Lords of Strategy – a history of the discipline and the people who developed it – has estimated that three-quarters of the largest companies in the US, and similar percentages elsewhere, use strategy consultants such as McKinsey, Boston Consulting Group or Bain. In this strategy niche alone – where McKinsey carved out a pre-eminent position in the 1970s and 1980s – industry analysts estimate that the Firm retains a 10 per cent share of a $21bn market globally, ahead of Deloitte and BCG. On a broader measure of revenues, between 2009 and 2010 – despite the arrest of Anil Kumar and the spreading rumours about Rajat Gupta – McKinsey expanded by nearly 9 per cent. Of the top 10 consulting practices, only PwC, which offers a broader range of services, registered higher sales growth. McKinsey is, however, by no means the world’s biggest consultancy: it ranks only seventh by revenues.

But league table positions and absolute size are not as important to McKinsey as the quality of its frontline consultants, clients and work, and the extent of its influence. The Firm has long aimed to mop up the top graduates from universities and business schools – Rhodes scholars from Oxford (such as Barton), Baker scholars from Harvard Business School (such as Gupta), and so on – and insists they stay sharp. The Firm expects the leading partners in each discipline to be in the top 50 in the world. Industry insiders say directors, the equivalent of senior partners, earn at least $1m-$3m annually – a comparatively modest sum by the standards of the global chief executive class they serve.

Prestige costs money. McKinsey does not publicise its fee structure. But as a condition of bidding for US government consultancy contracts, rates have to be made public online. For instance, it would cost the American taxpayer $164,165 a week to tap the wisdom of one McKinsey engagement manager and three associates (the consultants below partner level), with “guidance and support” from other senior leaders. Comparisons are inexact, but based on information supplied for the same purpose, four experienced Accenture partners working for seven days would cost about 20 per cent less than the McKinsey sub-partner team. Despite the premium price of its services – or perhaps because of it – McKinsey says the 3,200 clients it has served over the past five years include 90 of the top 100 companies worldwide.

McKinsey diligently cultivates its reputation as trusted adviser at the highest level. Author Walter Kiechel writes that “the Firm’s ability to insinuate itself into local elites drives its competitors slightly berserk with envy.” In new markets such as China, where it has built contacts from the Communist leadership down, this schmoozing converts into “engagements” (the McKinsey term for client projects). These in turn become the “reference cases” that will spawn recommendations that other organisations should employ the Firm.

At the same time, the seeming omnipresence of former McKinsey consultants in high corporate and political places helps foster a sense of its importance. Even a couple of years in McKinsey’s lower reaches – as a business analyst or associate – can lift graduates of the Firm towards the corporate troposphere. They become heads of strategy, vice-presidents of sales, or directors of business development. Longer-serving consultants who have made “principal” (junior partner) or director are sometimes launched from there straight into seats in the boardroom, round the cabinet table, or into leading prominent NGOs.

The McKinsey roll of honour is long. Lou Gerstner, chairman of Carlyle Group and former head of IBM, and James Gorman, boss of Morgan Stanley, are both alumni. Sheryl Sandberg, Facebook’s chief operating officer, worked at McKinsey. So did the CEOs of BHP Billiton, Amgen, Boeing and Vodafone. Britain’s foreign secretary William Hague, and its chief financial regulator Lord Turner, used to be McKinsey insiders. Italy’s new economic “superminister” Corrado Passera worked at the Firm.

The powerful alumni network is in part the fruit of McKinsey’s policy of “up or out” – perhaps the best example in global business of a mutually beneficial rolling redundancy programme. Every two or three years, McKinsey determines whether its consultants will make progress to the next level in the Firm. If not, it gently pushes them out. The internal talent pool is further distilled and the Firm extends its web of potential contacts and customers. As a result, McKinsey alumni are famously loyal. Even those who spoke on background for this article – and had left the partnership years earlier – occasionally slipped back into the first person plural when talking about the Firm.

McKinsey teams often work to a template – an approach lauded by fans, condemned by critics – applying fact-based, structured techniques to any problem they are handed. This approach does not differ much from that of other consultants. But the implicit contract with McKinsey is that nobody else has the intellectual wattage, or the relentless devotion to the task provided by what one ex-director describes as a band of “insecure, deeply left-brain, hyper-intellectual, OCD over-achievers”.

The chief executive of one Indian services company, who hired McKinsey for a time-sensitive project, says: “If an organisation can get 50 or 60 partners across the world incentivised on a project … then I think they have a competitive advantage.” Other consultants to which he offered similar contracts could not manage it, he claims.

The culture binds staff closely to their employer. Some speak, only half in jest, about a code of omertà. Those who have worked there put a more positive spin on it. “Privacy is a natural outcome of people putting the client first and the work first,” says the former director. “It isn’t like … the big swinging dicks [of Wall Street investment banks]. People who get bigger than the Firm don’t last.” Ex-partner James Kondo agrees. Ego is “one of the things that destroys consulting firms”, he points out. Dominic Barton, he adds, “embodies the humility and low-key ethos that’s important to maintaining the organisation”.

Certainly, the global managing director does not fit the caricature of McKinsey consultants as arrogant know-alls with, in the words of another former partner, “lots of IQ, not much EQ”. Barton – known as “Dom” – is the kind of corporate boss who comes down to the lobby to greet his guests, and emails them useful follow-up information before they have returned to their offices. His manner is that of a firm but kindly doctor – exactly the sort of person an anxious chief executive seeking a diagnosis of his company’s malaise might turn to. Though a Canadian, Barton was running the Firm’s Asian operations from Shanghai in 2009 when partners elected him to the top job, following a five-year stint in South Korea. He represented a clear choice by partners to seek a leader “from Asia”, says one colleague. It was a bet on expertise about the fast-growing region that has only looked shrewder as the crisis in the US and Europe has dragged on.
Marvin Bower

He also sits comfortably in a line that goes back to legendary McKinsey chief Marvin Bower, who took up the role of managing director in 1950, aged 47, only a year older than Barton when he took the top job.

Bower, who died in 2003, is still worshipped as the soul of McKinsey. He transformed it from James O. McKinsey’s bunch of “management engineers” into a modern consultancy and laid down the principles around which the Firm is supposed to revolve. A framed version hangs on the wall in Barton’s London office, overlooking the Trocadero centre near Piccadilly – and in McKinsey outposts around the globe.

Bower also helped enshrine the “obligation to dissent”, which encourages even junior associates to challenge their seniors if they think something is not right.

The firm itself highlights, in an online tribute, his 1967 farewell memo to the London office in his last year as managing director. In it, he urges directors and principals to “shout out whenever they feel we’re doing anything that might impair the enduring values of the professional approach, or just letting those values erode through inattention” [his emphasis]. Asked by Fortune magazine in 1993 which period in the firm’s history had worried him most, he replied: “Now … Have we grown too fast? Have we begun to think too much about money because we’ve got so much coming in? … People who make a lot of money get to thinking about having four homes to keep up, or maybe they want to buy a yacht. If an individual consultant has to make a professional decision on the spot and he has too many obligations, I worry that he is likely to make a decision to attract a client who shouldn’t be attracted.”

What shocks staff and alumni is that Rajat Gupta should stand accused of precisely these sins of self-enrichment and self-aggrandisement. In one of the most memorable passages from the tapes played at the Galleon trial, Raj Rajaratnam, the hedge fund’s founder, and Anil Kumar speculated that Gupta wanted to become a senior adviser to Kohlberg Kravis Roberts, the private equity firm, in order to become part of a “billionaire circle”. As industry observer Raju Patel of Fulcrium, a specialist strategy consultancy, puts it: “If Marvin Bower were alive today and this [scandal] happened, he’d have a heart attack.”
Rajat Gupta

But people who know Gupta echo the words of one Indian executive – “I can’t put the two pieces together”. On the one hand, there is McKinsey managing director Rajat Gupta, the highest-profile Indian-American business figure of the 1990s and early 2000s and the embodiment of the Bower values; on the other, there is post-McKinsey Rajat Gupta, alleged tipster of insider traders.

Born in Calcutta and educated in New Delhi at the prestigious Indian Institute of Technology, before attending Harvard Business School, Gupta joined McKinsey in 1973, having been turned down at the first attempt. He was a highly regarded leader of the Firm’s Scandinavian and Chicago operations and his election as global managing director in 1994 – the first non-American in the role – was a crowning achievement.

It brought him huge accolades in India, and he repaid his native country with big philanthropic gestures. He helped start the Indian School of Business, with the help of now-disgraced McKinsey colleague Anil Kumar, and raised and donated money for Indian earthquake victims and HIV-Aids programmes, all the while nurturing Indian business contacts for the Firm.

“Humility” is the word that crops up in most interviews with Gupta conducted during his tenure. In 1999, he told the FT that Marvin Bower “set the values and … was a role model in saying you have to leave the institution stronger than you found it”. His three, three-year terms as managing director, from 1994 to 2003, were marked by a public commitment to, in his description, “a value-based, participative, partnership model of governance”.

But he had his critics internally, some of whom felt he had expanded McKinsey too fast – the Firm’s self-diagnosed recurring weakness – with an aggressively commercial approach, particularly during the dotcom boom of the late 1990s. His re-election for a third term in 2000 was, unusually, contested. But contemporaries say the criticisms were based on strategic, not ethical, differences. “He did so much good, in such a modest way, for so long, that there must be another factor [that led to the current situation],” says one now.

The role of McKinsey managing director contains contradictions. As Walter Kiechel has written of consultants in general, even the best “can be fairly hermaphroditic creatures, one minute exhibiting a professor’s passion for the great clarifying concept, the next displaying sales skills worthy of a street hustler”. Like all heads of McKinsey, as well as espousing the Bower values, Gupta also dined at the highest tables of the corporate world, from Davos to New Delhi. Exploiting this network, he made some risky non-McKinsey business alliances. In 2006, the year before he retired from the Firm, he partnered, fatefully, with Galleon’s Rajaratnam, to establish the investment firm that became New Silk Route. Separately, according to SEC filings on behalf of a company called Infogroup, Gupta and Kumar’s wives had set up a company called Mindspirit, through which, in 2001, the two consultants offered business advice to Infogroup and its chief executive. McKinsey believes Mindspirit was an investment vehicle. If the pair were offering consulting services on the side, this would not have been illegal, but it would have violated the Firm’s standards.

“He never lacked for confidence,” says one ex-McKinsey director who knew Gupta. This self-confidence and web of contacts made him a natural candidate to join the boards of Procter & Gamble and Goldman Sachs as he prepared for his post-McKinsey career. But US prosecutors in Manhattan now allege Gupta disclosed inside information learnt there to Rajaratnam, who traded on it. For instance, they say Gupta picked up the phone to the hedge fund manager 23 seconds after a conference call with Goldman directors and passed on information that the investment bank was about to announce its first quarterly loss.

If the arrest of Kumar in 2009 – accused of leaking information gained while working for McKinsey clients – cut deep, the reports of Gupta’s alleged connection to insider trading, which started to circulate the following spring, risked infecting the whole partnership. “This was the guy who was representing the values globally,” says one corporate strategy head who was working for McKinsey as an associate at the time, adding that the sense of disappointment and betrayal was strongest among junior staff.

“Longer term, McKinsey only maintains its position if it can direct a large number of unbelievably smart and accomplished young people to it,” says one insider. “All they have to go on is McKinsey’s reputation.” If unsavoury suspicion tainted the gene pool for one or two years, the firm would be weakened over time, he points out. Similarly, if international companies stopped recruiting former McKinsey staff, it could clog the “up or out” refining process.

The Kumar and Gupta cases are different. Anil Kumar admitted leaking information learnt from McKinsey clients while working for the Firm. The accusations against Gupta relate to events that happened after he left McKinsey – and he denies the accusations. Yet the charges could still strike at the core not only of the McKinsey consulting model, but of the whole industry: the implicit recognition by customers that knowledge of industries, countries and individual companies built up within the firm will be recycled for their benefit. If trusted advisers are no longer seen as trustworthy or private information leaks out of the system – let alone is sold by consultants for personal gain – clients are “going to be a bit gun-shy and a bit more careful about which doors they leave unlocked”, says Paul Gronwall, senior analyst at Kennedy Consulting Research & Advisory.

The whole affair has stirred up the doubts of sceptics. Richard Rumelt, strategy professor at UCLA, points out that, “Ideally, companies want inside knowledge of their industry without spying on their competitors.” The dean of another business school puts a more critical gloss on McKinsey’s work: “The selling proposition for McKinsey is ‘We have worked for all of your competitors and we will bring that knowledge to bear on this task, but it will be scrubbed.’ The fact that these companies are willing to hire [McKinsey] on that basis is flabbergasting. [The Firm] is dependent on the supreme naivety of its client base.”

It is not the first time McKinsey’s reputation has suffered. But past attacks centred mainly on the work the Firm had done, or the mistakes its high-profile alumni had made. The Enron scandal, which broke 10 years ago (during Gupta’s tenure as global managing director), put the Firm in the line of fire because the energy company had been a client and because ex-McKinseyite Jeff Skilling had been the disgraced group’s chief executive. Swiss Air went belly up after pursuing a disastrous policy of acquisitions, following advice from McKinsey (the Firm’s standard defence is that the airline bought the right strategy but then did the wrong deals).

As the partnership has built closer relationships with governments, it has also found itself in the crosshairs of wider political debate and subject to accusations that its much-vaunted research is not as thorough or well-grounded as McKinsey likes to imply. For instance, one UK academic blames McKinsey for pushing too hard the 1990s fashion, in Britain and elsewhere, for a more market-oriented public sector, commenting: “McKinsey and other management consultancies provided the neo-liberal scripts for the New Public Management reforms. These scripts are not founded on validated knowledge.”

But McKinsey is better able to repel these sorts of criticisms than to see off the frontal assault on its reputation from the recent Kumar and Gupta cases. In attempting to do so, the Firm has, characteristically, applied the same hyper-analytical approach to its own predicament as it would to any knotty corporate problem.
“The partners’ principal anxiety was summed up in one recurring question: ‘Why didn’t we pick up on it?’”

The partnership has communicated with its staff and former staff regularly since Kumar was arrested in 2009, and with added intensity since the firestorm around its reputation grew hotter in the spring. With outside legal help and following an independent inquiry, it has improved protection of confidential client data, reviewed its ethics policies and standards. It has defined what constitutes “material non-public information”, created a formal “stop-list” of client stocks that no member of staff (not only those on that assignment) can trade, added new training policies and strengthened governance.

But McKinsey has also reacted in an idiosyncratic way. Its senior people have gone delving back through history – the Firm’s own and that of other institutions, including those with which it is most frequently compared. Interviewed by the FT in June, Dominic Barton said he had been “thinking what happened with the suppression of the Jesuits in the 1700s. This may seem strange, but [it was] an organisation that was thriving and doing well and all of a sudden was severely challenged.” At the same time, Barton has revisited setbacks the firm had suffered in the past. He has benefited from the coincidence that a team of historians, under the supervision of high-profile British academic Sir David Cannadine, is putting the finishing touches to an internal history of the partnership.

Interviewed again last month, Barton said: “We’ve spent a lot of time looking at our history: for instance, in 1937 we almost went down. We had a difficult period during the war and in the late ’40s when we lost a lot of people to industry.”

The perils of over-rapid expansion are a thread running through the Firm’s history – and potentially affecting its future. Paul Friga, who worked at McKinsey in the late 1990s and now lectures on consulting at the University of North Carolina’s Kenan-Flagler business school, says McKinsey needs to answer one key question: “How do you maintain quality with growth?”

What went unspoken when Barton’s predecessor Ian Davis took over from Rajat Gupta in 2003, but is now common currency among self-critical McKinseyites, is that the firm grew too quickly in the preceding decade, more than doubling the number of consultants from 3,300 to 7,700 between 1994 and 2001. The rapid ballooning of the size of the partnership put the apprenticeship model – by which juniors learn from partners – under strain.

Davis refocused McKinsey on the Bower principles. Rather than riding the boom of the mid-2000s, he turned away business, and said No to regional heads – including Barton, then heading Asia – who wanted to grow faster. Now Barton himself is doing the same thing, pacing the organisation’s growth. “What I’m most keen on is that we’re the most relevant institution,” he says, “and it’s not about size.”

Davis himself echoes his successor: “When McKinsey values come under pressure, it hasn’t been a matter of size but a matter of pace of growth,” he says.

To blame Kumar and Gupta’s alleged failings on rapid expansion is too simple, however. Partners point out that both men already held high office at the consultancy at the time of the late-1990s hiring boom. What is more, the introspective inquiry led by Davis in 2003 into that period of expansion – and the subsequent refocusing on the values – self-evidently did not prevent Kumar’s breach of the McKinsey code, or Gupta’s alleged divergence from it after his retirement. Even so, the Gupta-Kumar crisis has underlined the challenge of managing a partnership as large as McKinsey, with 9,000 consultants across the globe. Barton now urges his colleagues “to think of [the Firm] as a partnership of 15 people. How would we act if there were 15 of us?”

“‘Gupta-gate’ is absolutely traumatic,” says Roger Parry, former McKinsey consultant and now chairman of YouGov, the pollster, among other companies. “They [McKinsey partners] hated how much was made of it – because they knew how isolated it was.”

To date, there is no firm evidence of damage to McKinsey’s business. Even those that had Anil Kumar or Rajat Gupta leading their account express confidence in the firm and a willingness to continue using it. And people still long to work for McKinsey. Paul Friga at Kenan-Flagler confirms that for his students “the appetite is still there. In fact, we’re going to have more people go to McKinsey this year than we have in the past six or seven”.

“‘If Bower were alive today and this [scandal] happened, he’d have a heart attack,’ says one industry observer”

The Firm hired some 2,000 people in 2010. While the emphasis is still on grabbing a large share of top Baker and Rhodes scholars, or their equivalent, the intake is, if anything, more diverse than ever, including lawyers, philosophers, 250 medical doctors, and at least two poets. Certainly, the 100 London School of Economics students who attended a presentation last month were more interested in joining McKinsey than the threat to its ethical foundations. The Galleon case was not raised, either by the recruiters, or the potential recruits. “I don’t know how many students know [about Rajaratnam],” said one LSE student who attended. “I’m not sure if it has had any impact. We’ve never spoken about it.”

But McKinsey’s leaders cannot afford to stop patching and polishing the Firm’s pipeline to power. Two weeks after the LSE presentations, Rajat Gupta was arrested and charged with one count of conspiracy to commit securities fraud and five of securities fraud, prompting further blanket media coverage. He has pleaded not guilty. His lawyer has said the charges are baseless and that the former McKinsey boss “did not trade in any securities, did not tip Mr Rajaratnam so he could trade and did not share in any profits as part of any quid pro quo”.

The build-up to the trial could well coincide with the build-up to Barton’s expected re-election in the first quarter of next year: the managing director seems likely to be returned for a second term. He claims to be thinking as much about the judgment of ex-directors 20 or 30 years hence as that of his fellow partners in 2012 and implies he will continue to lead the chastened firm on a more conservative post-Gupta path, particularly in difficult emerging markets. “I’m more worried about being criticised for having gambled big, than for having missed an opportunity,” he says. Some McKinsey partners are now concerned that the firm may worry itself to a standstill about the implications of the Gupta and Kumar cases. “We have to be careful we don’t do a Sarbanes-Oxley-style overreaction,” says a current partner, referring to the over-bureaucratic US corporate reform bill rushed through after the Enron and WorldCom scandals a decade ago.

When Barton stood up last month in Istanbul to address 440 directors at their regular gathering, he made a joke about such meetings always coinciding with some development in the insider trading case. That was the extent of formal references to the scandal. Perhaps the meeting of partners in Washington seven months earlier, as the Gupta and Kumar revelations came out, was cathartic. One person present in Washington says he emerged from that meeting with the “sense that it was a very fortunate coincidence that we were all together that week … We could talk through exactly what this meant”. Or perhaps, as one ex-director puts it, McKinsey has started to acknowledge that “sometimes shit happens and you just have to move on”.

Talking about the Kumar and Gupta affairs to the FT last month, Barton said, “We will never forget it.” Doubts sown by the saga will persist. While McKinsey has conducted its own internal reviews, it still cannot explain how Gupta and Kumar reached the top of the Firm – with its obsessive recruitment process, its cross-checks, its self-analysis, its culture of challenge – and then apparently turned bad. The Firm has not yet answered the question posed by partners in Washington, on that morning in March: “Why didn’t we pick up on it?”

Presentations have to be KR(i)SP:
K – Knowledge
R – Respect
S – Skill
P – Preparation

What do investors look for?
Investors look for
1. Large and growing market
2. Scalable business model – start small but be replicable over time and profitable
3. Competitive advantage – what is built in to sustain the economics of the business model (e.g., IP, entry barriers)
4. External validation – someone else also needs to vouch for your business model and say it is a good idea
5. Reasonable valuation – risks in start-ups are so high that angels look for returns between 10x to 30x to get 25% IRR
6. Great people – neither the techie, UI designer, salesperson, or the biz/fin guy, but solely the entrepreneur – YOU.

Why are YOU standing there?
It’s important for investor to bet on the jockey and not the horse.

Characteristics of a desirable entrepreneur:
- Integrity
- Passion
- Experience (starting a business)
- Knowledge (domain expertise)
- Skills
- Leadership
- Commitment
- Vision (to create something)
- Realism
- Coachability

Three things to get the venture pitch presentation right:
1. Content
2. Presentation
3. Delivery

1. Content
Start with a story, an analogy, a captivating but very short video, and continue reinforcing the impression.
How to keep investor emotions positive: logical progression, things they know or understand, validators, and believable upside.
What spoils investor emotions: untrue or incomprehensible content, things that make them think, internal inconsistencies, and typos.

2. Presentation
Structure of the presentation:
- Logo/name
- Context setter
- Management team
- Market/pain
- Product/solution
- Business model
- Customers
- Getting to market
- Competition
- Unique advantage
- History and status
- Financial overview (primary driver to bring revenues and 4-year financials)
- Amount being raised & valuation (only if there is a term sheet)
- Closing remarks

“Perfection is achieved, not when there is nothing more to add, but when there is nothing left to take away” – Antoine de Saint-Exupery

3. Delivery
In a pitch presentation, use images, have a separate leave-behind presentation with bullet points that show the content after speaking. While delivering the presentation, you can monitor the slide flow by using programs like keynote on Mac to get dual monitors.

This sermon was delivered on the Ninth day of Dhul-Hijjah, 10 A.H. (623AD) in the Uranah valley of Mount Arafat in Mecca. It was the occasion of annual rites of Hajj. It is also known as the Farewell Pilgrimage. After praising and thanking Allah the Prophet Muhammad (May the Peace be upon him) began with the words:

O People! Lend me an attentive ear, for I know not whether after this year I shall ever be amongst you again. Therefore, listen carefully to what I am saying and take these words to those who could not be present here today.

As part of this sermon, the prophet recited to them a revelation from Allah, which he had just received, and which completed the Quran, for it was the last passage to be revealed:
“This day the disbeliever’s despair of prevailing against your religion, so fear them not, but fear Me [Allah]! This day have I perfected for you, your religion and fulfilled My favor unto you, and it hath been My good pleasure to choose Islam for you as your religion.” (Surah 5, Ayah 3)

At the request of the Prophet, Safwan’s brother Rabiah (RA) repeated the sermon. His loud voice faithfully relayed the sermon sentence by sentence to over ten thousand gathered on the occasion. Towards the end of his sermon, the Prophet asked “O people, have I faithfully delivered unto you my message?” A powerful murmur of asserted, “O Allah! Yes!” Arising from the thousands of pilgrims, the vibrant words “Allahumma na’m,” rolled like thunder throughout the valley. The Prophet raised his forefinger and said: “O Allah bear witness that I have conveyed your message to your people.”

Over the last few days, as I do these practice case interviews, I realized that it would be more efficient to create a standard checklist that I can then use to base my feedback on. While the checklist is more aligned with a particular case I have created to give a holistic feel, I think this can be relevant in a general context as well. And some of the tips could evoke a WTH! kinda response also but the idea is to be as comprehensive as possible to appeal to users at varying stages of interview preparation.

For the purpose of this post, I will use a specific case to make my guidelines easier to understand and implement.

Here goes the checklist…

1. Use blank white A4 papers in landscape mode
The idea behind this is that your work should mimic as if you’re working on a MS-Powerpoint deck.

2. Number your pages beforehand
Sometimes interviewers may notice it and regard you as being very structured.

3. Once the interviewer gives the case brief, recap key information to make sure you got everything correctly. In case of long case briefs, make sure you’re very crisp and succinct without relaying the complete brief verbatim to the interviewer.
Case brief given: Our client is Navigant Advisors, a retail brokerage firm doing $5Bn revenue in 2010. It has 200 branches in the U.S. of which 100 are corporate owned and the remaining 100 are franchised. We have been retained by this client to help them understand the economics of the business.
An illustrative recap would be: Navigant Advisors is a $5Bn retail brokerage firm looking to understand the economics of its business and has a 50-50 split for its 200 branches amongst corporate owned and franchised.

4. Before getting into the framework, you can ask clarifying questions only to help you:
- Define the problem statement very clearly in case the given issue was very vague.
You could say, “By economics of the business, are we expected to estimate profitability of the business or analyze the cost structure, or is it something else?” Interviewer would respond saying, “Economics means profitability.”
- Understand the high-level (often hidden) objective that the client has in mind.
You could say, “If profitability was the key objective, the client could have very well asked an internal accountant to do the same but chose to hire a strategy consulting firm so there is something more strategic. It would be important to understand the larger goal behind this exercise. Is the client looking to divest this business or pursue some other strategic intervention?” Interviewer would respond saying, “Client wants us to help them identify opportunities for profit growth in the near term.”
- Learn basics about the client industry only if it is totally unknown.
You could say, “I am not familiar with this industry but I think retail brokerage firm would operate in the financial services space offering broker services for clients to invest in the market.” Interviewer would respond saying, “Yes, it is a financial services firm operating two divisions… (1) trading – doing trade transactions on behalf of clients, and (2) asset management – sourcing client assets and outsourcing it to an asset manager to manage those client assets.”

5. At this point, you have all the information you need to structure your problem solving approach. Just to make sure you haven’t missed out on anything, you could very well ask a general question such as, “is there any other client objectives that I should be aware of before I structure my approach?”

6. Whenever there is a possibility of doing analysis at different levels (e.g., company-level, division-level, product category-level, branch-level), it is important to clarify the same.
You could say, “the client has different branches and also has two operating divisions. Is the profitability analysis required at either of these levels or at the overall company level?” Interviewer would respond saying, “The client is looking to understand profitability at a division level. As for branches, assume that the financials are homogeneous across all branches so you can ignore any distinction between corporate owned and franchised branches.”

7. Be very judicious in managing the time vs. detailing trade-off while drafting your structure. While people might say it should not take more than 2-3 minutes, I feel that’s an over-generalization. You would know it yourself when the silence becomes uncomfortable. So, to be ready to explain your framework midway through the detailing in case you feel its taking long, its better to start with identifying the major areas/ issues before detailing each of them. Always, have some depth of detail for each issue you identify atleast one level.

8. When you explain the framework, always follow the pyramid principle of communication i.e., top-down.
The framework could have had 4 major buckets – Financials/Profitability, Market Trends, Competition, Customers. Within financials, you could have had two buckets, Revenue and Cost Structure with another level of detail explaining the revenue levers and cost segments… and so on.
You could explain as follows: “To solve the problem at hand, I would investigate four broad issues. Firstly, financials or profitability of the business. Secondly, the market trends to help us understand profit growth drivers. Thirdly, the competitive landscape and finally, customers and their preferences. Within financials, I would look at two areas – revenue stream and cost structure. Within revenue streams, the possible levers to be explored are product mix (the kind of products and services offered by our client), the number of transactions or clients served, and the pricing strategy. Within cost structure, I would look at the fixed costs and the variable costs. Then moving on to market trends….”

9. At this point, some firms expect you to prioritize the issues while some firms/ interviewers would steer you through the next steps by asking you specific questions.
For purposes of this article, I will use the latter case which is the typical McKinsey style.

10. Now you move on to the analytical part whereby the interviewer will identify a specific issue to go into details with.
Interviewer would say, “Let’s look at the financials work stream. Why don’t you detail out what we can analyze here?” You could say, “Going back to the framework, I would source the following information. For pricing, I presume there could be a fee structure based on the kind of services we offer. And then for each division, I would look at the transaction mix and the volume. Moving on to cost structure, firstly, let’s look at the fixed costs. Being a financial services brokerage firm, some big cost components would be technology for the trading platforms and compensation. Then there are the usual overheads such as marketing, real estate rental, and office administration. On the variable costs, I would presume there is a fee we might have to pay to the exchanges for trades and also some external fee to be paid on the asset management side.” Interviewer would make it conversational and correct/ qualify your hypotheses as you speak but it would be more like, “Yes, there is standard fee charged for every transaction in trading uniform for all transactions. On the asset management side, there is again an annual fee charged as a percentage of AuM. For costs, the compensation has been moved to variable cost at this client so the only fixed costs are technology, marketing, and SG&A. Let’s do some math now to arrive at profitability.”

11. At any point in the interview when you’re analyzing something, never ask open-ended questions (such as, “what are the fixed costs for this business?”) but try and hypothesize on what you think could be the answer (such as, “looking at fixed costs, I would think it is technology, and administration overhead. Is that correct?”). In the latter case, you’re demonstrating that you’re immersed in the client situation and are thinking actively about what could be the answer in this context. There is no harm in going wrong and/or being corrected by the interviewer.

12. Now, when you get on to math, if the analysis was done already like in this example, the interviewer would just provide you the numbers directly.
Interviewer would say, “On the revenue side, trading volume is 300Mn transactions per year and fee charged at $10 per transaction. For asset management, the fee charged is 1% of AuM…” You can calculate the trading revenues as 300Mn x 10 = $3Bn. And then going back to the original case brief, you know overall revenues are $5Bn which means asset management revenues are $2Bn. If that is 1% of AuM, then AuM = 2Bn/1% = $200Bn. There would be cost data also provided on the same lines.

13. If the data is very complex, you could even choose the option of modeling out the math problem before getting the numbers or get the numbers and model it out before you plug in the numbers.

14. When you do math, use a new sheet of paper and lay out all the analysis very clearly using data labels wherever possible. This will help you structure your calculation, avoid making simple math mistakes, and also make it reusable in case you have to secondary analysis using this math analysis.

15. Once you have your answer for the math problem, don’t stop there but make an inference. Try and relate it back to the client problem/ context.
You could say, “Based on the information we had, both divisions seem to bring in equal profits of $200Mn each to the client business. However, if we look at profit margins, asset management division is relatively more profitable possibly due to disproportionate fixed cost structure owing to technology costs.”

16. At this point, interviewer might shift gears to the data interpretation part whereby you will be given an exhibit (graph/ chart / data tables) and asked to firstly explain the exhibit and then share insights that could matter to the current problem solving exercise. There is no need to do any number crunching unless specifically asked. The interviewer is looking to understand your thought process and also test you on how you can quickly translate complex data exhibit into manageable information and apply it to the client context.

You could say, “This exhibit provides gross revenue numbers for the retail brokerage industry for the last five years, 2006 through 2010. On the other dimension, the data is provided for 4 key players including our client along with another aggregate bucket for other market players. This seems to reflect the overall industry. Before we get into details at a company-level, let’s look at the aggregate numbers. Overall, the industry seems to have grown aggressively from 2006 to 2008 after which the growth has plateaued out. Moving onto our client, Navigant Advisors, we see that our client grew from 2006 to 2008 but shrank after that. This implies that there could be another company that grew in the last two years at our expense. Let’s look at Mega Corp, they grew till 2009 but shrank so while they are partly responsible for our client’s decline there has to be another company and that is Deutsche Group which grew in 2009 and 2010. As of 2010, our client is the third largest firm. Based on all this, if I am looking at profit growth opportunities, I would look at two areas – how the market is trending going forward, and secondly, what made Deutsche Group so successful in the last couple of years.”

17. Most likely, the interviewer might switch to another area from this i.e., analytics / idea generation. This is like a clean-slate thinking approach whereby you’re being tested on how creative you are, the breadth of your thinking, and also how you use available data to validate some of your ideas right away.
Interviewer could say, “Let’s look at some ideas that we can share with our client for improving profits in the near term. Why don’t you come up with those?” You could definitely ask for some time to gather your thoughts and then come up with a response like, “There are three ways to grow profits – increase revenues keeping costs constant, reduce costs keeping revenues constant, and increasing revenues while reducing costs. In all these possibilities, the two main levers are increasing revenues and reducing costs. For increasing revenues, one would be to increase transaction volume / client assets i.e., through new customers (current non-customers, competitors’ customers, or new geography) or selling more to current customers. Pricing could be difficult to increase due to competitive pressures and regulations. Our client can try and introduce new products and services also to add to the offering mix. On the cost side, looking at the data we have, the two big areas are compensation and technology. We can look at a progressive compensation structure and benchmark with industry to bring it down to reasonable levels, and for technology, we should either consider outsourcing or offshoring (if technology is proprietary).”

18. At this point, you have been tested on all the four broad areas – problem definition & structuring, analytical & idea generation, math, and data interpretation. The interviewer might ask you to summarize your key findings and recommendations for the client.
Interviewer could say, “At this point, why don’t you summarize our key findings and recommendations for our client.” You could respond like, “Firstly, looking at profitability, both divisions are equally profitable bringing in $200Mn annual profits each but on a profit margin level, asset management is more profitable at 10% vs. 6.7% for trading. Looking at the macro industry, industry growth has plateaued while a key competitor, Deutsche Group has gained a big share in the last two years so would be important to factor in while discussing profit growth. For growing profits, amongst the two levers, the first one is increasing revenues by introducing new offerings and adding customers. For reducing costs, the two big candidates are compensation and technology. As a next step, I would understand the market and customer preferences before developing specific recommendations on profit growth.”

The protest movement that began in Tunisia in January, subsequently spreading to Egypt and then to Spain, has now become global, with the protests engulfing Wall Street and cities across America. Globalization and modern technology now enable social movements to transcend borders as rapidly as ideas can. And social protest has found fertile ground everywhere: a sense that the “system” has failed and the conviction that even in a democracy, the electoral process will not set things right — at least not without strong pressure from the street.

Across all the protests visible in different part of the world, there is a common theme, expressed by the Occupy Wall Street movement in a simple phrase: “We are the 99 percent.” That slogan describes the enormous increase in inequality in the United States: one percent of the population controls more than 40 percent of the wealth and receives more than 20 percent of the income. And those in this rarefied stratum often are rewarded so richly not because they have contributed more to society — bonuses and bailouts neatly gutted that justification for inequality — but because they are, to put it bluntly, successful (and sometimes corrupt) rent-seekers.

This is not to deny that some of the one percent have contributed a great deal. Indeed, the social benefits of many real innovations (as opposed to the novel financial “products” that ended up unleashing havoc on the world economy) typically far exceed what their innovators receive.

But, around the world, political influence and anticompetitive practices (often sustained through politics) have been central to the increase in economic inequality. And tax systems in which a billionaire like Warren Buffett pays less tax (as a percentage of his income) than his secretary or in which speculators, who helped to bring down the global economy, are taxed at lower rates than those who work for their income, have reinforced the trend.

Research in recent years has shown how important and ingrained notions of fairness are. Spain’s protesters, and those in other countries, are right to be indignant: here is a system in which the bankers got bailed out, while those whom they preyed upon have been left to fend for themselves. Worse, the bankers are now back at their desks, earning bonuses that amount to more than most workers hope to earn in a lifetime, while young people who studied hard and played by the rules see no prospects for fulfilling employment.

The rise in inequality is the product of a vicious spiral: the rich rent-seekers use their wealth to shape legislation in order to protect and increase their wealth — and their influence. The US Supreme Court, in its notorious Citizens United decision, has given corporations free rein to use their money to influence the direction of politics. But, while the wealthy can use their money to amplify their views, back on the street, police wouldn’t allow me to address the Occupy Wall Street protesters through a megaphone.

The contrast between overregulated democracy and unregulated bankers did not go unnoticed. These protestors are right that something is wrong about our “system.” Around the world, we have underutilized resources — people who want to work, machines that lie idle, buildings that are empty — and huge unmet needs: fighting poverty, promoting development, and retrofitting the economy for global warming, to name just a few. In America, after more than seven million home foreclosures in recent years, we have empty homes and homeless people.

The protesters have been criticized for not having an agenda. But this misses the point of protest movements. They are an expression of frustration with the electoral process. They are an alarm.

The antiglobalization protests in Seattle in 1999, at what was supposed to be the inauguration of a new round of trade talks, called attention to the failures of globalization and the international institutions and agreements that govern it. When the press looked into the protesters’ allegations, they found that there was more than a grain of truth in them. The trade negotiations that followed were different — at least in principle, they were supposed to be a development round, to make up for some of the deficiencies highlighted by protesters — and the International Monetary Fund subsequently undertook significant reforms.

So, too, in the United States, the civil-rights protesters of the 1960s called attention to pervasive institutionalized racism in American society. That legacy has not yet been overcome, but the election of President Barack Obama shows how far those protests moved America.

On one level, today’s protesters are asking for little: a chance to use their skills, the right to decent work at decent pay, a fairer economy and society. Their hope is evolutionary, not revolutionary. But, on another level, they are asking for a great deal: a democracy where people, not dollars, matter, and a market economy that delivers on what it is supposed to do.

The two are related: as we have seen, unfettered markets lead to economic and political crises. Markets work the way they should only when they operate within a framework of appropriate government regulations and that framework can be erected only in a democracy that reflects the general interest — not the interests of the 1 percent. The best government that money can buy is no longer good enough.

Joseph E. Stiglitz is a Chazen Adivsor, University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.

Early 2011 overview:
- Long-term fundamentals in oil are robust; investing in 20- 30 year time frame; worried about long-run oil price (in 5+ years)
- Downstream: Large refinery in British Virgin islands – once people see uptick in margins, then people chase those margins. Only 1 in 7 years provide good margins! We are not going to make good money in the refining business for the next 5 years. Optimized 500,000 barrels a day to 250,000 barrels a day.
- Natural gas – more exciting hydrocarbon. This is an absolute game changer for the U.S. Today one of the top 4 resource holders in the world.
- Power generation: all incremental natural gas demand in the U.S. comes from the power sector. The largest and the fastest growing energy sector in the world

Overall energy picture: Bottom line – Asia overtakes – globalization
1. Oil demand and GDP – highly correlated (IMF, BP Statistical Review, PRA)
2. GDP / Per capita to crude oil per capita consumption. U.S an outlier. European and Japanese a step lower. Korea has made a step change. Magic figure – $15,000 GDP per person – after this level people buy personal transportation. China car sales exceeds U.S. car sales. If China got to the same level as U.S., then scare. China: 2 barrels per person vs. U.S. 22 per person – If China got to U.S., then global oil demand will be twice demand today – non feasible solution
3. Oil demand growth: key dependent variables: wealth, population, efficiency. Every country is getting more efficient in its use of oil.
4. China pulled the demand of oil up single handedly out of the 2009 recession due to its massive stimulus package
5. Capital budget in a few weeks for 2012 – predicting oil prices. Every $10 barrel change in oil price is $500 mm in cash flow
6. U.S. Govt spending up 7% while GDP up 4% since 2000; and revenues have been flat!. Unemployment rate; huge declines in savings rate in the U.S. Money was all spent on imports (bureau of economic analysis, IMF)- reflected in the U.S. current account balances – shifting manufacturing industries to Asia – moving energy intensive industries to India. Incremental oil growth today is dominated by Asia! To understand oil prices – look at rate of change of oil demand vs. oil supply. Key question: will Asian oil demand hold off
7. 2008 – 2009: lost 2 mm barrels of oil a day; got that 2 mm barrels back in 2010 – all from Asia and not from OECD; 2010: historic high of global oil demand
8. Crude oil is really good for transportation: need high energy density fuel for transportation – easy to carry – one gallon of oil gets 40 miles. We need high energy density oil fuels to replace oil for transportation.
9. Most of OPEC world is nationalized – hard for Hess to play – we play in non OPEC world – we are playing in a set of the world where there are shrinking discoveries . 46% of discoveries in the non-OPEC world are in Brazil. Have classic materiality problem. 30 bn barrels of crude oil a year. 6 bn barrel 2P field in Brazil. World needs to discover 6 such fields ever year! To make up losses. OPEC can chose to produce whatever it wants from its oil discovered in the 1950 – 1970. Non OPEC is focused
10. North Sea, Mexico – is in decline – Canterrel the biggest field is declining 17% a year – huge issue for country going forward.
11. Iraq is the only country in the world where people know oil is there, but the investment has not followed it.
12. Long run – we believe that OPEC will go for price. We look at OPEC spare capacity – is a key long-run indicator of oil price firmness. OPEC spare capacity will diminish by the end of this decade in determining oil price. Arab Spring – Govt. will spend more to keep citizens happy – If Saudi Arabia raises its govt. budget ; breakeven price for Saudi Arabia’s budget has gone up ($60 to $80)
13. Only two countries matter: Saudi Arabia and Iraq. Iraq has currently signed contracts for 11.6 mm incremental barrels of oil in 2017 above its 2.4 mm barrels today. This will be higher than Saudi Arabia’s 12.5 mm barrels a day today. Will Iraq co-operate on production with the rest of OPEC (i.e. Saudi Arabia)? Saudi Arabia: look at their annual spend – they are spending a lot of their money on their budget – currently their break even is at $75 – $80 a barrel!!! OPEC spare capacity shot down from 1980 to 1990 and then build up to 200 back again. From 2000, globalization began to occur and hence OPEC spare capacity began to decline again! Today Hess’ assumption on spare capacity is at the same levels in 2015 at all-time trough spare capacity in 1990
14. In 2007, at $60 a barrel, OPEC cut production, increased spare capacity to increase prices. In 2008 it increase +0.5 mmbl. At $40 a barrel in 2009-2010, they cut 4.5 mm barrels to defend prices! OPEC quotas are based on reserves base – supposed to work on reserves – but this is fiction! In theory it is allocated according to reserves but essentially everyone quota breaks and so the burden falls back to Saudi Arabia – the only player that can really move the market.

Hess oil view: demand back at historic highs, China and non-OECD drive growth, increasing dependence on Saudi Arabia and Iraq; declining spare capacity, robust price outlook.
Iraq – cheapest oil to find in the world today. With Exxon, BP and Shell, you have so much oil to replace, you kind ignore oil in Iraq. We have ignored Iraq and we are investing in Kurdistan – still has huge risk – we have swapped geopolitical risk for geological risk!
Iraq oil – costs $10 to $30 a barrel. Key question – what will be taxes.
Libya – back in; but just evacuated all out people again. 93% tax rate in Libya! So in value terms we haven’t lost much! Should have a low impact on our stock – need to evaluate govt. take!
Natural Gas
Not a global market yet – become increasingly linked. Three market chunks – U.S. Europe, Asia – long haul pipelines and LNG are linking these prices together. Cheapest LNG by far from Qatar. They can swing their volumes easily to balance global markets. Australia is rapidly developing LNG capacity. Mostly all of it is shipped. Supply of resource and distance shipped is key to understanding pricing.
Big game changer in Alaska – can you bring the gas south in a pipeline and then liquefy – though no longer attractive because of shale gale.
Russia, Qatar, Iran and U.S. – 54% of world natural gas resources.
Lots of demand in the U.S.; low resources but high demand in Europe – more resource dependent. Asia – loads of demand but not that much supply. China wants to develop indigenous shale gas resources.
Natural gas cartels are worse than OPEC! Top 10 suppliers of natural gas have 65% of supply!
Natural gas – big use in power generation. Coal plant input vs. output – 35% loss. Big efficiency gain using natural gas. Coal. Plateau-ing use of coal in the U.S. due to natural gas. Fundamental problem with natural gas – doesn’t go into transportation segment easily! We either need to develop LNG vehicles. There isn’t enough incremental gas demand to eat all the supply. Need to shut down a whole lot more coal plants.
Hayensville shale has seen the most rapid growth – people have been holding their acreage.
Wind is by far the most economic renewable!

Natural gas pricing drivers:
1. On the high side gas competes with fuel oil
2. On the low side – can switch coal plants to natural gas
3. Old paradigm – coal price floor for natural gas; not true any more. Today gas on gas competition – today market price for henry hub is below coal price floor.

Banking System We Can Trust
Turn all financial firms into mutual funds.

Before throwing more money at Wall Street, let’s understand what our financial system was supposed to deliver, what it did deliver and what price it charged.

The system was supposed to channel our hard-earned savings into the best real investments: new homes, offices, factories, equipment and research. And it was supposed to correctly price our assets.

It did neither. Instead, Wall Street morphed into a vast gambling enterprise, generating massive trades of existing securities without, in fact, raising the investment rate or growing the economy.

During the dot-com bubble, Wall Street funded all manner of silly businesses, and during the housing bubble, it put millions of people in homes they couldn’t afford. This “expertise,” which cost one-tenth of our output, was delivered by the best and brightest, with half of Harvard’s graduating classes becoming high-class croupiers.

As for pricing assets, the stock market’s been on a five-decade roller coaster, notwithstanding a relatively stable real economy. The market rose dramatically from 1950 through the mid-1960s. It then spent the next decade and a half falling through the floor. Then it rose like crazy in the late ’90s, crashed, soared and crashed again.

We need a financial sector but not one like this. Nor do we need Wall Street hitting us up for its gambling debts. What we need is Limited Purpose Banking (LPB), which would transform all financial corporations, including insurance companies and hedge funds, into mutual funds. They would, henceforth, be called banks.

Under this system, banks would never fail for a simple reason. They’d never hold any financial assets and they’d never borrow except to finance their mutual fund operations. Instead, they’d be limited to their legitimate purpose–financial intermediation. Under LPB, people, not companies, bear risk as their mutual funds do well or poorly.

A new Federal Financial Authority (FFA)–would rate, verify, supervise custody, disclose and clear all securities purchased, held and sold by LPB mutual funds. Private rating companies could stay in business, but no one would need to trust them ever again.

Banks would initiate personal and business loans (including mortgages), send them to the FFA for processing and then sell them to mutual funds, including their own. Loans would activate when sold, so no bank would ever have an open position.

All mutual funds would break the buck with one exception: cash mutual funds. These funds would strictly hold cash and be valued at $1 per share. Owners of these funds would write checks against their balances and never have to worry about a bank run. Fractional reserve banking and the FDIC would be history.

LPB would include insurance mutual funds. These funds would pay off based on the losses experienced by contributors. If losses are larger than expected, less is paid out per loss. Hence, LPB prevents insurance companies from insuring the uninsurable, e.g., claiming they’ll pay the same life insurance claims even if there’s a plague.

All risk allocation arrangements can be run through mutual funds, including credit default swaps. Take a bank that markets the GE-Defaults-On-Its-Bonds-In-2010 fund. Under this closed-end fund, shareholders specify in advance if they want to get paid off if GE does default on its bonds in 2010 or paid off if GE doesn’t default. All money put into the fund, less the mutual fund’s fee, would be held in one-year Treasuries and paid out at the end of the year to the winning shareholders in proportion to their holdings.

Hence, Limited Purpose Banking can accommodate credit default swaps (CDS) as well as any other risk product. But what Limited Purpose Banking won’t do is leave any bank exposed to CDS risk since people, not banks, would own the CDS mutual funds.

If such mutual funds sound revolutionary, they’re not. Funds of this kind have been around for centuries. They go by the name “tontines,” or systems of “pari-mutuel betting.”

Limited Purpose Banking would enhance liquidity, since all funds would trade in the market even if their underlying assets are illiquid. It would permit the extension of as much credit as the public–which is the ultimate source of credit–wishes to provide by buying mutual funds that purchase household and business loans. And it would force banks to charge fees and pay their employees based on their mutual fund performances as determined by the market.

What LPB will eliminate is insider rating, freeriding on FDIC insurance, self-custody arrangements, no-doc loans, institutionalized gambling, me-now compensation plans, financial malfeasance and the possibility of future financial collapse. In other words, it would be a system we can trust.

Source: www.Forbes.com

Five key principles that were defined as the cornerstone of a sound financial system are:
1. Increase share of equity and reduce share of debt in the total financing of economic activities
2. When the need of debt is justified, it should be extended on the basis of sound due dligence that includes logical risk-reward considerations
3. Credit should be confined primarily to transactions that are linked to the real sector to ensure that credit expansion moves more or less in tandem with the growth of the real economy
4. All financial institutions, not just banks, need to be properly regulated and supervised so that they remain healthy and do not become a source of systemic risk
5. Respite should be given to debtors who err in real distress beyond their control – the giving of respite in such circumstances along with necessary restructuring that Islamic Finance requires will help reduce risk of asset price reduction caused by forced liquidation/ acquisition of borrower’s assets

It is also important to note that the principles of Islamic Finance are not specific to the Islamic faith – they are part of all divine religions and also secular paradigms. The underlying principles of Islamic Finance have been described as ethical and universal.

This becomes all the more relevant in the current times as various forums (G20, IMF, World Bank, Central Banks, EU, etc.) are thinking about how to stop this financial contagion but are limited in their thinking to just merely making some tweaks in the existing order. Islamic Finance offers a radically different alternative that can mend this systemic epidemic. As the Economist noted, “the world needs new ways of thinking and the risk involved therein”, Islamic Finance offers basic principles for this very purpose.

Some western economists and finance experts have begun to understand the merits of the Islamic Finance system. A notable mention is the work done on “Limited-purpose banking” by Prof. Laurence Kotlikoff, Former Senior Economist on the President’s Council of Economic Advisors and currently an Economics Professor at Boston University. More on this subject in a separate post.

I am sitting in my New York apartment eager to ride out Hurricane Irene. Everywhere in Manhattan, there seems to be utter panic. One supermarket had this displayed: “We have water available even now”.

Anyways, rewinding to where I left in my first recount, I completed my client study in Florida in the first week of August and then quickly started another client study the next week. On the side, I also observed fast it being the Islamic month of Ramadan. However, my stint was made easier with the client being closer home in New Jersey (15min drive from New York city). Client from a new industry (consumer goods), this was a short study but very high visibility… direct work with the senior client leadership (CEO and downwards) on a daily basis. This study gave me a great opportunity to work on my client communication and client relationship building skills.

On the personal front, had some great milestones (wife’s birthday and wedding anniversary) that rounded off with me finishing my internship on a high note…
Client satisfaction. Check.
Team appreciation. Check.
Study completion. Check.
Return job offer. Check.

So, now am back into the school mode with a great relief of not having any recruiting pressures. I feel that I can put a lot of emphasis on extending my learning in the second year and also build my skill set. Also, this gives me a huge opportunity to focus on things beyond academics and recruiting.

Zooming into the next 2 weeks before I start classes, have plans to stay home to celebrate Eid with family here in New York following which I will round off my summer with a short trip to Chicago to meet my brother and his family. And then back in action… after possibly the most memorable summer in a long time!!!!