Goldman Says Due Diligence ‘Not Our Job’ in Dragon Sale

Goldman Sachs Group Inc.’s lawyer said it wasn’t the firm’s job to do financial due diligence for its client, Dragon Systems Inc., in the company’s 2000 sale to a Belgian competitor that collapsed in an accounting scandal.

John Donovan Jr., a lawyer for the New York-based bank, told a jury in federal court in Boston yesterday that Goldman Sachs was hired to negotiate the terms of the transaction for Dragon, not to uncover the fraud at the acquirer, Lernout & Hauspie Speech Products NV.

The founders of Dragon sued Goldman Sachs claiming its bad advice led to a disastrous $580 million all-stock transaction.

“Financial accounting diligence was not Goldman’s job,” Donovan, a partner in the Boston law firm Ropes & Gray LLP, told six jurors and six alternates yesterday in his opening statement. “You turn to auditors and accountants to ask questions about auditing and accounting.”

Jim and Janet Baker, pioneers in computer speech recognition, claim Goldman Sachs’s failure to pursue red flags cost them their company and access to technology they spent their professional lives creating, including the rights to Dragon NaturallySpeaking, the company’s popular dictation software.

Within months of the sale’s June 2000 close, Lernout & Hauspie, based in Ieper, Belgium, filed for bankruptcy after an investigation found the firm fabricated customers and reported phony revenue. Several executives were prosecuted and jailed.

Cooked Books

“Lernout & Hauspie was a fraud,” Donovan argued. “They cooked the books and it was a highly sophisticated scheme that took years to unravel.”

Donovan told jurors that Goldman Sachs urged Dragon to get its accountants at Arthur Andersen LLP to probe Lernout & Hauspie’s financial statements. Goldman Sachs didn’t owe a duty to the Bakers as shareholders because it was hired to advise Dragon, not them, he said.

“Goldman Sachs was to interact with the board and the management, not the shareholders,” Donovan said.

Donovan told jurors that the four-man Goldman Sachs team assigned to the Dragon transaction did a good job of bringing the deal to completion.

When Goldman Sachs was hired by Dragon in 1999, the company was badly managed, had poor finances and was overly dependent on a single product, Dragon NaturallySpeaking, which accounted for 85 percent of revenue, he said. The company had few alternatives to the Lernout & Hauspie sale, he said.

Offer Changed

The Bakers agreed to let Lernout & Hauspie change their offer from a half-stock, half-cash deal to one that was all stock without Goldman Sachs’s input, Donovan said. And Dragon’s owners failed to demand a collar on the deal, to protect them if the shares declined, because the Bakers thought the Lernout & Hauspie shares would increase in value, he said.

“Goldman did the job that Dragon expected,” Donovan told the jurors. “That’s what the evidence will be.”

The Bakers, who started Dragon with $30,000 in their West Newton, Massachusetts, home, owned 51 percent of the company. They are joined in the suit by Paul Bamberg and Robert Roth, Dragon co-founders who held a minority of its shares.

The trial started Dec. 10 with jury selection and opening statements by lawyers representing the Dragon founders.

Judge Saris

U.S. District Judge Patti Saris told jurors Dec. 10 that it may last until Jan. 25.

After Donovan’s opening statement, the Bakers’ lawyer, Alan Cotler of Reed Smith LLP, called Jim Baker as the first witness in the trial. Cotler immediately asked his client a series of questions to try to rebut the claims Donovan had made.

“What was Goldman hired to do?” Cotler asked Baker.

“They were hired to be our financial adviser for finding a suitable acquirer,” Baker answered. “And part of finding a suitable acquirer was to do due diligence, or what a layman might call ‘to kick the tires.’”

Dragon had “lots of other options” if it had been advised to reject the sale to Lernout & Hauspie, Baker said, including a possible sale to Visteon Corp., a former Ford Motor Co. unit.

Dragon’s Origins

After a break, Baker testified about the origins of Dragon, starting with his graduation in 1967 from Princeton University, as class valedictorian, and graduate studies in mathematics at Rockefeller University and in computer science at Carnegie Mellon University. He met Janet MacIver, a graduate student in biophysics, in 1970 and they married the next year, he told jurors.

After a series of positions in which they researched computer speech recognition, the Bakers, with physicists Bamberg and Roth, started Dragon Systems Inc.

“We had to be profitable, because that’s what we were living on,” Baker said of the company’s early years. Later, Dragon sold a minority share in the company to computer disk drive maker Seagate Technology PLC, he said.

The introduction in 1997 of Dragon NaturallySpeaking, the first large-vocabulary dictation program that could distinguish words as they were spoken at a natural rate, rather than with pauses between words, caused Dragon to grow to a company with more than 300 employees and offices in Newton, Massachusetts, the U.K., Germany and Japan, he said.

Acquisition Offers

When the company hired Goldman Sachs, it was fielding unsolicited acquisition offers, he said. It was seeking the money to pursue company-developed technologies including speech-recognition for cars and for telephones and other handheld devices.

Baker told jurors that Dragon’s technology and the people who developed it made the company valuable. The Goldman Sachs team had said Dragon was worth as much as $1 billion, he told jurors.

Baker’s testimony is scheduled to continue today.

The case is Baker v. Goldman Sachs & Co., 09-cv-10053, U.S. District Court, District of Massachusetts (Boston).

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