Goldman Sachs Tells Jury Dragon Rushed Toward Doomed Deal

Goldman Sachs Says Dragon Rushed Toward Doomed $580 Million Deal
Dragon Systems’s founders, Janet and James Baker, are seeking hundreds of millions of dollars in damages, claiming that four Goldman Sachs bankers assigned to the transaction committed gross negligence. Photographer: Gretchen Ertl/The New York Times via Redux

Goldman Sachs Group Inc. portrayed speech recognition pioneer Dragon Systems Inc. as rushing to close a $580 million deal without sufficiently vetting its buyer in a doomed union that triggered a negligence suit and landed the bank in Boston federal court.

Beginning its defense this week, Goldman Sachs made its case to jurors who have spent weeks hearing how the 2000 all-stock deal was quickly followed by an accounting scandal that led to the collapse of suitor Lernout & Hauspie Speech Products NV. Goldman Sachs, which advised Dragon on the deal, called witnesses to counter allegations by Dragon founders Jim and Janet Baker that its negligence cost them their life’s work.

Testifying Jan. 9 for Goldman Sachs, former Dragon president John Shagoury agreed with a bank attorney that Dragon’s board of directors was focused on “speed and certainty” in the months leading to the deal.

“Because the company’s financial situation was getting worse instead of better, and at the same time we felt it was creating a huge distraction for the employees, we needed to get something done, or decide how the company was going to continue,” Shagoury testified.

“Do you blame Goldman Sachs that the stock options became worthless in the merger?” Goldman Sachs attorney Paul Vizcarrondo asked.

“No,” said Shagoury, who became president of Lernout & Hauspie Holdings USA when the deal closed, and is now president of health care communications technology company Eliza Corp.

Gross Negligence

Dragon’s founders, who are seeking hundreds of millions of dollars in damages, claim that four Goldman Sachs bankers assigned to the transaction committed gross negligence by failing to pursue questions about Belgium-based Lernout & Hauspie’s finances that should have led them to avoid the deal.

They alleged in court papers that they lost their company and access to the technology they had spent their careers developing, including Dragon NaturallySpeaking dictation software, when Lernout & Hauspie filed for bankruptcy in November 2000. The deal closed in June of that year.

Goldman Sachs claimed its team gave Dragon competent advice and said it urged company management to press their accountants at Arthur Andersen LLP to probe Lernout & Hauspie’s finances.

The Bakers, who started Dragon in 1982, claim the bankers failed to do due diligence and never advised them to back away from the sale despite lingering questions about L&H’s unusual revenue spikes in Asia.

Due Diligence

Lawyers for New York-based Goldman Sachs have argued that due diligence wasn’t the bank’s responsibility under a five-page engagement agreement. Several members of the banking team who worked on the deal said in court testimony that Goldman Sachs properly shepherded the transaction to a final sale.

Dragon paid Goldman Sachs $5 million for its advice.

With the sale moving ahead in February 2000, Goldman Sachs sent Dragon an unsigned memo recommending the company have Arthur Anderson perform due diligence on Lernout & Hauspie, according to court papers.

Catherine Moy, who worked on the Dragon account for Arthur Anderson, testified Jan. 7 that her firm’s work was “very limited” on the deal. She said the accounting firm was never hired to do any of the tasks Goldman Sachs described in its Feb. 29 memo to Dragon.

Former Dragon President Shagoury testified that he remembered both Dragon’s chief financial officer, Ellen Chamberlain, and Goldman Sachs’s team wanted further due diligence. He said Chamberlain eventually declared it done.

Recalls Completion

“I recall she said the due diligence was completed,” Shagoury told jurors.

Chamberlain, who testified Dec. 18, told the jury that Dragon expected Goldman Sachs to conduct due diligence. She said no one from the bank ever expressed reservations about moving forward with the sale.

“I had a level of expectation of bankers driving a process, making due diligence happen, being very active, detailed and that was not the way Goldman Sachs operated,” she said.

Chamberlain also testified that no one on the Goldman team ever mentioned that the bank’s own investment division had investigated L&H in the late 1990s, under work labeled internally as “Project Sermon,” and decided not to invest.

In a videotaped deposition played for the jury Jan. 4, Goldman Sachs analyst Luca Velussi, who worked on Project Sermon, said he couldn’t remember specific reasons why that project didn’t move forward.

Abandoned Projects

“We abandon the vast majority of projects,” Velussi said under questioning by the Bakers’ attorney, Alan Cotler.

T. Otey Smith, a former member of the Goldman Sachs team who worked on the Dragon deal, testified in a taped deposition that the team’s leader, Richard Wayner, didn’t press the issue that there were unanswered questions about the merger when Dragon’s board of directors met and voted to approved it in March 2000.

Wayner testified last month that Goldman Sachs had unanswered questions about Lernout & Hauspie’s suspicious surges in sales in Asia -- revenue that turned out to be fictitious -- but never sought to stop Dragon from selling.

Wayner told the jury that, after informing Dragon that Goldman Sachs didn’t receive satisfactory answers from L&H, it was “the client’s decision whether or not they want to do the deal.”

Inadequate Standards

A former investment banker testifying on behalf of Dragon this week told jurors Goldman Sachs’s team “didn’t provide the level of standards Goldman sets for itself,” nor did it meet industry standards.

“Their failure to do that gave the folks at the March 27 meeting a flawed and inaccurate picture of what a merger with L&H would actually look like,” said Donna Hitscherich, a former investment banker with JPMorgan Chase & Co. who now lectures at Columbia Business School, referring to the board meeting.

She said she spent more than 700 hours reviewing records from the case.

“I was shocked,” she said. “It was grossly subpar and inadequate for the type of engagement they were assigned to.”

She said she would have expected Goldman Sachs to take additional action after sending Dragon the February 2000 memo.

“In my mind, that’s a showstopper,” Hitscherich said.

Next Week

Testimony in the case, presided over by U.S. District Judge Patti Saris, is scheduled to resume Jan. 14. Goldman Sachs Vice President Chris Fine, who was chief technology strategist for the bank’s high-tech group during the Dragon sale, is to return to the witness stand. Goldman Sachs also said that it plans to call Wayner to testify again. Closing arguments are expected to begin at the end of next week.

On Jan. 9, Fine testified the Goldman Sachs team working on the deal developed a list of questions that needed answers in the months prior to the sale, and advised Dragon to obtain an accounting firm with knowledge of accounting regulations in Belgium.

“Did Dragon follow up on the recommendation to do more due diligence?” a Goldman Sachs’s lawyer asked Fine.

“Not that I recall,” he responded.

Another case against New York-based Goldman Sachs filed by Paul G. Bamberg and Robert Roth, two other Dragon founders who held minority shares in the company, is being heard at the same time before Saris.

Lernout’s Collapse

According to the U.S. Securities and Exchange Commission, Lernout & Hauspie created bogus customers, booked circular transactions with shell companies and recorded loans as sales from 1996 to 2000. The company was forced to restate $373 million in earnings.

The suit against Goldman Sachs was put on hold by agreement of both sides for years while the Bakers sued other participants and advisers in the deal. They’ve reached a total of about $70 million in settlements, their lawyer, Cotler, has told Saris.

Based on the value of Dragon at the time of the sale, the Bakers’ lost as much as $288.8 million in the deal and its aftermath, they said in court papers. Bamberg and Roth have said they lost as much as $50 million.

In court filings, Goldman Sachs said the plaintiffs’ damages are less than the amount they’ve already recovered.

On Jan. 2, Bamberg, now a senior lecturer on mathematics at Harvard University, testified he initially opposed the merger and was shocked when the deal became an all-stock offering. In one conversation with Dragon board members, he said he compared partnering with Lernout & Hauspie to joining the Serbian Army.

Bamberg said the Goldman Sachs team never raised any concerns about the deal at the board of directors meeting. He said he would have rejected the sale if they had.

“Anything significant I would have said I’m not signing until we get more information about this,” Bamberg said.

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

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