Jury Sides With Goldman Sachs in Dragon Lawsuit

While the internet boom led to a lot of money in a very short amount of time for many people and businesses, it is important to remember that developing business and making business deals are two very different things. The makers of Dragon Systems, a company that sold speech recognition software, learned this the hard way after they sold the company to Lernout & Hauspie in exchange for $580 million in Lernout stock. The deal was made in 2000 and, in 2001, Lernout’s accounting was exposed as a huge fraud. The company collapsed into bankruptcy, taking with it Dragon’s shareholders, including James and Janet Baker, the founders of Dragon and owners of 51% of its stock.

Since then, the Bakers have spent the better part of the past 12 years in litigation against several parties, taking about $70 million in court. In 2009, they turned their legal sights on Goldman Sachs, who had helped negotiate the deal. According to the Bakers, the advice they were given came from a team of four investors who they referred to as the “Goldman 4”. Their testimony presented this team as a group of inexperienced young bankers who had failed to properly perform their jobs. Their inadequacies allegedly cost the Baker’s a fortune while making a pretty $5 million for Goldman Sachs.

The Goldman Sachs side however, tells a very different story. Their financial engagement letter, which was heavily negotiated by high-powered lawyers on both sides, required that it provide nothing more than “financial advice and assistance in connection with the transaction”. As an investment bank, its job did not include that kind of research and due diligence. According to Goldman Sachs, that part of the deal was up to Dragon and its accountants. The firm was responsible only for coordinating the sale, negotiating the price and evaluating growth prospects for Lernout.

In its briefs, Goldman refuted the depiction of the “Goldman 4”. During the trial, the firm provided testimony saying that the Bakers were in a rush to sell Dragon, in part because it was in financial trouble. (Dragon was later sold out of the Lernout bankruptcy for $33 million). Goldman Sachs also pointed out that there were warning signs about Lernout, including news reports about Lernout’s questionable accounting practices. Goldman even provided a memo to Dragon warning that, for these reasons, it should conduct extensive research on Lernout before making the deal.

One of the “Goldman 4”, Richard Wayner, testified voluntarily in order to clear his name. He testified that, after Goldman Sach’s memo warning Dragon about the possible risks involved in selling to Lernout, he had “a very heated conversation” with Ellen Chamberlain, Dragon’s CFO. In this conversation, Chamberlain allegedly said that “Dragon did not want to do this additional level of detail.”

Other problems included Dragon choosing to take an all-stock deal instead of the standard half-stock and half-cash. This was arranged during a meeting which did not include Goldman Sachs (the bank says it was never invited, whereas the Bakers called the bank a no-show). Once the stock was received, the Bakers allegedly did not take steps to hedge the Lernout stock they received, even after they were advised to do so.

After 16 days of trial, the jury sided with Goldman Sachs on all counts and also found that the Bakers had breached their fiduciary duties to the board in failing to inform it of Lernout’s issues.

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