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Goldman Sachs: Financial diligence not its job in Dragon sale

A lawyer for Goldman Sachs Group Inc. 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 company 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 Tuesday that Goldman (NYSE: GS) 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 claiming its bad advice led to a disastrous $580 million all-stock transaction.

“Financial accounting diligence was not Goldman’s job,” Donovan told six jurors and six alternates 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’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.”

Sullivan told jurors that Goldman urged Dragon to get its accountants at Arthur Andersen LLP to probe Lernout & Hauspie’s financial statements. Goldman 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,” Sullivan said.

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

When Goldman was hired by Dragon in 1999, the company was poorly 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’s input, Sullivan 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,” Sullivan told the jurors. “That’s what the evidence will be.”

The Bakers, who started Dragon with $30,000 in their West Newton, Mass., 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 Monday, with jury selection and opening statements by lawyers representing the Dragon founders.

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

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

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