Goldman/Dragon TrialM&A Bankers on Trial: A Review of the
Goldman Sachs/Dragon Systems Litigation and its Implications for
Deals
Background
– Acquired by a competitor, Lernout & Hauspie Speech
Products
– Deal closes in June 2000
– Dragon shareholders agree to lock-ups
• Lernout & Hauspie unravels in an accounting fraud
• Lernout & Hauspie stock becomes worthless
• Former Dragon shareholders sue Dragon’s financial advisor,
Goldman Sachs
• Goldman Sachs wins a five-week jury trial
2
Dragon Systems
• Founded in 1982 by Jim and Janet Baker, Bob Roth, Paul
Bamberg
• Well regarded technology
• Tried to attract investors in 1999
• Two main suitors: Visteon and Lernout & Hauspie
3
• Dragon instructs Goldman not to seek other acquirors
• Goldman raises questions about health of L&H’s business
• Dragon board chooses to pursue Visteon rather than L&H
4
• Visteon drops out in early February 2000
• Unable to get to the $500-600 million valuation that Dragon
wanted
• L&H is Dragon’s only remaining option
• Dragon’s priorities are “speed and certainty”
5
• L&H offers half-cash deal at lower price
• Janet Baker rejects without consultation
• Signs “cocktail napkin” agreement for all stock
7
Cocktail Napkin to Definitive Deal
• Dragon CFO has one brief phone call with L&H auditors
– 1999 audit not complete as of late March 2000
– Unable to confirm L&H revenues in Korea
• Board meeting called on short notice
• Goldman makes no formal presentation and gives no formal
opinion
• Goldman does not reiterate due diligence concerns
8
– Height of tech bubble
– No due-diligence out
• Deal closes on June 7, 2000
– Value of L&H shares has declined to $460 million
9
• August 8, 2000: WSJ questions legitimacy of L&H
revenues
• Contacts L&H customers who turn out not to be customers
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• Achieve significant settlements
KPMG (L&H auditor) $18.5 million $2.5 million
SG Cowen (L&H banker) $24.7 million $3.8 million
Dexia Bank $25.0 million $0.2 million
L&H parties $3.2 million
TOTAL $71.4 million $6.4 million
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Plaintiffs Sue Goldman
• Bakers bring suit in 2008, followed by Roth/Bamberg (Seagate does
not sue)
• Breach of contract
• Negligence (professional malpractice)
12
• Claim Dragon was worth $580 million
– Based on L&H share price as of March 27, 2000 (date of Dragon
board meeting)
• Treble damages claimed under Massachusetts statute
13
Motion to Dismiss
• Goldman moves to dismiss: duties owed to Dragon, not its
shareholders
• Court denies motion in part, allows tort claims to proceed
– Relationship between Goldman and shareholders is “muddy” under
engagement letter
– Alleged direct interaction between Goldman and plaintiffs
• Three years of discovery and motion practice follow
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17
Press Coverage
• Boston Globe: one week after court admonishes parties not to
litigate in press • After Goldman prevails on motion to exclude
evidence of WSJ story
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• NPR story on eve of jury selection
• After Goldman prevails on motion to bar plaintiffs from claiming
post- 2000 developments of Dragon technology
– E.g., Siri
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Ethical Rules on Trial Publicity
20
Rule 3.6 Trial Publicity
(a) A lawyer who is participating or has participated in the
investigation or litigation of a matter shall not make an
extrajudicial statement that the lawyer knows or reasonably should
know will be disseminated by means of public communication and will
have a substantial likelihood of materially prejudicing an
adjudicative proceeding in the matter
Ethical Rules on Trial Publicity
21
Rule 3.6 Trial Publicity
[…]
(5) Information the lawyer knows or reasonably should know is
likely to be inadmissible as evidence in a trial and would, if
disclosed, create a substantial risk of prejudicing an impartial
trial
Trial
• Co-counsel with Ropes & Gray
• Jurors pose questions directly to witnesses
• Issues
– What is investment banker’s role in due diligence?
– Must investment banker reiterate its advice to the client’s full
board?
22
24
12 Q. One of the reasons you didn’t need advice on
13 valuation was because of the tremendous amount of
14 experience you already had with investment bankers?
15 A. I’ve already said, we’ve had almost nothing in
16 terms of experience.
17 Q. Lets look at Clip 4, from your lawsuit against
18 KMPG and Cowen.
Plaintiffs’ Prior Testimony
15 Q. You wouldn’t have expected Goldman to be primarily
16 responsible for financial due diligence, would you?
17 A. I now know that we were in fact very dependent on
Goldman
18 Sachs doing exactly what Ellen Chamberlain spelled out in
her
19 video testimony.
20 Q. Now that you’re suing Goldman Sachs, that’s
21 what you know, but let’s see what you said in 2004 when
you
22 were suing KPMG.
Rule 3.3 Candor Toward the Tribunal
(a) A lawyer shall not knowingly:
(3) offer evidence that the lawyer knows to be false…
26
Ethical Rules on False Evidence
…
The lawyer must not allow the tribunal to be misled by false
statements of law or fact or evidence that the lawyer knows to be
false.
27
28
• Comment on Model Rule 3.3 (cont’d)
[5] Paragraph (a)(3) requires that the lawyer refuse to offer
evidence that the lawyer knows to be false, regardless of the
client’s wishes. This duty is premised on the lawyer’s obligation
as an officer of the court to prevent the trier of fact from being
misled by false evidence. […]
[8] The prohibition against offering false evidence only applies if
the lawyer knows that the evidence is false. A lawyer’s reasonable
belief that evidence is false does not preclude its presentation to
the trier of fact…. Thus, although a lawyer should resolve doubts
about the veracity of testimony or other evidence in favor of the
client, the lawyer cannot ignore an obvious falsehood.
• Permissibility vs. effectiveness
– Reaction to “lazy, incompetent”
• Dragon’s CEO (video)
• Dragon’s CFO (video)
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• Dragon’s outside counsel
• Dragon’s outside auditor
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Compensating Fact Witnesses
• Rule 3.4(b) of Model Rules of Professional Conduct prohibits
lawyers from offering “an inducement to a witness that is
prohibited by law.”
– Comment says “it is not improper to pay a witness’s
expenses”
– “Common law rule in most jurisdictions is that it is improper to
pay an occurrence witness any fee for testifying.”
• New York’s Rule 3.4(b) is more specific and permissive:
– “A lawyer may advance, guarantee or acquiesce in the payment of
reasonable compensation to a witness for the loss of time in
attending, testifying, preparing to testify or otherwise assisting
counsel, and reasonable related expenses.”
• Permissibility vs. advisability
• Close-knit and color-coordinated
33
• Bakers found to have breached duties to Roth and Bamberg
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Post-Trial
• Roth and Bamberg now seek to amend their complaint
• Trying to add claims against Bakers to conform to jury
verdict
• Allege the Bakers are liable for not informing them of:
– Goldman’s February 29 memo
– L&H’s half-cash offer that Janet Baker rejected on March
8
• Chapter 93A claim is pending with the court
35
M&A Bankers on Trial: A Review of the Goldman Sachs/Dragon
Systems Litigation and its Implications for Deals
Background
Merger Goes Forward
Plaintiffs’ Other Lawsuits
Plaintiffs Sue Goldman
Trial
Goldman’s Fact Witnesses
Goldman’s Fact Witnesses