
Goldman Sachs and the $580M Black Hole (2012) - luxpir
http://www.nytimes.com/2012/07/15/business/goldman-sachs-and-a-sale-gone-horribly-awry.html?_r=1
======
shadowsun7
It's worth noting that James Baker is very active on Quora these days. His
profile: [https://www.quora.com/profile/James-
Baker-69](https://www.quora.com/profile/James-Baker-69)

Here's his response to "What is your worst memory as an entrepreneur":
[https://www.quora.com/What-is-your-worst-memory-as-an-
entrep...](https://www.quora.com/What-is-your-worst-memory-as-an-
entrepreneur/answer/James-Baker-69)

And here's one where he explains that he's financially ok, despite the Dragon
fiasco, because he saved enough for retirement: [https://www.quora.com/How-
did-James-Baker-lose-several-hundr...](https://www.quora.com/How-did-James-
Baker-lose-several-hundred-million-dollars-in-six-months/answer/James-
Baker-69)

Most of his answers are really good.

~~~
bhauer
From the worst memory answer, this stood out:

> _The technology has progressed less in the last fifteen years than it did
> every two or three years under Dragon Systems._

I suspect he is biased, but it's hard to not agree with the sentiment. It's a
shame that someone with such enormous personal motivation in the specific
technology space lost the ability and the will to be part of it. And as such,
that technology space has suffered. It's a matter of belief since we cannot
know how things would have played out differently, but I agree with the
sentiment.

~~~
jondubois
Finance firms are the parasites of society, they take advantage of all the
flaws in the system to make money for themselves and give their top employees
massive bonuses to keep doing what they do whilst keeping their mouths shut.

~~~
hueving
That's a pretty childish view. Lots of people enjoy home mortgages, savings
accounts, and investing in companies, all of which depend on finance firms.

~~~
jondubois
Nobody 'enjoys' their mortgages. Mortgages are responsible for making housing
less affordable for everyone.

In the old days when people actually saved up to buy a house, the average
house would cost something like 4 times the average person's annual salary.
Today, we're looking at 10 to 20 times.

Mortgages allow people who would otherwise not have been able to afford a
house to buy it outright - This increases the demand for housing and thus
drives prices up. In the old days, people worked hard to achieve the American
dream (it was an optimistic pursuit). Today, people work hard to avoid
bankruptcy (we have become a fear-driven society).

As for 'investing in companies' \- Big firms like Goldman Sachs mostly invest
in big corporations which enslave people for profit. People in finance are
more interested in helping big companies create and maintain strategic
monopolies than allowing new companies to improve people's lives. Monopolies
are profitable and don't require any R&D investment.

As for savings accounts, well they're not so bad, but what is the point of
having a savings account if you have no money to put in it? Also, with all the
new automated payment features offered, people are encouraged to spend all
their little money on things that they don't need. That means everything
significant has to be purchased using credit.

What's worse is that all of these evils leverage off of each other to make
things even worse overall. For example, the rise of corporations means that
people are forced to move to big cities to find jobs (since jobs are harder to
find in smaller towns - Because small businesses there are being crushed by
corporations), this drives city apartment prices up, which increases the
amount of mortgage people have to take to buy a house, which increases
peoples' dependence on their jobs and reduces their ability to negotiate
better salaries and prevents them from improving their conditions of living.

As corporations take a hold on agriculture, the nutritional quality of food
keeps going down (see [http://calmscience.net/2015/12/11/tale-of-tasteless-
tomatoes...](http://calmscience.net/2015/12/11/tale-of-tasteless-tomatoes-why-
vegetables-do-not-taste-good-anymore/)) and the standard of living of the
working class keeps dropping lower and lower.

~~~
hueving
Mortgages offered far more people their own house that could have _never_
purchased a house otherwise. Increased demand was met in the majority of the
country with increased supply (you may have noticed that houses can be built
and the majority of the US is empty). Only a few places on the coasts are so
constrained that it pushes people out. The main reason that houses have gotten
to be so expensive is because wages stagnated and people don't want to
compromise on their demands for space/features (look at the features and size
of a new KB home and compare that to the box of shit you got in the 70s).
Stripping demand would not make it any cheaper to build houses the way people
want.

You can buy a unit in a trailer park on a year or two of low salary. Why do
you think people aren't doing that?

If you eliminate mortgages, it only forces people to rent which is a massive
waste of money that concentrates wealth into those who are privileged enough
to own homes.

WRT wall street, if they were only interested in supporting monopolies, they
wouldn't be involved in the IPOs of any company that has a competitor ever.
It's not even optimally greedy to only support monopolies because the best
returns come from investments in companies that disrupt competition. So you're
whole rant against wall street is a bit dumb because it doesn't even line up
with the behavior of purely sociopathic greedy actors like you seem to think
they all are. Keep ripping down those strawmen.

~~~
kombucha2
How do you feel this contrasts with the Student Aid/Loan/FAFSA regime? I made
the exact same argument as op the other day about higher education and I
really thinks it fits much better in that context than it does when used with
housing finance.

~~~
hueving
Student loans are awful because they entice students to take on massive
amounts of debt that they will have a really hard time repaying. Taking on a
mortgage eliminates your rent cost. Taking on a student loan eliminates
nothing.

Additionally, with student loans there is essentially no due diligence on the
lender's behalf because the loans are not dischargeable in bankruptcy. So
students are paying a hundred+ thousand dollars for a masters in art history
that will have no return (other than intellectual). Compare that to a house,
where a bank won't give you a loan if they don't agree that the house is worth
that.

------
toyg
Oh, so this is how Dragon died, I always wondered where they had gone.
NaturallySpeaking was one of the most, ahem, _shared_ programs of the late
'90s. Tried it a few times but with all the corrections it never felt faster
than my own typing (and I don't even touch-type).

The lessons from this story are two, basically: never cut all-stock deals and
never deal with the likes of Goldman if you are not a billion-size business.

~~~
spacehome
> Tried it a few times but with all the corrections it never felt faster than
> my own typing (and I don't even touch-type).

Then you weren't the target audience. I got it for my grandfather, whose hand
tremors made typing all but impossible.

~~~
pc86
The target audience was anyone who typed a lot. It was not a piece of medical
software and was not targeted as such.

~~~
psykovsky
can you speak faster than you type?

~~~
ubercow13
Can't most people?

~~~
forgotmysn
i definitely type faster than i talk

source: grew up in the 90's in Silicon Valley

~~~
biot
The Guiness World Record holder for typing can sustain 150 wpm on a Dvorak
keyboard for 50 minutes [0]. Compare this to the average audiobook:
"Audiobooks are recommended to be 150–160 words per minute, which is the range
that people comfortably hear and vocalize words." [1]

So either you speak really slowly or perhaps you should challenge the world
record. I've been touch typing for more than 25 years (though not in Silicon
Valley, so maybe I'm lacking some magical force as a result) and can
comfortably sustain 60 wpm, bursting up to about 100 wpm. There's no way I can
even come close to the rate at which I'm able to speak in a sustained manner.

[0]
[https://en.wikipedia.org/wiki/Words_per_minute#Alphanumeric_...](https://en.wikipedia.org/wiki/Words_per_minute#Alphanumeric_entry)

[1]
[https://en.wikipedia.org/wiki/Words_per_minute#Speech_and_li...](https://en.wikipedia.org/wiki/Words_per_minute#Speech_and_listening)

------
lhh
As a banker, I figured I'd offer my perspective:

I don't think Goldman did anything illegal, but they certainly did a terrible
job serving their client. In my view, investment bankers have an obligation to
offer whatever financial and strategic advice the particular client needs,
which is a function of that client's sophistication. Some clients are highly
sophisticated, don't need any advice, and just want you to find them a buyer
at a good price. Others can, for example, simply be good technologists but
otherwise not be particularly business or finance savvy, and so will need
additional guidance along the way.

To look at this particular case, moving from a 50/50 cash/stock deal to an
all-stock deal without an increase in total consideration, or without the
client REALLY loving the stock of the acquiring company, makes no sense.
Guaranteed money upfront is always preferable (unless there are unusual tax
circumstances, which I don't see being the case here). This should have been a
major point of discussion and negotiation. And if an all-stock deal was
decided upon, the client should've been advised with no ambiguity that there
are substantial risks involved in such a deal.

In any case though, even for the 50/50 deal, substantial due diligence on the
acquirer should have been recommended. Spending $50k to verify the quality of
$290mm+ in sale proceeds is a no-brainer. This legitimately falls outside of
the realm of responsibility of the banker to conduct this due diligence
though, and should've been performed by a third party with guidance and
oversight by the bankers. The bank here is conflicted anyway - their
incentives would clearly be to give the "all clear" sign. Falsified revenue is
extremely easy to catch - just follow the cash.

I guess the lessons here are don't work with service providers who don't value
you, and always keep in mind that ultimately, as the client, you're the one
that has to live with the decisions that get made.

I'd be remiss if I didn't mention that there are better sources of financial
advice. At my firm, we take pride in deeply aligning ourselves with our
clients by only charging fees upon successful completion of a transaction, and
by being compensated in the same form that our clients are (e.g. had we
advised Dragon, we would've been compensated in L&H stock, and would've
therefore been highly incentivized to strongly recommend due diligence!). The
Dragon/L&H deal is actually one of the case studies that inspired the genesis
of our firm. I'd love to chat if this resonates with you:
lharris@belstone.com.

~~~
rconti
Having worked for a Big Four firm in an exceedingly junior role, it's quite
clear how this happened, and how it could happen anywhere. These big firms
attach their names to work done by very junior people. The companies have a
lot of experience at what they do, so their processes tend to be okay at
producing an acceptable end result, but so much of their work is done by
utterly clueless junior folks, that it's amazing things don't go sideways more
often. Then again, an accounting opinion is just that -- an _opinion_. In the
end, the liability tends to be very limited.

To use a legal word I don't fully understand, it seems Goldman was completely
negligent here, but not necessarily in a criminal way -- if that's possible.
They had a client that needed a lot of hand-holding, but it was small potatoes
to a big bank, and they utterly failed to serve their client's interests.

Of course, because they're the big fish, they've probably covered their asses
pretty well in a legal sense, and won't owe a dime. It's not right, but it's
probably what will happen, legally.

~~~
IkmoIkmo
> These big firms attach their names to work done by very junior people.

Can confirm, work at a pretty large firm. Most stuff is drafted by junior
dudes and signed off by their superiors. But I've also seen how the superiors
sign, and mostly they do some basic checks and sign off. Further, companies
tend to work with a four eyes principle that requires two signatures to sign
off, and what tends to happen is that the second person says 'oh, I see xyz
signed, so it must be okay' and signs it off without really checking. In fact
we have folders of docs drafted by juniors that an assistant walks around with
to collect the relevant signatures, which are stamped, not written.

Essentially everyone is overworked and manage way too many clients and the
budget is being squeezed. And there's a bit of a race to the bottom, the sales
people have clients telling them 'this office can do it for $270k per year,
you're offering us $350k'. And the sales people say 'alright we'll match it',
which means they're going to have to generate cost-cutting measures of $80k on
that client that year, which mostly involves shifting the work to interims,
interns and juniors who get $15-20 an hour and invoice $150 to the client.

~~~
55555
> which mostly involves shifting the work to interims, interns and juniors who
> get $15-20 an hour and invoice $150 to the client.

Do you think you guys could just make a little less profit?

~~~
IkmoIkmo
Yes and no.

Yes in the sense that all employees except the management hate the current
regime because they're having their budgets and teams cut and workloads
increase, so me and my peers would fully agree with you. Less cost cutting,
less profit, but a more sensible workload.

No in the sense that the prices to the customer aren't coming down to cost-
price. The reason for this is that we deliver ridiculous value (i.e., with
$250k of annual legal work, which is puny, you can generate millions in cost
savings). You'd think then, that competing business would quickly arise and
drive prices down, but the industry is so cyclical (and doomed to die as lots
of things get automated etc), that it's not a great industry for new entrants
to compete with the incumbents (which have consolidated with lots of mergers
the past 20 years become quite massive firms with strong brand names that
drive tons of inbound leads, besides if you're a small new entrant you tend to
get bought out anyway)

Hell these firms are all in private hands and have been for a long time, the
shareholders appoint a board to squeeze as much profit... which is why I
concur with the OP, a lot of the business is driven by cheap juniors under the
guise of a strong brand name, where senior staff spend the majority of their
time on sales rather than actual work, and are called 'vice presidents' for
that reason.

On the other hand, it's not all that crazy. The funny thing is, all the
juniors are 100x more educated than the seniors. You've got 23 year olds with
a double master's in econometrics and tax law, while you'll find some senior
VPs who got into the business in the 70s or 80s who may or may not have a
bachelor's in something. Sure the seniors have the experience and the kids are
often clueless when they just start out, but they're also usually sharp, hard-
working, well-read (in subject material), have quantitative skills and broad
competencies. So it's not all that crazy.

~~~
55555
Thanks for the reply. It's not all that crazy and I'm glad you elaborated on
why new entrants don't come into the market and suck up that
profit/inefficiency.

------
luxpir
For those who also read comments first...

Some of the code in Siri originated from Mr. and Mrs. Baker's company, Dragon,
which they eventually sold for stock options. Those options tragically turned
out to be based on cooked-books and worth nothing, after completion of the
sale guided by GS.

The ensuing legal battle continues, as do the fortunes of those who bought the
remaining Dragon tech (Nuance, specifically) and licensed it to Apple et al.

~~~
jmnicolas
>Some of the code in Siri originated from Mr. and Mrs. Baker's company, Dragon

It's not a fact : "The Bakers believe that some of their technology made its
way into Siri."

~~~
jdmichal
Siri was developed by SRI International, basically as the commercialization of
the CALO project [0]. It was initially developed as an app, and was even
available in the store. The project was then spun-off into a company, and the
developers were working on versions for other platforms. Apple then bought the
company, making it exclusively an iOS product and integrating it into the OS.

The voice recognition technology was indeed based on Nuance technology [1].
Nuance was also a spin-off from SRI.

EDIT: This was all after ScanSoft purchased Nuance, which means it had both
Nuance and Dragon technology at the time. However, due to Nuance's history
with SRI, I would lean towards that being the more likely option, if they
hadn't been integrated by that point.

(I worked at SRI during the Siri spin-off time period, and worked with one of
the Siri developers on another project.)

[0] [https://en.wikipedia.org/wiki/CALO](https://en.wikipedia.org/wiki/CALO)

[1] [http://techpinions.com/nuance-exec-on-iphone-4s-siri-and-
the...](http://techpinions.com/nuance-exec-on-iphone-4s-siri-and-the-future-
of-speech/3307)

------
yellowstuff
GS isn't blameless, but this article makes things sound a lot worse than they
really were. Fortunately for us, the best finance writer in the world is also
a former GS banker and a lawyer, and he wrote a much better article on this
case 3 years ago:

[http://dealbreaker.com/2013/01/dragon-systems-
shareholders-c...](http://dealbreaker.com/2013/01/dragon-systems-shareholders-
cant-see-the-bright-side-in-extremely-successful-ma-transaction-that-wiped-
out-their-lifes-savings/)

The summary is that it's not really the merger adviser's responsibility to
look into the stock of a public company acquirer, even though it feels like it
ought to be.

~~~
at5
They absolutely need to take blame for not atleast advising James Baker to put
in a collar. All stock deals are hugely risky. A deal being run by a VP and
associate is also a no no at most banks, and one would presume Goldman after
this fiasco.

~~~
morgante
> They absolutely need to take blame for not atleast advising James Baker to
> put in a collar

It would seem they actually did. [1] Goldman certainly didn't provide the best
service here, but I don't think what they did were illegal.

The blame for going through with this transaction falls on the clients who
refused to hire an accountant when Goldman recommended it and pushed for an
accelerated schedule. Heck, they agreed to an all-stock deal without even
having their bankers present. (Of course, the ultimate blame lies with L&H who
committed criminal fraud.)

[1] [http://dealbook.nytimes.com/2013/01/29/lessons-for-
entrepren...](http://dealbook.nytimes.com/2013/01/29/lessons-for-
entrepreneurs-in-rubble-of-a-collapsed-deal/)

~~~
at5
Oh not illegal for sure. But they dropped the ball. Bankers are shielded from
practically every type of litigation based on engagement letters. But that
doesn't mean that they didn't fail their client. I mean practically speaking
if bank A botched a deal for Facebook, not many large tech companies would be
lining up to engage them. They can't hold their hands up and say well its your
fault so boo hoo. If that was acceptable behaviour in the market, nobody would
hire bankers. Having seen bankers roll out a deal on a company that later
proved to be a complete fraud, believe me when I say that people get fired for
messing up. Which should give you some idea of whether the bank itself thinks
someone dropped the ball.

Also it sounds like he said she said on the all stock thing. The Bakers say
bankers weren't around. Also any decent banker would be able to tell you to up
your asking price to account for rolling hedging costs and/or other risks.

------
gregdoesit
This case was very well covered at the time. Top 3 things I've learned from
this story:

1\. If you sell do your company, never do it for all-stock (or at least almost
never)

2\. Have a plan B in case the company who aquired you goes bankrupt - the very
next day.

3\. No one will care about your company as much as you do. So don't outsource
important parts of the process such as: reading all the paperwork and checking
references of the acquirer.

~~~
alm0stn3v3r
The almost never:

[https://en.wikipedia.org/wiki/Broadcast.com#Acquisition_by_Y...](https://en.wikipedia.org/wiki/Broadcast.com#Acquisition_by_Yahoo.21)

~~~
CPLX
The much more fascinating part of that story is how Mark Cuban had the
foresight to convert the all stock deal to an all cash deal (from his
perspective) by engineering a sophisticated straddle hedge on the stock of the
acquiring company. A scheme he created by collaborating with, you guessed it,
Goldman Sachs.

~~~
Mvandenbergh
A few people have been asking how this worked:

He bought put options (his right to sell at a particular price) below the
market price and sold call options (a counterparty's right to buy at a
particular price) above the market price.

If you price them right you can use the money from selling the call options to
buy the put options which makes it costless in net cash terms.

Market price was: $95 Put: $85 Call: $205

The reason the spread between the two is so high has to do with the time value
of money and some other technical stuff, but those were the collar values.

Yahoo's stock went up to the $230s which was above the call option price, if
the options had been exercised at that time, Mark Cuban would have lost out on
the gain in price above the cap ($205). By the time they were exercised
however, the stock was totally in the toilet and Mark Cuban was able to sell
at $85.

It's not really an unusual deal but not many people were doing that in 1999,
collar trades are much more common now because people remember the first
crash.

~~~
beachstartup
i'm not familiar with options trading - can you confirm if this is the right
intuition?

he basically sold an option on the high end to cap out his gains and used that
money to buy an option on the low end to ensure a profit, which guaranteed
that he ended up with stock that was guaranteed to be worth _something_?

i.e. he traded away an unlimited upside in order to gain a protected downside?

~~~
Mvandenbergh
That's exactly right.

------
youngtaff
Looks like Goldman Sachs won the case too -
[http://www.bloomberg.com/news/articles/2013-06-12/goldman-
sa...](http://www.bloomberg.com/news/articles/2013-06-12/goldman-sachs-s-
trial-win-in-dragon-systems-deal-upheld)

~~~
jjoonathan
> The judge called [Goldman Sachs' actions] “professionally negligent”

> the jury concluded that the banking team satisfactorily performed its role
> for Dragon Systems in all respects

> I [the judge] conclude otherwise

Yuck.

~~~
CPLX
Goldman did apparently win a jury trial. While this case looks horrible the
idea of a judge respecting a jury's verdict doesn't seem like the horrible
part.

~~~
pc86
Is there precedent for a judge overturning a jury's verdict immediately after
it's handed down? I imagine you'd need a reason quite a bit above and beyond
"I disagree" but even so I'm not sure if that would violate the right to a
jury trial or not.

~~~
dctoedt
In general, in the U.S. a judge can overturn a jury's verdict only if the
judge concludes:

(i) that _no_ reasonable jury could have reached the verdict on the evidence
of record -- if reasonable people could disagree, given the evidence of
record,, then the verdict must stand; or

(ii) that the verdict was _(or was likely to have been -- I forget which it
is)_ the product of bias or prejudice; or

(iii) that (in hindsight) the judge screwed up in giving the jury its
instructions about how to apply the law.

There are also some procedural prerequisites, e.g., for item (i) the losing
party must have moved for "judgment as a matter of law" before the case was
submitted to the jury, while for item (iii) the losing party must have
objected to the flawed jury instructions before they were given to the jury.

For federal courts these requirements derive from the Seventh Amendment to the
Constitution, which provides in part: " ... no fact tried by a jury, shall be
otherwise reexamined in any court of the United States _[which means federal
courts]_ , than according to the rules of the common law." [1]

[1]
[https://www.law.cornell.edu/constitution/seventh_amendment](https://www.law.cornell.edu/constitution/seventh_amendment)

------
tobltobs
I still can remember how 20 years ago my image processing professor used this
guy as an example how you can create a successful company out of nothing with
the help of computers.

The successful image processing company of this professor was killed lately by
a patent troll.

------
dh997
Dragon NaturallySpeaking could transcribe continuous speach in the late 90's
at nearly full speed, it was amazing. But then it disappeared, this explains
it.

Moral of the story: don't ever pay upfront for deal advice because interests
aren't aligned, light a fire under the due-diligencers by making it a % of the
deal.

Not everyone at Goldman is evil I can vouch for that personally, but also not
everyone there (or in M&A / wall st circles) doesn't gradually acquire some
degree of jaded entitlement or dispassionate, insular inhumanity either...
that's what a city and high earnings does to some people. Plus, not knowing
business, not having a strong relationship with an IB and not doing your own
due-diligence are all contributing personal failures. Regardless, the other
party spears to have committed fraud and Goldman seems it didn't completely
live up to its fiduciary duty in this instance. The nails in these employees'
coffins is not meeting with the press to express reasonable and legally-
defensible answers, it makes them look guilty. (You've got to know when a
blanket best-practice such as not speaking to the press during ongoing legal
matters should be broken without compromising the case.)

------
rcarrigan87
It's interesting that the ages of the bankers are so prominently mentioned in
the article. Everyone is fairly young, how much experience do they really
have?

It could be justified if a more senior banker with a lot of experience was
overseeing them. But seems like that wasn't the case.

It really makes me wonder, how much value are these guys actually adding to
the transaction? If a bunch of 20 somethings can broker this deal, are the
services really worth the insane fees being charged?

~~~
refurb
Someone else with IB experience will be here to add details, but those 20 and
30 year-olds were not running the deal. They would have had someone more
senior overseeing them. I'm guessing it was a couple analysts and an associate
or VP. Those are very junior people.

Now as the article said, the deal was quite small for GS, so it's likely the
amount of time spent on the deal by the senior person was small.

~~~
at5
Actually not surprising that GS would let a VP and an associate run this deal.
$580MM is small potatoes for Goldman, and it was 99 so they were up to their
eyeballs in deals. There was probably a senior banker committee overseeing the
deal but they really just rubber stamp stuff and never look at the details.
The details in this case were what crushed James Baker's take. Note that a
good/experienced banker would advise the client to put in a collar in an all
stock deal.

------
qaq
The biggest take away is find a partner appropriate for the deal size you are
doing. A smaller IB for which 5m fee would actually matter would have being a
smarter bet.

~~~
gmarx
This is true for many services you buy from other companies. The reputation of
a giant is likely based on the top people in that company and sometimes based
on the top people who were in that company years ago. Unless you are also a
giant company you are probably getting junior people brought on to feed the
pyramid. If you can find a smaller practice with smart people you will usually
be better off

------
jonknee
In the Big Short Danny Moses was not going to do the deal (to short mortgage
backed securities) until he got the answer to a question from the bank's sales
person:

> I'll do it, but only after you explain to me how you are going to fuck me.

Seems like an appropriate question whenever dealing with an investment bank.

~~~
mseebach
Actually, slightly rephrased, it's a reasonable thing to consider for any non-
trivial interaction: "What are _your_ stakes here?"

Even with the best of intentions, people are complex and complex transactions
between two or more of them are complex-squared. Taking the time to make sure
both parties understands what the other does and doesn't bring to the table is
important for success.

------
jackgavigan
A cautionary tale about relying entirely on external advisors. There had been
rumours about L&H's book-cooking for a couple of years before the Dragon
acquisition and a Goldman Sachs analyst was quoted on the topic [1].

A sad outcome for the Bakers but they weren't entirely blameless (although
Goldman Sachs were certainly very lucky to get away scot-free).

1:
[http://www.wsj.com/articles/SB912638848485991000](http://www.wsj.com/articles/SB912638848485991000)

------
leroy_masochist
A few things to keep in mind:

1\. Although GS had passed on investing in L&H, that decision would have been
completely unknown to the investment bankers working on the deal for Dragon --
by design. The "Chinese Wall" between the investment banking, securities, and
asset management divisions of large financial institutions severely limits the
communication between and among these parts of the firm.

2\. Investment bankers are not accountants or lawyers. This is stated on the
cover page of every investment banking presentation and at the bottom of every
email that leaves the network. Telling the Bakers to hire accountants to do
accounting diligence was not an abdication of responsibility; it was sound
advice, not to mention GS's legal responsibility per numerous SEC regulations.

3\. Apart from what may have been discovered during an unrushed diligence
process conducted by accountants, there were rampant rumors at the time of the
deal that L&H faced cashflow issues.

4\. This is the big one: the Bakers got impatient with GS taking what they
felt was too long to look at the deal, and decided to meet with L&H _on their
own_ in order to get things moving faster. At a meeting _not attended by the
investment bank they hired to maximize the value received by shareholders in a
sale_ they agreed to take all-stock consideration instead of 50/50 cash/stock.
Let that one sink in for a bit.

5\. The main reason that the Bakers lost the case against Goldman is that they
previously, and successfully, sued L&H and its bankers/accountants alleging
that they fraudulently covered up problems to an extent that said problems
could not have been reasonably uncovered during a thorough diligence process.
Goldman's lawyers used this previous sworn testimony to withering effect in
cross-examining the Bakers.

Disclaimer: I'm a former GS investment banker. I wasn't there in the late 90's
and I'm not there now.

My own personal take on this is that, when M&A markets are frothy, banking
teams get younger and less experienced because a relatively fixed-quantity
resource (licensed investment bankers at a given firm) are being spread
thinner and thinner against an increasing number of deals. Keep that in mind
and proceed with caution if you have to sell your company under such
conditions.

In terms of what GS could have done better: I think one of the big issues here
was that Gene Sykes, who is a genuinely brilliant guy with excellent bedside
manner, was MIA on the deal even though he was nominally in charge of the
team. My guess is that if Gene were doing weekly update calls with the Bakers,
they would not have done colossally stupid shit like try to hijack the process
themselves. I think they were likely getting the right advice from the younger
bankers on the team -- don't rush this, we need to do this right, let us have
these conversations for you, etc -- but that advice does not carry the same
weight coming from a 27-year-old associate compared to when it comes from one
of the most accomplished dealmakers of his generation.

Also: cash is king. Be very wary of all-stock deals.

~~~
at5
What? Part of a due diligence process is looking at internal financial
statements. Cashflow issues would have jumped out immediately. GS absolutely
dropped the ball on this one. Also not recommending your client put in a
collar after an all stock deal? Don't know about Goldman but that was pretty
much standard advice at mine.

~~~
leroy_masochist
> Part of a due diligence process is looking at internal financial statements.

L&H conducted accounting fraud; both of its founders received criminal
convictions for doing so [0]. The whole point of accounting fraud is
_falsifying internal financial statements_. It is true that investment banks
conduct diligence by looking at a company's financials, but this is for
valuation purposes -- i.e., analyzing how the company has performed relative
to other comparable companies. Investment banks do not employ forensic
accountants who specialize in sniffing out fraud; accounting firms do. The
issues in question were the kind that would be discovered in the diligence
process by competent accountants, not competent investment bankers.

> Also not recommending your client put in a collar after an all stock deal?
> Don't know about Goldman but that was pretty much standard advice at mine.

As a matter of fact, GS did recommend a collar, and the Bakers ignored this
advice: "the Bakers did not take steps to hedge the Lernout stock they
received when advised of their ability to do so." [1]

[0]:
[http://www.wsj.com/articles/SB100014240527487039893045755035...](http://www.wsj.com/articles/SB10001424052748703989304575503500899087566)

[1]: [http://dealbook.nytimes.com/2013/01/29/lessons-for-
entrepren...](http://dealbook.nytimes.com/2013/01/29/lessons-for-
entrepreneurs-in-rubble-of-a-collapsed-deal/)

~~~
at5
Technically you're right. But a banker's role is really to provide advice on
the deal and work in the best interests of the client. Sophisticated clients
don't need bankers so don't pay them much (PE firms sometimes pay as little as
a few hundred grand). And it's fairly justified because short of leveraging
their sales force and/or balance sheet, bankers add little value in standard
processes like M&A or capital raises. Definitely dropped the ball. If Goldman
was a no name shop their argument that they were let off the hook in a court
of law would not help them win clients.

Cash flow fraud is extremely easy to follow if you look for it; more so if you
have monthly/weekly invoices and reconcile that with the cash flows. You'd
have noticed the loan treatment of factored receivables quite quickly.

On the hedge (and the whole lawsuit); looks like a he said she said really.
Goldman says the all-stock deal was approved without their presence; Baker
says they didn't show up.

~~~
morgante
> But a banker's role is really to provide advice on the deal and work in the
> best interests of the client.

In this case, they strongly recommended that the clients hire an external
accountant who would be more skilled in investigating cash flow fraud.
Forensic accounting is out of the scope of the banker's engagement, but
recommending that they hire someone to do it was serving the client.

It really seems like Dragon was pushing the transaction to go faster, against
Goldman's recommendation.

> Goldman says the all-stock deal was approved without their presence; Baker
> says they didn't show up.

So they both agree that the Bakers accepted an all-stock deal _without_
Goldman's recommendation. While Goldman comes off looking lazy here, it
doesn't make them liable.

~~~
at5
I think you misunderstand. It's not a legal issue. It's whether you provided
adequate service. And Goldman didn't. And bankers are almost never liable fyi
because of the language baked into engagement letters.

It's also not about forensic accounting. A 5 person deal team is quite tiny
especially if they're mostly junior. The acquiree should absolutely have
access to internal documents in an all stock deal; your future is at stake
here. Something like already factored receivables somehow requiring payments
to be made in future periods makes no sense and would jump out immediately to
anyone half competent who bothered to look.

Not showing up for a meeting is not the same as saying after the fact, 'ok
guys let's close this'. I can guarantee you Goldman signed off on it. You
don't sign merger documents at the meeting itself. GS likely said "fuck it all
stock it is". They get paid anyway, in cash.

~~~
leroy_masochist
> GS likely said "fuck it all stock it is". They get paid anyway, in cash.

Massive category-mistake here. Investment banks don't have sign-off authority
on these kinds of transactions, they serve as a advisors. And in this
particular case, GS's defense was based on the fact that Dragon didn't follow
their advice. Both in terms of the consideration and in terms of Dragon's
option to hedge the stock they received as consideration.

By the way -- GS got 1% on this deal, when it's normally up around 2 or 3. The
engagement letter didn't even make them advisors to the board, just to
management. That's a much lower standard of care. If I had to guess, I'd say
that the Bakers were trying something along the lines of, "Potential buyers
won't fuck us over if we hire Goldman. What's the cheapest we can hire Goldman
for?"

They hired the firm on an extremely limited mandate at a time when the tech
M&A market was going haywire. They got a junior team that, while it provided
substantively good advice, did not do remotely enough to protect the client
from its own brash stupidity (this is not a formal responsibility, but is the
kind of thing that partners like Gene, who was nominally on the deal but
couldn't even remember it under oath, are good at). FWIW, I agree that GS does
not come across well in this particular episode.

~~~
at5
Ah yea but bankers are like real estate agents; their incentive is to maximize
their return per unit of time invested. If GS didn't think there's going to be
a large marginal return (on time) in asking for more from the buyer then
they'll say ok, you're happy I'm happy. It's about incentives. And yea I am
aware they don't sign off but the Bakers aren't exactly experts; they would
have said yes if the bankers said yes and the numbers seem high enough for
them. It raises the question of whether there is any value in standalone M&A
advice. Sophisticated sellers don't need pitchbooks and are well able to pull
together their own models. Unsophisticated sellers basically go along with the
bankers; who have no skin in the game and just want to close the deal. And
then these sellers potentially end up with bad outcomes.

And yea the Bakers definitely should have gone with a smaller bank given the
deal size. But hey, BODs make that mistake all the time too. Also given the
size of the Bakers stake (50+%), not much difference between board advisory
and management advisory is there? Theirs is the deciding vote.

Agreed with you on the last point. Been on more than one deal team where we've
had to talk clients out of shooting themselves in the foot. But that's part of
the game. No engagement letter covers that but a sensible client would expect
that from their banker. Legally GS was always in the clear.

~~~
leroy_masochist
> And yea I am aware they don't sign off but the Bakers aren't exactly
> experts; they would have said yes if the bankers said yes and the numbers
> seem high enough for them.

What are you trying to say here? The whole crux of this case is about the
Bakers ignoring GS' advice.

> the Bakers definitely should have gone with a smaller bank given the deal
> size

$500mm is right about the median deal size of GS sell-side M&A engagements (at
least it was when I left several years ago).

> not much difference between board advisory and management advisory is there?
> Theirs is the deciding vote.

If you are in fact an investment banker, you should be familiar with the non-
trivial differences in the bank's responsibilities to the BOD and management
team, regardless of BOD makeup and/or management's ownership of Company.

~~~
at5
1) In practice there is no way the deal would have proceeded without GS giving
the go ahead. Nowhere in your sources does GS say they said no to the deal as
was consummated.

3) Was a lawyer before banking. Can assure you the stake matters. Try not
practising law without a license perhaps? In a court of law the difference is
trivial.

2) Depends on the market. 99 was a once in a career market hence a VP leading
the deal.

In any case never said it was a legal issue. GS messed up. No bank wants to be
in a position where they point to clauses in their engagement letter to point
out that they did fine by the client.

------
chatmasta
What an interesting story.

I'm surprised the Bakers did not try to repurchase their technology in the
bankruptcy sale. If other firms scooped it up for as little as $7m, surely the
Bakers could have raised that much from a few opportunistic venture
capitalists who understood the technology was better under the care of the
Bakers than any other third party.

Of course this was right when the dotcom bubble popped, so maybe raising $7m
from VCs to buy back technology they just lost in a messy bubble popping deal
would be incredibly difficult and require more dilution than it was worth.

Also, what if they had just recreated a new company with the same technology?
Who would sue them? The acquirer of their IP was bankrupt. Why not rebuild the
technology and wait until the secondary acquirer sues? By that time they could
have had a fully formed legal argument for their rights to the IP, and
probably a better argument than whatever they're using against Goldman.

Ultimately, Dragon hired Goldman as an advisor. Only the Dragon board had the
ability to approve or deny a deal. Goldman had no vote. Therefore all
responsibility for poor decision making should fall on the board, not Goldman.
Did Goldman give shitty advice, or none at all? Yes. But it sounds like Dragon
knew the advice was shitty, but chose to proceed anyway. No way this case
falls in their favor. I just hope they don't lose even more money in the
Goldman counter suit.

There best hope is a sympathetic jury (is it even a jury trial?) that rules
emotionally based on the story of a nice couple of people getting screwed by
the venerable Goldman Sachs. I hope for the Bakers' sake they win this case.
They seem like remarkably caring people who got tangled up in the wrong place
at the wrong time.

~~~
patmcguire
Re: auction, it's impossible to tell how much the other side would have been
willing to pay if the Bakers were bidding it up over $7m.

------
smenyp
While I do feel for Dragon Systems and James Baker, I agree with the finer
line toed by Matt Levine's article here:
[http://dealbreaker.com/2013/01/dragon-systems-
shareholders-c...](http://dealbreaker.com/2013/01/dragon-systems-shareholders-
cant-see-the-bright-side-in-extremely-successful-ma-transaction-that-wiped-
out-their-lifes-savings/):

"Why would you hire an investment bank to advise you on an M&A deal? It’s sort
of an uncomfortable question."

This reminds me about Warren Buffet saying that asking an investment bank
about M&A advice is like asking a barber if you need a haircut.

------
rajacombinator
An odd article. I suppose it was written at the time (2012) to capitalize on
anti-GS fervor, while at the same time not actually covering anything bad they
did. Because in the grand scheme of their criminal activities, this is an
absolute nothing burger.

In fact, without other info, I'm inclined to side with GS on this one. Some
things that would make the story actually interesting include: what were/are
GS's connections with senior execs at the L&H co, or at Nuance. Without
intent, there's no story here, just incompetence in the worst case.

Otherwise it seems like a simple case of a mom n pop team getting in way over
their heads and penny pinching at the wrong time. The abnormally low
transaction fee (guaranteeing poor service), lack of other DD, failure to
instantaneously hedge out their exposure to the acquirer's stock, etc. Also
they probably knew the deal was too good to be true at the time, hence the
rush to take the all stock deal. Afterwards, seller's remorse and failing to
accept their part in the blunder. Very typical.

~~~
at5
86bps is an ok fee given that you had a VP running this who was on vacation
for a number of key events during the deal
([http://dealbreaker.com/2013/06/goldman-was-professionally-
ne...](http://dealbreaker.com/2013/06/goldman-was-professionally-negligent-on-
an-ma-deal-but-its-fine/))

PE firms pay a few hundred grand for senior level attention more often than
you'd think. Fee grids are based off the complexity of the deal, and frankly
the seniority and number of people involved. Banks think about the ROI of
their salary payments on a daily basis

------
chad_strategic
This is another reason to hate the banks. Goldman Sachs is a ruthless
organization and will do anything and everything to make money. They make the
mob look, Disney characters.

I do agree the Bakers should have done a little better, but still Goldman will
take both sides of the trade as point out in the article.

This is another example of the banking system destroying intellectual
property, for the sake of profit. Meaning, SIRI or voice technology could be a
few years ahead had it not been for the fact that Dragon was auction off. (We
will never now for sure.)

If you want to hire the leader of the goldman four you can do so here:

[http://richardwayner.com/index.php/about-richard-
wayner](http://richardwayner.com/index.php/about-richard-wayner)

------
LargeCompanies
Man I am sorry to see one of the major driving forces behind Siri and the
alike not getting paid his fair share(billions is his fair share).

Personally, I have much smaller inventor-ship horror stories that have taught
me any further advances from big money people/companies is that I need to paid
... X huge billion to million dollar company deposit money in my bank and do
it now before we go any further with any type of business relationship.

Don't ever get drunk on the excitement of the biggest companies and such in
the world chasing you .... focus on them paying you/depositing CASH in your
bank or hand ..otherwise tell them to take a jump in the lake and to come back
to you when they are ready to deposit money in your bank!!!

~~~
mseebach
If they'd gotten cash, they still wouldn't have gotten what you claim is their
"fair share (billions)". They would have gotten about $464mm (80% of $580mm,
Seagate had a 20% stake), assuming they didn't get a premium for taking the
all-stocks. Taking the stock was their bet on getting their billions.

------
nvlr
Jury found in Goldman's favor. It also found that the Bakers had mishandled
their roles in the transaction. The jury determined that the Bakers had
breached their fiduciary duty to their co-founders in failing to advise them
about potential problems with the deal.

[http://dealbook.nytimes.com/2013/01/24/goldman-overcomes-
its...](http://dealbook.nytimes.com/2013/01/24/goldman-overcomes-its-latest-
headache/)

------
softyeti
"It was at this meeting that L.& H. proposed shifting the $580 million deal
from half stock and half cash to all stock. The Bakers, with their high-priced
investment bankers M.I.A., agreed."

Case closed.

------
aftbit
"Goldman’s lawyer, John D. Donovan of Ropes & Gray in Boston, has argued that
under the terms of the engagement letter, only Dragon Systems had the right to
sue, and Dragon no longer exists. Goldman has even filed a countersuit against
Ms. Baker, contending that by suing Goldman she had breached the contract."

Wow. I don't know enough colorful language to describe that position.

------
padseeker
How the hell is it that ALL of the posts saying anything negative about GS
have been reported or downvoted or in gray. When did HN become such a staunch
defender of investment bankers? Goldman Sachs repeatedly acts in the interest
of themselves over their own clients.

This is going to be downvoted too, isn't it?

------
boreas
I actually took a math class taught by another former Dragon co-founder not
mentioned in this article. I think he got screwed even harder than the Bakers,
he always said he was good at math but bad at "business stuff".

------
oneJob
At this point, we have to ask, exactly what is require to get a legal decision
that goes against these folks. Given that this case was settled after the
financial crisis, and so sentiment would not be on the bankers' side, it is
even more surprising.

~~~
pc86
Some of the comments here surprise me. Why should sentiment matter at all?
Defendants are presumed innocent. Except under pretty specific circumstances
they do not have to _prove_ their innocence, just cause enough doubt to be
construed as reasonable.

Some people are able to vote not guilty for a defendant they despise, because
that's what you're supposed to do as a juror if the facts dictate. If you're
not able to do that, you have no business being on _any_ jury, whether the
defendant is a bank or a pauper. And even if you lie during voir dire (which
is a crime), with a presumption of innocence all you'll achieve is a hung
jury.

~~~
xixi77
It wasn't a criminal case, so there was no presumption of innocense. The jury
found that preponderance of evidence was in favor of the defendant. In theory,
sentiment shouldn't matter, but in practice it might, which suggests that
perhaps the case was not actually quite as clear-cut as the article implies...

------
known
Legalize insider trading; It'll fix HFT;

------
ikeboy
Should say 2012

------
danmaz74
Should be marked as [2012] in the title. Unfortunately, it looks like the
Bakers lost the case, as someone else already pointed out.

------
ratsmack
This may sound rather vindictive, but I have personal reasons for this
statement... and that is I hope I can live long enough to see the smoldering
corpse of Goldman Sachs being buried in a grave covered with a thick layer of
cement. They are a corrupt organisation.

~~~
at5
Why do you say that?

------
jessaustin
Wow that sucks. One is tempted to admire the _chutzpah_ of GS defense lawyers,
simultaneously claiming both that their contract was with a company that no
longer exists _and_ that the lawsuit was a breach of that contract by the
Bakers. Now that was a shitty contract! If one requires M&A work, one must
already have an experienced M&A attorney to approve the "engagement letter".
To get a reference to such an attorney, one must already have spent lots of
money with a different law firm that is large enough to have a partner with a
clue. Good luck with that, if you've been spending all your time developing
technology rather than e.g. orchestrating dodgy real estate schemes like a
particular presidential candidate. The house always wins.

As a juror, I would never vote "guilty" on a drug crime. Also, I would always
find for the plaintiff if GS were the defendant.

~~~
pc86
> _As a juror, I would never vote "guilty" on a drug crime._

What in the world does that have to do with anything?

> _Also, I would always find for the plaintiff if GS were the defendant._

"Presumption of innocence unless I don't like them" and all that, I guess.

~~~
bittercynic
While it may be slightly OT for this, I think it is an important
consideration.

It is a very coherent answer to the question: "What should you do if you're
required to report for jury duty as part of a system that you think is likely
to produce an unjust outcome?"

