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...
[1]: http://dealbook.nytimes.com/2013/01/29/lessons-for-entrepren...
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.
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.
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.
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.
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.
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.
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.
Since this article is literally about a lawsuit, it does seem like a legal issue.
I think we probably agree though. Goldman absolutely did a poor job on this deal, but that doesn't make what they did illegal (as many commenters here seem to feel).
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.