UNITED STATES OF AMERICA
In the Matter of
CHARLES A. DAIRAGHI, C.P.A.,
ORDER INSTITUTING PUBLIC ADMINISTRATIVE PROCEEDINGS, MAKING FINDINGS AND IMPOSING REMEDIAL SANCTIONS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted against Charles A. Dairaghi, C.P.A., ("Dairaghi" or "Respondent") pursuant to Rule 102(e)(1)(ii).1
In anticipation of the institution of these proceedings, Dairaghi has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, Dairaghi consents to the issuance of this Order and to the entry of the findings and imposition of the remedial sanctions set forth below, without admitting or denying the Commission's findings, except that Dairaghi admits that the Commission has jurisdiction over him and over the subject matter of this proceeding.
On the basis of this Order and the Respondent's Offer, the Commission finds2 that:
1. Charles A. Dairaghi ("Dairaghi"), a certified public accountant, was the chief financial officer for Eisner Securities, Inc. ("ESI") from June 2000 through September 2001. In September 2000, ESI terminated Joseph E. Erwin ("Erwin"), the former manager of its Columbus, Ohio branch office, after discovering that he had misappropriated approximately $2 million from at least 11 ESI customer accounts from 1997 through 2000.3 Erwin misappropriated the funds by abusing the special access he had been given to ESI's clearing firm's computer system. ESI's liabilities stemming from the misappropriation resulted in its SIPC liquidation in October 2001. From October 2000 until it ceased conducting business in September 2001, ESI failed to include the liability to customers incurred as a result of Erwin's misappropriations in its net capital computations, quarterly FOCUS reports, and underlying books and records, which were prepared by Dairaghi.
2. Charles A. Dairaghi, age 38, resides in St. Louis, Missouri. Dairaghi has been licensed in Missouri as a certified public accountant since 1989. He also has been licensed by the National Association of Securities Dealers ("NASD") as a financial and operations principal ("FINOP") since July 2001. Dairaghi is a partial owner of Saxony Securities, Inc. ("Saxony"), a broker-dealer that began operations in February 2002. Prior to entry of the Order, Dairaghi was also the registered FINOP for Saxony.
3. ESI, formerly headquartered in St. Louis, Missouri, was registered with the Commission as a broker-dealer from May 15, 1996 until December 2, 2001. On September 26, 2001, ESI notified the Commission and the NASD that it was not in compliance with its $50,000 minimum net capital requirement and was ceasing operations immediately. On October 2, 2001, ESI filed a Form BDW with the Commission that voluntarily withdrew its registration as a broker-dealer. On October 30, 2001, ESI was placed in SIPC liquidation. On December 2, 2001, ESI's Form BDW became effective. ESI was a member of the NASD.
4. Bruce D. Oakes ("Oakes"), age 39, resides in Ballwin, Missouri and was ESI's chief operating officer and registered FINOP from its inception in 1996 until it ceased conducting business in September 2001. Oakes also held the title of president from January 2001 until September 2001.
5. ESI was an introducing broker, carrying and clearing its customer accounts on a fully-disclosed basis through a clearing firm. ESI's clearing firm retained customer funds, generated statements for ESI's customers, and effectuated transactions in ESI's customers' accounts at the direction of ESI. ESI's minimum net capital requirement was $50,000.
6. Oakes hired Erwin in 1997 and granted him direct access to ESI's clearing firm's computer system, which included the ability to change customer addresses. Erwin used his access to the clearing firm's computer to change customer addresses to addresses he controlled and then submitted check requests from the accounts. Erwin forged signatures on the checks he received and deposited the funds in accounts he controlled. Erwin generated and mailed fake statements to the customers.
7. In September 2000, ESI terminated Erwin after discovering that he had misappropriated approximately $2 million from at least 11 ESI customer accounts since being hired. By October 2000, ESI had created a spreadsheet of the exact amount misappropriated from each customer account, totaling approximately $2 million. Erwin's misappropriations represented more than 100% of ESI's total assets. Dairaghi knew in September 2000 that ESI had terminated Erwin for misappropriating approximately $2 million in customer funds and that ESI had created a spreadsheet reflecting his misappropriations by the next month.
8. In November 2000, ESI sent letters to most, if not all, of the customers affected by Erwin's misappropriations promising to handle their claims directly by March 31, 2001 if the carrier of ESI's Errors and Omissions professional liability insurance policy ("E&O policy") had not paid the claims by then. ESI had a $1 million E&O policy. ESI's claim under that policy was denied in October 2000, which Dairaghi knew at the time of the denial. Dairaghi did not know at the time about ESI's November letter to the customers affected by Erwin's misappropriations.
9. In December 2000, ESI, through counsel, sent letters to most, if not all, of the customers affected by Erwin's misappropriations identifying the exact amount of each customer's loss and saying that "[ESI] intends to restore your loss as promptly as possible." The December 2000 letters went on to offer to restore to the customers 50% of the amount misappropriated from their accounts, in cash, immediately, with the remaining 50% paid out over 18 months, with interest. ESI did not have sufficient reserves to pay the 50% cash reimbursements. Dairaghi did not know at the time about ESI's December 2000 letters through counsel to the customers affected by Erwin's misappropriations offering to restore their losses.
10. From at least March through September 2001, ESI admitted the liability created by Erwin's misappropriations during merger negotiations with another broker-dealer. From the beginning of negotiations, ESI discussed establishing a $4 million "holdback" escrow fund to pay any settlements or judgments arising from Erwin's misappropriations or other litigation matters. Dairaghi knew at the time that the $4 million holdback escrow fund was part of the merger negotiations.
11. Dairaghi's duties as ESI's chief financial officer included calculating ESI's net capital computations, preparing payroll, preparing ESI's quarterly FOCUS reports, and maintaining ESI's books and records. Oakes supervised Dairaghi and signed ESI's FOCUS reports.
12. Paragraph 8 of Statement of Financial Accounting Standards No. 5 ("FAS 5") required ESI to accrue the amount misappropriated as a liability if it was probable that a liability had been incurred as a result of Erwin's misappropriations and if the amount of loss could be reasonably estimated. Under this analysis, it was probable that a liability had been incurred by ESI because Erwin was an ESI branch manager and he stole ESI's customers' funds using the special access that ESI granted him to the clearing firm's computer. Further, ESI never disputed its liability with the customers affected by Erwin's misappropriations. The amount of loss for Erwin's misappropriations also was estimated by at least October 2000 when ESI created a spreadsheet of the exact amount misappropriated from each customer account.
13. From at least October 2000 through September 2001, ESI did not include the liability owed to customers resulting from Erwin's misappropriations in its net capital computations, and books and records, which Dairaghi prepared. ESI also did not include the liability owed to customers resulting from Erwin's misappropriations in its FOCUS reports filed with the NASD for the quarters ended December 31, 2000, March 31, 2001, and June 30, 2001, which Dairaghi prepared. Had ESI accrued Erwin's misappropriations as a liability between October 2000 and September 2001, then those records would have reflected a net capital deficit ranging between $1.7 million and $2 million.
14. Dairaghi's failure to accrue a liability for Erwin's misappropriations in ESI's net capital computations, books and records, and FOCUS reports from at least October 2000 through September 2001 was reckless, or at a minimum, highly unreasonable. Under FAS 5, the amount stolen was a liability required to be accrued upon discovery in September 2000 and was estimated by at least October 2000. Moreover, given the information Dairaghi did know about Erwin's misappropriations, his ignorance of the November and December 2000 letters was reckless, or at a minimum, highly unreasonable. Finally, Dairaghi's failure to accrue a liability for Erwin's misappropriations was reckless, or at a minimum, highly unreasonable because he knew from at least March 2001 that ESI was negotiating a $4 million holdback escrow fund to pay any settlements or judgments arising from Erwin's misappropriations or other litigation matters as part of merger negotiations.
15. Dairaghi prepared ESI's financial statements for its fiscal year ended December 31, 2000 for audit by ESI's auditors, Rubin, Brown, Gornstein & Co, LLP ("RBG"). During the planning stage of RBG's audit in the Fall of 2000, Dairaghi informed RBG about Erwin's $2 million misappropriation. Nonetheless, Dairaghi did not include the liability owed to customers as a result of Erwin's misappropriations in the ESI financial statements audited by RBG.
16. By correspondence dated February 2, 2001 under signature of Oakes and Dairaghi, ESI submitted its management representation letter to RBG. Although Dairaghi had informed RBG about Erwin's misappropriations during the planning stage of the ESI audit, in this letter Oakes and Dairaghi informed RBG that (1) "we are not aware of any . . . instances of errors or fraud involving management or employees that could have a material effect on the financial statements," and (2) "there are no unasserted claims or assessments that our lawyer has advised us are probable of assertion and must be disclosed in accordance with Statements of the Financial Accounting Standard No. 5."
17. By correspondence dated February 23, 2001, ESI's counsel sent RBG an attorney letter that contradicted, rather than confirmed, ESI's management representation letter by disclosing two pending NASD arbitrations and ten unasserted claims related to Erwin's misappropriations. In the attorney letter, ESI's counsel referenced his December 2000 correspondence offering to restore customer losses, saying that his firm "has contacted each customer on behalf of ESI and initiated discussions in order to resolve any matters pertaining to Mr. Erwin's acts." Dairaghi received a copy of the attorney letter. Dairaghi did not read the section of the attorney letter that disclosed the unasserted claims, which contradicted the representations Dairaghi had made in ESI's management representation letter.
18. ESI did not include the liability incurred as a result of Erwin's misappropriations in its audited financial statements for its fiscal year ended December 31, 2000, which were filed with the Commission on February 28, 2001.
19. Dairaghi's failure to accrue a liability for Erwin's misappropriations in the financial statements that RBG audited was reckless, or at a minimum, highly unreasonable. Likewise, Dairaghi's conduct relative to ESI's management representation letter to RBG was reckless, or at a minimum, highly unreasonable. At the time Dairaghi signed ESI's management representation letter representing that there were no instances of fraud by ESI's management or employees, Erwin already had pled guilty on federal mail and wire fraud charges related to his misappropriations. Finally, Dairaghi's failure to read the section related to unasserted claims in the attorney letter to RBG, which contradicted the representations Dairaghi previously made to RBG in ESI's management representation letter, was reckless, or at a minimum, highly unreasonable.
20. Dairaghi engaged in the above conduct when he knew, or should have known, that heightened scrutiny was warranted. The amount of Erwin's misappropriations exceeded ESI's total assets. Moreover, Erwin's thefts exposed ESI to potential claims for customer losses and to possible regulatory action.
21. Dairaghi had a duty to ensure that ESI's financial statements and FOCUS reports were prepared in accordance with GAAP, including FAS 5. As a result of Dairaghi's reckless or highly unreasonable conduct under circumstances warranting heightened scrutiny, ESI's financial statements were not prepared in accordance with GAAP because no liability was accrued for Erwin's misappropriations, as required by FAS 5. As a result, ESI's net capital computations, quarterly FOCUS reports, books and records, and annual audited financial statements also were inaccurate.
Accordingly, by engaging in the conduct alleged in paragraphs 1 through 21 above, Dairaghi engaged in improper professional conduct within the meaning of Rule 102(e) of the Commission's Rules of Practice in that his conduct: (i) constituted intentional or knowing conduct, including reckless conduct, that resulted in a violation of applicable professional standards; or (ii) constituted negligent conduct, consisting of a single instance of highly unreasonable conduct that resulted in a violation of applicable professional standards in circumstances in which Dairaghi knew, or should have known, that heightened scrutiny was warranted.
On the basis of this Order and the Respondent's Offer, the Commission finds that Dairaghi engaged in improper professional conduct for purposes of Rule 102(e) of the Commission's Rules of Practice.
In connection with this proceeding and any related judicial or administrative proceeding or investigation commenced by the Commission or to which the Commission is a party, the Respondent undertakes to: (i) produce documents within his possession, custody or control and provide interviews at the request of the Commission staff; (ii) accept service by mail or facsimile transmission of subpoenas for documents or testimony at depositions, hearings or trials; (iii) in connection with such subpoena, waive the territorial limits on service contained in Fed. R. Civ. P. 45 or applicable local rules for such subpoenas, and waive the requirements of Fed. R. Civ. P. 28; (iv) appoint John Short of the law firm of Blackwell, Sanders, Peper, Martin LLP as agent to receive such service; (v) give truthful and accurate information and testimony and not assert any evidentiary or other privilege other than the attorney-client and work product privileges; and (vi) in the event of his failure to testify truthfully or to comply with the above requirements, be subject to contempt proceedings, charges of perjury and/or charges of obstruction of justice.
In determining whether to accept the Offer, the Commission considered these undertakings.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Respondent's Offer.
Accordingly, it is hereby ORDERED, effective immediately, that:
A. Respondent is denied the privilege of appearing or practicing before the Commission as an accountant.
B. After one year from the date of this Order, Respondent may request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
C. The Commission will consider an application by Respondent to resume appearing or practicing before the Commission provided that his state CPA license is current and he has resolved all other disciplinary issues with the applicable state boards of accountancy. However, if state licensure is dependant on reinstatement by the Commission, the Commission will consider an application on its other merits. The Commission's review may include consideration of, in addition to the matters referenced above, any other matters relating to Respondent's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
Jonathan G. Katz
(1) The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter..:
(ii) To be lacking in character or integrity or to have engaged in unethical or improper professional conduct…;
(iv) With respect to persons licensed to practice as accountants, "improper professional conduct" under Rule 102(e)(1)(ii) means: (A) intentional or knowing conduct, including reckless conduct, that results in a violation of applicable professional standards; or (B) either of the following two types of negligent conduct: (1) a single instance of highly unreasonable conduct that results in a violation of applicable professional standards in circumstances in which an accountant knows, or should know, that heightened scrutiny is warranted…
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