SIMULTANEOUSLY CONCEALING THE COMPANY'S GROWING DEBT BY HIDING ITS INVENTORY OF "HOUSE STOCKS" IN CUSTOMERS' ACCOUNTS OR AT OTHER BROKERAGE HOUSES. IT IS UNDISPUTED THAT BDO'S AUDIT REPORTS NEVER NOTED SUCH PRACTICES. AS REQUIRED BY SEC RULE, BDO ISSUED AN ANNUAL OPINION ASSESSING BARON'S INTERNAL BOOKKEEPING PRACTICES AND PROCEDURES FOR SAFEGUARDING SECURITIES (17 CFR §240.17A 5[G]). IN ITS OFFICIAL STATEMENTS FOR ALL FOUR YEARS OF BARON'S OPERATION, BDO NOTED NO MATERIAL WEAKNESSES WITH BARON'S INTERNAL CONTROLS OR PROCEDURES FOR SAFEGUARDING SECURITIES.
SIPC'S COMPLAINT FURTHER CHARGES THAT, BY FAILING TO PERFORM A PROPER AUDIT, BDO WAS ABLE TO CERTIFY THAT BARON MAINTAINED A HEALTHY RATIO OF DEBT TO NET CAPITAL. THE SEC PRESCRIBES THE RATIO OF DEBT THAT A BROKER MAY CARRY RELATIVE TO ITS READILY LIQUID CAPITAL (SEE, 17 CFR §240.15C3 1). THIS "NET CAPITAL RULE" REQUIRES THAT A BROKER'S DEBT NOT EXCEED 15 TIMES THE AMOUNT OF LIQUID CAPITAL. IN FISCAL YEARS 1992, 1993 AND 1994 DEFENDANT'S AUDITS CERTIFIED THAT BARON'S DEBT WAS APPROXIMATELY EQUAL TO ITS NET CAPITAL, A FIGURE FAR BELOW SEC LIMITS. IT WAS NOT UNTIL ITS AUDIT FOR FISCAL YEAR 1995, ISSUED WEEKS BEFORE BARON DECLARED BANKRUPTCY, THAT BDO REPORTED FOR THE FIRST TIME THAT BARON'S DEBT EXCEEDED 15 TIMES ITS NET CAPITAL.
BDO ALSO INCLUDED AN "INDEPENDENT AUDITOR'S REPORT" WITH EACH OF ITS ANNUAL FILINGS (SEE, 17 CFR §240.15A 5[J]). THESE REPORTS SUPPLEMENTED THE OTHER DATA REQUIRED BY THE RULES. IN FISCAL YEAR 1993, THE AUDITOR'S REPORT NOTED THAT THE COMPANY HAD INCURRED SIGNIFICANT LOSSES FROM OPERATIONS WHICH RAISED SUBSTANTIAL DOUBTS AS TO THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. THE 1993 AUDITOR'S REPORT ALSO NOTED THAT THE SEC HAD BEGUN AN INVESTIGATION OF BARON AND THAT BARON WAS IN ARBITRATION WITH SEVERAL OF ITS CUSTOMERS OVER LOSSES INCURRED.
THE 1994 AUDITOR'S REPORT ONCE AGAIN MENTIONED THE SEC'S ONGOING INVESTIGATION OF POSSIBLE SECURITIES LAWS VIOLATIONS, IN PARTICULAR THAT THE SEC SUSPECTED THAT BARON HAD ILLEGALLY MANIPULATED THE MARKET, HAD EXECUTED UNAUTHORIZED STOCK TRADES AND FAILED TO EXECUTE CUSTOMERS' SELL ORDERS, AND THAT THE SEC WAS CONSIDERING VARIOUS SANCTIONS AGAINST THE COMPANY. THE 1994 REPORT REVEALED THAT THE NASD WAS ALSO CONDUCTING AN INVESTIGATION OF BARON FOR IMPROPRIETIES RELATING TO ANOTHER SECURITY AND LIKEWISE CONSIDERING SANCTIONS AGAINST THE COMPANY. THE 1994 AUDITOR'S REPORT AGAIN MENTIONED THE CUSTOMERS' ARBITRATION PROCEEDINGS AGAINST BARON, WITH TOTAL CLAIMS EXCEEDING $10 MILLION. IN ITS LAST AUDITOR'S REPORT FOR FISCAL YEAR 1995, DEFENDANT REPEATED REFERENCE TO THE SEC INVESTIGATION, ADDED THAT CUSTOMER ARBITRATIONS AND LAWSUITS HAD GROWN TO CLAIMS EXCEEDING $80 MILLION AND THAT, AS A RESULT OF THE BANKRUPTCY OF BARON'S CLEARING BROKER, BARON WAS IN DANGER OF BEING UNABLE TO COLLECT A RECEIVABLE OF OVER $3.3 MILLION.
THE AUDIT REPORTS PREPARED BY BDO WERE ALL SENT TO THE NASD AS THE REGULATORY ORGANIZATION DESIGNATED BY THE SEC TO OVERSEE BARON'S COMPLIANCE WITH SECURITIES LAWS (SEE, 15 USC §78O3). NONE OF BDO'S AUDIT REPORTS WERE SENT TO SIPC.
SIPC WAS CREATED BY THE SECURITIES INVESTOR PROTECTION