Two New York City CPAs face hearing over SEC charges their lack of knowledge of accounting for derivatives played a major role in a client's substantially overstating assets and losses for two fiscal years. The SEC said the two, who were auditors for Kentucky Energy, turned over preparation of the clients' 2004 and 2005 financial statements to a consultant who was not a CPA and whose father was a VP and director of Kentucky Energy.

The SEC made the allegations against partners Philip C. Kempisty and John Anthony Rubino of Kempisty & Company. Its action called for a public hearing on a cease-and-desist order, which is to be held within the next 60 days. A cease-and-desist order was issued to  Kentucky Energy, formerly known as Quest Minerals & Mining Corp. Kempisty's clients and some of its staff joined MaloneBailey in 2009.

The CPA firm was Kentucky Energy's auditor from 2003 through Feb. 13, 2009. The SEC complaint says the two were aware that the consultant, Eugene Chiaramonte III, who was not a CPA, had prepared the company's financial statements for 2004 and 2005. Chiaramonte's company, Clear Mountain Associates, was retained by Kentucky Energy, the firm's only client. Chiaramonte was also ordered to stop violating SEC rules. Kentucky Energy was required to keep two independent directors on its board and to produce written internal controls.

Neither Rubino, the engagement partner, nor Kempisty, the concurring review partner, had the training or proficiency to properly apply GAAP to accounting for warrants and convertible notes, according to the complaint. The SEC also claims that the workpapers show no analysis of the treatment of these financial instruments.

During fiscal 2004 and 2005, Kentucky Energy obtained loans in the form of notes convertible into common stock and also issued a warrant for each note. While the consultant needed to account for the warrants for the year ended Dec. 31, 2004, Rubino had not dealt with accounting for warrants or the beneficial conversion feature of convertible notes.

The consultant was advised to visit a web-based calculator regarding the Black-Scholes pricing model for options. But instead of applying the correct number, the SEC continued that Chiaramonte used generic data that was given on the site and these numbers were utilized for the fourth-quarter statements.

Rubino then incorrectly told the consultant that that warrants should be recorded as an asset instead of as expenses and that he should have amortized that amount over the life of the underlying convertible note. The SEC said the warrants should have been recognized as additional paid-in capital.

But following the accountant's advice for the first quarter of 2005, the consultant recorded the value of the warrants as a $13.8-million asset. That exceeded the $1.9 million in notes the company received in 2005 and also overstated assets so that the net loss for the second quarter of 2005 was overstated by about 174 percent.

Bob Scott
Bob Scott has provided information to the tax and accounting community since 1991, first as technology editor of Accounting Today, and from 1997 through 2009 as editor of its sister publication, Accounting Technology. He is known throughout the industry for his depth of knowledge and for his high journalistic standards.  Scott has made frequent appearances as a speaker, moderator and panelist and events serving tax and accounting professionals. He  has a strong background in computer journalism as an editor with two former trade publications, Computer+Software News and MIS Week and spent several years with weekly and daily newspapers in Morris County New Jersey prior to that.  A graduate of Indiana University with a degree in journalism, Bob is a native of Madison, Ind
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