Hong Kong’s Securities and Futures Commission (SFC) has launched legal proceedings against Ernst & Young
for its failure to produce audit working papers and the underlying accounting documents relating to the Big Four firm’s work with Chinese company Standard Water.
The SFC went to the Court of First Instance in Hong Kong after Ernst & Young’s affiliate in China, EY Hua Ming, “failed to produce the records to the relevant Mainland authority as requested,” said the Hong Kong regulator. The SFC had asked China’s assistance under an arrangement for mutual assistance in investigatory matters between the two jurisdictions.
The case is being closely watched in accounting and auditing circles because of its potential to clarify ambiguous requirements under Chinese law. The US Securities and Exchange Commission has also encountered problems gaining access to audit papers done by Chinese auditors on Chinese companies under investigation in the US.
Standard Water had applied to list in Hong Kong in 2009, but withdrew its application several months later after Ernst & Young informed the Hong Kong stock market that it had resigned as the company’s reporting accountant and auditor.
The SFC then issued a formal notice to Ernst & Young for the audit working papers and underlying accounting documents. The accounting firm said the documents were held in China by EY Hua Ming and that it was constrained from producing the papers because of restrictions under Chinese law.
In a 2009 statement, the relevant Chinese authorities affirmed that accounting records, including audit working papers, may be covered by claims of state secrecy under the law.
“All Hong Kong accountants are required to obtain the consent of the relevant Mainland authorities before handing over any accounting records to regulators like the SFC, even if the records are kept in Hong Kong,” the SFC concedes.
But it argues that “accounting and audit working papers relating to private companies applying for listing in Hong Kong must be capable of being produced either directly to the SFC or via the relevant Mainland authority under the standing arrangements for cooperation, especially where the SFC is investigating suspected misconduct.”
“Given Ernst & Young was the reporting accountant and EY Hua Ming was Ernst & Young’s agent, the failure to produce these records to the relevant Mainland authority on the SFC’s request is a matter of serious concern,” the regulator maintains.
The SFC says the proceedings were launched “after consulting the relevant Mainland authority about access to these records” and that it continues to work with the Chinese regarding the issue.