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Wednesday August 29, 2012

HK regulator takes Ernst & Young to court on work papers


HONG KONG: Hong Kong's securities regulator, in an unprecedented move, took Ernst & Young to court after the audit giant failed to turn over accounting records related to a China-based company.

The auditor now faces the dilemma of whether to comply with the order by the regulator and risk a possible breach of China's state secrecy laws or face regulatory sanctions in Hong Kong.

The case is the first of its kind in Hong Kong and mirrors one in the United States where Ernst & Young's rival, Deloitte Touche Tohmatsu, is fighting a request from US regulators to hand over its audit work papers of Chinese computer company Longtop Financial Technologies.

Accounting scandals at mainland companies listed in America such as Longtop and Sino-Forest Corp have dented investor confidence in US-listed Chinese stocks. The blowups have spurred regulators there to demand access to audit work papers kept in China and inspect mainland-based auditors.

“This risks throwing H-share and red chip companies into the same mess that all the US-listed Chinese companies are in,” Paul Gillis, professor of accounting at Peking University and author of the China Accounting Blog, said by phone yesterday.

Red chips and H-shares refer to companies operating in mainland China but listed in Hong Kong. Reuters

Between them, they make up more than half of the city's stock market.

The US Securities and Exchange Commission (SEC) last September asked a federal court to force Deloitte to produce records related to possible accounting fraud at Longtop, but Deloitte has resisted, citing Chinese secrecy laws.

That case has currently been postponed as the SEC said it wa trying to reach a solution with Chinese regulators.

The Securities and Futures Commission (SFC) in Hong Kong said late on Monday it wanted the Ernst & Young unit in the city to hand over its records from its audit work for mainland-based water provider Standard Water Ltd.

The SFC said the audit firm had claimed it did not have the relevant records, as they were held in mainland China by its joint-venture partner, Ernst & Young Hua Ming, and could not be produced due to restrictions under China's state secrecy laws.

“The secrecy rules are a fairly grey area the mainland authorities have made announcements reminding firms of their obligations under them in recent years, but have not gone on to define fully what they are,” said Chris Joy, executive director at the Hong Kong Institute of CPAs.

The SFC said auditors should always be able to provide documents, especially with Standard Water having applied for a listing in Hong Kong on Nov 9.

“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,” the SFC said in a statement.

The regulator added that it already had consulted its mainland counterparts about the records and was working with them on this issue.

Ernst & Young in Hong Kong did not immediately respond to calls seeking comment.

Peking University's Gillis said the fact that the Hong Kong firm was acting as Standard Water's main auditor means it was in a difficult position to defy the SFC's request.

“If the Hong Kong firm is signing the reports, that are to be used in Hong Kong, then under auditing standards the majority of the work should have been done in Hong Kong and they should have evidence of that work,” he said.

Under the action taken by the SFC, the Hong Kong court will inquire into why Ernst & Young has not complied with the regulator's request. It can order the auditor to hand the papers over if it is satisfied it does not have a reasonable excuse.

A date for the first hearing is yet to be set. Reuters

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