Regulatory Efforts To Obtain Audit Papers In China Continue To Fail

The Securities and Futures Commission of Hong Kong instituted a proceeding against Ernst & Young Hong Kong for failing to produce audit work papers. The proceeding, which is virtually identical to one brought by the SEC earlier this year, is another involving a Chinese company that entered a market requiring transparency but whose audit papers are inaccessible under PRC law.

The SFC requested that EY produce the audit work papers for Standard Water, a company which applied for listing to the Stock Exchange of Hong Kong in November 2009. In March 2010 E&Y told the Exchange that it was resigning as the reporting auditors for Standard after discovering certain inconsistencies in documentation provided by the company. Later the company withdrew its application for listing.

Subsequently, the SFC issued a formal notice to E&Y for the audit work papers. The firm failed to produce the papers since they are held by an affiliate in the Peoples Republic of China. A request to the PRC firm, Ernst & Young Hau Ming, also proved fruitless. Under an October 2009 statement by PRC authorities accounting records, including audit working papers, may be subject to claims of state secrecy. That law specifies that Hong Kong accountants are required to obtain the consent of the relevant PRC authorities before producing any accounting records to regulator even, even those in Hong Kong.

The SFC has applied to the court, seeking an order against E&Y. The court may, under the articles invoked, order the firm to comply with the request if it is satisfied that the audit firm does not have any reasonable excuse for not complying. The regulator is also continuing discussions with the mainland authorities who were consulted prior to the initiation of this its court proceeding.

The SFC proceeding is virtually identical one brought earlier this year by the SEC involving the PRC based affiliate of Deloitte. SEC v. Deloitte Touche Tohmatsu CPA, Ltd., File No. 1:11-MC-00512 (D.D.C. Filed Sept. 8, 2011). There the Commission alleged that the PCAOB registered firm served as the outside auditors for Longtop Financial Technologies Ltd., a Cayman entity based in Shanghai. In May 2011 the firm resigned from the engagement after discovering numerous improprieties during a year end audit.

The SEC issued an investigative subpoena for documents to the audit firm. To date no documents have been produced. Initially, the Commission sought to move forward with the court action, requesting an order the documents produced. In July 2012, however, the SEC asked the court to stay the proceeding for six months because of “ongoing negotiations with a foreign regulator that could impact the appropriate resolution of this case. The stay was granted. The Commission informed the court it would file a status report no later than January 18, 2013 regarding the status of the discussion.

To date the SEC’s efforts to obtain audit work held papers in the PRC have yielded the same results as those of its Hong Kong counterpart. Both regulators have sought to investigate companies that chose to enter their respective jurisdiction. Both regulators sought to review audit work papers that are supposed to be available when questions arise. Both regulators have held talks with the appropriate officials in the PRC. Neither regulator has been able to obtain the requested audit work papers.

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