Threat of jail will get in way of professional audit judgment

PUBLISHED : Tuesday, 26 June, 2012, 12:00am
UPDATED : Tuesday, 26 June, 2012, 12:00am


Every person specified in subsection (2) commits an offence if the person knowingly or recklessly causes a statement required to be contained in an auditor's report under section 398(2)(b) or (3) to be omitted from the report.

Companies Amendment Bill,
clause 399

When legislators turn righteous they turn to jail sentences. They now want to impose criminal penalties on auditors who have an understanding of 'knowingly or recklessly' different from their own amateur grasp of these words.

Let's get a minor stupidity out of the way first. If you think this bill will protect you from rapacious corporate sharks in the stock market, here is some news. It won't.

Clause 399 does not apply (cannot apply) to non-Hong-Kong companies incorporated in mainland China or such localities as the British Virgin Islands and the Cayman Islands. These represent 75 per cent of the market capitalisation on our exchange and the figure is rising. We have a teeny-tiny loophole, you see. Apart from this, our government now also welcomes non-Hong-Kong auditors for such firms on the grounds that it will encourage further listings from the mainland. It will also serve to make that oh-so-little loophole big enough to allow a planetary system through.

Who the bill will actually target are the youngsters. The Institute of Certified Public Accountants reckons that nearly one million companies in Hong Kong now require audits and the bulk of this work unavoidably falls to audit staff members who have only a few years' experience and may not yet have full professional qualifications.

They cannot check every transaction a company makes. They must spot-check and otherwise rely heavily on management representations. How are they to be sure that a civil servant following the letter of the law upon receiving a complaint will not take the view that they have 'knowingly or recklessly' omitted something important?

But how would the civil servant know it was reckless? How would he react if he could be thrown in jail for doing something that a non-bureaucrat deems reckless? What would the lawyers who proposed this legislation say if they were made subject to the same threat?

There is one good way for the young accountant to avoid this danger and that is to take up a job in finance, instead of auditing, on attaining professional qualifications. There are signs that rising numbers of them are doing just that. What a fine way to improve audit standards.

The institute takes the view that 'knowingly and recklessly' is not succinct enough to provide clear guidance to the profession and want it changed to the more rigorous 'dishonestly or with intent to defraud'.

As chief executive Winnie Cheung put it in a letter to legislators earlier this month: 'It is almost a cliche to say that an auditor is a 'watchdog and not a bloodhound'. He cannot investigate everything and should display a reasonable degree of professional scepticism. This calls for judgment. Inevitably mistakes will sometimes be made and sometimes the auditor will be the victim of deliberate deception.'

Exactly. It is simply unfair to make auditing, which relies significantly on matters of professional judgment, subject in hindsight to outsiders' whims of what auditing should be and, even more so, to make contravening these whims a criminal offence. The prison mania that afflicts our legislators has gone much too far.

But they show little sign of returning to common sense in the matter and the bill is likely to go through as it stands, in which case I am pretty sure of the result.

Auditing will be mechanised entirely. It will consist purely of a checklist of the sort that pilots make before a flight - flaps on, lights off, doors closed - all devised by lawyers from case law and all done with the cameras and voice recorders rolling, black box-style.

Ask your auditor then whether you can carry your office premises at cost and he will consult his enormous case rule book and give you the one and only prescribed answer. It will be the only way he can be sure of escaping jail. Professional judgment, the whole idea of accounts giving you a 'fair view' of a company's financial position, will go out the window.

It won't make those accounts any more shark-proof. The sharks will read the rule book, too, and will take advantage of its many inevitable loopholes. Clause 399 will weaken, not strengthen, public accounting.