Little hope regulators will act on Ernst & Young case

PUBLISHED : Saturday, 17 October, 2009, 12:00am
UPDATED : Saturday, 17 October, 2009, 12:00am

So is the regulator going to do anything about Ernst & Young following the Akai Holdings scandal? That is the question being asked loud and clear about town and which has revealed itself in angry messages in my e-mail inbox this week.

I wish I could tell you that even though the corporate world may have been too lackadaisical to sack the Big Four auditor following the Akai scandal (as I argued last week), our regulator will do something to restore public confidence in financial reporting.

But unfortunately I cannot give you that guarantee.

The whole Akai scandal boils down to three fundamental questions. Has Ernst & Young done a proper job in auditing the collapsed electronics company? Have the audit files been tampered with and if the answer is yes, by whom? If a proper job has not been done and the files have been tampered with, what should be done?

Which regulator is going to give us an answer?

The law enforcer? The police raided Ernst & Young and arrested a partner who allegedly doctored some Akai files, so we will have to await the results of that.

The Hong Kong stock exchange? No, it regulates the listed entity, not the accounting profession. And besides, it has no statutory powers.

The Securities and Futures Commission? It has statutory teeth, but it does not regulate the accounting profession. By law, it can bring people to court in regards to providing misleading information, such as false accounting, to shareholders intentionally. But a convenient defence for an auditor is that he or she has relied on the information provided by the management.

The other problem is that the two regulators have been silent on the Akai scandal over the past decade.

That leaves us with the Financial Reporting Council (FRC). According to its website, 'it has the sole and statutory responsibility of enhancing the integrity of financial reporting by means of investigation and enquiry, of listed entities in Hong Kong.'

Sounds hopeful but let's look at its brief track record.

It was established in late 2006 as Hong Kong responded to a series of accounting scandals such as Enron Corp and WorldCom in the international arena. At home, there had been domestic scandals such as Euro-Asia Agricultural (Holdings) claiming to be selling orchid shoots at HK$100 apiece as well as book-cooking initial public offerings.

In October 2007, the council launched its first investigation. It was about 'the allegations of the complaint related to the audit of [Subsidiary] included as a subsidiary in the consolidated financial statements of [Listed Entity] for the years ended [preceding financial year-end date] and [financial year-end date].'

'[Auditor] was the auditor of [Listed Entity] for the years ended [preceding financial year-end date] and [financial year-end date],' said an FRC report.

You will have to excuse the brackets - unlike its US and British peers, the council has to withhold any information that can identify the auditor being investigated. It's a compromise between the government and the accounting industry.

From the sanitised bits and pieces, one can work out that the complaint was about a listed firm that suffered a major loss because it had acquired an asset that ended up in liquidation and a shareholder did not repay a sum of money. No write-off of the asset has been made two years later and no impairment on the receivable has been made either. In short, shareholders were kept in the dark for two years.

A year later, the council completed the investigation. Six months later, a report was published. That's not too bad, given the limited resources it commands - a HK$10 million per annum contribution from the accounting profession and the stock exchange.

Here are its findings: (1) The auditor knew the recoverability of the receivable was crucial. Yet, it did not seek written confirmation of this amount since the management of the listed company requested it not to do so. When the management said a future transfer of assets would settle the amount, the auditor made no independent verification.

(2) A subsidiary of the listed firm reported a loss a year after buying the asset. The auditor explained that the loss was caused by a significant increase in administrative and selling expenses. Yet, the increase in these expenses was in fact less than the loss. There was an impairment indication. But the auditor has not performed impairment valuation.

The conclusion: The audit work did not comply with the relevant standards, namely sufficient independent evidence had not been obtained on the recoverability of the receivable; insufficient professional scepticism in respect of the valuation of certain assets; insufficient documentation in the audit working papers.

The penalty: the Hong Kong Institute of Certified Public Accountants (HKICPA) decided that the auditor had failed to comply with the auditing statement on documentation. It did not adequately document the audit work and evidence in support of their conclusion regarding the recoverability of an amount receivable and the valuation of the asset. 'Accordingly, it is considered that the matter is not of sufficient gravity to warrant disciplinary actions'.

No, I didn't miss a line or two from the report. Neither did you.

All the auditing non-compliance was reduced to a matter of insufficient documentation. The only penalty was a 'disapproval letter' issued by HKICPA, the industry's self-regulatory body. That was not even a smack on the hand.

What about the FRC? Sorry, unlike its British and US peers, the council only has investigative powers not disciplinary powers. The HKICPA has the sole say on punishing its members.

Even if council investigators are unhappy with that, they can't even do the name and shame thing. Remember, the identity cannot be revealed.

Shouldn't the HKICPA explain its decision? Well, its disciplinary process has never been transparent or public. After all, it is a 'self-regulatory' body.

Now you can see why my hopes are not high.

(Wait a second. I have written something similar before. It was in 1998. A red chip, Guangnan Holding, had collapsed overnight and its auditor, Deloitte, failed to notice that billions of dollars in receivables were based on transactions that never existed and it had counted tonnes of long-dead and rotten eels as inventory. The management was jailed. Our regulators did nothing in regard to the audit work. )