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  • Dec 24, 2014
  • Updated: 5:15am
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Hong Kong court orders Ernst & Young to hand over mainland audit papers

Ernst &Young's claim that mainland secrecy laws prevented disclosure to city regulator rejected

PUBLISHED : Friday, 23 May, 2014, 11:37pm
UPDATED : Saturday, 24 May, 2014, 12:28am

A Hong Kong court rejected accounting firm Ernst & Young's argument that the mainland's state secrets law meant it could not hand over information to the city's securities regulator.

The landmark ruling by the Court of First Instance supports international regulators wanting access to auditors' papers to investigate mainland companies listed in their markets.

Ernst & Young has deliberately withheld information from the SFC

But analysts say it may prompt the Ministry of Finance to speed up planned reforms that would ban Hong Kong and international accountants from working on the mainland. The South China Morning Post reported on Monday that the ministry planned to implement rules this year preventing international accountants from conducting audits on the mainland alone.

They would have to team up with mainland accountants to do so. The rules also say all accountants must strictly follow the state secrets law and should not take audit papers out of the mainland.

Brokers said the new rules were prompted by concerns in Beijing that overseas regulators could force accountants or mainland firms to disclose government or company information while checking their books.

Mainland e-commerce giant Alibaba, which is planning to list in the US, and other technology firms have gathered sensitive data on many firms and individuals on the mainland.

Mainland law has a wide definition of "state secrets", which can range from accountants' working notes to student examination papers.

Ernst & Young (EY) said the papers in question in the case were state secrets so it could not comply with nine requests from the Securities and Futures Commission (SFC) between April 2010 and October 2011 for auditing papers related to listing candidate Standard Water. The SFC filed a writ against EY in 2012.

"The court has come to the conclusion that EY has deliberately withheld from SFC information in its knowledge which is responsible to the notices," Mr Justice Peter Ng Kar-fai said in a written judgment released yesterday.

The court accepted a witness' opinion that the mainland's secrecy law was designed to "safeguard the security of the state's economy and protect the public interests of society".

As such, the law "does not impose a blanket prohibition on cross-border transmissions of audit working papers to overseas securities regulatory authorities", the court said.

Instead, the law banned only the transmission of state secrets, but EY could not prove its papers contained such information.

EY was ordered to pay court costs. It said it would review the judgment before deciding whether to appeal

SFC chief executive Ashley Alder said yesterday: "This case is primarily about the obligations of an accounting firm in Hong Kong to comply with requirements under Hong Kong law. The case is not about [mainland] law.

"Auditors should not withhold information which is in their possession and sought by the SFC in connection with suspected misconduct in Hong Kong's markets."

The president of the Hong Kong Institute of Certified Public Accountants, Clement Chan, said the ruling clarified the powers of the regulator.

"But it has not solved the disputes between China and the overseas regulators, which have different interpretations of the mainland secrecy law.

"The Ministry of Finance's new rules will continue to ban accountants from taking our papers out of the country while the international regulators force us to do so," Chan said.


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This article is now closed to comments

This is not about state secrets but the Mainland government trying to keep the lid on the corrupt "can of worms" that purports to be auditing in PRC. It's common knowledge that accounts are manipulated in PRC for various reasons and are frequently not worth the paper they are written on. The poor shareholder who invests is usually the only victim.
If PRC wants international investment they must comply with international auditing and transparency rules otherwise they will forever remain in the "well dodgy" category.
A professional firm should not take clients who give them state secrets, or should cease to act once that happens. The reputational and compliance costs are too high otherwise as clarified in Mr. Justice Peter Ng's case.
So let the mainland Chinese auditors protect the frauds of their mainland Chinese clients and do not let them sell their securities outside of the Mainland so that international investors are not defrauded. Works for me.
the ultimate reason is the evil communism
Is this to say, that E&Y withhold student examination papers?
Whatever the reasons on the Chinese side, one may interpret the rules being suitable to protect cheating mainland firms. In consequence, this would mean stock exchanges outside China must deny listing to mainland firms. Chinese acrimony again?
As i see it one of the big problems here is that China can work on a double standard they can claim that anything is a state secret and make it basicly imposible to chek Chinese company that act in a international arena.
EY's behavior in this case was shameful as the judge pointed out.
The existing 'state secrets' restriction on transmission of audit records of Chinese firm done by foreign accounting firms was justifiable as most Big Cap Chinese firms and banks are SOEs. This is China.It also protects sensitive market and commercial data, although it also makes it easier to deny access even in a prima facie case of malfeasance. Increased private participation in SOEs will weaken this line of argument.
The proposed new requirement that foreign accountants may not independently audit Chinese firms but must work with one of the 100+ recognized Chinese accounting firms is seized on it as reinforcement of the 'state secrets' excuse.I disagree - foreigners want a free hand, don't want to share fees or give up free luxury trips to China. It stops audits by Chinese branches of a foreign accounting firm which is blamed for shortcomings. It stops high-handed audit by a corps of foreign hounds arrogantly demanding access to any file over the heads of local staff and hierarchy. This is real bad in a forensic audit where the scent of a hunt is inescapable.
Most importantly, it is hypocritic, restrictive trade practices. They want to keep Chinese auditors out of the game. Joint audit allows Chinese accounting firms and staff to acquire skills, learn more about standards and understand what is being looked at and for in such audits. Also, how many big Chinese firms have been shorted and ruined by accounting reports? Where did details of these report come from?


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