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Accountants face challenge over disclosure of state secrets

Auditors await clearer guidelines on provision of sensitive information from High Court ruling


Accountants in Hong Kong are facing a challenge that goes beyond balance sheets and profit and loss accounts - how to handle state secrets.

At issue is whether companies can use such secrets as a reason for not disclosing information to auditors and if accountants can use that same excuse to not give information to the Securities and Futures Commission (SFC).

The debate will take centre stage on September 11 when the High Court will rule on whether Ernst & Young can use state secrecy as a reason for not providing audit papers to the SFC.

Last Monday, the commission filed a writ in the High Court seeking a court order to require the Big Four accounting firm to deliver accounting information regarding mainland company Standard Water. The company applied to list in Hong Kong in November 2009 but Ernst & Young resigned as auditor four months later. Standard Water later withdrew its application.

Despite nine notices from the SFC, Ernst & Young has failed to hand in the requested papers. It claimed they contained state secrets and could not be disclosed.

Roy Lo Wa-kei, managing partner of ShineWing HK, said he was surprised that Ernst & Young had not complied with the SFC's requests. Lo said that although mainland secrecy laws generally banned firms from giving out audit papers, it could be done if the relevant consents were obtained. "From the SFC announcement, it appears the SFC has already received the consent of the relevant mainland regulators to access the accounting record," he said.

Hong Kong Institute of Certified Public Accountants (HKICPA) chief executive Raphael Ding said accountants had become sandwiched between the Hong Kong regulator and the requirements of mainland secrecy laws.

"The HKICPA has clear guidelines requiring all accountants to provide assistance to SFC investigations and they must hand in information to the commission. However, all accountants also need to comply with the mainland secrecy law which says accountants' working papers are state secrets," Ding said.

In this case, Ernst & Young's mainland joint venture, EY Hau Ming, handled the audit preparing Standard Water for its IPO.

"The mainland joint venture is another entity and it may not be necessary to give information to the Hong Kong office," Ding said, adding a High Court ruling would provide a clear guideline for Hong Kong accountants in such situations.

"It is not good from the perspective of investor protection if the SFC cannot get the information it needs to conduct an investigation. If the court rules in favour of any firm using mainland secrecy laws as an excuse for non-disclosure, there should be some sort of reform to solve the problem," he said.

Two weeks ago, the SFC ordered the suspension from trading of Fujian-based watch component and industrial measurement maker China High Precision Automation.

The move came after the company also used state secrecy as the reason for not giving information to its former auditor KPMG.

The watchdog is becoming concerned that the increasing number of the companies citing mainland state secrecy laws as reasons for non-disclosure will tarnish corporate transparency and enforcement in Hong Kong.

Lo said if a company could not make a disclosure because its business dealt with state secrets then it was not a suitable listing candidate.

"Investors rely on a company's disclosure to make investment decisions," Lo said.

Some US firms such as Boeing did not list parts of their business, such as weapons, if they were covered by government secrecy laws.

Keith Pogson, president of Hong Kong Institute of Certified Public Accountants, said there was no international auditing standard on how to handle state secrets.

"This is a particularly difficult topic for auditors working in China. In certain areas, Chinese law restricts certain types of information being shared," he said.

Pogson said both China and Hong Kong auditors followed International Auditing and Assurance Standards, which did not have specific advice or guidance regarding "state secrets".

"However, there is guidance on where insufficient information is provided by management for the auditor to be able to form their opinion," he said.

"Auditors will generally look for or consider other ways of gaining evidence to support their opinion, but if there really is a lack of an ability by management to share that evidence to support the financial numbers, then the auditor will have to determine the impact of those restrictions and … give a qualifying opinion or withholding their audit report."

Terence Cheung, a partner of Deloitte, said that generally speaking, state secrets themselves might not have an impact on financial reporting.

"The auditor should follow the auditing standards to carry out necessary audit works and procedures for an expression of audit opinion," Cheung said.

"Should the state secrets impose restrictions or limitations on the scope of audit work and procedures, the auditor should look for alternative procedures or consider disclosing such limitations in the auditor's report."

This article appeared in the South China Morning Post print edition as: State secrets the new challenge for accountants Disclosure the new big challenge for auditors