There is a bill working its way through the Hong Kong legislature that would criminalize certain audit failures. Under the bill, auditors would face criminal liability if they knowingly or recklessly omit a required statement in the audit report. Naturally, Hong Kong accountants are up in arms over the proposal. Keith Pogson, President of the HKICPAs (and an E&Y partner) says the effect of the rule will be to “drive more business offshore” and to “create unnecessary barriers for business operations and companies set up in Hong Kong”. The main concern is that the proposed law would not require any dishonest intent, but rather "knowingly or recklessly” omitting a required statement.
A government spokesperson told the South China Morning Post: “the new proposal was an important step towards enhancing the reliability of financial statements and improving the regulatory regime for auditors”. Concerns about audit quality increased significantly after the Financial Reporting Council put 13 listed companies on watch for alleged auditing problems.
Hong Kong legislators have identified the right problem, but they are proposing the wrong solution. Hong Kong has ineffective audit regulation, but the solution is not to criminalize incompetence. Existing fraud laws are adequate for cases where the auditors are complicit in frauds. The new proposal criminalizes recklessness and incompetence.
There are better ways to deal with that.
The accounting profession in Hong Kong is self-regulated. The Professional Accountants Ordinance of 1973 designated the Hong Kong Institute of CPAs (formerly known as the Hong Kong Society of Accountants) as the regulator of the accounting profession. Self-regulation of the accounting profession was the standard in much of the world back in 1973. Since then, however, it became clear that self-regulation is ineffective. The accounting profession will rarely hold its members feet to the fire, even more rarely the feet of the powerful big firms. Increasingly, the global trend is for independent audit regulators. The most visible of these regulators are the Public Company Accounting Oversight Board of the United States and the Canadian Public Accountability Board. There are now 43 members of the International Forum of Independent Audit Regulators (IFIAR). Hong Kong is not a member of IFIAR because it does not have an independent audit regulator.
It is time for Hong Kong to separate audit regulation from the profession. An independent audit regulator will enhance the reliability of financial statements and improve the attractiveness of Hong Kong as a global capital market. Threatening auditors with criminal liability will not achieve those goals. Providing effective, independent regulation will improve the quality of auditing and the attractiveness of Hong Kong as a major capital market for China and the world.