In a carbon copy of the SEC’s case against the Big Four, a Hong Kong High Court judge has ruled that EY cannot withhold working papers on Standard Water, a mainland company that pursued a listing in Hong Kong. The ruling is a major blow to the accounting profession in Hong Kong.
The Securities and Futures Commission (SFC) brought the case against EY. While EY Hong Kong was the accountant of record, they apparently outsourced the audit to EY Hua Ming, EY’s mainland affiliate. When SFC asked to see the working papers, EY Hong Kong demurred, saying they did not have them and that EY Hua Ming had refused to provide them because Chinese laws prohibited doing so.
I am surprised that SFC was not able to work out a compromise with Chinese regulators along the lines of the PCAOB agreement. The PCAOB deal, which allows for a rigorous redaction process, might have been unacceptable to the SFC. Chinese regulators might have been reluctant to give up any turf for fear that the precedent would work against them with the SEC.
EY’s service as reporting accountant raises the question as to whether it should have been willing to sign the audit opinion in the first place. It is questionable whether EY could be the principal accountant if they outsourced the entire audit to their mainland affiliate. Instead, the mainland affiliate should have been the reporting accountant.
But that would not work under Hong Kong rules. As a privately owned company, or P-Chip, Standard Water must use a Hong Kong CPA in order to list in Hong Kong. H-shares are allowed to use certain mainland accountants. Hong Kong accountants say that they must sign Red Chips and P-chips from Hong Kong despite the question of whether they are the principal accountants.
To make matters worse, Chinese regulators have proposed rules to force Hong Kong CPA firms to outsource audit work on the mainland to affiliates on the mainland. That, of course, is what EY appears to have done on Standard Water.
That puts everyone in an untenable position. Hong Kong exchange rules require a Hong Kong firm to audit all Red Chip and P-Chip listings, yet the mainland requires that the audits be done by mainland affiliates. When the audit is done by the mainland affiliate, the report should be signed by the mainland affiliate, but the Hong Kong Exchange will not accept opinions signed by the mainland affiliate. Something has to give.
That something is probably the Exchange rules that require Hong Kong CPAs to sign all Red Chips and P-Chips. The exchange already allows H-shares to be signed by mainland accountants. It will have to extend those rules to Red Chips and P-Chips. Nevertheless, it seems highly unlikely the SFC will be seeing any mainland audit working papers.