All has been quiet on the U.S. front with respect to the SEC’s case against the Big Four and BDO over turning over working papers. Ernst & Young (E&Y) were in court in Hong Kong on Thursday to make final arguments on their failure to turn over the working papers for Standard Water to the Securities and Futures Commission (SFC).
Ernst & Young seems to keep opening up cans of worms in this case. It is the Hong Kong affiliate of E&Y that the SFC has dragged into court because that is the firm that was the accountant of record. E&Y had to make the embarrassing admission that it did not have any working papers because it didn’t actually do the audit. The audit was done by E&Y Hua Ming, its mainland affiliate who refused to turn over the working papers because China won’t allow it. E&Y Hong Kong has not explained how it can be the signing accountant when it does not do audits. The Big Four in China have often overlooked the principal auditor rule that requires the audit firm that does most of the work to sign the report. The problem in Hong Kong is that the Exchange requires a Hong Kong accountant to sign most red chips, and the Big Four have ignored their legal structure and the way they do audits to accommodate this requirement.
In the earlier hearing, SFC and the judge were skeptical that E&Y did not have access to the working papers on SFC. In the hearing on Thursday, E&Y admitted that some of the working papers inadvertently found their way to Hong Kong on a partner’s laptop, but that they were not going to turn them over since they never should have been brought to Hong Kong in the first place. I can’t see that argument impressing the judge. I would be surprised if many of the working papers are actually on the laptop. Audit working papers tend to be stored on servers where access can be secured. I expect that giving a Hong Kong partner access to China working papers from Hong Kong is simply a matter of putting them on the access control list, and I would further speculate that that was common practice before the SFC brought suit. E&Y appears to be skating on very thin ice.
I am surprised that the case has not been settled. CSRC has agreed to turn over working papers on Longtop Financial Technologies to the SEC. That case, however, has yet to be dropped by the SEC. With that precedent, I would have expected that the CSRC would have authorized the release of the Standard Water working papers. Perhaps they have a reason to withhold them.