EY loses on state secrets | China Accounting Blog | Paul Gillis

EY loses on state secrets

Ernst and Young (EY) Hong Kong lost an important case in Hong Kong that may have widespread impact on the profession and the securities markets. 

The South China Morning Post reports that the Court of First Instance on Friday rejected EY's plea that it could not hand over to the Securities and Futures Commission the auditors' working papers relating to mainland listing candidate Standard Water as they constituted a "state secret".

This case was particularly embarrassing for EY, since its Hong Kong affiliate served as accountant of record for Standard Water’s proposed IPO, despite doing nearly no audit work. Instead, the audit was done by EY’s mainland affiliate. When SFC asked to see the working papers, EY said they did not have them – a violation in itself, and that its mainland affiliate, EY Hua Ming, had refused to turn them over citing state secrets. EY was finally cornered in Court and had to admit they actually had the work papers on a computer that had been brought to Hong Kong, but said that China’s state secrets laws prohibited them from turning the papers over to SFC.  

State secrets protection is at the heart of the dispute between the US Public Company Accounting Oversight Board and the CSRC. I find it unlikely that audit working papers include any state secrets, and believe that the claim of state secrets is being used as justification for non-cooperation, or perhaps to avoid disclosing information embarrassing to the audit firms or government. With the corruption crackdown in China in full swing, the working papers do not likely contain any information the government would not like to get out anyway. 

Claiming state secret protection is inconsistent with allowing companies that have state secrets to list in foreign markets. If foreigners should not be allowed to know about a company then that company should not be allowed to sell shares to foreigners. Regulators on both sides need to step back and be more reasonable. The SFC and PCAOB should avoid needlessly provoking Chinese officials by picking sensitive companies to probe – that does not appear to be the case with Standard Water.  Chinese officials need to not overplay the state secrets card by asserting state secrets protection where there are no secrets to protect.  

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