* E&Y says relevant records are in mainland China
* E&Y says restricted by Chinese secrecy laws
* Mirrors SEC action against Deloitte in U.S.
By Anne Marie Roantree and Rachel Armstrong
HONG KONG/SINGAPORE, Aug 28 Hong Kong's
securities regulator, in an unprecedented move, took Ernst &
Young to court after the audit giant failed to turn
over accounting records related to a former China-based client.
The auditor now faces the dilemma of whether to comply with
the regulator's order and risk a possible breach of China's
state secrecy laws or face regulatory sanctions in Hong Kong.
The case is the first of its kind in Hong Kong and mirrors
one in the United States, in which Ernst & Young's rival,
Deloitte Touche Tohmatsu, is fighting a request from
U.S. regulators to hand over its audit work papers of Chinese
computer company Longtop Financial Technologies.
Accounting scandals at mainland companies listed in the
United States, such as Longtop and Sino-Forest Corp,
have dented investor confidence in U.S.-listed Chinese stocks.
The blow-ups have spurred regulators there to demand access to
audit work papers kept in China and inspect mainland-based
"This risks throwing H-share and red chip companies into the
same mess that all the U.S.-listed Chinese companies are in,"
Paul Gillis, professor of accounting at Peking University and
author of the China Accounting Blog, told Reuters by telephone
Red chips and H-shares refer to companies operating in
mainland China but listed in Hong Kong. Between them, they make
up more than half of the city's stock market.
The U.S. Securities and Exchange Commission last September
asked a federal court to force Deloitte to produce records
related to possible accounting fraud at Longtop, but Deloitte
has resisted, citing Chinese secrecy laws.
In July, the SEC asked a U.S. federal court to postpone that
case for six months while it tried to work out an arrangement
with Chinese regulators to get audit documents.
The U.S. Public Company Accounting Oversight Board, which
regulates auditors of U.S.-listed companies, has also been
negotiating with Chinese authorities to be allowed to inspect
audit firms in China and look at their work papers. PCAOB
Chairman Jim Doty has said that some resolution to that
stalemate needs to come this year.
The Securities and Futures Commission in Hong Kong said late
on Monday it wants the Ernst & Young unit in the city to hand
over its records from its audit work for mainland-based water
provider Standard Water Ltd.
The SFC said the audit firm has claimed it does not have the
relevant records, as they are held in mainland China by its
joint venture partner Ernst & Young Hua Ming, and could not be
produced due to restrictions under China's state secrecy laws.
"The secrecy rules are a fairly grey area -- the mainland
authorities have made announcements reminding firms of their
obligations under them in recent years, but have not gone on to
define fully what they are," said Chris Joy, executive director
at the Hong Kong Institute of CPAs.
The SFC said auditors should always be able to provide
documents, especially since Standard Water applied to list in
Hong Kong a few years ago.
"Accounting and audit working papers relating to private
companies applying for listing in Hong Kong must be capable of
being produced either directly to the SFC or via the relevant
mainland authority under the standing arrangements for
co-operation," the SFC said in a statement.
The regulator added that it already has consulted its
mainland counterparts about the records and is working with them
on this issue.
Ernst & Young said it was working to try and resolve the
situation as soon as possible.
"We understand our obligations to the SFC and endeavour to
fully comply, while also meeting our compliance obligations with
mainland China's laws and regulations," the firm said in a
statement on Tuesday.
"We will work closely with the relevant regulators, and
trust that there will be a quick resolution to enable our full
compliance with applicable laws and regulations," it said.
It also said that while it performed IPO audit work for
Standard Water in 2009, it resigned in 2010 and did not issue an
accountant's report on the company.
Ernst & Young resigned as auditor upon discovery of
"inconsistencies in documentation" provided by the Chinese
company, and Standard Water withdrew its Hong Kong listing
application shortly afterwards, according to the SFC.
Peking University's Gillis said the fact that the Hong Kong
firm was acting as Standard Water's main auditor means it is in
a difficult position to defy the SFC's request.
"If the Hong Kong firm is signing the reports, that are to
be used in Hong Kong, then under auditing standards the majority
of the work should have been done in Hong Kong and they should
have evidence of that work," he said.
Under the action taken by the SFC, the Hong Kong court will
inquire into why Ernst & Young has not complied with the
regulator's request. It can order the auditor to hand the papers
over if it is satisfied it does not have a reasonable excuse.
A date for the first hearing is yet to be set.