May 23, 2014 / 8:51 AM / 5 years ago

UPDATE 3-Hong Kong court orders EY to hand over mainland China audit papers

* Ruling boosts regulators seeking access to China books

* EY to review ruling before deciding whether to appeal

* Audit firm has 28 days to comply, court says (Adds SFC comment)

By Clare Baldwin and Nikki Sun

HONG KONG, May 23 (Reuters) - A Hong Kong court has ordered auditor EY to hand over documents related to a former Chinese client in a boost for international regulators seeking access to the books of mainland China companies listed outside their home territory.

In a case filed by Hong Kong’s Securities and Futures Commission (SFC) in 2012, the court on Friday rejected EY’s contention that Chinese law prohibits the mainland partner of the firm, previously known as Ernst & Young, from passing on documents.

EY must explain why it resigned as auditor of Standard Water in 2010 and provide a list of all staff involved in an application by the company to list in Hong Kong that was eventually scrapped, the court said in its ruling, the first of its kind in Hong Kong. EY has 28 days to comply, it said.

The ruling comes a week after China’s Ministry of Finance reiterated the country’s secrecy laws and said that accountants may not pass information to overseas regulators or exchanges.

The Ministry further said that all audit work in China must be done by mainland firms and international auditors will no longer be able to obtain temporary licenses to audit mainland companies. The new rules banning international auditors from acting independently in China are expected to be implemented this year, according to the Ministry’s website.

“The ruling creates a really messy situation and it gets worse with the regulatory changes that were composed by the mainland last week,” said Paul Gillis, an accounting professor at Peking University’s Guanghua School of Management.

“I am surprised that mainland regulators and Hong Kong regulators haven’t found a way to negotiate a solution to this. I think it’s probably tied up in the fight with the SEC (U.S. Securities and Exchange Commission) and China doesn’t want to set any precedents with respect to Hong Kong that it might have to follow through on with the SEC.”

The Hong Kong ruling also comes as international regulators including U.S. watchdogs continue to press the case for access to documents regarding mainland Chinese companies in ongoing investigations into cases of possible irregularities and previous accounting scandals.

EY said it would review the judgment carefully before deciding whether it would appeal.

SFC’s chief executive Ashley Alder said the Hong Kong authorities were acting independently.

“This case is primarily about the obligations of an accounting firm in Hong Kong to comply with requirements under Hong Kong law. The case is not about PRC law. Auditors should not withhold information which is in their possession and sought by the SFC in connection with suspected misconduct in Hong Kong’s markets,” Alder said in an emailed statement.

The SFC brought the case to court seeking access to documents related to EY’s unfinished audit of Standard Water, the Chinese municipal water services provider. The company couldn’t immediately be reached for comment.

The audit firm has said it didn’t have the relevant records, which were held in mainland China by its joint venture partner, Ernst & Young Hua Ming, and could not be produced due to Chinese state secrecy laws.

In its ruling, the Hong Kong court said it was dismayed at EY’s failure to initially disclose the fact that it had in Hong Kong three hard drives related to the case.

EY, along with PricewaterhouseCoopers, Deloitte Touche Tohmatsu and KPMG, review the books of most of the world’s largest corporations through networks of legally separate, nationally based audit firms.

The ‘Big Four’ accounting firms say paperwork at their Chinese affiliates, which audit Chinese companies listed overseas as well as the operations of multinationals, are protected by China state secrecy laws and may not be handed over to foreign regulators without Beijing’s permission.

While Hong Kong is a special administrative region of China, it operates under separate legal and regulatory systems. Chinese companies make up more than half of the market capitalization of the Hong Kong Stock Exchange.

Accounting scandals at mainland China companies listed in the United States such as Longtop Financial Technologies and Sino-Forest Corp have shaken investor confidence in U.S.-listed Chinese stocks in recent years, spurring regulators to take action after financial losses and de-listings.

A U.S. judge ruled the Chinese affiliates of the ‘Big Four’ global accounting firms should be suspended from practising in the United States for six months for failing to comply with Securities and Exchange Commission document requests.

The suspension will not go into effect, however, until all legal appeals processes are exhausted. The Chinese affiliates of the accounting firms have all said they will appeal.

U.S. authorities including the SEC and the U.S. Public Company Accounting Oversight Board, which regulates auditors of U.S.-listed companies, continue to work with Chinese regulators to gain access to audit documents for U.S.-listed Chinese companies. (Additional reporting by Anne Marie Roantree, Grace Li and Rachel Armstrong; Editing by Kenneth Maxwell, Greg Mahlich)

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