Introduction
Enforcements against corporate fraud and misfeasance have always been top priorities for the Securities and Futures Commission of Hong Kong (the “SFC”). In investigating the business affairs and conduct of a listed issuer, audit working papers of the listed issuer are crucial for the SFC to gain a thorough understanding of the business and may constitute important evidence in any subsequent proceedings. Following the People’s Republic of China’s (the “PRC”) Ministry of Finance (the “MOF”), the PRC Securities Regulatory Commission (the “CSRC”) and the SFC signing a memorandum of understanding (the “MOU”) on 3 July 2019. Under the MOU, Hong Kong’s securities watchdog will be able to see audit working papers kept on the mainland for investigations under an expanded cooperation accord that allows Hong Kong regulators to access Mainland-based companies’ audit records.
Background
According to the SFC, when it conducts investigations into Mainland-based Hong Kong issuers or listed companies and their related entities and persons, the cooperation agreed under the MOU will facilitate the SFC’s access to audit working papers created by Hong Kong accounting firms but are kept in the mainland PRC. The MOF and the CSRC have also agreed to provide the fullest assistance in response to the SFC’s requests for investigative assistance regarding the provision of such audit working papers.
The MOU addresses the situation that trapped auditors between the violation of Chinese law barring Hong Kong’s access to Mainland audit documents and risking offshore legal challenges. Hong Kong stock exchange data showed that about half of the over two thousand companies traded on the Hong Kong stock market are based on the Mainland. Major global accounting firms have faced legal proceedings outside the Mainland for failure to submit audit papers to Hong Kong regulators.
In May 2014, the Hong Kong’s High Court handed down an unprecedented judgment, ordering Ernst & Young Hong Kong (“EY”) to produce to the SFC accounting records and audit working papers relating to its work as reporting accountants and auditor for Standard Water Limited (“SW”), a company carrying on business in the PRC. In the case, while EY alleged that it could not produce the accounting records and audit working papers as they contained State secrets, the court held that EY had the burden to prove the existence of State secret in the accounting records and audit working papers. As EY failed to demonstrate such existence, EY was compelled to deliver to the SFC accounting records and audit working papers with respect to SW pursuant to the SFC’s issuance of production notices in accordance with section 183(1)(a) of the Securities and Futures Ordinance (Cap. 571) (the “SFO”)
Under section 183(1)(a) of the SFO, a person, whom the investigator has reasonable cause to believe that he has in his possession any record or document which contains information relevant to an investigation under section 182 of the SFO, shall produce to the investigator any record or document specified by the investigator. Under section 184(1)(a), a person who, without reasonable excuse, fails to so produce, commits a criminal offence.
Tripartite MOU
In light of the legal battle between the SFC and EY, the SFC, MOF and CSRC entered into a tri-partite MOU in July 2019, aiming to foster cooperation between the Hong Kong and Mainland PRC authorities in obtaining Mainland audit documents and reduce the need for the SFC to obtain such documents by court proceedings.
Pursuant to the MOU, the SFC can directly request from the MOF and CSRC audit working papers which are prepared by Hong Kong accounting firms but are kept in Mainland PRC in respect of Mainland PRC entities trading in Hong Kong, and the MOF and CSRC will have to provide fullest assistance in providing so.
Before the execution of the MOU, whenever the Hong Kong accounting firms are requested by the SFC to produce accounting documents with respect to mainland PRC entities, they would need to consider whether the documents requested contain State secrets or commercial confidential information. They may find themselves in a difficult position as such decision is not easy to make. Therefore, the MOU has the effect to easing the Hong Kong accountant’s difficulty in experiencing conflicts between complying with the production notices issued by the SFC and the obligations of state secret protection. Besides, such MOU will be able to reduce the SFC’s time and costs in obtaining audit working papers with respect to mainland PRC entities and hence, ensuring the integrity of the Hong Kong’s security market.
Conclusion
Ashley Alder, the Chief Executive Officer of the SFO, heralded the tri-partite MOU as a significant milestone to enhance cooperation with the mainland PRC regulators in order to combat instances of misconduct among Mainland businesses listed in Hong Kong. The enhanced cooperation serves to refine existing cooperative processes in securities regulation between Hong Kong and the PRC, which is an important measure to protect the legitimate interests of investors and enhance public confidence as described by CSRC’s Vice Chairman Fang Xinghai. It is believed that the tripartite would be a big leap towards a competitive, efficient, fair, orderly and transparent securities and futures markets in Hong Kong.
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This article was originally published on ONC Lawyers.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to a practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.
