THE SECURITIES AND FUTURES COMMISSION v. ERNST & YOUNG (a firm)

HCMP 1818/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1818 OF 2012

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REASONS FOR DECISION

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Introduction

1.  By an Originating Summons dated 27 August 2012, the Plaintiff seeks an inquiry under section 185 of the Securities and Futures Ordinance Cap 571 (“SFO”) into the failure of the Defendant (“EYHK”) to inter alia produce copies of records or documents or to give assistance to an investigator directed by the Plaintiff to conduct an investigation concerning Standard Water Limited ("Standard Water") upon having been required to do so in 9 statutory notices issued by the Plaintiff under section 183 of the SFO between April 2010 and October 2011 (“the Notices”). The Plaintiff further seeks an order compelling EYHK to comply with the Notices, if the court should find that it has no reasonable excuse not to do so.

2.  The substantive hearing of the Originating Summons has been scheduled to take place on 27 and 28 March 2013.

3.  By summonses dated 25 and 27 February 2013 respectively, EYHK and the Plaintiff applied for case management directions from this court. The summonses were heard on 8 March 2013.

4.  The principal matters which divided the parties were whether there should be cross-examination of EYHK’s factual witness viz Mr Leung Kwok Ki Alden on his Affirmation dated 7 December 2012 (“the Affirmation”) and whether the substantive hearing should be re‑fixed with four days reserved. Mr Leung is a partner of EYHK responsible for quality and risk management.

5.  After considering the submissions from the parties, this court directed Mr Leung to attend the hearing on 27 and 28 March 2013 for cross‑examination on the Affirmation. This court then suggested to the parties to exchange lists of factual issues arising from the Affirmation with a view to defining the scope of cross-examination. Upon receiving no contrary suggestion from the parties, this court directed them to do so by 15 March 2013.

6.  As for directions on expert evidence, this court gave leave to the parties to file a supplemental or final expert opinion, as the case may be, on PRC law and set aside two extra days ie 15 and 16 May 2013 for the substantive hearing to cater for cross-examination of the parties’ PRC legal experts.

Background

7.  The following synopsis of the background is taken from an affidavit of Luk King Yip, director, Enforcement Division of the Plaintiff, dated 27 August 2012 and is recited here to facilitate easier understanding of this Decision.

8.  In 2009, Standard Water intended to launch an IPO of its shares in Hong Kong and to list them on the main board of the Stock Exchange of Hong Kong Limited (“Stock Exchange”). By a letter dated 28 August 2009, it engaged EYHK as reporting accountant and independent auditor in relation to the listing application ("the Engagement"). On 9 November 2009, Standard Water made a formal listing application to the Stock Exchange.

9.  On 16 March 2010, while the listing application was still pending, EYHK resigned as reporting accountant and auditor with immediate effect, citing “inconsistencies in documentation in a number of areas that lead us to the conclusion that we can no longer continue as auditors”. Two days later, EYHK informed the Stock Exchange of its resignation. On 24 March 2010, Standard Water withdrew its listing application, after having been asked by its joint sponsors to do so.

10.  On 29 March 2010, the Plaintiff requested EYHK to provide documents and information relevant to the Plaintiff’s initial assessment of whether there was any implication of false accounting in Standard Water’s listing application. On 7 April 2010, EYHK replied that it was bound by the Code of Ethics for Professional Accountants which permitted disclosure of its clients’ affairs in limited circumstances only, and that it could not provide to the Plaintiff the information sought. On 9 April 2010, the Plaintiff gave a Direction to Investigate whether any offences or market misconduct under sections 277, 298 and 384 of the SFO might have been committed in relation to the listing application of Standard Water (“the Investigation”).

11.  On 12 April 2010, pursuant to the Direction to Investigate, Ms Agnes Man (“the Investigator”) issued to EYHK a notice under section 183(1) of the SFO requiring it to provide information and documents relating to its resignation as specified therein.

12.  By letter dated 30 April 2010, EYHK explained to the Plaintiff, for the first time, that it had used the services of Ernst & Young Hua Ming (“EYHM”), a joint venture established under the laws of the PRC, to perform the Engagement. According to the letter, “all the underlying working papers of the Engagement were created by EYHM in the PRC and all communications with the Company and Sponsors were also conducted through staff of EYHM in the PRC.” EYHK further explained that there were legal impediments under PRC laws and regulations which restricted the ability of EYHM and its staff to disclose information and documents generated in the course of the Engagement and that EYHK was unable to compel EYHM to provide any more information or documents than those given in the letter.

13.  Meanwhile, on 21 April 2010, Macquarie Capital Securities Limited (“Macquarie”), one of the joint sponsors of the listing application, provided certain information and documents to the Plaintiff relating to its resignation as a joint sponsor. According to Macquarie, EYHK had outlined to it the inconsistencies in the documentation of Standard Water, which were serious in nature, including inter alia (1) the discovery of documents containing information contrary to what was contained in documents previously provided by Standard Water to EYHK; and (2) discrepancies in documents relating to the genuineness of documents Standard Water had previously provided to EYHK.

14.  On 6 May 2010, the Investigator issued another notice to EYHK requiring it to make all audit working papers relating to Standard Water available for inspection.

15.  By letter dated 14 May 2010, EYHK replied that it was unable to compel EYHM to provide copies of the documents or to give it access to the relevant audit working papers because of legal impediments under PRC laws and regulations.

16.  Between 14 May 2010 and 28 October 2011, the Investigator issued 7 more notices to EYHK, the details of which need not be repeated here.

17.  In summary, the information and documents required from EYHK under the Notices principally relate to (1) the reason for its resignation; and (2) the audit working papers of the Engagement. It is the Plaintiff’s case that for the purpose of the Investigation, it is necessary to have access to such information and documents.

18.  EYHK’s position is set out in the Affirmation. As summarized  in Mr Maurellet’s skeleton submissions, EYHK contends that it cannot assist the Plaintiff further than it already has since as a matter of PRC law:

(1)    EYHK has no power or right to compel EYHM to surrender the audit working papers and, even if such a right exists, a PRC Court would not enforce it on the basis that there are rules and regulations which would prohibit any cross-border transmission of audit working papers save with the prior approval of relevant PRC authorities;

(2)    even if EYHK had a strict legal right to the audit working papers, it would have a "reasonable excuse" in not acceding to the Plaintiff’s requests, given the very real risk of breaching PRC laws and regulations.

Cross examination on affidavit

19.  It is accepted by both parties that the court has an unfettered discretion to permit cross-examination of a deponent on his affidavit. An applicant ie the Plaintiff in the present case has no right to it as a matter of course. What he has to establish is that, in all the circumstances of the case, there is a good and sufficient reason for the application: Wendy Wenta Seng Yuen v Philip Pak-yiu Yuen [1984] HKLR 431, 436 E-H, per Fuad JA; and that it is in the interests of justice to order cross-examination: Grand Empire Holdings Limited v Marco International (HK) Limited, unreported, HCA 14891/1999, 7 December 1999, paragraph 2, per Burrell J. Other factors which a court would take into account include whether the evidence contained in the affidavit will lead to a final order and whether there will be undue delay or expense if cross-examination is permitted: Grand Empire Holdings Limited v Marco International (HK) Limited op cit paragraph 4.

20.  EYHK's factual case is contained in the Affirmation. It is divided into six parts viz

(1)  Background of EYHK, EYHM and Standard Water.

(2)  Conduct of the audit of Standard Water by EYHM.

(3)  Relationship between EYHK and EYHM.

(4)  Steps taken by EYHK to comply with the Notices.

(5)  Legal issues faced by EYHK in complying with the Notices.

(6)  Alternative means by which the Plaintiff could obtain the requested materials.

21.  While he did not personally take part in the Engagement, Mr Leung said he had acquired sufficient knowledge concerning the background of Standard Water and the manner in which the Engagement was performed from his involvement in EYHK’s decision to resign and in the handling of the Notices: paragraph 7 of the Affirmation. He also said “The facts and matters to which I refer are within my own knowledge and are true”: paragraph 3 of the Affirmation.

22.  In the Affirmation, Mr Leung explained that the Engagement was performed substantially in the mainland by EYHM, the PRC member firm of the EY network. According to him, all the audit working papers were held by EYHM and have been in their physical possession at all material times.

23.  In his skeleton submissions, Mr Jat, for the Plaintiff, described the Affirmation as “unhelpfully vague”. He referred to a number of paragraphs as illustrations:

(1)  Paragraphs 17-18: where Mr Leung explained the working relationship between EYHK and EYHM as well as the common arrangement for audit clients to engage EYHK as their reporting accountant when a listing was sought in Hong Kong, as required by Rule 4.03 of the Listing Rules, even though it was EYHM which undertook the audit work in the PRC. 

(2)  Paragraphs 29-37: where Mr Leung set out what he described as the very limited involvement of EYHK in the Engagement. In contrast, Mr Leung had stated earlier in the Affirmation at paragraph 27 that Mr Benjamin Yam, a partner of EYHK but based in EYHM’s offices in Beijing until his resignation in March 2011, took responsibility for the Engagement to ensure compliance with Rule 4.03 of the Listing Rules. Further, at paragraph 28 of the Affirmation, Mr Leung also referred to Clause 10 of EYHK’s General Terms which provides that “We may from time to time use the service of the partners or staff of any other member of the EY Network to assist us in our provision of services to the Company. When we use the service of such partner or staff in the performance of this Engagement, such partner or staff will be regarded as our employees or agents…We will be responsible for their actions as if they were our partners or staff…”.

(3) Paragraphs 41-48: where Mr Leung explained the location of the Working Papers and that in the course of the Engagement, EYHK’s staff were permitted access to them ie (1) hard copies physically held in EYHM’s Beijing offices; (2) electronic work papers stored in the laptops of EYHM’s audit team, located at EYHM’s Beijing offices; and (3) email correspondence amongst EYHM’s audit team, Standard Water’s representatives and other professional advisers, stored on EYHM’s server in the PRC, in order for EYHK to discharge its obligations as reporting accountant and independent auditor. But such access ceased when the Engagement was terminated in March 2010 and EYHK no longer had access to the Working Papers or any right to demand their production outside the PRC.

24.  Mr Jat submitted to this court that, under section 185 of the SFO, the court’s function is to inquire into the matter and, if satisfied that there is no reasonable excuse for EYHK’s alleged failure to comply with the Notices, make the appropriate orders.  To that end, the court must have all the material facts including inter alia the precise relationship between EYHK and EYHM and the extent of EYHK’s access to the audit working papers generated from the Engagement.

25.  I agree, subject to the caveat that the court’s function is to inquire into the matter within the parameters of an adversarial court system. It is important for a proper inquiry of this kind, and in the interests of justice, that where Mr Leung’s evidence is said to be vague, it should be clarified; where it may appear to be inconsistent or incredible, it should be tested. That is precisely the point of cross-examination. In the end, the alleged vagueness or the apparent inconsistency may all be satisfactorily explained and resolved, or it may not. Without cross‑examination, this court’s primary task of securing the just resolution of disputes in accordance with the rights of the parties, as enshrined in RHC O1A r 2, will be severely hampered.

26.  In these circumstances, this court considers that there is a good and sufficient reason for the Plaintiff’s application and that it is in the interests of justice to order cross-examination of Mr Leung.

27.  It is up to the Plaintiff, not this court, to formulate the scope of its cross-examination. In a writ action, the scope is largely defined by the issues raised in the pleadings. This is not a writ action and there are no pleadings. In order to minimise surprise and promote a sense of reasonable proportion and procedural economy in the conduct of these proceedings, this court also considers it appropriate to direct the parties to exchange lists of factual issues arising from the Affirmation, and if possible come up with an agreed list.