THE JOINT AND SEVERAL PROVISIONAL LIQUIDATORS OF CHINA MEDICAL TECHNOLOGIES INC. v. KPMG (A FIRM) AND OTHERS

HCCW 435/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO 435 OF 2012

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D E C I S I O N

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The Application

1.  I have before me an application[1] by Mr. Cosimo Borrelli and Ms. Yuen Lai Yee Liz, who were appointed by me as provisional liquidators (“Liquidators) of China Medical Technologies, Inc. (“Company”) on 29 November 2012.  The Liquidators seek the production of documents by the 1^st Respondent[2] (“KPMG HK”) and the examination of a number of the Firm’s partners, employees and people from other KPMG entities in connection with the affairs of the Company and, in particular, the audit of its subsidiaries in the Mainland[3].  The scope of the application for production of documents is very wide.  For all practical purposes the Liquidators seek every document that KPMG HK and other associated KPMG entities have in their possession concerning the Company and its subsidiaries.  The Liquidators are particularly concerned to obtain access to KPMG HK’s audit working papers.  The precise categories of documents that the Liquidators request in their summons are set out in the Appendix to this Decision.

2.  Prior to issue of the application KPMG HK provided the Liquidators with copies of a limited amount of documents: the Company’s audited accounts for the year ending 31 March 2008, management accounts prepared by the Company for the year also ending 31 March 2008, invoices, information on properties, deposits, accounts receivables, bank accounts, documents supplied by the Company regarding its future plans, strategies and proposals, certain engagement letters and ten boxes of largely draft and superseded working papers.

3.  The application raises an issue of considerable importance.  The principal ground for opposing it is that taking audit working papers currently in the possession of by KPMG affiliates in the Mainland out of the Mainland would be unlawful as would allowing inspection of them by the Liquidators at a location in the Mainland.  The significance of this issue will become apparent as I describe the Company and the circumstances in which it came to be wound up in more detail.

Background

4.  The Company was incorporated in the Cayman Islands in 2004.  On 10 August 2005 it was listed on the NASDAQ and its shares traded until it was delisted on 28 February 2012. 

5.  The Company was purportedly carrying on business developing, manufacturing and marketing advanced surgical and medical equipment in Mainland China, using in-vitro diagnostic products such as FISH and SPR Technology.

6.  The Company carried on its business through its corporate group which included:

6.1   three wholly-owned indirect holding companies incorporated under the laws of Hong Kong, namely CMED Diagnostics (Hong Kong) Limited, East Crest Enterprises Limited and CMED ECLIA Diagnostic Technology (Hong Kong) Limited; and

6.2   three wholly-owned indirect operating subsidiaries incorporated under the laws of the Mainland, namely Beijing GP Medical Technologies Company, Limited, Beijing Bio‑Ekon Biotechnology Company, Limited and Beijing Yuande Bio-Medical Engineering Company, Limited.

7.  Prior to the purported disposal of the Company’s Mainland China incorporated operating subsidiaries on 9 February 2012, the structure of the Company’s corporate group was as follows:

8.  On 9 February 2012, 60% of the equity interests of the Company’s Mainland China incorporated operating subsidiaries were transferred by the Company’s management to two Mainland China companies, which the Liquidators believe are connected to the Company’s management. To date, the Liquidators have not found any evidence that any consideration was actually received by the Company for the sale of the equity interests and the transfers are the subject of further investigations and legal proceedings brought by the Liquidators in the Mainland.  The information available to the Liquidators to date indicates that these purported transfers were not bona fide.

9.  Between August 2005 and December 2010, the Company raised net debt and equity capital of US$631 million, including by issuing various senior unsecured convertible notes.  The Company had US$515 million of funds available to it following the repayment of amounts due to Deutsche Bank Trust and Bank of America totalling US$116 million.

10.  On 15 December 2011, the Company failed to make an interest payment of US$4,687,500 on its 6.25% senior unsecured convertible notes.  Two months later, on 15 February 2012, the Company failed to make an interest payment of US$4,930,000 on its 4% senior unsecured convertible notes.  These two interest payment defaults formed the basis of a petition to the Grand Court on 15 June 2012 for the winding up of the Company in the Cayman Islands and the appointment of Mr Krys and Mr. Borrelli as liquidators (“Cayman Liquidators”) on 27 July 2012.

11.  On 11 October 2012, the Cayman Liquidators obtained an Order under Chapter 15 of the United States Bankruptcy Code.  Pursuant to that Order, Judge Robert E. Gerber of the United States Bankruptcy Court for the Southern District of New York ordered that the Company’s winding‑up proceedings in the Cayman Islands be recognised as “foreign main proceedings” and that Mr Krys be recognised as the “foreign representative” for the purposes of Chapter 15 of the US Bankruptcy Code.

12.  On 26 November 2012, the Company, acting at the direction of the Cayman Liquidators filed a petition for an ancillary winding-up in Hong Kong (“Hong Kong Petition”).  As I have already explained the Liquidators were appointed provisionally on 29 November 2012.

13.  On 1 September 2014 I made an order winding up the Company in Hong Kong.  The grounds for so doing are explained in 2 decisions[4], which describe in detail what would appear to be the principal cause of the Company’s being unable to pay interest on the 2 tranches of senior unsecured convertible notes, namely, the misappropriation of at least the US$355,000,000 of US$631,000,000 raised through the share offerings and issue of senior unsecured convertible notes.  In summary, the Liquidators believe for credible reasons that the misappropriation was achieved by the bogus acquisition of technology and intellectual property rights from two companies: Molecular Diagnostics Technologies Ltd and Supreme Well Investments Limited (“Supreme Well”). They also believe, once again for credible reasons, that the misappropriation was orchestrated by, and for the benefit of, the former Chairman, Chief Executive Officer and major shareholder of the Company, Mr. Wu Xiaodong, and its Chief Financial Officer, Mr. Samson Tsang Tak Yung.

14.  The Liquidators have been able to obtain few of the Company’s documents or those of its subsidiaries.  Those they have obtained have principally come from production by the Bank of China and Bank of East Asia, which, as I explain in my August 2014 decision, has allowed the Liquidators to identify how the sums received by Supreme Well have been channeled through bank accounts of which Mr. Tsang is a signatory and to accounts in which he and Mr. Wu would appear to have a beneficial interest.  It is in these circumstances that they seek from KPMG HK, at one time the Company’s auditor, extensive production of documents and examination of partners and staff of KPMG HK with involvement in the engagement.

KPMG

15.  KPMG HK was initially engaged by the Company to perform the audit of the Company’s financial statements and act as the reporting accountant for the purposes of its initial public offering.  KPMG HK performed a review of the Company’s unaudited quarterly financial statements prior to the Company’s filings with the United States Securities and Exchange Commission (“SEC”).  KPMG HK was then appointed the auditor of the Company for the audit years ending 31 March 2006 to 2008.  KPMG HK commenced the audit for the year ending 31 March 2009, but they were replaced by PwC Zhong Tian CPAs Limited Company in August 2009.  In addition KPMG HK reviewed an offering memorandum and interim financial statements for 6 months ending 30 September 2005 and 30 September 2006 in respect of the filing by the Company of Form F3 with the SEC in connection with a share repurchase and convertible bond offering in 2006.  KPMG HK also reviewed an offering memorandum and quarterly financial statements for three months ending 30 June 2007 and 30 June 2008 in respect of another Form F3 filing with the SEC in connection with a bond offering in 2008.

16.  KPMG HK says that it does not have the first engagement letter it signed.  It has produced the engagement letter in its final form for the audit years ending 31 March 2006 and 2007, which is dated 23 March 2007 and was signed by Mr. Wu and Mr. Iain Bruce, the Chairman of the audit committee, on behalf of the Company.  The engagement letter is comprehensive and runs to 9 pages it provides, amongst other things, that:

“We will issue a written report upon our audit of the consolidated balance sheets of the Company as of March 31, 2007 and 2006, the related consolidated statements of income and comprehensive income, cash flows and changes in stockholders’ equity for each of the years in the three-year period ended March 31, 2007, and schedules supporting such financial statements, all of which are to be included in the annual report (“Form 20F”) proposed to be filed by the Company under the Securities Exchange Act of 1934.

We have a responsibility to conduct and will conduct the audit of the consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), with the objective of expressing an opinion as to whether the presentation of the consolidated financial statements and schedules, taken as a whole, conforms with U.S. generally accepted accounting principles (“USGAAP”). It should be understood that our report and the consolidated financial statements and schedules may be subject to review by the U.S. Securities and Exchange Commission (“SEC”) staff and to the application by them of their interpretation of the relevant rules and regulations.

It is important to note that the PCAOB, created as a result of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), has the authority to establish auditing quality control, ethics, independence and other standards relating to the preparation of audit reports for issuers, as that term is defined in the Sarbanes-Oxley Act, subject to oversight by the SEC.

….

Our report will be addressed to the board of directors of the Company and will be in a form that is in accordance with the published rules and regulations of the SEC. We cannot provide assurance that an unqualified opinion will be rendered. Circumstances may arise in which it is necessary for us to modify our report or withdraw from the engagement.

….

We understand that the consolidated financial statements and schedules and our written audit report thereon, as described above, are to be included by the Company in its annual report (Form 20-F), and that in so doing the Company will be incorporating by reference these consolidated financial statements and schedules and our report thereon in previously filed and effective Form F-3 and S-8. Prior to issuing our consent to the incorporation by reference in these registration statements of our report with respect to the consolidated financial statements and schedules described above, we will perform procedures as required by the standards of the PCAOB, including, but not limited to, reading information incorporated by reference in these registration statements and performing subsequent event procedures.

….

This letter is made under, and shall be governed by Hong Kong laws and all disputes arising from or under this letter shall be subject to the exclusive jurisdiction of the courts of Hong Kong Special Administrative Region of the People’s Republic of China.

….

KPMG is a limited liability partnership comprising both certified public accountants and certain principals who are not licensed as certified public accountants. Such principals may participate in the engagements to provide the services described in this letter.

….

Work Paper Access by Regulators and Others

The work papers for this engagement are the property of KPMG. In the event KPMG is requested pursuant to subpoena or other legal process to produce its documents relating to this engagement for the Company in judicial or administrative proceedings to which KPMG is not a party, the Company shall reimburse KPMG at standard billing rates for its professional time and expenses, including reasonable attorney’s fees, incurred in responding to such requests.

However, we may be requested to make certain work papers available to the PCAOB and Regulator pursuant to authority given to it by law or regulation. If requested, access to such work papers will be provided under the supervision of KPMG personnel. Furthermore, upon request, we may provide photocopies of selected work papers to PCAOB and Regulator. PCAOB and Regulator may intend, or decide, to distribute the photocopies or information contained therein to others, including the SEC and other government agencies. We agree to communicate to you on a timely basis any requests by the PCAOB for direct contact with members of the Audit Committee.”

17.  As the Company was listed on NASDAQ it was subject to the SEC’s regulations, which imposed reporting requirements additional to those imposed by the Public Company Accounting Oversight Board (“PCAOB”) standards and US Generally Accepted Accounting Principles (“USGAAP”). 

18.  KPMG HK audited the Company’s consolidated financial statements.  This is clear from the audit reports, which, taking 2005/6 as an example, commences: “We have audited the accompanying consolidated balance sheets of China Medical Technologies, Inc. and its subsidiaries as of March 31, 2005 and 2006, and the related consolidated statements of income and comprehensive income, shareholders’ equity and cash flows for each of the years in the three-year period ended March 31, 2006.” In the financial statements themselves it provides, in the notes summarising significant relevant accounting policies and practices, that the “consolidated financial statements include the financial statements of the Company and its subsidiaries”.

19.  Ms. Jacqueline Wong of KPMG HK, who is a partner in KPMG HK and works in the Quality and Risk Management Department, explains in her evidence that up to the audit for the year ended 31 March 2007, the audit field work undertaken in the Mainland, where the Company’s main operating subsidiaries were located, was carried out by partners and staff of KPMG HK.  For the audit year ended 31 March 2008 onwards whilst KPMG HK remained the Company’s auditor, the audit field work in the Mainland was carried out by what Ms. Wong describes as a component auditor, namely, KPMG Huazhen.  KPMG Huazhen was a Beijing based joint venture between KPMG HK and 华振会计师事务所有限公司 (“KPMG Huazhen”) a Mainland firm of certified accountants.  KPMG Huazhen was formed during a period in which the Mainland Government permitted international accounting firms to form joint ventures with local firms affiliated to the Ministry of Finance (“MOF”).  KPMG HK, and the other Big 4 accounting firms, were granted 20-year licences to operate on this basis.  During that period it was intended that the profession on the Mainland would develop and in time be able to operate without the direct participation of international firms.  These licences expired in 2012.  The existing joint ventures were converted into special general partnerships, which was a legal structure created by the MOF specifically for the Big 4 Sino-foreign cooperative accounting firms in recognition of their contribution to the development of the accounting profession.  In August 2012 KPMG Huazhen[5] converted into a special general partnership and all its staff transferred to the new entity, which continued the existing business.

20.  I asked for evidence to be filed by KPMG HK explaining the extent to which KPMG HK and KPMG Huazhen were interrelated in terms of common partners and management.  As a consequence an affidavit was filed by Andrew Weir who is a partner in KPMG HK and also, what Mr. Weir describes as “KPMG China’s” Regional Senior Partner for Hong Kong, in which capacity he sits on the Executive Committee of KPMG China. Mr. Weir explains that the original KPMG Huazhen joint venture was owned 50% by KPMG HK and 50% by Huazhen.  When the special general partnership was established it consisted of 66 equity partners of whom 20 were also partners in KPMG Hong Kong.  As at 30 September 2015 KPMG Huazhen consisted of 102 equity partners of whom 32 were also partners in KPMG HK.

21.  The original joint venture was managed by a committee consisting of 3 persons from each of KPMG HK and KPMG Huazhen. The  special general partnership has been managed by an Executive Committee.  Its first senior partner was Stephen Yiu who was also KPMG HK’s Chairman and has since retired.  After 3 years the chairman has to be a Chinese national.  However, when the Executive Committee was formed it comprised of 10 partners of whom 6 were equity partners of the special general partnership only.  The other 4 were also partners in KPMG HK.  The current Executive Committee consists of 11 partners of whom 6 are partners in KPMG Huazhen only including the senior partner.

22.  This does not, however, tell the full story.  KPMG’s website refers to “KPMG China”, which includes, so the websites says, offices in various cities in the Mainland, Hong Kong and Macau. KPMG China operates with a single management structure.  For this reason I asked to be told whether KPMG China is a virtual partnership and whether it exercises effective management control over KPMG HK and KPMG Huazhen. Mr. Weir accepts in paragraph 38 of his affidavit that “KPMG China could be characterized as a “virtual partnership” because it operates under a single governance structure” and in paragraph 39 he explains:

“39. KPMG entities operating in Mainland China and Hong Kong are collectively referred to as KPMG China and work together on a collaborative basis, subject to local applicable laws. KPMG China, itself, is not a legal entity. It does not own or have power to control the operations of individual KPMG entities. Collectively, KPMG China has offices in 16 cities, of which Hong Kong is one city. Each of these has its own senior partner who has autonomy to manage his or her local office”

23.  KPMG China, which I note was not referred to at all in the evidence of Ms. Jacqueline Wong purporting to describe the structure of the relevant part of KPMG’s operations, has its own executive committee, which Mr. Weir says has 13 members.  The table provided by Mr. Weir listing its members shows that 11 of the 13 members are partners in KPMG HK and of the 2 remaining members, 1 is not a partner in either KPMG HK or KPMG Huazhen.  I assume he has a purely management function.  There are only 2 members, who are partners only of KPMG Huazhen.

24.  In paragraph 51 Mr. Weir asserts that:

“51. The Executive Committee of KPMG China does not exercise management control over KPMG Huazhen LLP’s operations, including in relation to matters concerning regulatory compliance or compliance with the laws of the PRC. These are matters for which each KPMG entity has responsible autonomy. The same is true of KPMG HK.”

25.  I accept that KPMG China’s executive committee may not exercise direct management control over KPMG Huazhen’s general operations, but its membership indicates that KPMG HK’s partners exercise, or purport to exercise, ultimate de facto control over KPMG Huazhen’s affairs. 

26.  This is further demonstrated by the fact that when it was decided to engage KPMG Huazhen as component auditor to audit the Mainland subsidiaries the engagement team was led by Mr. Bruce Zirlen, who is the 4^th Respondent.  Ms. Jacqueline Wong describes him in paragraph 31 of her affirmation as “Lead Audit Engagement Partner. Mr. Zirlen was a partner in KPMG HK who was based in Beijing.  He is an US-qualified CPA, with experience of auditing SEC issuers and their affiliates.  Mr. Zirlen was designated a “partner” in KPMG Huazhen, although, as a joint venture, strictly speaking KPMG Huazhen did not have partners and only had employees.”  She goes on in paragraphs 32 to 34:

“32. While the engagement of KPMG Huazhen to carry out the audit field work in the PRC was not recorded in any written contract, it was regarded by KPMG HK as a sub‑contracting arrangement, in line with the arrangements that KPMG HK usually has with its component auditors (including other KPMG member firms and non‑KPMG firms) to whom it delegates performance of specific elements of the audit. In this case KPMG Huazhen invoiced the Company directly in respect of the work which it carried out on the audit for year ended 31 Mar 2008 onwards, as recorded in the Affirmation of Isaac Yan Kei Yan of KPMG Huazhen, of even date.

33. Consistently with the provisions of AU543 promulgated by the US Public Company Accounting Oversight Board established under the Sarbanes-Oxley Act of 2002, KPMG HK issued the auditor’s report as principal auditor in respect of the Company’s consolidated financial statements for year ended 31 Mar 2008, without making reference to the fact that the audit work had been carried out by a component auditor, namely KPMG Huazhen. As can be seen from AU543, this is acceptable practice in the industry. A copy of AU543 can be found at “JW-1” tab 1.

34. I am advised by Mr Zirlen that the relevant audit engagement team at KPMG Huazhen reported to him in Beijing, in his capacity as a partner of KPMG HK, such that KPMG HK was able to discharge its duty as principal auditor and issue an auditor’s report for the year ended 31 March 2008.”

27.  It seems to me clear from the evidence that so far as possible KPMG China operates as one commercial entity and, so far as permissible by law, is managed as such by a panel of partners very largely drawn from the Hong Kong partnership.  Subject to any specific legal restriction KPMG HK is, therefore, in practice able to direct that KPMG Huazhen comply with its directions.  I did not understand this to be disputed by KPMG HK in the present application.  However, I note that in a letter from KPMG HK to the Liquidators’ solicitors dated 21 December 2012 and also a letter from Smyth & Co dated 12 August 2013, KPMG HK suggested that in respect of papers held by KPMG Huazhen the Liquidators “enquiries may be best served if they are made by your client” to KPMG Huazhen.  It seems to me that this was disingenuous given what has become clear as a result of my request for information was the substantive nature of the relationship between KPMG HK and KPMG Huazhen.

28.  It seems to me also to be clear that those behind the formation of KPMG China, largely partners in KPMG HK, choose to represent themselves as operating one, integrated operation in the Mainland and Hong Kong.  It seems to me that this representation sits uncomfortably with KPMG HK’s evidence, which I address in detail later, seeking to explain the regulatory environment in which it operated in the Mainland and the restrictions on its ability to produce to the Liquidators the documents that they seek.  If KPMG HK’s assertions contained in the evidence of Jacqueline Wong about the relationship between KPMG HK and KPMG Huazhen and the restrictions on the transfer of documents out of the Mainland are correct KPMG China cannot fairly hold itself out as one business entity.

29.  Further KPMG HK signed the audit reports without reference to the fact that the audit of the subsidiaries was carried out by a component auditor in the Mainland.  Presumably this was done, and I understand that it is the normal practice of the Big 4 accounting firms, to give the impression that KPMG in China is one firm.  I explain in paragraph 32 this was permissible under the PCAOB standards, but as a consequence obligations were imposed on KPMG HK, which they now say they are unable to comply with.  I now turn to consider the relevant accounting standards and the obligations that they imposed on KPMG HK to obtain and retain documents.

Accounting Standards

30.  A foreign company listed on the NASDAQ is required by the United States Securities Exchange Act of 1934 to file its audited annual report with the SEC as Form 20-F.  The financial statements were required to be audited by reference to the standards of the PCAOB. It is stated in the letter of engagement from which I have quoted that this would be the case.  These standards require an audit to be properly documented and the auditor is required to prepare adequate audit working papers.  Audit working papers are described and their purpose explained in PCAOB AU Section 339A.  Paragraphs .01, .03 and .07 provide:

“.01 The auditor should prepare and maintain working papers, the form and content of which should be designed to meet the circumstances of a particular engagement. The information contained in working papers constitutes the principal record of the work that the auditor has done and the conclusions that he has reached concerning significant matters.

….

.03 Working papers are records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the engagement. Examples of working papers are audit programs, analyses, memoranda, letters of confirmation and representation, abstracts of company documents, and schedules or commentaries prepared or obtained by the auditor. Working papers also may be in the form of data stored on tapes, films, or other media.

….

.07 Certain of the auditor’s working papers may sometimes serve as a useful reference source for his client, but the working papers should not be regarded as a part of, or a substitute for, the client’s accounting records.”

31.  Paragraph 14 of PCAOB Auditing Standard 3 provides that the auditor is to retain audit working papers for 7 years from the date of the audit report.  If an audit is not completed the documents must be retained for 7 years from the date the engagement ceased. Rule 2-06 of SEC Regulation S‑X also requires an auditor to retain working papers for 7 years after an audit is completed. 

32.  As I have already explained the audit of the subsidiaries was carried out by KPMG Huazhen.  The PCAOB standards permit this and the auditor carrying out audits of financial statements of subsidiaries, which are to form part of the consolidated financial statements of the holding company, if, other than the auditor of the holding company, is referred to in the standards as a “component auditor”.  The role of the principal auditor where there is a component auditor is dealt with in detail in paragraphs 2 and 3 of AU 543.  Paragraph 3 provides that “If the auditor decides that it is appropriate for him to serve as the principal auditor, he must then decide whether to make reference in his report to the audit performed by another auditor.  If the principal auditor decides to assume responsibility for the work of the other auditor insofar as that work relates to the principal auditor’s expression of an opinion on the financial statements taken as a whole, no reference should be made to the other auditor’s work or report.”  This is what KPMG HK decided to do in the present case.

33.  AU 543 deals in paragraph 12 with what the principal auditor must do if he decides not to make reference to the audit of subsidiaries performed by another auditor.

“.12 When the principal auditor decides not to make reference to the audit of the other auditor, in addition to satisfying himself as to the matters described in AU sec. 543.10, the principal auditor must obtain, and review and retain, the following information from the other auditor:

a. An engagement completion document consistent with paragraphs 12 and 13 of PCAOB Auditing Standard No. 3

Note: This engagement completion document should include all cross-referenced, supporting audit documentation.

b. A list of significant fraud risk factors, the auditor’s response, and the results of the auditor’s related procedures.

c. Sufficient information relating to significant findings or issues that are inconsistent with or contradict the auditor’s final conclusions, as described in paragraph 8 of PCAOB Auditing Standard No. 3.

d. Any findings affecting the consolidating or combining of accounts in the consolidated financial statements.

e. Sufficient information to enable the office issuing the auditor’s report to agree or reconcile the financial statement amounts audited by the other firm to the information underlying the consolidated financial statements.

f. A schedule of audit adjustments, including a description of the nature and cause of each misstatement.

g. All significant deficiencies and material weaknesses in internal control over financial reporting, including a clear distinction between those two categories.

h. Letters of representations from management.

i. All matters to be communicated to the audit committee.

The principal auditor must obtain, and review and retain, such documents prior to the report release date. In addition, the principal auditor should consider performing one or more of the following procedures:

• Visit the other auditor and discuss the audit procedures followed and results thereof.

• Review the audit programs of the other auditor. In some cases, it may be appropriate to issue instructions to the other auditor as to the scope of the audit work.

• Review additional audit documentation of the other auditor relating to significant findings or issues in the engagement completion document.” (footnotes omitted, emphasis added)

34.  Paragraph 18 of PCAOB Auditing Standard 3 (9 June 2004) requires the principal auditor to ensure that the component auditor produces the required audit working papers and that the principal auditor must keep copies of them or have access to them.  Paragraph 19 requires, like paragraph 12 of AU543, the principal auditor to obtain, review and retain the documentation relating to work performed by a component auditor if the component auditor is not referred to in the audit report.  The documents required by paragraph 19 are substantially the same as those required by paragraph 12. 

35.  It follows from this that KPMG HK should have in its possession at least the documents required by the PCAOB Auditing Standards and, in particular, AU543.  The documents that KPMG HK have disclosed do not appear to include the documents required by paragraph 12 of AU543 and Ms. Ismail did not suggest otherwise.

36.  KPMG HK does not suggest that they have an office in the Mainland.  It follows that these documents should be kept in Hong Kong.  In practice one would expect KPMG HK to have access to KPMG Huazhen’s audit working papers and I do not understand it to be suggested that they do not.  KPMG HK have not suggested that they failed to comply with the requirements of the PCAOB’s standards in either regard.  I note that in her second affirmation Ms. Jacqueline Wong suggests in paragraph 14 that KPMG HK had retained them by virtue of the fact that they are securely held by KPMG Huazhen in the Mainland.  I disagree and find it disingenuous for Ms. Wong to suggest this given the arguments KPMG HK advance opposing the Liquidators’ application.  It is KPMG HK’s case, which I address later in detail, that:

(1)   KPMG HK and KPMG Huazhen are separate legal entities (which is uncontroversial);

(2)   KPMG HK does not have control of the audit working papers[6];

(3)   KPMG HK cannot take the audit working papers it chose to transfer to KPMG Huazhen out of the Mainland or show them to the third parties even if this Court were so to direct.

I do not see how it can sensibly be suggested in these circumstances that KPMG HK retained the papers it transferred to KPMG Huazhen.  It is notable that in paragraph 56 of KPMG HK’s written submissions they assert that they have already disclosed all the documents sought in the summons “within its custody”.  The clear implication is that they do not have possession, custody or meaningful control of the documents sought in the summons, which have not already been disclosed and, in particular, the documents referred to in paragraph 1.4 of the Appendix to this decision, namely, audit working papers.

37.  KPMG HK must be taken to have appreciated that the reason why the PCAOB’s standards required working papers to be retained and accessible was in order that it would be possible for the Company, PCAOB, regulators, and professional bodies to review the audit if they had lawful grounds for so requesting.  That is apparent from the final paragraphs of the letter of engagement that I have quoted in paragraph 16. They must also be taken to have appreciated as one of the Big 4 accounting firms with a significant insolvency practice, that in the event that the Company were to go into liquidation any liquidator might want to access to all or some of KPMG HK’s papers.  They must also be taken to know that it is common for the Hong Kong Companies Court to so order. 

38.  Although this point was not addressed before me it would seem from the accounting standards I have referred to that if a principal auditor considers that he might have difficulty in complying with his obligations to obtain and retain documents he should make express reference to the audits undertaken by component auditors and, as required by AU 543.02, before deciding whether or not to accept any engagement give careful consideration to whether or not, given the significance of the subsidiaries and the audit of their financial statements, and any limitations placed on his ability to comply with the letter and intention of the standards, he should accept the engagement. 

39.  If, as in the present case, the subsidiaries in the Mainland are significant in terms of holding company’s activities and turnover and, if KPMG HK are correct that the Laws and Regulations in the Mainland restrict transfer overseas and access to documents produced and obtained by auditors during their audits, in my view a principal auditor outside the Mainland is unable to comply with the PCAOB accounting standards to which I have referred and the standards require the engagement to be declined.

KPMG HK’s grounds of opposition

40.  In summary KPMG HK opposes the application on the following grounds:

40.1   The excessive breadth of the terms of the orders sought compared to the stated areas of necessary investigation in their supporting affirmation.

40.2   The lack of evidence of other routes for obtaining information.

40.3   The documents sought by the Liquidators are located in the Mainland and held by a separate legal entity, KPMG Huazhen.  There is a real possibility that KPMG HK and KPMG Huazhen would breach the laws of the Mainland if they permitted the documents to be transferred out of the Mainland or allowed the Liquidators access to them in the Mainland.

40.4   The 2^nd to 9^th Respondents would be required to answer questions about matters that took place between 6 and 11 years ago and in the case of the 7^th to 9^th Respondents they had very little knowledge of the engagement.  None of the Respondents have been given the opportunity to provide information by answering questionnaires.

41.  In order to address these grounds I will divide the remainder of this decision into the following sections:

41.1   Relevant legal principles;

41.2   The first 2 grounds of opposition;

41.3   The 3^rd ground, the legality issue; and

41.4   The terms of the order that I will make, which will address the 4^th ground of opposition.

Legal Principles

42.  Section 221(1) and (3) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap. 32, provides:

“(1) The court may, at any time after the appointment of a provisional liquidator or the making of a winding-up order, summon before it any officer of the company or person known or suspected to have in his possession any property of the company or supposed to be indebted to the company, or any person whom the court deems capable of giving information concerning the promotion, formation, trade, dealings, affairs, or property of the company.

….

(3) The court may require him to produce any books and papers in his custody or power relating to the company, but, where he claims any lien on books or papers produced by him, the production shall be without prejudice to that lien, and the court shall have jurisdiction in the winding-up to determine all questions relating to that lien.”

43.  The principles that govern this Court’s exercise of the discretion conferred by s221 is explained by Lord Millett in the following paragraphs of his judgment in the Joint and Several Liquidators of Kong Wah Holdings Ltd v Grande Holdings Ltd [7]:

“23. Section 221 and corresponding provisions overseas are designed to enable a liquidator to carry out his functions. These are twofold: (i) to collect the assets of the company, settle its liabilities and distribute its surplus funds amongst its creditors; and (ii) to investigate the causes of the company’s failure and the conduct of those concerned in its dealings and affairs: see Re Pantmaenog Timber Co Ltd [2004] 1 AC 158 at pp. 164, 172‑173, 177. The first of these functions is primarily of concern to the company’s creditors and shareholders; the second serves a wider public interest in enabling the authorities to take appropriate action against those guilty of misconduct in relation to the company. The appellants have never challenged the bona fides of the Liquidators in making the present applications or alleged that they have done so for an ulterior purpose.

….

25. The section is a vital part of the statutory insolvency regime. It is designed to meet the difficulties faced by liquidators in finding out what has happened to the company’s assets and what has caused the failure of the company. It has often been observed that a liquidator is usually a stranger to the affairs of the company. He relies on orders for examination and production to reconstitute the knowledge of the company, in circumstances where the records are often inadequate, in order to be able to perform his duties in recovering the company’s assets and generally to enable him to carry out his functions effectively and with as little expense and as expediently as possible

26. The section’s purpose, however, is not limited to reconstituting the state of the company’s knowledge, even though that may be one of the purposes most clearly justifying the making of an order: see British & Commonwealth Holdings Plc v Spicer & Oppenheim [1993] AC 426 at p.439. It may be used to discover facts and documents relating to potential claims by the liquidator against third parties or to enable him to report to the authorities with a view to taking action against those responsible for the company’s failure: see Re Pantmaenog Timber Co Ltd [2004] 1 AC 158, where it was used to enable disqualification proceedings to be taken against former directors. There is an important public interest ensuring that the liquidator should obtain the information needed to understand the company’s affairs and the reasons for its failure; and to report to the authorities to enable them to take appropriate action against those guilty of misconduct in relation to the company’s affairs.

27. It has been repeatedly stated, and the legislative purpose demands, that the powers conferred on the court by the section or its overseas equivalents are wide, general and unlimited. The liquidator must satisfy the court that the information or documents sought are reasonably required to enable him to carry out his functions. In considering this question, the authorities establish that great weight should be given to the views of the liquidator, for he is an officer of the court and alone has the necessary knowledge of the problems facing him in understanding the affairs of the company and his reasons for seeking production of documents in the terms proposed; moreover, there are often great difficulties in seeing how the terms of the order can be cut down and remain effective: see Re Rolls Razor Ltd (No 2) [1970] Ch 576 at p.592 per Megarry J; Re Castle New Homes Ltd [1979] 1 WLR 1075 at p.1092, per Slade J; Cloverbay Ltd (Joint Administrators) v Bank of Credit and Commerce International SA [1991] Ch 90 per Sir Nicolas Browne-Wilkinson V-C at p.104; and British & Commonwealth Holdings Plc v Spicer & Oppenheim [1993] AC 426.

….

29. In exercising its discretion, the court must endeavour to strike a balance between the liquidator’s reasonable requirements and the need to avoid making an order that is unreasonable, unnecessary or oppressive to the party from whom the documents or information are sought: see for example British & Commonwealth Holdings Plc v Spicer & Oppenheim [1992] Ch 342 at p.370 per Ralph Gibson LJ, and at p.384 per Woolf LJ; British & Commonwealth Holdings Plc v Spicer & Oppenheim [1993] AC 426 at p.439; Re Bank of Credit and Commerce International SA (No 12) [1997] 1 BCLC 526 at p.537 per Robert Walker J. These cases have been consistently followed in Hong Kong: see for example the Joint Liquidators of Chark Fung Securities Co Ltd & Others v Chan Kwong Hung [2001] 1 HKLRD 772 case.

30. over the years the courts have laid down general principles governing the balancing exercise which the court is called upon to undertake. They are conveniently set out in the Cloverbay Ltd (Joint Administrators) v Bank of Credit and Commerce International SA [1991] Ch 90 at pp.102-103 per Sir Nicolas Browne-Wilkinson V-C and British & Commonwealth Holdings Plc v Spicer & Oppenheim [1992] Ch 342 at p.372 per Ralph Gibson LJ and at p.392 per Woolf LJ. They can be summarised as follows:

(1) The liquidator must show that the documents are reasonably required to enable him to carry out his functions, not that they are necessary to enable him to do so;

(2) the case for making an order under the section in respect of a former officer is usually stronger than in respect of a stranger who owes no fiduciary duties to the company and who is not under a statutory duty to assist the liquidator;

(3) there is an element of oppression in requiring a party to provide information which exposes him to potential liability;

(4) an order for oral examination is likely to be more oppressive than an order to produce documents;

(5) it is oppressive to require a person suspected of wrongdoing to prove the case against himself on oath prior to proceedings being brought;

(6) an order is not necessarily oppressive because it is inconvenient for the party subject to it or causes him a lot of work or may make him vulnerable to future claims;

(7) in the light of the summary nature of the procedure and the need for expedition, the court cannot be expected to indulge in fine judgments as to the precise width of the order which should be made; and

(8) the court must take care not to cut down the width of the order sought by the liquidator in a way which would risk making it ineffective.”

Is the order reasonably required?

44.  KPMG HK contend that the Liquidators have not demonstrated that the order is reasonably required.  They suggest that the justification for the application focuses on the need to investigate the FISH and SPR acquisitions, which the Liquidators believe were the means by which monies were misappropriated from the Company.  However, the Liquidators seek production of all papers generated by KPMG HK or received by them in connection with their audit work, which is a very considerable quantity of documents.  Further the Liquidators have not demonstrated that they cannot obtain the information that they require from other sources including the directors of the Company.

45.  As Mr. Borrelli explains in his affidavit in support of the application, that the Liquidators have been unable to retrieve the Company’s books and records and the Company’s former management and directors have refused to provide any meaningful assistance to the Liquidators.  I do not understand KPMG HK to question the accuracy of Mr. Borrelli’s assertion.

46.  It is correct that in his affidavit Mr. Borrelli focuses on the most significant matter that the Liquidators wish to investigate, namely, the FISH and SPR acquisition.  He, however, also mentions the sale of the equity interests of the 60% of the Company’s Mainland incorporated operating subsidiaries.  More generally it is clear from Mr. Borrelli’s evidence that the Liquidators have simply been unable to obtain the information about the Company and its subsidiaries that the Liquidators need in order to carry out their functions as described in Kong Wah.  It is not necessary, as KPMG HK’s submissions suggest, for the Liquidators to explain why they need each category of documents that they seek from KPMG HK and demonstrate in detail their efforts to obtain them from other sources.  Where, as in the present case, the Company’s affairs cry out for thorough investigation and the Liquidators have been unable to obtain documents from the Company and its subsidiaries, it seems to me sufficient for them to explain this and that consequently it is necessary for them to look to the auditors to provide documents that may assist them in investigating the Company’s failure and the conduct of those concerned in its dealings and affairs.

47.  The Company’s auditors are an obvious source of information about the Company and its subsidiaries, particularly, in the circumstances the Liquidators find themselves in.  It is correct that the Liquidators are seeking production of a very considerable quantity of documents.  However, if KPMG HK has ensured that the PCAOB standards have been complied with it does not seem to me that producing them would (subject to what I have to say later about the illegality issue) be especially onerous.  Presumably the files are readily identifiable and locatable.  All that would be required of KPMG HK is for them to make them available for inspection.  It may be that the production of some categories of documents is more difficult than others.  This can be addressed in the framing of the order.

48.  It does seem to me, subject to what I say in relation to the precise terms of the order, that the Liquidators have demonstrated a reasonable need for the documents that they seek.

Illegality - Audit working papers in the Mainland

49.  KPMG HK’s case in relation to restrictions imposed on them in the Mainland is largely contained in 3 affirmations of Melody Wang.  Ms. Wang is a partner in Fangda Partners, which is a law firm based in Beijing.  She explains that she has been instructed to advise them in relation to the application of relevant laws and regulations in the Mainland, which impact on the lawfulness of KPMG HK and KPMG Huazhen producing working papers in the possession of KPMG Huazhen to the Liquidators.  It is not clear from Ms. Wang’s affirmations what relevant expertise she has.  Ms. Ismail argued that the Respondents were entitled to rely on those parts of Ms. Wang’s affirmations, which contained evidence of Mainland Law, although it was not produced in the form of an expert’s report.

50.  The Liquidators have produced a report, in the form of an affirmation, of Professor Fu Hualing of the Department of Law at Hong Kong University, which complies with RHC O38 r37C(1).  Professor Fu’s expertise is in public law, State secrets law, archives law, criminal law and cross-border legal relations between Hong Kong and the Mainland.  He is not an expert in securities law or the regulation of the accountancy profession and practice in the Mainland.

51.  The Liquidators object to the admission of Ms. Wang’s evidence on Mainland Law on the grounds that it does not satisfy RHC O38 r37C(1) and that she is the Respondents’ legal adviser and not independent.  Ms. Ismail submits that this is wrong and drew my attention to the decision of Anthony Chan, J in Re Loong San Investment Ltd [8], in which he held that RHC O38 r37C(1) only applies where there is an application to adduce oral opinion evidence.  RHC O38 r36(2) expressly states that nothing in paragraph RHC O38 r36(1) shall apply to evidence, which it is permitted to give by affirmation.  It is permissible to give evidence by affirmation in the present application.

52.  Mr. Manzoni invited me to take a different view.  Mr. Manzoni argued that RHC O38 r37(2) means that it is not necessary to make an application to the court for leave to adduce evidence in proceedings in which evidence is adduced by affidavit and affirmation. It does not mean that the regime in Part IV of RHC O38, which is intended to ensure that the court receives opinion evidence from experts who are subject to the procedures required by RHC O38 rr37A, 37B and 37C, which are intended to ensure that the court receives opinion evidence from witnesses who understand that their duty to the court is to give independent evidence, does not apply.  I agree.  It seems to me that the wording of RHC O38 r36(2) is open to the interpretation that it simply means that the requirement in r36(1) that an application is necessary for leave to adduce expert evidence does not apply.  This interpretation leads to a conclusion which is more consistent with the purpose of Part IV than the alternative interpretation preferred by Anthony Chan J, whose conclusion I, with respect, disagree with.  It follows that insofar as Ms. Wang is purporting to give expert evidence on matters of Mainland Law her affirmations cannot be relied on as they simply do not comply with the mandatory requirement of O38 r37C(1). 

53.  As Anthony Chan J points out, notwithstanding his interpretation of the Rules, it is desirable that all experts’ reports contain a declaration of their duty to the court.  With this I firmly agree.  Appendix D to the Rules contains the Code of Conduct for expert witnesses and the form of declaration that they are required to make. The Code provides that an expert has an overriding duty to help the court impartially and independently and that this paramount duty is to the court and not to the person instructing him.  The declaration required of an expert states that the expert has read the Code, understands his duty to the court and agrees to be bound by the Code.  I cannot see how Ms. Wang could ever have signed such a declaration.  She states in paragraph 2 of her 1^st affirmation that she is “instructed by the 1^st to 9^th Respondents to advise them in relation to the application of relevant laws and regulations of the PRC to the factual matters which are set out in the body of this Affirmation.”  It is apparent from her affirmations that this is precisely what she had done and that she has represented them in relation to the production of the audit working papers at meetings with the MOF.  She was not instructed to provide impartial and independent expert evidence to the court. If I had taken a different view on the interpretation of O38 r37 I would still have given Ms. Wang’s evidence less weight than that of Professor Fu given the basis on which she was instructed and the fact that in my view inevitably she would have been inclined to interpret the Mainland’s Laws and Regulations mindful of the Respondents’ interests.

54.  Given the importance of this issue it seems to me extraordinary that it was not thought prudent by those advising the Respondents to retain a genuinely independent expert to assist this Court. It does not seem to me to be an answer to this criticism, as Ms. Ismail suggested, that the Court does not have to reach a conclusion on Mainland Law, because the material issue is whether or not it is demonstrated that there is “any risk that compliance with the order would or might expose the [Respondents] to claims for breach of confidence, or to criminal penalties, in the jurisdiction in which the documents are” as Ms. Ismail argued quoting from Chadwick LJ’s judgment in Re Mid East Trading Inc.[9]. This still requires the court to take a view, albeit not a final one, on the content, scope and operation of foreign laws and in so doing the court needs independent opinions, not ones that are likely to be slanted to suit a particular party’s interests, in order to assess whether any alleged risk is real or exaggerated.

55.  Although in my opinion KPMG HK is not entitled to rely on Ms. Wang’s evidence to establish the relevant Laws in the Mainland in case I am wrong in that conclusion, and given the importance of this issue, I will have regard to her evidence, although I consider that the weight to be given to it restricted by Ms. Wang’ s lack of independence and, for reasons which will become apparent when I deal with that evidence, what in my view is her partial approach to the issues on which she expresses views.

56.  Before turning to address KPMG HK’s case on the restrictions placed by the Laws and regulations in the Mainland on disclosure of the audit working papers to the Liquidators there is one further point concerning the evidence on those Laws and regulations I will address.  In  the Securities and Futures Commission v Ernst & Young [10] Ng J considered the extent to which Mainland Laws and regulations restricted the ability of Ernst & Young in Hong Kong to obtain from its associated firm in the Mainland papers in connection with an initial public offering for onwards transmission to the Securities and Futures Commission (“SFC”).  I will address Ng J’s judgment later in this decision.  However, Ms. Ismail argued that the issues are not exactly the same (the documents were sought by a foreign regulator not a foreign liquidator) and the Law has developed further since the hearing of the SFC’s application.  Section 59(2) of the Evidence Ordinance, Cap. 8, provides that:

“(2) Where any question as to the law of any country or territory outside Hong Kong with respect to any matter has been determined (whether before or after the commencement of this Part) in any such proceedings as are mentioned in subsection (4), then in any civil proceedings (not being proceedings before a court which can take judicial notice of the law of that country or territory with respect to that matter)–

(a) any finding made or decision given on that question in the first-mentioned proceedings shall, if reported or recorded in citable form, be admissible in evidence for the purpose of proving the law of that country or territory with respect to that matter; and

(b) if that finding or decision, as so reported or recorded, is adduced for that purpose, the law of that country or territory with respect to that matter shall be taken to be in accordance with that finding or decision unless the contrary is proved:

57.  It follows, says Ms. Ismail, that it is open to KPMG HK to demonstrate that the findings in SFC v Ernst & Young is not applicable or no longer reflects (Ms. Ismail did not accept that it was correctly decided on the law as it stood at the time Ng J heard the application) the Law in the Mainland.

58.  I accept that it is open to KPMG HK to argue before me that the relevant Laws of the Mainland are not as found in SFC v Ernst & Young.

59.  KPMG’s case is as follows.  KPMG Huazhen is required to comply with the Laws in the Mainland.  This, unsurprisingly, is not in issue.  This includes Laws dealing with State secrets.  On 20 October 2009 a provision came into force which, in translation, is entitled “Provisions of China Securities Regulatory Commission, State Secrecy Bureau and State Archives Administration on Strengthening Confidentiality and Archives Administration on Overseas Issuance and Listing of Securities”.  Before me it has been referred to as Regulation 29.  Paragraphs 3and 6 provide:

“3. In the event that an overseas listed company shall provide or publicly disclose to the relevant securities company, securities service institution and overseas regulatory authority any document, material and other items which involve any State secrets in the course of any overseas issuance and listing of securities, the overseas listed company shall report the same to the in-charge authorities with examination and approval power for approval in accordance with the law and shall make a filing with the secrecy administrative department at the same level for records. Where it is uncertain or in dispute whether such item contains State secrets, such issue shall be submitted to the relevant secrecy administrative department for determination.

….

6. Any archives, including workpapers, which are created in mainland China by the securities company and securities service institution providing relevant securities service in the course of any overseas issuance and listing of the securities, shall be stored in mainland China.

In the event that the workpapers referred to in the preceding paragraph involve any State secrets, national security or vital interests of the State, such workpapers shall not be stored in, processed with and/or transferred via any non-confidential computer information systems; without the approval of the relevant in-charge authorities, such workpapers shall not be carried or shipped overseas, or delivered to overseas institutions or individuals through any means such as information technology.”

60.  These provisions do not refer expressly to audit working papers.  Giving them a generous interpretation they seem to be saying that a listed company should not disclose to any overseas person carrying out a regulatory function any documents that “involve any State secret” and if the company has any doubts about whether or not any document contains State secrets it should make an application to the relevant secrecy administrative department for determination.  Ms. Wang suggests that this prohibits cross-border transmission of audit work papers.  Ms. Wang refers expressly to this restriction of “audit work papers” in paragraph 47 of her first affirmation.  The justification for so doing seems to be the reference in the first line of Article 6 of Regulation 29 of “workpapers”.  However, nowhere in her affirmations does Ms. Wang explain what she understands is meant by the term “audit work papers”, which is the expression used by her throughout her affirmations or “workpapers” in Article 6.  Ms. Wang does not explain whether she uses the expression to cover the documents described in PCAOB AU section 339A para .03, alternatively those referred to in paragraph 1.4 of the summons (paragraph 1.4 of the Appendix).  It is as a result unclear what documents she is referring to.  It would appear to be the case that she is only addressing the documents referred to in paragraph 1.4, because those are the only documents described in the summons as working papers.  It follows that the objections that she advances in her affirmations to production of documents do not apply to the other categories of documents sought.  Similarly, Ms. Wang does not tell the Court whether she uses the expression to cover the documents required to be kept and retained by AU 543 paragraph 12.  It would appear not.  Accordingly, the objections do not apply to those documents.

61.  It is not clear from article 6 what “workpapers” include.  This article appears to be addressed to documents produced by securities companies rather than auditors.  It requires the archives containing such documents to be kept in the Mainland.  The final paragraph provides that if such documents contain State secrets they should not be sent overseas.  This suggests that if they do not contain State secrets copies can be transferred overseas although the original files must be maintained and kept in the Mainland.

62.  Ms. Wang has referred to a number of other Laws and Regulations, which she argues demonstrate that the audit working papers cannot lawfully and safely be transferred out of the Mainland.

63.  On 2 May 2012 the MOF promulgated a “Plan for Localised Transformation of Chinese-Foreign Cooperative Accounting Firms”.  This contains the regime for the transformation to which I have referred earlier of Chinese-Foreign accounting firms including KPMG Huazhen[11] into special general partnerships.  Article 22 provides:

“After accounting firms adopt the organization form of special general partnership, the various document files of original Chinese-foreign cooperative accounting firms shall be kept properly and shall not be disposed of arbitrarily or carried out of the territory of China in any way without the approval of the Ministry of Finance. All staff of accounting firms shall strictly comply with national confidentiality regulations and systems.”

64.  The relevant documents which are the subject of this application consist both of documents of KPMG Huazhen, the special general partnership, and documents of KPMG HK, which were transferred to KPMG Huazhen for storage.  Article 22 has no application to the latter.

65.  Ms. Wang points to a document entitled “Interim Provisions for Performing Cross-border Auditing Practices by Accounting Firms”, which is dated 2014 and is described as an “exposure draft”, which I understand to be in the nature of a press release indicating the MOF’s view.  However, it states in Article 2 that it does not apply to the overseas listing of enterprises which are registered overseas but whose operating entities are in the Mainland and does not, therefore, appear applicable to the present case.  It also seems mainly concerned with regulation of overseas accounting practices, who undertake audit work in the Mainland for the purposes of overseas listings rather than controlling the use of audit working papers.

66.  Ms. Wang also refers to a speech given by an unnamed MOF official in May 2014, which Ms. Wang suggests makes it clear that it is the MOF’s view that audit working papers of Chinese companies cannot be taken out of the Mainland.  The relevant part of the press release reads as follows in translation:

“Different regulations on auditors for regulatory authorities in the listing locations make it a normal practice for overseas accounting firms that assume audit responsibility, in certain circumstances, to enter China to carry out audit business for Chinese mainland companies listed overseas and to work closely with the mainland firms, but in practice, the following outstanding problems are revealed: First, some overseas firms fail to perform any filing or reporting procedures and enter China to carry out auditing in a variety of names and even carry audit working papers overseas. This practice severely violates the Regulations on Strengthening Confidentiality and Archives Administration in Overseas Issuance and Listing of Securities (Announcement of the China Securities Regulatory Commission, the State Secrecy Bureau and the State Archives Administration [2009] No. 29), and this traceless practice are not allowed in any legal countries or regions.”

67.  A number of points arise in relation to this document.  First, it is not a law or a regulation.  Secondly, it is clear from the paragraph that I have quoted that the unnamed official is not aware of the provisions of PCAOB and GAAP and is mistaken in the suggestion that in developed legal systems in which the major stock exchanges are located there are restrictions on taking audit working papers in and out of the country.  I do not consider that this document should be treated as authoritative.

68.  Ms. Wang suggests that her view of what she describes as “the regulatory trend that PRC regulatory authorities emphasise the importance of ensuring that work papers related to red-chip companies do not leave Mainland China without approval”[12] is supported by a document issued by the MOF entitled “Interim Provision on the Audit Services Provided by Accounting Firms for the Overseas Listing of Mainland Chinese Enterprises” which is stated to have an effective date of 1 July 2015 and was promulgated on 25 May 2015.  Article 5 of this document provides that where an overseas accounting firm audits a Mainland enterprise the audit working papers should be kept in the Mainland.  Article 12 provides:

“Article 12 Mainland Chinese enterprises and accounting firms that provide audit services for the overseas listing of Mainland Chinese enterprises shall strictly abide by the Provisions on Strengthening Confidentiality and Archives Management Work Related to Securities Issuance and Listing on Overseas Markets (Announcement [2009] No. 29 of the China Securities Regulatory Commission, the National Administration for the Protection of State Secrets and the State Archives Administration).

Where overseas judicial departments or regulatory authorities need to retrieve and inspect audit working papers because the overseas listing of Mainland Chinese enterprises involves litigations or other relevant matters, or where overseas regulatory authorities need to retrieve and inspect audit working papers for performing regulatory functions, the regulatory agreements reached by domestic and overseas regulatory authorities shall prevail.”

69.  It does not seem to me that Article 12 can be fairly read as saying that audit working papers, which there is no reason to think contain State secrets cannot be taken out of Mainland or shown, within the Mainland, to the Liquidators.

70.  Ms. Wang suggests that as KPMG Huazhen is not in a position to determine whether or not any of the information in the audit working papers constitutes a State secret that it needs to obtain a determination by the relevant Government authority before releasing any of them.  She then goes on to consider the law specifically dealing with State secrets.

71.  “State secrets” are broadly defined in article 2 of the State Secrets Law to include “matters that have a vital bearing on State security and national interests”.  Article 8 provides that the relevant national interests include “secrets in the national economic and social development” and “secrets concerning science and technology”. 

72.  The description of a document is not determinative of whether it is a State secret.  This is not in dispute.  Ms. Wang notes that it may not be immediately obvious whether or not it is a State secret.  This may be correct, but it does not follow that every document should be approached on the basis that it may contain a State secret.  Presumably very large quantities of documents in physical form and electronic form pass out of the Mainland every day without anybody worrying whether their contents infringe State secrecy laws.  If every document had to be scrutinised to assess whether or not it contained sensitive material that needed to be referred to a Government agency for consideration commercial activity would grind to a halt.

73.  Ms. Wang seems to acknowledge in paragraphs 6 to 7 of her second affirmation that the Laws and Regulations relating to State secrets do not require every document to be checked for sensitivity before it can be taken out of the Mainland.  I note that in paragraph 6 she chooses, in my view rather disingenuously, to suggest that this is because it would not be possible rather than the more likely explanation that this is not what the legal regime requires.  In paragraph 7 she goes on to try to justify what in my view is the substance of her position, namely, documents should be presumed to contain State secrets unless the opposite can be demonstrated, by emphasising that the relevant criminal law makes it an offence to disclose a document that is known or should be known to contain a State secret. This, however, does not address the rather obvious point that necessarily the vast majority of the audit working papers for any company will not contain State secrets.  Rather than address this point Ms. Wang chooses in paragraphs 12 to 15 to emphasise how complex and obscure the State secrecy regime is.  In paragraphs 23 and 24 of her 2^nd affirmation Ms. Wang suggests that the correct approach is not to ask whether there is a genuine risk that documents may contain State secrets and if there is seek the approval of the relevant authorities, rather the correct approach is to ask for all documents to be checked.  She refers by way of example of the correct approach to cases (she does not give details) of documents being passed by accountants to the Securities and Exchange Commission of the United States only after all such documents have been checked.  Unfortunately, Ms. Wang does not tell the Court which authority the documents were checked by.  This information would have been helpful, because it is part of KPMG HK’s case, which I address later, that despite their inquiries they have not managed to identify an authority who acknowledges responsibility to do so.

74.  In paragraphs 64 to 73 of her first affirmation Ms. Wang explains that she has not looked at any of the audit working papers.  As I have already noted Ms. Wang does not explain in her affirmation what she understands audit working papers to consist of.  What Ms. Wang does do is to speculate on what State secrets the audit working papers might contain.  The Company’s subsidiaries purported businesses concern medical technology and Ms. Wang speculates that in particular there is a risk that the Regulations on Guarding Scientific Technology Secrets within Chinese and Western Medicine and Medical Devices and also the Regulation on Guarding Scientific Technology Secrets might be infringed.  In paragraph 69 of her first affirmation she says this:

“69.   In this case, I am instructed that CMED has been a medical devices producer with multiple inventions on both products and technologies recognized under Chinese law. In its 2007-2009 Form-20 CMED stated that its products and manufacturing techniques were in a leading position within China, and that it was the first domestic company to have invented and produced certain medical devices (“MW‑1” Tab 26). On the basis of that understanding, when conducting audit work for CMED, KPMG HK or Huazhen could likely have come across various products of CMED, which could include products that might fall within the scope described above, such as inventions, partial discoveries, unique design of certain medical devices, and secret manufacturing methods. All of this information could have been recorded in the audit work papers. As a result, in our view there is an appreciable risk that the audit work papers of the Engagement may contain State secrets as such are understood in the Regulations on Guarding Medical Secrets, the disclosure of which without the appropriate approvals would amount to a breach of the Regulations.”

75.  Ms. Wang does not explain why she thinks “all of this information could have been recorded in the audit work papers” and neither do any of KPMG HK’s other witnesses.  It seems to me that there is no sensible reason to suggest that “all of this information could have been recorded in the audit work papers” and this must be known to KPMG HK. If she had proper regard to what constitutes audit working papers I would not expect her to express this view.  Ms. Wang has also not recognised that her opinion is difficult to reconcile with the fact that the Company or subsidiaries has registered patents outside the Mainland and provided technical information to customers, which if her evidence is correct, would seem to have resulted in the distribution of State secrets overseas.  Ms. Wang does not seem to recognise that as this part of her argument relies on the application of the State Secrets Law, which is of general application, if she is correct it would appear to follow that any document of any type generated by any person or organisation that there is any possibility (as is clear from Ms. Wang’s evidence she considers the bar to be very low in this regard) might contain a State secret cannot be transferred or transmitted outside the Mainland without first being vetted by some official agency.  Ms. Wang does not, however, suggest that there is well established procedure for dealing with, what, if her evidence is correct, must be a very large problem for people and companies in the Mainland trying to do business overseas.  On the contrary it is both the evidence of Ms. Wang, Ms. Wong and Mr. Yan that there is no established procedure[13]. There must be a way for commercial enterprises operating in the technology field in particular to deal with these practical problems, but Ms. Wang neither acknowledges them nor addresses them, which calls into question the objectivity, accuracy and value of her opinion.

76.  Ms. Wang also rejects the suggestion that it might be possible to overcome her suggested problems in taking work papers out of the Mainland by allowing the Liquidators to inspect them in the Mainland.  She says that this would be inconsistent with Regulation 29 and also it would defeat the legislative intent behind the Regulation.  Ms. Wang does not say what she understands the legislative intent to be, but the implication is that Chinese companies that list overseas should not allow other than most innocuous information about their activities in the Mainland to leave the Mainland without first having it vetted by the responsible Government department or agency.  In paragraphs 50 and 58 of her 1^st affirmation Ms. Wang goes so far as to suggest that information obtained by component auditors cannot be transferred out of the Mainland for the use of auditors of a holding company incorporated elsewhere and listed on a foreign stock exchange such at NASDAQ.  It would also follow that records of information obtained by a component auditor, or a principal auditor while in the Mainland, about inadequacies in accounting practices or misappropriations could not be passed to foreign directors of the listed company including independent non-executive directors.

77.  Professor Fu disagrees with Ms. Wang’s evidence.  He explains that the Mainland State Secrets Laws and the State Council’s 2014 regulation dealing with the implementation of laws guarding State secrets comprise the legislative framework for the protection of State secrets.  In addition there are ministerial rules that deal with the implementation of procedures and mechanisms of classification of State secrets. Professor Fu says that Order No. 1 of 2014, that Ms. Wang herself refers to, is an example of this.  Professor Fu opines that contrary to Ms. Wang’s evidence the import of which is that things are deemed State secrets until it is determined otherwise, it is clear from articles 2 and 4 of the State Secrets Law that this is not the case.  Article 4 provides that “The work of guarding State secrets shall be carried out in line with the principle of actively preventing their leak and laying emphasis on priorities so that State secrets are kept while work in all other fields is facilitated.”  This indicates, says Professor Fu, that the Law is not intended to provide sweeping restrictions on the dissemination of information.  The ministerial regulations that have been produced are intended to implement procedures that provide for the identification of State secrets not, as Ms. Wang suggests, to establish a default position where everything is assumed to be a State secret until the contrary is established.

78.  I recognise that the authorities in the Mainland maybe more cautious in allowing the dissemination of commercially valuable information than the major Western economies and that the Mainland’s Laws and Regulations extend to subjects that might not be thought in overseas jurisdictions to be State secrets.  It does not seem to me that it follows, or that Ms. Wang has demonstrated, that the State Secrets Law is an impediment to audit working papers being transferred out of the Mainland unless there is reason to believe that, and this I anticipate would be very rare, a particular document may contain a State secret.

79.  The position is more complicated in relation to the position of the MOF.  The documents to which Ms. Wang refers produced by the MOF do suggest, even though they do not refer expressly to audit working papers produced by component auditors for subsidiaries of a company with an overseas listing, an intention to control the transfer of audit working papers outside the Mainland.  KPMG HK and KPMG Huazhen were obviously aware of this by the time they were faced with the request for documents from the Liquidators.

80.  KPMG HK have filed 2 affirmations from Mr. Isaac Lap Kei Yan, who is a partner in KPMG Huazhen LLP (which was formerly KPMG Huazhen) and is responsible for Quality and Risk Management.  Mr. Yan explains in his 1^st affirmation that KPMG Huazhen approached the China Securities Regulatory Commission (“CSRC”) in March 2015 (he does not provide details) to discuss the Liquidators’ request for disclosure of documents.  KPMG Huazhen were told the MOF was the appropriate authority to deal with the matter.  At the time Mr. Yan made his 1^st affirmation, KPMG Huazhen were still awaiting “a formal response” from the MOF to a screening procedure that KPMG Huazhen has proposed.  In paragraph 28 of his 1^st affirmation he explains KPMG Huazhen’s previous experience of disclosing audit working papers.

“I am aware from other occasions where KPMG Huazhen has been asked to disclose audit work papers held in the PRC that the PRC regulatory authorities have approved and implemented a screening process for the identification, removal and redaction of information which constitutes State secrets from audit work papers prior to the cross-border production of those work papers. My understanding of that screening process is that it operates as follows:

(a) The relevant PRC regulatory authorities engage in meetings and discussions with the accounting firm, which discussions would include providing examples of potential State secrets and state sensitive information in audit work papers;

(b) Pursuant to direction from the regulatory authorities, the accounting firm reviews the audit work papers, with the assistance and advice from external PRC counsel it retains. There may be interim meetings with regulatory authorities for further discussions on the review as the review progresses;

(c) Upon completion of the review, the accounting firm submits to the regulatory authorities a report on the review and seeks approval from the regulatory authorities; and

(d) The regulatory authorities then conduct their own internal examination and evaluation of the audit work papers, before deciding on whether to give approval.”

81.  Mr Yan does not explain to what kind of parties the audit working papers were disclosed, how extensive were the papers, which regulatory authority conducted the screening process and how the screening process was instigated.  Mr. Yan gives evidence in his 2^nd affirmation about a telephone call between a member of his team, Priscilla Miao, with an unidentified representative of the MOF.  He explains what she was told and how the matter progressed in paragraphs 10 to 16:

“10. On 15 June 2015, a member of my team at KPMG Huazhen, Priscilla Miao, who reports directly to me, had a telephone call with a representative of the MoF, in order to follow up on the previous meeting and explore how best to progress the resolution of the legal and practical difficulties faced by KPMG Huazhen in releasing the Company’s audit work papers to KPMG HK in Hong Kong for possible disclosure to the Liquidators.

11. In the course of this telephone call, Ms Miao was informed by the MoF that such request should be dealt with by way of a “judicial assistance channel”. In the alternative, the request should first be submitted to the State Archive Bureau and to the State Secrets Bureau for their approvals and then be submitted to the MoF, as KPMG Huazhen’s regulatory body, for further approval.

12. With the agreement of KPMG Huazhen, Fangda approached the PRC Ministry of Justice, in order to explore the availability of the “judicial assistance channel” to review the audit work papers and, potentially, approve their release to KPMG HK.

13. On 24 July 2015, KPMG Huazhen was informed by Jacqueline Wong of KPMG HK that Fangda Partners had approached the Ministry of Justice and had been advised that at present there is no established judicial procedure for dealing with cross-border document production issues between the PRC and Hong Kong.

14. On that basis and with the agreement of KPMG Huazhen, KPMG HK instructed Fangda to approach the relevant central or provincial offices of the State Archive Bureau and the State Secrets Bureau to establish whether they would accept jurisdiction over the review of the audit work papers.

15. As recorded in the Second Affirmation of Melody Wang, Fangda’s communications with the Beijing State Secrets Bureau and the State Archive Bureau have so far been inconclusive.

16. On that basis, KPMG Huazhen is seeking a further meeting with the MoF to obtain their guidance as to how best to move the matter forward. As things currently stand, however, the MoF’s position remains that the audit work papers for the Company which are held by KPMG Huazhen in the PRC must not be removed from the PRC without the approval of a relevant regulatory body.”

82.  This is all very vague.  The Court has not been told who at the MOF KPMG Huazhen have spoken to.  Nothing appears to have been recorded in writing.  The evidence does not sit comfortably with Mr. Yan’s evidence in paragraph 28 of his 1^st affirmation, which suggests that KPMG Huazhen have previously been able to arrange for documents to be screened and released.  Mr. Yan does not explain why it has been possible to do so in other cases, but not the present one.  The explanation may lie in what the China Securities Regulatory Commission and MOF have been told by KPMG Huazhen.  KPMG Huazhen and Ms. Wang have not written to the China Securities Regulatory Commission or MOF about the matter and not in their affirmations descended to detail of what precisely they said.  It is, therefore, not possible for the Court to assess to what extent the authorities may have been influenced by the way in which KPMG Huazhen framed its request and a preference on KPMG Huazhen’s part for receiving exactly the kind of unhelpful response they say they received from the MOF.  If KPMG Huazhen exaggerated the possibility of the audit working papers containing confidential information it would be unsurprising if what may be, the Court has not been told, a low level administrator in the MOF gave what he saw as the safest response without any regard to precisely what the relevant Laws and regulations say or how the issue might be addressed.

83.  Another relevant omission from KPMG HK’s evidence is its failure to explain how in practice it goes about audits of foreign companies with operating subsidiaries incorporated in the Mainland and carrying on business there.  It appears quite clear from PCAOB AU 543 paragraph 12 that documents containing information about subsidiaries must pass out of Mainland and to KPMG HK’s office in Hong Kong and possibly to other overseas offices for the purposes of the audit of consolidated accounts. KPMG HK has not provided documents complying with paragraph 12 to the Liquidators.  My impression is that it has been overlooked that Ms. Wang’s evidence only appears to apply to the documents sought in paragraph 1.4 of the summons.  It seems to have been assumed that what she is saying is that no documents can be taken out without prior approval from the relevant regulating authority.  It may be that this is what she intended to say.  Be that as it may it is certainly the case that this is what Ms. Ismail argued before me, which invites the question I have referred to earlier: what does KPMG HK do in practice?  Either KPMG HK does not obtain and retain the documents required by the PCAOB standards or it does obtain them and it is being less than candid with the Court.

The authorities

84.  This is not the first time this issue has come before the Court.  In 2013 the SFC sought an order under s185 of the Securities and Futures Ordinance, Cap 571, against Ernst & Young Hong Kong (“EY”) for the disclosure of, amongst other documents, audit working papers and related correspondence produced by EY’s associated firm in the Mainland (in other words the equivalent of KPMG Huazhen) in connection with the listing on the The Stock Exchange of Hong Kong Limited of a company incorporated in the Cayman Islands whose business was conducted through subsidiaries in the Mainland[14]. Some of the issues that arose for determination concerned whether or not EY had a right to obtain the documents sought from its associated firm in the Mainland.  In the present case KPMG HK are not advancing that objection.  As I have explained their objections concern the necessity of the order sought (which I have rejected) and the restrictions imposed in the Mainland on disclosure of the audit working papers.  EY argued before Ng J that the Laws in the Mainland restrict cross-border transmission of audit working papers and prohibit direct production of them to overseas security regulators (“Regulators”) (§§58(3) and 75(2)). 

85.  As is explained by Ng J in paragraph 78(3) the experts before him, who were Professor Fu for the SFC and Professor Liu Yan of the Law School of Peking University, agreed that Regulation 29 is the most important departmental rule governing cross-border transmission of audit working papers to Regulators.  It was also common ground between the experts that Regulation 29 is neither a law nor an administrative regulation, but a departmental rule which only helps clarify the application of the Securities Law, State Secrets Law and the Archive Law – it does not create new legal obligations with regard to cross-border transmission of audit working papers. 

86.  Both Professors agreed that Regulation 29 does not provide a blanket prohibition on cross-border transmission of audit working papers.  It is permissible if prior approval of the relevant governmental department is obtained.  The experts disagreed on what documents needed to be approved before they could be transmitted out of the Mainland to Regulators.  They did agree that whether or not a document contained a State secret was fact sensitive and depended entirely on the contents of the document.

87.  They agreed that other than Regulation 29 the most germane law was Article 18 of the Archives Law and Article 19 of the Archives Law Implementation Rules.  It has not been argued before me that the Archives Law and associated Rules are relevant.

88.  Neither expert had seen the relevant documents and EY did not identify any document that it believed might contain a State secret.  Ng J took the view that in the absence of any evidence that anybody suspected any of the documents contained State secrets the objection based on State secret fell away (§§135-141)[15]. The Judge did, however, go onto consider the application of Regulation 29.  Ng J concluded that Articles 6 and 8 of Regulation 29 did not prevent the cross-border transmission of audit working papers. Article 6 draws a distinction between a requirement to keep archives including audit working papers in the Mainland and a requirement in respect of documents that contain State secrets that they should not be sent abroad.  The distinction would not need to be drawn if the intended effect of Article 6 was that audit working papers, regardless of their content, should not be sent abroad.  Articles 8 states that the CSRC shall, for the purposes of protection of secrets, be responsible for liaising and cooperating with overseas securities regulatory authorities and other relevant authorities.  It goes on to provide that where an overseas regulatory authority or other relevant authority requests inspection of documents involving State secrets the request must be reported to the competent Mainland authority empowered to approve the inspection.  Ng J found that Article 8 was dealing with documents, which it was believed contained State secrets. It did not contain a blanket restriction on allowing inspection of audit working papers.  With both these conclusions I agree.  Having reached this view and found that there was no evidence that any of the documents the subject of the application before him contained State secrets Ng J found that it followed that it had not been demonstrated that Regulation 29 restricted cross‑border transmission of audit working papers.  A conclusion with which I also agree.  I would note that in paragraph 178 of his judgment Ng J records the following:

“178. Lastly, it is noteworthy that HM itself has not raised any issue of Regulation 29 with the CSRC when it refused to produce the audit working papers back in mid-2010. Regulation 29, the Archives Law, State Secrets law and CPA Law were all in existence at that time. As evident from its reply letter to SFC dated 23 July 2010, the CSRC was also not troubled by any issues concerning Regulation 29 and apparently took the view that, but for HM’s refusal to cooperate and its challenge to CSRC’s jurisdiction (on the ground that the Company was incorporated in the Cayman Islands) the audit working papers could be provided to SFC. This is so notwithstanding the absence of evidence that prior approval from the State Secrets Bureau, the State Archives Administration and the MoF as ‘other relevant department” has been obtained. Subsequently, HM, through its PRC legal advisers Fangda Partners, said in a letter dated 5 December 2012 that it was prepared to cooperate with the CSRC, again without making any reference to Regulation 29 or the need to also seek prior approval from the various other government departments.”

89.  This does not sit comfortably with Ms. Wang (of Fangda Partners) and Mr. Yan’s evidence about their discussions with the CSRC and MOF.

Conclusion

90.  I am satisfied for the reasons explained earlier that the Liquidators do reasonably require the documents that they seek.  I am also satisfied as a result of the evidence filed by Mr. Weir that the fact that KPMG HK and KPMG Huazhen are separate legal entities does not prevent KPMG HK obtaining the documents to the extent that they are in the possession or control of KPMG Huazhen.

91.  In my view KPMG HK has not demonstrated that the transfer or transmission of copies of the documents sought in this application to the Liquidators in Hong Kong would infringe any Law or Regulation controlling the dissemination of State secrets. 

92.  It also seems to me that KPMG HK has failed to demonstrate that the Laws and Regulations in the Mainland dealing expressly with the storage, use, disclosure and transmission of what the Laws and Regulations I have been referred to describe as “working papers”, provide a blanket restriction on the transmission of copies of the documents to the Liquidators in Hong Kong or the disclosure of their contents to the Liquidators in the Mainland.  In particular, it does not seem to me that Ms. Wang’s unsatisfactory evidence provides a basis for refusing production of the documents sought in paragraphs 1.1 to 1.3 and 1.5 to 1.12 of the Appendix.

93.  I accept that the test for determining whether or not the application for production of documents is oppressive because it puts KPMG HK at risk in some way is as explained by Chadwick LJ in Re Mid East Trading Ltd[16], namely, whether it has been demonstrated that there is “any risk that compliance with the order would or might expose the [Respondents] to claims for breach of confidence, or to criminal penalties, in the jurisdiction in which the documents are”.  In determining whether an order might expose a respondent to a claim or penalty the Court needs to be satisfied that the risk is real and not speculative.  Therefore, even if it seems to me that given my conclusions on the affect of the relevant Laws and Regulations it should be possible for KPMG HK to, for example, allow the Liquidators to inspect the documents they seek that are in the Mainland, I should have regard to whether the reality is that the authorities in the Mainland might take a different view and the consequences of them doing so might be serious for KPMG HK.  I recognise that the interpretation of Laws and Regulations and the actions of the authorities in the Mainland are less predictable than they would be in more developed legal and regulatory environments.  Therefore, the order that I will make, the precise terms of which I address later, needs to be tailored to allow for this reality.

94.  Before turning to deal with the terms of the order, there are a number of matters about which I am concerned and which have made the determination of this application and the formulation of an order more difficult for the Court than was necessary.  The first relates to the way in which KPMG HK has approached this application.

95.  There is nothing wrong with KPMG HK’s lawyers considering the impact of Ng J’s judgment in SFC v Ernst & Young and concluding that issues were not fully explored before him or that the Law has developed and as a consequence this Court should be invited to take a different view.  It does not seem to me that this is what has happened.  KPMG HK’s evidence seems to have been carefully crafted to overcome the problem posed by the absence of any substantive evidence that the papers sought contain State secrets.  Rather than adduce an expert’s report which addresses objectively the difficulties of determining what restrictions the Laws and Regulations and MOF practice create in determining whether or not the Liquidators can be given access to the audit working papers, KPMG HK has chosen to adduce evidence from its own lawyer in the Mainland who has not been asked to sign the declaration required of witnesses giving expert evidence to the Court and whose evidence it seems to me is clearly tailored to advance KPMG HK’s case.  KPMG HK’s legal team has exploited Anthony Chan J’s decision in Re Loong San Investment Ltd ibid to avoid adducing impartial opinion evidence. Similarly, Mr. Yan’s evidence and the associated evidence of Ms. Wong and Ms. Wang in connection with KPMG HK’s discussions with the MOF is unsatisfactory.  It manifestly lacks the detail necessary for the Court to assess how much weight should be given to whatever was said to the unnamed official at the MOF who it is suggested told KPMG HK that the audit working papers should not be taken out of the Mainland.  The evidence amounts to saying to the Court “take our word for it, we are not meant to take the documents out of the Mainland.”  It does not seem to me to have been a genuine attempt to find a solution to the problem that KPMG HK say that they face in providing access to the documents to the Liquidators.

96.  It also seems to me unsatisfactory that KPMG HK has not dealt with what happens in practice to the audit of overseas incorporated listed companies with subsidiaries in the Mainland.  If KPMG HK could have confidently explained how they comply with the accounting standards that I have discussed in this decision I would have expected them to do so.  The fact that they have chosen not to do so invites the suspicion that KPMG HK has exaggerated either the extent of the problem it faces in taking papers out of the Mainland or is reluctant to admit that it does not comply with accounting standards.

97.  It is necessary for the terms of the order to provide flexibility to address any genuine problems that KPMG HK and KPMG Huazhen encounter.  In determining the extent and the form of that flexibility I take into account the way in which KPMG HK has dealt with this application and what I consider to be the unreliability of their evidence.

Terms of order

98.  There is one category of documents of which I am satisfied that production is not necessary and that is the time entries referred to in paragraph 1.9 of the Appendix.  I am satisfied that they will not contain any material information.  I understand that they are limited to recording time rather than detailed activities.

99.  So far as the other categories of documents of which production is sought in the summons (“Documents”) are concerned I order that except for those that have already been provided:

(1)   Insofar as the Documents or copies of them are located in Hong Kong or a jurisdiction other than the Mainland or they are stored in a form, at the date of this decision, which allows them to be accessed outside the Mainland, copies of the Documents shall be provided to the Liquidators in Hong Kong within 28 days of the date of this decision or such other date as the parties agree or the Court directs.

(2)   Insofar as the Documents or copies of the Documents are located in the Mainland or are stored in a form which only allows them, at the date of this decision, to be accessed in the Mainland, the Liquidators shall be given access to the Documents within 35 days of the date of this decision or such other date as the parties agree or the Court directs.

(3)   In the event of any matter occurring subsequent to this Order which in the view of the Respondents or any of them inhibits or prevents them from complying with any part of this order there be liberty to apply for the terms of the Order to be varied.

(4)   Should any matter occur, or be anticipated, which the Respondents or any of them consider may or will inhibit or prevent them complying with any part of this order the Respondents and each of them shall, without prejudice to their right to assert legal privilege, maintain in written form a complete and accurate record of all communications concerning the relevant matter between (a) the Respondents themselves, their employees and agents or (b) between the Respondents, their employees and agents or their legal advisers on the one part and third parties on the other part.

100.  I will make an order for the service of an affirmation or affidavit within 28 days or such other period as the parties agree or the Court directs dealing with the matters referred to in paragraphs 3 of the summons.  I do not consider that an affirmation or affidavit dealing with the matters referred to in paragraph 4 of the summons is currently required and ordering it at this time would in my view be unnecessarily onerous.  The Liquidators have liberty to apply for such an order if they consider that in some respect the production of documents is materially unsatisfactory.

101.  So far as examination is concerned I do not intend to order immediate examination of the 2^nd to 9^th Respondents.  I accept, as Ms. Wong explains in her 1^st affidavit, that a number of the Respondents are unlikely to be able to provide much useful information to the Liquidators given their limited scope of involvement with the retainer.  The matters that I anticipate the Liquidators wish to obtain information in respect of occurred some time ago and it seems to me more efficient and fairer to the Respondents that initially they are given the opportunity to provide information in writing.  In the first instance the Liquidators should serve a questionnaire, which each of the Respondent shall respond to in writing within 35 days of its receipt.  In case this proves inadequate I will give the Liquidators liberty to restore the application for an examination.

102.  The Liquidators solicitors should send a copy of the draft order to KPMG HK’s solicitors for their comments before sending it to the Court.

103.  I will make an order nisi that the Respondents pay the Applicants’ costs forthwith on a party and party basis.

Appendix to HCCW 435 / 2012

1.   KPMG (“1^st Respondent”) produce to the Provisional Liquidators (“PLs”) all documents within the 1^st Respondent’s custody or power which relate to China Medical Technologies, Inc. (“Company”), including its subsidiaries and associated companies (particulars of which are set out in Schedule 1) (collectively “CMED Group”), whether in printed or any other form including but not limited to computer generated records and information inscribed on, stored in or otherwise fixed in a tangible medium or other medium that it retrievable in a perceivable form in particular computer server, computer hard drive, floppy disk, compact disk, USB flash drive, memory card and/or zip storage device or other electronic storage media or device, including, without limitation:

1.1. All signed engagement letters entered into between the Company and the 1^st Respondent for the provision f auditor or any other professional services.

1.2. All draft and final audited financial statements and interim reviews of the CMED Group issued by the 1^st Respondent.

1.3. All documents provided by the CMED Group to the 1^st Respondent and / or its agents or contractors (collectively “KPMG”) between the date when the 1^st Respondent was engaged by the Company in whatever capacity and 31 December 2009 (the 1^st Respondent having been replaced as auditor of the CMED Group on 7 August 2009) (“Relevant Period”) including, but not limited to:

1.3.1.statutory records;

1.3.2.management accounts;

1.3.3.memoranda and reports of the Company and CMED Group;

1.3.4.accounting records including vouchers, ledgers and trial balances; and

1.3.5.bank statements.

1.4. All working papers produced by KPMG in connection with all audits of the CMED Group’s financial statements for each accounting period, whether the audit was completed or incomplete, during the Relevant Period including, but not limited to all:

1.4.1.documents in the audit permanent file;

1.4.2.documents in the audit and interim working files;

1.4.3.audit planning documentation;

1.4.4.audit program documentation;

1.4.5.site attendance notes; and

1.4.6.internal memoranda and / or communications associated with the audits.

1.5. All correspondence between KPMG and the CMED Group, the Company’s Audit Committee and/or professional advisors during the Relevant Period including, but not limited to all:

1.5.1.email correspondence;

1.5.2.reports and / or memoranda issued by the 1^st Respondent;

1.5.3.management letters issued by KPMG to the CMED Group in connection with the audits;

1.5.4.representation letters issued by the CMED Group to KPMG in connection with the audits of the CMED Group’s financial statements during the Relevant Period;

1.5.5.letters issued by the 1^st Respondent to the CMED Group in respect of the 1^st Respondent’s resignation as the auditor of the CMED Group;

1.5.6.the professional clearance issued by the 1^st Respondent to PricwewaterhouseCoopers Zhong Tian CPAs Limited Company after it was appointed as the auditor of the Company in place of the 1^st Respondent; and

1.5.7.notes of telephone attendances and meetings between KPMG and the CMED Group, the Company’s Audit Committee and / or the Company’s professional advisors.

1.6. All documents created by the 1^st Respondent and/or any other KPMG entity regarding the CMED Group including all internal communications and deliberations regarding the anonymous letter dated 4 February 2009 which was sent to the 1^st Respondent.

1.7. All documents created by the 1^st Respondent and/or any other KPMG entity regarding all discussions or deliberations as to whether or not the 1^st Respondent should resign as the auditor of the CMED Group and also the Company’s request that the 1^st Respondent resign.

1.8. The 1^st Respondent’s internal audit manuals applicable to each of the audits of the Company during the Relevant Period.

1.9. The time entries of the 1^st Respondent’s personnel who carried out the audit of the CMED Group including, but not limited to, the identity of the personnel, the description of each activity performed and the time spent on each activity.

1.10. All documents relating to the provision of financial, tax, valuation, accounting advice or other advice or professional services provided by KPMG to the CMED Group (or the companies therein) during the Relevant Period.

1.11. All invoices issued by the 1^st Respondent to the CMED Group in respect of the audit and other professional services provided by KPMG to the CMED Group.

1.12. Any documents evidencing the relationship between the 1^st Respondent and KPMG Huazhen in regard to the audit of the CMED Group or otherwise.