E&Y “State Secrets” Case Kicks Off in Hong Kong – But a Long Way to Go

by Reed Smith

Evidence kicked off last week on March 27-28, in the highly anticipated case brought by Hong Kong's Securities and Futures Commission ("SFC") against Ernst & Young Hong Kong ("E&Y") over its failure to adequately respond to statutory requests for information in relation to an SFC investigation of the failed 2009 IPO of Chinese waste management company, Standard Water Limited ("Standard Water").1 A copy of the SFC’s August 2012 originating summons can be found here.

In 2010, the SFC issued nine formal notices to E&Y seeking the working papers and underlying accounting documents relating to Standard Water’s pre-IPO audit. With respect to several notices, E&Y claimed that it did not possess the relevant records, as they were held in the Mainland by its PRC joint venture partner, Ernst & Young Hua Ming ("Hua Ming"), whose staff was principally involved in the audit. Furthermore, E&Y claimed that PRC law, including China's state secrets and archives law, prohibited it from producing the requested documents.

When Hua Ming still failed to produce documents in spite of the SFC’s request for assistance from the China Securities Regulatory Commission (“CSRC”), the SFC turned to Hong Kong’s High Court to inquire into the circumstances of E&Y’s non-compliance. If satisfied of no reasonable excuse for said non-compliance, the Court has the power to compel production.

In opening submissions, E&Y argued that firstly, E&Y did not have access to Hua Ming’s documents, and secondly, that Chinese law specifically requires that the SFC make its request for documents to the CSRC, who would in turn request Hua Ming to produce the documents. Notwithstanding the SFC’s allegation that it has already done so, E&Y asserted that Hua Ming has expressed willingness to cooperate with any such CSRC request.

During cross-examination of E&Y’s singular fact witness, Mr. Alden Leung, an E&Y partner and its Greater China Quality and Risk Management Leader, the SFC tested E&Y’s assertion that it was not in possession of or had access to any working papers. The SFC also focused on what were characterized as misleading or evasive answers made by E&Y in response to other questions in the SFC notices. E&Y objected to such questioning, arguing that the SFC’s originating summons failed to give notice of this particular inquiry, and that it believed that these proceedings only concerned the failure to produce Hua Ming’s working papers. However, it was clear that Mr. Justice Peter Ng Ka-fai was not satisfied with Mr. Leung’s inability to provide meaningful answers to the SFC’s questions.

Cross-examination could not be completed and has been adjourned to May 16, 2013. Additionally, PRC law experts are to be examined for two days to be fixed thereafter. Based on the two hotly demanded barristers’ diaries, expert evidence is unlikely to commence earlier than October of this year.

This case is obviously being closely watched by the Hong Kong accounting community, which frequently comes up against restrictive Chinese laws restraining the production of documents, and the Securities and Exchange Commission (“SEC”) has taken up a similar case in the U.S. Unfortunately, not only are the Hong Kong proceedings expected to take significant time, but based on the SFC’s emphasis on possession and control, it is possible that such decision would be unlikely to resolve the fundamental conflict between PRC’s restrictive laws governing production of documents and information to foreign regulators and Hong Kong law and the SFC’s statutory power to require parties to produce information.

1 E&Y withdrew its engagement from Standard Water after finding certain undisclosed inconsistencies.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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