Legislative Council Panel for Financial Affairs
Regulatory Mechanism for Auditors
Introduction
The Professional Accountants Ordinance ("PAO") (Cap. 50), provides for a statutory regulatory framework for the accountancy profession in Hong Kong. Under the PAO, the Hong Kong Society of Accountants ("HKSA") is vested with statutory powers to establish entry requirements for the accounting and auditing profession, specify professional standards for its members, carry out regular reviews of members' practices, conduct investigations and order disciplinary actions.
Governing Body of the HKSA
2. The HKSA is governed by its Council whose establishment and composition is provided for in the PAO. The PAO stipulates that the Council shall consist of 14 members: 12 professional accountants, of whom at least five are practising accountants and at least five are non-practising accountants; the Financial Secretary ("FS") or his representative, and the Director of Accounting Services ("DAS"). At present, the Registrar of Companies ("R of C") represents the FS on the Council. The two ex-officio members act as a bridge of communication between the Government and the HKSA by reflecting Government concerns over issues of public interest to the Society, and keeping the Government informed of the development in the Society.
Entry requirement for being an auditor
3. Under the PAO, a professional accountant has to fulfil the following professional requirements, amongst others, in order to obtain a practising certificate (i.e. to be eligible as a Certified Public Accountant ["CPA"],) in Hong Kong:
- 30 months' post qualifying approved accounting experience;
- four years' full time approved accounting experience;
- such local experience and knowledge of local law and practice as the HKSA Council may consider necessary.
As at 30 June 1999, there are about 2700 CPAs on the register of the HKSA.
Regulatory mechanism for auditors
4. The HKSA monitors the work of auditors on a continuous basis through reviews of the financial statements of listed companies as well as reviews of the practice of certified accountants. It will initiate investigation into the affairs of its members should it have reasonable suspicion of significant non-compliance with professional standards or misconduct. The investigatory power of HKSA was strengthened in the 1994 PAO amendment exercise on HKSA's own initiative.
5. In addition, the Society acts on complaints from the public and referrals from other regulatory bodies, such as the Stock Exchange of Hong Kong Ltd. ("SEHK") and the Securities and Futures Commission ("SFC"). The Society is empowered to conduct disciplinary hearings and impose sanctions on its members, including reprimand orders, penalties up to $500,000 and removal from its professional accountant register. A more detailed account on how the HKSA performs its self-regulatory functions through various regulatory committees, is set out in the following paragraphs.
Professional Standards Monitoring Committee ("PSMC")
6. The HKSA carries out regular reviews of annual reports of listed companies through the PSMC, which is a non-statutory committee set up by the Council of the HKSA. The PSMC selects a sample of annual reports for review every year. At present, the PSMC consists of 13 members, including a representative from the SEHK. The purpose of the exercise is to conduct a regular review of the financial statements of listed companies to ensure that those statements are prepared in compliance with the required professional standards. There have been occasions where the PSMC considers accounting and auditing matters of listed companies which stemmed from complaints or referrals by outside parties.
7. The PSMC reports significant cases of non-compliance with professional standards to the Council of the HKSA for consideration of formal investigation, if there is reasonable suspicion of non-compliance with professional standards, or disciplinary actions if a prima facie case is already established.
8. Under a joint monitoring arrangement between the HKSA and SEHK, the SEHK representative in the PSMC is authorized to take necessary follow-up action with the management of the listed company concerned based on the remarks or observation which the PSMC has made in respect of the financial statement of that company.
9. In the past three years, over 400 reviews have been conducted by the PSMC and four cases out of these reviews were referred to the Council.
Practice Review
10. Practice reviews were introduced through the 1992 amendments to the PAO at the request of HKSA. All CPA practices (including firms and sole practitioners) in Hong Kong are randomly chosen for review by the HKSA under this review system. Audit procedures and working papers of the chosen CPA practices are inspected on-site. The purpose is to monitor compliance with professional standards in auditing in a proactive manner.
11. Every year, about 10% (on average) of all practice units in Hong Kong are selected for practice review. In the past three years, over 440 practices have been reviewed and seven cases out of the reviewed were referred to the Disciplinary Committee.
Investigation Committee
12. Investigation will be conducted by the HKSA into its members where there is reasonable suspicion or belief of misconduct or non-compliance with professional standards. The power to investigate enables HKSA to follow up on complaints where initial evidence, especially that made available by a layman, is thin; and to follow up on matters of public concern even in the absence of a formal complaint, or where voluntary co-operation from its members is not forthcoming.
13. Under the PAO, HKSA can compel the member under investigation and their employer or former employer, and employee or former employee to produce information required for investigation.
14. Information obtained during the investigation is subject to the secrecy provision under section 42G of the PAO, which prohibits the use of such information for purposes other than for HKSA's disciplinary proceedings. Whereas providers of information are protected from any legal liability for complying with the Investigation Committee's information requirements.
Disciplinary Committee
15. Complaints originating from outside HKSA or from HKSA's own monitoring process are submitted to Council for consideration of referral to the statutory Disciplinary Panel where a prima facie case is established.
16. Under the PAO, when the HKSA Council decides to refer a complaint to the Disciplinary Panel ("DP"), the Council needs to form a five-member Disciplinary Committee ("DC") from the Panel to hear the case. There are at present three lay members in the DP; all are reputable figures in the community.
17. This lay participation in HKSA's disciplinary process was introduced at HKSA's own initiative, in the 1994 amendment to the PAO, to enhance the openness and independence of its disciplinary process. Apart from the Disciplinary Committee, the Corporate Governance Committee, Examinations Board, Insolvency Practitioners Committee, Securities Industry Committee etc. under the HKSA Council also have non-accountants participating in the work.
Legal responsibility of auditors in respect of their audit reports
18. Section 141 of the Companies Ordinance ("CO") specifies that auditors are to state their opinion, in their audit report, on whether the company's accounts have been properly prepared in accordance with the provisions of the CO and whether in their opinion a true and fair view is given on the company's accounts. They are however not responsible for preparing the company's accounts or managing the company.
19. Although auditors can provide a "reasonable assurance" on the annual accounts, they cannot guarantee financial health of the company. Auditors are only required to form an opinion on the view given in the accounts by checking the accounting records and documents presented to them by the management. They are however not required to investigate the authenticity of the transactions presented to him. If the management is perpetrating well-planned frauds or conspiring to hide information from the auditors, they will not always be able to find this out.
20. The first auditors of a company may be appointed by the directors at any time before the first Annual General Meeting. Subsequent auditors will be appointed at the Company's AGM. The duty of an auditor is to report to the shareholders on the accounts examined by them and on every balance sheet, profit and loss account and all group accounts laid before the company in general meeting. The auditors must act honestly and with reasonable skill and care. The auditor may be liable to the Company for any loss caused by negligence arising out of the audit. The auditor may also in very special circumstances be liable to other persons who rely on the report and who also suffer financial loss.
21. In addition, auditors are also required to follow a rigorous code of auditing and ethical standards to ensure quality of their work. Those who fail to observe the standards in Hong Kong are subject to disciplinary actions by HKSA.
Protection of investors
22. An audit is carried out primarily for the benefit of the shareholders of a company, to enable them to carry out a financial check on the directors' management of the company. The audit is an independent and external check on the company's accounts which themselves reflect the financial health of the company. The HKSA may investigate into the conduct and standards of the auditor concerned and take disciplinary actions where appropriate. This serves as an additional deterrent to auditors for breaching their professional standards and conduct.
23. Moreover, the work of auditors comes under the monitoring, directly or indirectly, of the relevant authorities, such as the Police and various market regulators in their enforcement of relevant ordinances. For example, auditors of listed companies, who are involved in listing matters, are also subject to regulation by the Stock Exchange ("SEHK") and Securities and Futures Commission ("SFC") under the Stock Exchange Unification Ordinance. The SFC and the SEHK may from time to time refer questionable cases to the HKSA for follow up action or further investigation, as unveiled in the process of their carrying out of their regulatory duties.
Continuous Improvements
24. The regulatory regime for the accountancy profession, as laid down in the PAO, has served the community generally well over the last 26 years. We should however not be complacent. The Government is in close liaison with the HKSA on possible areas of improvement which help to enhance the regulatory mechanism for auditors. We are mindful of the need to meet the rising expectations of the investing public and the business sector, and to ensure a fair and transparent market. The improvement drive is a continuous process, as evidenced in previous legislative amendment exercises.
25. Both the Government and the HKSA are committed to putting in continuous effort to improve the effectiveness of the regulatory system of auditors, with a view to enhancing the protection of users of audit services, and to improving the quality of auditing work.
Financial Services Bureau
July 1999
