On July 12, 2012, the Hong Kong Legislative Council passed a comprehensive rewrite of the existing Companies Ordinance of Hong Kong (Cap 32) (the “Companies Ordinance”).1 A notable provision in the new legislation provides for the imposition of criminal liability on auditors of Hong Kong incorporated companies if the auditors fail to declare in their audit reports the existence of certain accounting discrepancies or the inability to obtain all information and explanations necessary for the preparation of the audit. This reform follows other recent efforts by Hong Kong to enhance investor protections, including (i) a recent proposal by the Securities and Futures Commission of Hong Kong (the “SFC”) to impose criminal liability on sponsors of initial public offerings for untrue statements (including material omissions) in a prospectus2 and (ii) a recent landmark court decision pursuant to which the SFC was able to require a Chinese textile company accused of overstating its earnings to convene an independent shareholders’ meeting to approve making an offer to investors to repurchase shares sold in its initial public offering or purchased in the secondary market.
Similar to the current requirements under the existing Companies Ordinance (other than the newly added materiality standard), the new legislation will require auditors to include appropriate statements in audit reports if:
- the auditors are of the opinion that the financial statements are not in agreement with the accounting records of the company in any material respect; or
- the auditors fail to obtain all the information or explanations that, to the best of such auditor’s knowledge and belief, are necessary and material for the purpose of the audit.
However, unlike the existing Companies Ordinance, the new legislation will make the omission of any of the above statements from an audit report, if done knowingly or recklessly by the auditor, a criminal offense with each instance punishable by a fine of up to HK$150,000. Despite lobbying efforts by auditors opposing the criminal liability aspect of the new legislation, including efforts to limit both the standard for liability (i.e., by excluding reckless omissions) and the scope of persons subject to liability, the Legislative Council passed the new legislation as proposed.3
Although Hong Kong incorporated companies represent a minority percentage of companies listed on the Main Board of the Hong Kong Stock Exchange, this new liability framework does indicate the importance that the Legislative Council attaches to the role of auditors in both the listing process and continuing audit work. Following criticism arising from troubled offerings after record years of listings, Hong Kong’s imposition of auditor liability is another step towards enhancing investor protections and maintaining the integrity of the Hong Kong market.