On September 19, 2014, the Ontario Securities Commission released a Notice of Hearing,advising a hearing has been scheduled for late September to consider whether it is in the public interest for the Commission to approve a Settlement Agreement entered into by OSC Staff and Ernst & Young LLP (“Ernst & Young”). The Settlement Agreement relates to allegations concerning audits conducted by Ernst & Young of two now-bankrupt Chinese companies, Sino-Forest Corp. (“Sino-Forest”) and Zungui Haixi Corp. (“Zungui”). The Settlement Agreement is noteworthy in that it has been entered into with the audit firm on a no-contest basis. This will mark the first no-contest settlement considered by the OSC since it introduced its amended Credit for Cooperation Program in March 2014, and highlights the increased risk now faced by gatekeepers, including auditors, from regulatory proceedings.
The allegations against Sino-Forest were initially filed in December 2012, when OSC Staff issued a statement of allegations alleging that Ernst & Young had failed to perform sufficient audit work to verify the ownership and existence of Sino-Forest’s most significant assets. OSC Staff also alleged that Ernst & Young had failed to undertake their audit work on Sino-Forest with a sufficient level of professional skepticism. Roughly six months later, in June 2013, OSC Staff issued another statement of allegationsagainst the audit firm, this time alleging that Ernst & Young had failed to conduct audit work for Zungui in accordance with industry standards, and that Ernst & Young relied on audit results that raised more questions than they answered.
Ernst & Young also faced civil liability exposure with regard to both audits, reaching settlement in two related class-action lawsuits filed by investors of both companies relating to claims arising from its audit practices. In December 2012, Ernst & Young announced a $117 million settlement with Sino-Forest investors, which settlement was ultimately approved by the Ontario Superior Court of Justice in March 2013. That decision was appealed to the Supreme Court of Canada, where leave was denied. In May 2013, Ernst & Young also obtained court approval of a settlement whereby it agreed to pay $2 million to settle audit claims with Zungui investors.
The exact terms of any no-contest Settlement Agreement with Ernst & Young will not be disclosed until and unless approval is granted by the Commission in late September. If the Settlement Agreement moves forward, it would mark the first no contest settlement considered by the OSC since launch the enforcement tool. No-contest settlements were introduced by the OSC in March 2014, when the OSC amended its Credit for Cooperation Program to permit, in “limited circumstances”, alleged wrongdoers to settle cases launched against them without admitting to any “facts or liability”. No-contest settlements are common south of the border, however, as previously discussed on this blog, success has been mixed and debate surrounds the role of court approval and review.
The enforcement action taken by the OSC against Ernst & Young reflects a trend of increased scrutiny by Canadian regulators at corporate gatekeepers, including auditors. This increased scrutiny is particularly acute in cases involving an alleged corporate fraud that results in an insolvency, where regulators have turned their focus towards directors, officers and auditors. Indeed, OSC Staff have been open about their intention to hold gatekeepers accountable for their role in protecting investors. In a December 2012 release, Tom Atkinson, the OSC’s Director of Enforcement, stated “investors rely on auditors to conduct their audits in accordance with professional standards, particularly when foreign companies are listing on Canadian exchanges. If auditors fail to abide by Canadian auditing standards and securities law, we will hold them accountable”. Audit firms must, therefore, be live to the risk of not only civil liability in conducting their audits, but also the increasing risk of parallel regulatory proceedings. We will continue to closely monitor the OSC’s progress with their no-contest settlement program, and watch with interest the direction provided by the Commission following the Ernst & Young hearing.