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PRC Laws No Excuse for Non-compliance with SFC Requests




by:
Susanne J. Harris
John M. Hickin
Nicholas D. Hunsworth
Billy Y. C. Lam
Thomas S. T. So
Mayer Brown JSM - Hong Kong Office

 
June 11, 2014

Previously published on June 5, 2014

On 23 May 2014, the Court of First Instance ordered Hong Kong accounting firm Ernst & Young (EY) to produce documents relating to a PRC company, Standard Water Limited (the "Company"), to the Securities and Futures Commission (SFC). The court rejected EY's argument that it did not have access to the documents or was otherwise prevented under PRC law from complying with the SFC's section 183 Notices ("the Notices"). This landmark decision in Hong Kong provides some important guidance from the Hong Kong court on compliance with section 183 notices where doing so may contravene foreign laws.

Key Findings

A party subject to a section 183 notice must itself decide how best to comply with a section 183 notice. At a minimum, the documents must be reviewed to determine whether there are any laws which may restrict disclosure to the SFC. If prior approval of other authorities is required to comply with the SFC's requests, the party is responsible to seek such approval. The SFC is not in a position to determine what approvals may be required under PRC law in circumstances where it has not been provided with the documents.

A reasonable excuse includes any excuse which would be accepted by a reasonable person to justify non-compliance with the section 183 notice. The party asserting the reasonable excuse defence bears the burden of satisfying this objective test. Physical or practical difficulties in producing the documents may constitute a reasonable excuse.

Asserting that compliance with the notice may or will constitute a breach of foreign law is insufficient, but a court will weigh the effect of compliance in determining whether this constitutes a reasonable excuse. The court has a discretion to order compliance. Each case is highly sensitive to its own facts.

SFC v. EY

In November 2009, the Company applied to be listed on the Hong Kong Stock exchange, but it subsequently withdrew its application after EY resigned as its auditor in March 2010. Following the Company's withdrawal of its listing application, the SFC issued the Notices requiring EY to provide documents, including EY's audit working papers, and other records concerning the Company (the "Documents").

EY did not challenge the validity of the Notices but argued that it had a reasonable excuse for non-compliance with the Notices because:

1. The Documents were created by a separate legal entity namely, Ernst & Young Hua Ming LLP ("HM") in the PRC, and EY did not have any right to access HM's data.
2. Even if EY could compel HM to hand over the Documents, PRC laws restricted cross-border transmission of the Documents and prohibited direct production of them to overseas regulators, including the SFC.

In August 2012, the SFC commenced High Court proceedings seeking orders to compel EY to disclose the Documents.

On 23 May 2014, the court held that EY had no reasonable excuse to not comply with the Notices and ordered EY to produce the Documents within 28 days.

The court (Justice Ng) held on the facts that HM acted as EY's agent in carrying out the audit field work on the Company in the PRC. As HM was the agent of EY it had a duty under both Hong Kong and PRC law to produce the Documents to EY. Therefore, the Documents were within EY's possession or control.

Prior to the hearing, EY also informed the court that three imaged hard drives which contained information responsive to the Notices, including the audit working papers, were erroneously brought to Hong Kong and disclosure of these documents to the SFC may violate PRC laws.

The court considered various PRC laws and regulations, including the State Secrets law, and concluded that none of the laws identified imposed a blanket prohibition on cross-border transmission of the Documents to the SFC.

As the Documents were not produced to the parties' expert witnesses or the court for consideration, the court could not determine whether there were applicable restrictions in respect of the precise documents at issue here, a matter which is fact sensitive. However, the court rejected EY's blanket submission that HM was prohibited from passing the Documents to EY to comply with the Notices.

It is yet to be seen whether EY will appeal the court's decision or whether, following a review, EY will maintain that some or all of the Documents cannot be disclosed because the contravention of the PRC laws outweighs compliance with the Notices. Either outcome may prompt further comment from the court on this highly contentious topic.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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Susanne J. Harris
John M. Hickin
Nicholas D. Hunsworth
Billy Y. C. Lam
Thomas S. T. So
 
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