INTRODUCTION
1. The Consumer Council appreciates the Government consulting the public on the oversight reform of auditors and the quality of financial reports, before a decision is taken on the way forward.
2. In principle, the Council pledges its support to the Government's determination to promote a more transparent and accountable regulatory regime for the accountancy profession, with the aim of maintaining investor confidence and financial market stability.
3. The Council sets out below its views on the following proposals in the Consultation Paper, for consideration of the Government:
- the setting up of an Independent Investigation Board (IIB) and an independent practice review (IPR) oversight body to enhance the oversight of the public interest activities of the auditing profession; and
- the establishment of the Financial Reporting Review Panel (FRRP) to oversees the application of accounting requirements of the Companies Ordinance, accounting standards and the true and fair view requirement.
COUNCIL COMMENTS
4. The Council's comments are directed to those specific questions raised in the Consultation Paper that are relevant to the interests of investors.
Independent Investigation Board (IIB)
The IIB Proposal
5. With regard to the Hong Kong Society of Accountants (HKSA) proposal in respect of setting up an IIB to monitor and consider complaints of alleged accounting, auditing and /or ethics irregularities committed by professional accountants involving 'listed entities', the Council considers that an effective investigation body should comprise the following features:
- The complaints mechanism should be an independent body that will examine complaints against the conduct of the accountants; and
- The complaints mechanism should be accessible to the consumer and transparent in operation.
6. In answering the specific questions raised in paragraph 49 of the Consultation Paper, the Council's views are as follows -
(a) Given the proposed changes to the Council, Disciplinary and Investigation Committees of the HKSA, is there a need to establish a separate IIB to monitor and consider complaints of alleged accounting, auditing and/or ethics irregularities committed by professional accountants involving 'listed entities'?
7. Firstly, the Council welcomes the HKSA's reform proposals to enhance the independence and transparency of its key functions by bringing in more lay participation in the regulatory process. The Council fully supports and urges the HKSA to take necessary steps to implement the proposals on increasing lay membership. This needs to be addressed regardless of whether an IIB is set up for oversight of the accountancy profession. Allowing a considerable degree of lay participation in the regulatory process would enhance public confidence in the accountancy profession.
8. As to the status of the oversight body, in view of rising problems of financial reporting failures and changes in public expectations, the Council considers that there is a need to change the existing arrangement, which relies on industry self-regulation. This change is necessary as a means of providing public assurance on the oversight of the accountancy profession. The Council agrees therefore with the view that an accounting oversight body, independent of the accountancy profession, should be established.
(b) If so, should the IIB's jurisdiction be limited to accounting, auditing and ethical irregularities involving listed companies only?
9. The Council understands that the wider the types of companies covered by the IIB the greater the benefit to the wider community. However, noting that there will be cost implications for expanding the scope to also cover non-listed companies, the Council is of the view that the IIB's jurisdiction should be confined to listed companies at the outset but the scope of coverage should be subject to review at a later stage. A definite time span should be set out for the review.
(c) Are there any views on the composition of the IIB as proposed by the HKSA?
10. The HKSA proposes in paragraphs 49 and 50 of Annex B that the IIB should comprise a Board made up of 7 to 9 members; with at least 3 to 4 "professional accountants". The Chairman and two vice-chairman should not be professional accountants.
11. With regard to the proposed composition of the IIB, the Council considers that
- a majority of the members should come from cross sections of the community in order to avoid skewing towards narrow interests; and
- the key persons of the board should not be from the accountancy profession to avoid any perception of a lack of independence.
12. The Council further suggests that where there is a need for professional knowledge or advice on accounting practice, for example, specialists can be brought in. Professional knowledge is, in effect, only required on a needs basis depending on the nature of the complaint.
(d) Should the IIB be empowered to request information and to investigate or should it only act on referrals from other regulators and complaints?
13. To be an effective enforcement body, the Council supports the policy that the IIB should be empowered to act in a proactive stance by requesting relevant information and performing investigation into alleged cases concerning professional accountants. In addition, the IIB should take up referrals from other regulators and complainants.
14. Nevertheless, the Council queries whether there would be some overlapping in the functions of the SFC and the IIB, for example, in the demand for financial information from companies. Some thought may need to be given on making necessary arrangements between these two bodies. For example, a formal 'memorandum of understanding'.
(e) Should the IIB's functions remain purely investigatory and where it considers there is sufficient evidence, the IIB should refer a case as a complaint to the HKSA's re-constituted Disciplinary Committee?
(f) Is there any need for referring public interest cases to a disciplinary entity institutionally independent of the HKSA, given that the HKSA's proposal that a Disciplinary Committee should comprise a majority of lay members (including the Chairman) with hearings primarily held in public?
15. Since questions (e) and (f) are related to the operating procedures of the IIB, the Council provides its views together, below.
16. The HKSA has expressed a strong view that the IIB should not possess any disciplinary powers, otherwise it will have conflicting roles and will be acting as policemen, complainant, judge as well as jury.
17. The Council is concerned that if the IIB decides that it has sufficient evidence on a complaint and refers the case to the HKSA for determination of what disciplinary action should be taken, the public may perceive that the HKSA has been swayed by its conflict of interest if it does not take disciplinary action against its professional colleagues.
18. The Council considers that the HKSA's earlier proposals for allowing a majority of lay members and an independent chairman on its Disciplinary Committee and open disciplinary hearings, may help to resolve, to some extent, the public concern about the independence of the disciplinary entity. The Council is therefore not against having disciplinary action remain with the HKSA in the initial stage but suggests that it should be subject to review in light of experience.
Institutional form
19. The Consultation Paper seeks views on what institutional form the IIB should take and whether the IIB should be responsible to the Administration, the SFC or the HKSA.
20. The Council considers that if the jurisdiction of the IIB only covers public companies, the SFC would be the appropriate responsible body.
Funding arrangement
21. In paragraph 51 of the Consultation Paper, views are sought on what form the funding arrangement for the IIB should take. The proposed possible sources of funding include contributions from government and regulators (e.g. SFC/HKEx), and levies on listed companies and investors.
22. The Council's comments focus mainly on the investors' perspective. That is, "(b)Should investors be required to contribute because the existence of the IIB would lead indirectly to better quality assurance on financial data and hence better protection for investors?" .
23. The Council can understand the reasons behind requiring issuers, the accounting profession, the Administration and the regulators to contribute. However, it queries that investors, as indirect beneficiaries of good quality audits should contribute directly for funding the work of the IIB. By reference to other jurisdictions quoted in the Consultation Paper, none of them requires direct contribution from investors. The Council would also like to point out that providing good quality financial reporting is a fundamental responsibility of issuers and the accounting profession to attract the public to investing in a company's shares. The Council therefore considers that the funding requirement should not be imposed directly on investors.
Independent Practice Review Oversight Body (IPR)
24. Paragraphs 54 - 56 of the Consultation Paper discuss another public interest matter which relates to quality control of audit practices.
(a) The proposal on the establishment of an independent practice review oversight body within the HKSA?
25. The Council recognizes that in assessing quality assurance work, accounting professionals are in an appropriate position to pass judgment on the professional practice and conduct of their peers, where matters of professional standards are of concern. However, in terms of satisfying needs of transparency, it would be desirable to set up an independent body which would be responsible for oversight of practice review. This body, in the opinion of the Council, does not necessarily have to be established within or as part of the HKSA.
(b) The constitution, membership, scope of work and funding arrangements for such an entity, i.e., should the same considerations in respect of the IIB be applied to this oversight body?
26. Please refer to the Council's previous comments in this submission in respect of the IIB for the constitution, membership, scope of work and funding arrangements for the IPR oversight body.
Financial Reporting Review Panel (FRRP)
27. The Council fully supports establishing a regulatory mechanism, the FRRP, in Hong Kong to provide for the making of enquiries into compliance of companies' financial statements with the accounting requirements of the Companies Ordinance. This will serve the objective of strengthening Hong Kong's regulatory regime in financial reporting
Types of Companies
28. Paragraphs 59 - 60 of the Consultation Paper seeks views on the FRRP's jurisdiction, namely whether the FRRP's work should be confined to certain categories of companies, for example, listed companies and/or unlisted public companies incorporated in Hong Kong and/or all unlisted companies incorporated in Hong Kong.
29. It is noted that in addition to listed companies, there are also a substantial number of unlisted public companies in Hong Kong. The Council considers that it would be desirable from the public perspective to include all of these under the jurisdiction of the FRRP. However, there is also a need to balance the cost and benefit of its coverage. The Council therefore agrees that the FRRP should focus on listed companies as a start, but a definite time period for review of scope of coverage should be set.
Types of financial documents
30. As noted in paragraphs 61 - 62 of the Consultation Paper, it is raised for consideration whether FRRP's purview should be extended to cover documents such as auditors' reports, directors' reports and management discussion and analysis, apart from the annual financial statements of companies. It is also noted that consideration is being given in the UK to extending the FRRP's remit to cover all published financial information issued by listed companies, including interim reports and preliminary announcements, where such information is presented in accordance with mandatory requirements.
31. The Council agrees with the Administration's view that, at the outset, it would be desirable for the FRRP to limit its remit to the statutory annual financial statements of companies, namely, the balance sheet and profit and loss account.
Mode of Establishment
32. Paragraphs 63 - 66 of the Consultation Paper seek public views on the mode of establishing the FRRP. The possible options include setting up bodies constituted specifically for the purpose, or under a regulator (e.g. SFC).
33. As noted in the Consultation Paper if the FRRP is set up as an independent statutory body, this has the advantage of it being seen as more focused and it would be in a better position to communicate with the stakeholders in financial statements. Alternatively, placing the FRRP under a regulator has the advantage of it being able to capitalize on the regulator's enforcement experience and achieve some economies of scale. Furthermore, given the regulator's track record, there would be greater public confidence in the regulator's ability to safeguard the public interest.
34. With regard to the mode of establishment, the Council considers that if the type of companies covered is confined to listed companies only at the initial stage, placing the FRRP under the SFC would seem to be practical and cost-effective. Nonetheless, this should be subject to review if the FRRP is to cover unlisted public companies or private companies in the future.
Powers
35. In respect of the powers of the FRRP, the Council agrees that it should be given adequate powers to compel rectification by a company when necessary. The Council has no objection to the proposed powers which include directing a company and its directors to make changes and seeking an order of the court for changes to be made.
Composition
36. As regards the composition of the FRRP, it is proposed in the Consultation Paper that the Chairman and members should include persons with a wide range of financial reporting and commercial experience and expertise. The Council supports this and suggests that the membership requirement does not necessarily imply that a majority of members on the FRRP should come from the accountancy profession. The Chairman and members should come from the wider community such as the legal, academic, business sectors and non-profit making organizations as well as relevant regulatory bodies.
Operation - Reactive or Proactive
37. As noted, the FRRP could adopt either a reactive or proactive approach in its work, i.e. the FRRP could actively monitor company financial statements or passively rely on matters being brought to its attention.
38. The Council recognizes that taking a proactive approach would lead to an increase in the funding requirement for the FRRP. It therefore concurs with the Administration's view that the FRRP should adopt a reactive operating mode, but keep this under review in the light of experience of its overseas counterpart.
Governance
39. The Administration recommends that as an entity that is vested with an enforcement responsibility, the FRRP's procedures should be made transparent and its decisions should be published. The FRRP should also keep its operating procedures under periodic review and publish annual reports on its work. The Council supports all these initiatives.
40. However, the Council has concerns with one of the governance arrangements, i.e. where the FRRP has considered a case and concludes that there is no cause for action, that no public statement on the case needs to be issued. The Council considers that in the interests of enhancing transparency in operation and serving public education purposes, no cause for action cases should also be made available for public scrutiny.
Resource Arrangements
41. The Council agrees that adequate resources would be necessary for the FRRP to operate effectively and the FRRP should be funded by direct 'users'. However, as mentioned in respect of IIB funding arrangement, the Council does not consider investors should be required to contribute directly for funding of the work of the FRRP.
