The Registrar of the Hong Kong Institute of Certified Public Accountants v. Wong Tak Man Stephen and Another

CACV 233/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 233 OF 2015

(ON APPEAL FROM THE ORDER MADE BY THE

DISCIPLINARY COMMITTEE OF THE HONG KONG

INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS)

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BETWEEN

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REASONS FOR JUDGMENT

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Hon Cheung CJHC :

1.I agree with the reasons for judgment of Cheung JA.

Hon Cheung JA :

I.   Background

1)  The parties

2.1The 2^nd respondent is a firm of certified public accountants.  It was instructed to audit the financial statements for the year ended 30 June 2009 of a listed company, Heng Tai Consumables Group Limited (‘Heng Tai’).  The 1^st respondent was the engagement partner of the audit on behalf of the 2^nd respondent.  The complainant is the Registrar of the Hong Kong Institute of Certified Public Accountants (‘HKICPA’).

2)  China Zenith Shares

2.2Heng Tai held 71,060,000 ordinary shares in a listed company called ‘China Zenith Chemical Group Limited’ (‘the China Zenith Shares’).  The China Zenith Shares were classified in Heng Tai’s financial statements as ‘available-for-sale financial assets’ (‘AFSFA’). The shares had an original cost of HK$37.7 million.  However the fair value of the shares calculated at the quoted market price on 30 June 2009 was only HK$14.922 million which means that there had been a cumulative decline of over 60% from the original cost.  Heng Tai recognized the cumulative loss in value in the China Zenith Shares in the sum of HK$22,768,000. 

2.3Pursuant to Heng Tai’s accounting policy set out in Note 3(k)(ii) of the financial statements, the cumulative loss was recognized directly in equity.  Heng Tai considered the loss as being a temporary fluctuation in value, rather than an irreversible and permanent loss in value which would constitute ‘impairment’ under Hong Kong Accounting Standard (‘HKAS’) 39.  However, if the decline in the fair value was objective evidence of impairment under HKAS 39.61, the cumulative losses should have been removed from equity and recognized in profit or loss in the 2009 Financial Statements in accordance with HKAS 39.58 and 67.

2.4The 2^nd respondent issued an unqualified opinion on the financial statements. 

3) The Complaint

2.5On 27 February 2012, the Financial Reporting Council (‘FRC’) received an HKICPA’s referral concerning a possible auditing irregularity by the 2^nd respondent in relation to the non-recognition of impairment losses of the China Zenith Shares in the financial statement of Heng Tai.

2.6On 3 May 2012 the FRC decided to initiate an investigation and directed the Audit Investigation Board (‘AIB’) to investigate whether or not there was such an auditing irregularity.  AIB gave its report on 19 October 2012.

2.7The question for the AIB was whether the 2^nd respondent had formed an appropriate audit opinion on the financial statements of Heng Tai in accordance with Hong Kong Standard on Auditing (‘HKSA’) 700.11 and 13 and hence there was a potential auditing irregularity (paragraph 5.1.1.6 of the report). 

2.8As the non-recognition of impairment losses represented approximately 21% of the consolidated profit of the Heng Tai Group for the year ended 30 June 2009, the AIB found that the 2^nd respondent should have expressed a modified opinion on the financial statements, and considered that there was non-compliance with HKSA 700.11 and 13.

2.9The AIB Report was adopted by the FRC on 1 November 2012.  By a letter dated 2 November 2012, the FRC referred the AIB Report to the HKICPA pursuant to section 9(f) of the Financial Reporting Council Ordinance (Cap 588) for HKICPA to determine what appropriate actions should be taken.

2.10On 23 June 2014, the HKICPA issued a complaint letter for its Council’s consideration.  The respondents were invited to make representation to the complaint, which they did on 24 July 2014.  After the HKICPA’s Council had considered the matter, the complaint was referred to the HKICPA’s Disciplinary Committee (‘the Committee’) under section 33(3) of the Professional Accountants Ordinance (Cap 50) (‘PAO’).

4) The decision of the Disciplinary Committee

2.11The Committee found that the respondents were in breach of section 34(1)(a)(vi) of the PAO in that they failed or neglected to observe, maintain or otherwise apply professional standard, namely, HKAS 39 by failing to ensure that the decline in value of the China Zenith Shares be reflected in profit and loss in the audited consolidated financial statements of Heng Tai for the year ended 30 June 2009.

2.12The Committee ordered that:

(i)  each of the respondent pay a penalty of HK10,000 to HKICPA; and

(ii)  the respondents to pay the costs and expenses of and incidental to the proceedings of the complainant in the sum of HK$66,800, that of the Clerk in the sum of HK$21,000 and disbursements in the sum of HK$7,601.  The costs and expenses shall be borne equally between the respondents.

2.13The Committee further directed that no publicity of the aforesaid sanction should be made unless with the consent of the respondents.

II.  The appeal and cross-appeal

3.1The respondents appealed against the order to this Court and asked for the complaints against them to be dismissed.  The complainant issued a respondent’s notice asking that the order made by the Committee in respect of the non-publication of its decision and costs be varied so that

1) there be no restriction on the complainant publicizing the sanctions imposed on the respondents by the Committee; and

2) the respondents do pay the costs and expenses of the FRC.

3.2At the conclusion of the hearing, this Court dismissed the respondents’ appeal and the complainant’s respondent’s notice.  I now give reasons for our decision.

III.  The respondents’ appeal

1)  The respondents’ case

4.1The respondents seek to set aside the decision on three grounds:

(i) The Committee should have held that the charge was wrongly laid against the respondents (‘the wrong charge issue’).

(ii) The respondents’ interpretation of HKAS 39 was not unreasonable or improper, and hence should not have been found guilty of the charge (‘the construction issue’).

(iii) The respondents’ analysis and conclusion on the reliability of the published price of the China Zenith Shares, and hence the resulting accounting treatment adopted by the management of Heng Tai, was not unreasonable or improper, and hence they should not have been found guilty of the charge (‘the merits issue’).

2)  The wrong charge issue

(1) Section 34(1)(a) of PAO

4.2Before the Committee, the complainant contended that the respondents were in breach of section 34(1)(a)(vi) of the PAO in that they had ‘failed or neglected to observe, maintain or otherwise apply a professional standard namely HKAS 39’. 

4.3Section 34(1)(a)(vi) provides that a complaint that a certified public accountant had failed or neglected to observe, maintain or otherwise apply a professional standard shall be made to the Registrar who shall submit the complaint to the Council which may, in its discretion but subject to section 32D(7), refer the complaint to the Disciplinary Panels.

(2)  Professional guidelines

4.4Section 18A of PAO provides that:

‘ (1) The Council [of the Institute of Certified Public Accountants] may, in relation to the practice of accountancy, issue or specify any―

(a) statement of professional ethics; or

(b) standards of accounting, auditing and assurance practices,

required to be observed, maintained or otherwise applied by any certified public accountant.’  (emphasis added)

4.5Under the definition provision of section 2 of PAO :

‘ “professional standards” (專業標準) means any―

(a) statement of professional ethics; or

(b) standards of accounting, auditing and assurance practices,

issued or specified or deemed to be issued or specified under section 18A;’

(3) HKAS 39

4.6HKAS 39 is a standard of accounting, auditing and assurance practices issued by the Council of the HKICPA.  The title of HKAS 39 is ‘Financial Instruments: Recognition and Measurement’.  The objective of this standard is provided by HKAS 39.1:

‘ The objective of this Standard is to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items.’

4.7The relevant part of HKAS 39 is under the heading ‘Impairment and Uncollectibility of Financial Assets’.  The relevant provisions for the purpose of considering the first ground of appeal are HKAS 39.58 and 67:

‘ 58. An entity shall assess at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets is impaired. If any such evidence exists, the entity shall apply paragraph 63 (for financial assets carried at amortised cost), paragraph 66 (for financial assets carried at cost) or paragraph 67 (for available-for-sale financial assets) to determine the amount of any impairment loss.’

‘ Available-for-Sale Financial Assets

67. When a decline in the fair value of an available-for-sale financial asset has been recognised directly in equity and there is objective evidence that the asset is impaired (see paragraph 59), the cumulative loss that had been recognised directly in equity shall be removed from equity and recognised in profit or loss even though the financial asset has not been derecognised.’  (emphasis added)

(4)  The respondents’ argument

4.8Mr Eugene Fung SC (together with Mr Adrian Lai) for the respondents argued that the proper charge should be in breach of HKSA 700.11 and 12 and not HKAS 39.  Mr Fung submitted that the entity referred to in HKAS 39.58 is Heng Tai and not the respondents.  The position can be contrasted with another standard, namely, HKSA 700 which is entitled ‘The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements’.  This standard specifically addressed the respective role and responsibility of an auditor and the management.  In respect of the role of the auditor the following provisions in HKSA 700 are relevant:

‘ 9. The auditor’s judgment regarding whether the financial statements give a true and fair view or are presented fairly, in all material respects, is made in the context of the applicable financial reporting framework. ….

10. In the case of financial statements that are within the scope of this HKSA, application of a financial reporting framework determined to be acceptable for general purpose financial statements will, except in the extremely rare circumstances discussed in paragraph 15, result in financial statements that achieve fair presentation.  ….

Forming an Opinion on the Financial Statements

11. The auditor should evaluate the conclusions drawn from the audit evidence obtained as the basis for forming an opinion on the financial statements.

12. When forming an opinion on the financial statements, the auditor evaluates whether, based on the audit evidence obtained, there is reasonable assurance about whether the financial statements taken as a whole are free from material misstatement. This involves concluding whether sufficient appropriate audit evidence has been obtained to reduce to an acceptably low level the risks of material misstatement of the financial statements and evaluating the effects of uncorrected misstatements identified.

13. Forming an opinion as to whether the financial statements give a true and fair view or are presented fairly, in all material respects, in accordance with the applicable financial reporting framework involves evaluating whether the financial statements have been prepared and presented in accordance with the specific requirements of the applicable financial reporting framework for particular classes of transactions, account balances and disclosures.  This evaluation includes considering whether, in the context of the applicable financial reporting framework:

(a) The accounting policies selected and applied are consistent with the financial reporting framework and are appropriate in the circumstances;

(b) The accounting estimates made by management are reasonable in the circumstances;

(c) The information presented in the financial statements, including accounting policies, is relevant, reliable, comparable and understandable; and

(d) The financial statements provide sufficient disclosures to enable users to understand the effect of material transactions and events on the information conveyed in the financial statements, for example, in the case of financial statements prepared in accordance with Hong Kong Financial Reporting Standards (HKFRSs), the entity’s financial position, financial performance and cash flows.’

4.9In respect of the management’s responsibility the following are the relevant HKSA 700 provisions:

‘ Management’s Responsibility for the Financial Statements

28. The auditor’s report should state that management is responsible for the preparation and the fair presentation of the financial statements in accordance with the applicable financial reporting framework and that this responsibility includes:

(a) Designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error;

(b) Selecting and applying appropriate accounting policies; and

(c) Making accounting estimates that are reasonable in the circumstances.

29. Financial statements are the representations of management. Management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework…’

4.10The auditor’s responsibility is spelt out in the following provisions of HKSA 700 :

‘ Auditor’s Responsibility

32. The auditor’s report should state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit.  

33. The auditor’s report states that the auditor’s responsibility is to express an opinion on the financial statements based on the audit in order to contrast it to management’s responsibility for the preparation and fair presentation of the financial statements.’

4.11Mr Fung submitted that the term ‘entity’ is not defined in HKAS 39.  However, the meaning of the term can be ascertained from the definition of the terms ‘financial instrument’, ‘financial asset’ and ‘financial liability’, which, according to HKAS 39.8, are to be found in HKAS 32.11.  The term means the contracting parties to the ‘financial instrument’ and in the context of the present case, Heng Tai is the relevant entity.

4.12The gist of Mr Fung’s argument is simply that since HKAS 39 deals with the responsibility of the entity i.e. Heng Tai and not that of the auditor i.e. the respondents, the respondents could not have been in breach of HKAS 39. The auditor’s responsibilities are spelt out in HKSA 700.  The proper basis of the complaint against the respondents should be under HKSA 700.

4.13The meaning of entity is not disputed by Mr Duncan SC (together with Ms Christy Wong) for the complainant, but he disputed that a wrong charge had been laid.

(5) The Committee’s view on wrong charge

4.14This argument was raised before the Committee as well.  The Committee held against the respondents. It held that:

‘ 3.1 The Committee originally found the Respondents’ argument very attractive. However, the Committee has adopted a “substance over form” approach and concluded that whether the Respondents would be in breach of HKAS 39 or HKSA 700.11 or 700.13, the indisputable fact is that the breach, if any, had originated from the improper interpretation of HKAS 39 by the Respondents when issuing an unqualified opinion on the Financial Statements. As the auditors of Heng Tai, the Respondents should have ensured proper interpretation of HKAS 39. Any failure on the part of the Respondents in this regard is sufficient for the Committee to conclude that HKAS 39 had been breached.’

(6) Substance over form

4.15Mr Fung described the complaint as a charge.  This is disputed by Mr Duncan who argued that the allegation against the respondents is by way of a complaint and not in the nature of a charge as in criminal proceedings. 

4.16For the purpose of this appeal, it is not necessary to discusswhetherthecomplaintisinthenatureofa charge.  It is sufficient to note that the complaint was made under the disciplinary provisions of section 34(1)(a)(vi) in respect of a failure or negligence to observe, maintain or otherwise apply a professional standard.  By contrast, section 34(1)(a)(viii) deals with a complaint that a certified public accountant was guilty of professional misconduct.

4.17 What cannot be disputed is that if the respondents were being accused of a failure or negligence to observe a professional standard etc., they must know what was the subject matter of the accusation.  It is apparent from the facts of this case that the respondents were fully aware of the accusation, namely, they had failed to give a qualified opinion on the financial statements of Heng Tai arising from the drop in value of the China Zenith Shares.  Further they had been able to respond to it, first, when they were investigated by the AIB and second, at the disciplinary hearing before the Committee.

4.18The issue identified by the AIB is set out in paragraph 5.1.1.6 of its report which I have already set out in paragraph 2.7.

4.19The 2^nd respondent’s answer to AIB’s investigation about the complaint that it ought to have issued a qualified opinion was to go directly into the merits of whether an impairment had in fact occurred in the first place.  Its view was summarized in paragraph 5.3.3 of the report :

‘ On the basis as set out in the preceding paragraph, RSM [i.e. the 2^nd respondent] maintained its view that “a significant or prolonged decline in fair value of an investment below its costs ALONE is not sufficient to constitute Objective Evidence of Impairment. Only where it co-exists with information showing that the cost of the investment may not be recovered (i.e. Costs Unrecoverable Information), Objective Evidence of Impairment will be properly constituted.’

4.20In other words, it was the view of the 2^nd respondent that if there was no objective evidence of impairment under HKAS 39, then there was no need to issue a qualified opinion.

4.21The focus then by the AIB was, of course, on the breach of HKSA 700 but nonetheless it was tied up with HKAS 39.  By the time of the disciplinary hearing before the Committee, the complaint (as identified in the Amended Complainant’s case) was that the respondents had been in breach of HKAS 39 :

‘ 5. The 2^nd Respondent (‘RSM’) issued an unqualified audit opinion on the Financial Statements ….. The 1^st Respondent (“Wong”) was the engagement partner.

6. The Respondents had accepted the decision of management not to reflect the decline in value of the shares in China Zenith in the profit and loss.

7. For the reasons stated above, the Respondents were in breach of section 34(1)(a)(vi) of the Professional Accountants Ordinance, Cap 50 in that they had failed or neglected to observe, maintain or otherwise apply a professional standard namely HKAS 39.’

4.22It is equally apparent that the respondents were able to meet head on the complaint of a HKAS 39 breach. This is what they said in the ‘The Respondents’ case’ which was their written response to the complainant’s case.

‘ II. Response to the Complaint

3. The Complaint against the Respondents is referred to the Disciplinary Committee pursuant to section 34(1)(a)(vi) of the PAO, which provides:

“A complaint that-

(a) a certified public accountant

…

(vi) failed or neglected to observe, maintain or otherwise apply a professional standard;

…

   shall be made to the Registrar who shall submit the complaint to the Council which may, in its discretion but subject to section 32D(7), refer the complaint to the Disciplinary Panels.”

4. The word “neglect” is defined in Shorter Oxford English Dictionary as “disregard, paying little or no respect or attention to”.  In our respectful submissions, it denotes, in the context of s.34(1)(a)(vi) of the PAO, that the respondent has turned a blind eye to the relevant professional standard(s).  It is submitted that the word “failure” should be similarly construed.

See Shorter Oxford English Dictionary5th Ed. (“Appendix A”)

5. The Complainant bears the burden of proof and to satisfy the Disciplinary Committee that the Respondents have “disregarded, paid little or no respect or attention to” HKAS 39.

See Disciplinary Committee Proceedings Rules, r.13

6. The Respondents, by the submissions below, deny the Complaint and submit:

1) That the Complainant's interpretation of HKAS 39, namely one jumping to the conclusion of impairment solely by reason of

“significant or prolonged decline in the fair value of an investment in an equity instrument below its cost” is erroneous, and not in line with the correct interpretation of the requirements of HKAS 39 and industry practice at the material times;

2) That on proper construction of the impairment review regime under HKAS 39 (in particular HKAS 39.58–39.62), the impairment review involves a two-stage process, namely (a) considering whether there is an event that gives rise to an objective evidence of impairment (and hence a “loss event”), AND (b) whether the loss event has indicated that the investment cost may not be recovered;

3) HKAS 39.59 sheds light on how HKAS 39.61 is to be interpreted.  Accordingly, HKAS 39.61 suggests two additional “loss events” pertinent to equity instruments. Insofar as this Complaint is concerned, there is no case of possible existence of impairment unless one of the following criteria is satisfied:

a) Thattherehavebeensignificantchangeswithanadverseeffectthat have taken place in the technological, market, economic or legal environment in which the issuer operates; or

b) That there was a significant or prolonged decline in the fair value of the China Zenith Shares;

4) That existence of one or more of the events in (3)(a)-(b) above only suggests a loss event. It does not by itself prove impairment.

5) That upon existence of a loss event, the entity then needs to consider whether the investment cost may not be recovered.

6) That the assessment in (5) above is inevitably judgmental and the entity in making the assessment has to take into account all relevant information available.

7) That without prejudice to the above, no loss event existed because:

a) The quoted price of the shares in China Zenith had been affected by the thin market at the material times, and hence was not a reliable indicator to suggest that the fair value in the China Zenith Shares had significantly declined;

b) On the assumption (not admitted) that there had been significant decline in the fair value in the China Zenith Shares, there was no evidence to indicate that the investment cost might not be recovered.

8) That, instead, the evidence available to the Respondents, who only assumed the duty as the auditor of the Heng Tai Group, suggested that the China Zenith Shares were not impaired; and

9) That as a result the Respondents were entitled to come to the conclusion that they did, and had not neglected or failed to, “observe, maintain or apply” HKAS 39 (assuming such obligation existed).’

4.23No point was taken then by the respondents that they were not aware of the nature of the complaint against them or that they were facing a wrong charge.  It was in such a context, when the Committee eventually rejected the wrong charge argument, that it relied on the ‘substance over form’ approach.  In my view the Committee cannot be faulted.  The issue can simply be stated as follows.  In order for the respondents to properly discharge their responsibility as auditors, they must determine whether HKAS 39 was properly observed by Heng Tai in respect of the loss in value of the China Zenith Shares.  By wrongly agreeing with the view of Heng Tai, the 2^nd respondent had failed or neglected to observe, maintain or otherwise apply a professional standard as set out in HKAS 39.  There was simply no room for argument that a wrong charge had been brought against them.

3)  The construction issue

(1)  The respondents’ case

4.24It is the respondents’ case that impairment under 39.58 would only be engaged if the following two events are present:

(i) first, there is an event that gives rise to objective evidence of impairment (‘a loss event’), and

(ii) the loss event has an impact on the estimated future cash flows of the financial asset that can be reliably estimated.

4.25The respondents argued that:

(i) HKAS 39.58 sets out the main principles in relation to the impairment of financial assets.  It obliges Heng Tai to assess at each balance sheet date whether there was any objective evidence that the China Zenith Shares were impaired.

(ii) HKAS 39.59 supplements HKAS 39.58 by providing that impairment materializes if, and only if, (a) there is objective evidence of impairment as a result of a ‘loss event’ (i.e. an adverse event occurred after the initial recognition of the asset), and (b) the loss event(s) has an impact on the estimated future cash flows of the financial asset that can be reliably estimated.

(iii) In addition, HKAS 39.59 sets out a non-exhaustive list of loss events.

(iv) HKAS 39.61 further supplements HKAS 39.58 and 39.59 by identifying two more ‘loss events’ specifically for equity instruments.  One of them is ‘a significant or prolonged decline in the fair value of an investment in an equity instrument below its cost.’

(v) Impairment is not defined in HKAS 39.  Nonetheless, both HKAS 39.59 and 39.61 suggest that impairment occurs only if the available objective evidence suggests that it gives rise to an adverse financial impact on the recoverability of the investment cost.  The mere existence of a loss event, whether identified under HKAS 39.59(a)-(f) or HKAS 39.61, does not by itself justify the conclusion of impairment.  The reporting entity needs to evaluate the financial impact brought about by the loss event so identified.  An impairment adjustment will only be made in accordance with HKAS 39.67 if, and only if, the two-stage test in HKAS 39.59 is satisfied.

4.26The respondents submitted that their interpretation is consistent with the nature of the AFSFA (which are to be held for the long term), for which temporary fluctuations in fair value are not recognized in the income statement.

(2)  My view on the construction issue

4.27I have already set out HKAS 39.58 in paragraph 4.7 herein.  HKAS 39.59 is as follows:

‘ 59.  A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. It may not be possible to identify a single, discrete event that caused the impairment. Rather the combined effect of several events may have caused the impairment. Losses expected as a result of future events, no matter how likely, are not recognised. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the holder of the asset about the following loss events:

(a) significant financial difficulty of the issuer or obligor;

(b) a breach of contract, such as a default or delinquency in interest or principal payments;

(c) the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider;

(d) it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

(e) the disappearance of an active market for that financial asset because of financial difficulties; or

(f) observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including:

(i) adverse changes in the payment status of borrowers in the group (e.g. an increased number of delayed payments or an increased number of credit card borrowers who have reached their credit limit and are paying the minimum monthly amount); or

(ii) national or local economic conditions that correlate with defaults on the assets in the group (e.g. an increase in the unemployment rate in the geographical area of the borrowers, a decrease in property prices for mortgages in the relevant area, a decrease in oil prices for loan assets to oil producers, or adverse changes in industry conditions that affect the borrowers in the group).’

4.28I disagree with the construction urged upon the court by the respondents.  The triggering event as identified by HKAS 39.58 is where there is ‘objective evidence that a financial asset … is impaired.’  If such evidence exists, the consequence will be as provided for in the same provision.  One that is relevant to this appeal is to apply HKAS 39.67, that is, the loss must be reflected in the profit and loss accounts.  Paragraph 67 comes into operation ‘when a decline in the fair value of an AFSFA has been recognized directly in equity and there is objective evidence that the asset is impaired (see paragraph 59)’.  This requirement directly contradicts the respondents’ submission that the ‘objective evidence of impairment’ is separate from the additional requirement that the ‘investment costs may not be recovered’. 

4.29In my view the proper interpretation of paragraph 59 is that ‘A financial asset … is impaired and impairment losses are incurred, if and only if, there is objective evidence of impairment,

[first] as a result of one or more events that occurred after the initial recognition of the asset (a loss event) and

[second] that loss event has an impact on the estimated future cash flows of the financial asset’.

4.30Hence objective evidence of impairment encompasses both of these two elements.

4.31In terms of investment in equity instruments like the China Zenith Shares, objective evidence of impairment includes a significant or prolonged decline in its fair value below its costs as provided for by HKAS 39.61 :

‘ 61. In addition to the types of events in paragraph 59, objective evidence of impairment for an investment in an equity instrument includes information about significant changes with an adverse effect that have been taken place in the technological, market, economic or legal environment in which the issuer operates, and indicates that the cost of the investment in the equity instrument may not be recovered. A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of impairment.’

4.32Further, in my view, that a significant or prolonged decline in the fair value of the equity instrument below its cost is objective evidence of impairment is expressly recognized in the following provisions of HKAS 39:

‘ BC105. Under IAS 39, investments in equity instruments that are classified as available for sale and investments in unquoted equity instruments whose fair value cannot be reliably measured are subject to an impairment assessment. The original IAS 39 did not include guidance about impairment indicators that are specific to investments in equity instruments. Questions were raised about when in practice such investments become impaired.

BC106.  The Board agreed that for marketable investments in equity instruments any impairment trigger other than a decline in fair value below cost is likely to be arbitrary to some extent. If markets are reasonably efficient, today’s market price is the best estimate of the discounted value of the future market price. However, the Board also concluded that it is important to provide guidance to address the questions raised in practice.

BC107.  The revised IAS 39 includes impairment triggers that the Board concluded were reasonable in the case of investments in equity instruments (paragraph 61). They apply in addition to those specified in paragraph 59, which focus on the assessment of impairment in debt instruments.’

4.33It is precisely because of the risk of arbitrariness referred to in BC 106 that paragraph 61 expressly recognizes a significant or prolonged decline in the fair value of the equity instrument below its cost as objective evidence of impairment.  The Committee was correct to adopt this view.

4)  The merits issue

(1)  The respondents’ argument

4.34The respondents submitted that HKAS 39.61 was not engaged and that they were not unreasonable in subscribing to Heng Tai’s view that there was no significant or prolonged decline in the fair value of the China Zenith Shares below their cost.  They argued that the term ‘fair value’ is defined in HKAS 39.9 as ‘the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’.  Although it is acknowledged by the respondents that HKAS 39.AG71 provides that the ‘existence of published price quotations in an active market is the best evidence of fair value’, they argued that this application guidance is only applicable where there is ‘an active market’ and where the published prices reflect the true ‘fair value’ of the listed shares.

4.35They submitted that, as a matter of principle, where the relevant shares have not been widely traded in the stock market (i.e. they have been thinly traded), the trading volume of the company is a relevant factor to take into account in deciding whether the quoted market price on the stock exchange is the best method to determine the fair value for the shares by reference to Silber v BGR Precious Metals Inc [1998] 41 OR (3d) 147 at 152a-155a (Ferrier J) and Hong Kong Financial Reporting Standard 3.27.  It is reasonable to determine whether the market was thin by comparing average daily trading volume with the number of shares in issue. 

4.36The respondents submitted that in the present case, they had adduced evidence before the Committee to demonstrate that the China Zenith Shares were thinly traded at the material times by reference to their Working Papers.  The Committee was in error when it stated that there was ‘no evidence to show that the share price was either unreliable or the market was ‘thin’’.  It follows that the Committee failed to take relevant evidence into account in determining the fair value of the China Zenith Shares.  The Committee also erroneously assumed that the market price of the shares ‘clearly reflected the fair value’.

4.37In any event the respondents submitted that the complaint should not be upheld just because the Committee had come to a different view on the reliability of the published price of the China Zenith Shares as representing their fair value when :

(i) the Committee had expressly found that they were not in dereliction of their duties. Specifically, the Committee found that the respondents had ‘duly carried out [their] evaluation of Heng Tai’s impairment assessment’ including ‘[assessing] the reliability of the published share price by performing tests and performed alternative bases of valuation’.  The most that it can be said is that the respondents exercised a different professional judgment (to that of the Committee and the complainant) in assessing Heng Tai’s view that the published price of China Zenith Shares was an unreliable measure of their fair value;

(ii) the Committee had also found that (a) Heng Tai’s judgment and rationale for not making an impairment, as well as the change in fair value of the AFSFA, had been sufficiently stated in the Financial Statements, (b) no substantial impact on the financial position of Heng Tai as at 30 June 2009 was caused, and (c) it was unlikely that investors would have suffered a loss as a result. 

4.38The respondents stressed that the evaluation of an accounting estimate made by the management inevitably involves weighing different competing factors and exercise of professional judgment.  Reasonable professionals may come to different views.  Accordingly, the complaint against them should not be upheld simply because their judgment was not shared by the regulator.  If it were otherwise, it would impose an overly onerous burden on auditors, and expose them to unjustifiable risk of disciplinary action purely due to differences in judgment.

(2)  My view on the merits issue

4.39HKAS 39.AG71, provides, among other things, that,

(i) the existence of published share price quotations in an active market is the best evidence of fair value and when they exist they are used to measure the financial asset or financial liability;

(ii) a financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis.

4.40I agree with the Committee when it held that there was no evidence to show that the market price of the China Zenith Shares was either unreliable or the market was thin.  The respondents are challenging a finding of fact by the Committee.  The Committee was provided with the share price data and trading volume of the China Zenith Shares and it cannot be said that it was plainly wrong in its finding.  This is what the Committee found :

‘ 5.1    The Respondents lastly submitted that the share price of China Zenith as at 30 June 2009 was unreliable because of thinness of the market and equate “thinly traded” as “unreliable”. The Committee does not agree. In fact, there is no evidence to show that the share price was either unreliable or the market was “thin”. A review of the share price data and trading volumes show that:

(i) the share price of China Zenith shares remained relatively stable within the band of approximately HK$0.15 and HK$0.25 per share;

(ii)  for most of the time during the post balance sheet event period, the share prices kept below HK$0.2; and

(iii) there was no evidence of an inactive market as there had been a continued trading in China Zenith shares.

5.2   The Committee took the view that the market price of China Zenith shares clearly reflected the fair value that a willing buyer and a willing seller in an arm’s length transaction would agree upon (cf. AG 71 of Appendix A).  In fact, the quoted market price was adopted to adjust the carrying amount of Heng Tai’s investment in the shares of China Zenith apparently in purported compliance with paragraph 55(b) of HKAS 39 (cf. note 24 of the Notes to the Financial Statements contained in Heng Tai’s 2009 Annual Report).’

4.41In view of the evidence that was adduced before the Committee, it is not necessary to discuss the two cases referred to by the respondents on using other methods to assess the fair value of the shares.

4.42In my view the ‘thin trading’ argument now advanced by the respondents is strained and ignored the evidence that was before the Committee.  In view of such evidence, their argument on ‘difference in professional judgment’ is likewise strained and unsustainable.  The favourable comments by the Committee on the respondents, which they now sought to rely upon to challenge the finding of liability against them, are in the context of mitigating factors in favour of the respondents for the purpose of the orders to be made by the Committee.  These factors have no place in deciding whether the respondents had failed or neglected to observe, maintain or otherwise comply with a professional standard. 

4.43It is worth repeating what this Court said earlier in Tong Pon Wah v Hong Kong Society of Accountants [1998] 2 HKLRD 427 on the approach of the Court in hearing appeals from a professional disciplinary committee, like that of the Committee in this case, particularly on technical matters unique to the profession itself :

‘ … The question remains whether this court can, and should, reverse the decision of the disciplinary committee on substantive, as distinct from procedural, grounds. In order to do that, we must be satisfied, in my judgment, that no disciplinary committee properly directing itself on the material before it could reasonably have come to the conclusion to which it did come, (per Godfrey JA at 439J – 440A)

…   Every professional body is entitled to apply its own professional judgment to a case in which one of its members is called on to justify his conduct in (allegedly) failing to observe a standard or guideline laid down by that professional body for the protection of those dealing with members of that professional body.  It is not, in my judgment, for this court to second-guess the professional judgment of a disciplinary committee such as this except where it can be seen that it has plainly misread the evidence and come to a conclusion which is contrary to the evidence or is otherwise plainly wrong. (per Godfrey JA at 440 C-E)’

5)  Conclusion on the respondents’ appeal

4.44Accordingly, the respondents’ appeal was dismissed.

IV.  The complainant’s challenge

1)  Jurisdiction of this Court

5.1The complainant by its respondent’s notice challenged the Committee’s decision on not publishing the sanction against the respondents and the costs orders.  This challenge centres on the discrete issue of whether the Committee is entitled to raise such a challenge in this appeal at all.  This touches upon the jurisdiction of this Court to hear cross appeals from the complainant.

5.2The jurisdiction of this Court in civil appeals is governed by section 13 of the High Court Ordinance ‘HCO’ (Cap 4) :

‘ (1) The Court of Appeal shall be a superior court of record.

(2) The civil jurisdiction of the Court of Appeal shall consist of –

(a) ―

(b) ―

(c) any other jurisdiction conferred on it by any law.’

5.3This Court has no inherent jurisdiction to hear appeals outside what is prescribed by statute.  See So Wing Keung v Sing Tao Ltd and Another [2005] 2 HKLRD 11 at para 31 (Ma CJHC); Mok Charles Peter v Tam Wai Ho and Another (2010) 13 HKCFAR 762 at para 36 (Ma CJ).

5.4The jurisdiction of this Court to hear appeals against a decision of the Committee is invoked under section 13(2)(c) of the HCO.  The ‘law’ which conferred this Court with the jurisdiction is section 41 of PAO :

‘ (1) An appeal shall lie to the Court of Appeal by –

…

(b) a certified public accountant –

…

(iii) who is aggrieved by an order made in respect of him under section 35(1);

(c) a corporate practice –

…

(ii) in respect of which an order is made under section 35(1)(a) or (b),

and the Court of Appeal may confirm, vary or reverse the order or decision appealed against.

(2) (Repealed 10 of 2005 s. 47)

(3) In any such appeal the Court of Appeal may exercise such powers as are vested in it by the High Court Ordinance (Cap. 4) and the practice and procedure shall be in accordance with rules of court made under that Ordinance:’    

5.5It is clear from section 41 of PAO, that the right to appeal is only conferred on a certified public accountant or a corporate practice.  The reference in section 41(3) to ‘In any such appeal’, must be to the appeal by these two entities.  There is no provision for an appeal by the complainant against the decision of the Committee.

5.6Mr Duncan relied on Order 59 Rule 6 of the High Court Rules to argue that there has been conferred on the complainant the right to challenge the decision of the Committee

‘ Respondent’s notice (O.59, r.6)

6. – (1) A respondent who, having been served with a notice of appeal, desires –

(a) to contend on the appeal that the decision of the court below should be varied, either in any event or in the event of the appeal being allowed in whole or in part, or

(b) to contend that the decision of the court below should be affirmed on grounds other than those relied upon by that court, or

(c) to contend by way of cross-appeal that the decision of the court below was wrong in whole or in part,

must give notice to that effect, specifying the grounds of his contention and, in a case to which sub-paragraph (a) or (c) relates, the precise form of the order which he proposes to ask the Court to make.’    

5.7I disagree Order 59 Rule 6 confers right of appeal on the part of the complainant.  The High Court Rules is subsidiary legislation to the High Court Ordinance and it cannot confer on this Court any jurisdiction not available in the principal legislation.

5.8The complainant’s challenge to the Committee’s decision on publication and costs is in reality in the nature of a cross-appeal.  A cross-appeal is in essence an appeal by another name.  That right must be conferred on them before they can appeal.  Bokhary PJ in Common Luck Investment Ltd v Director of Legal Aid (2002) 5 HKCFAR 467 stated that :

‘ 31. Where, as happens under a respondent’s notice under sub-para.(a) and (c), the Court of Appeal is asked to change the trial court’s order, the situation is in reality that of a cross-appeal.  But where, as happens under a respondent’s notice under sub-para.(b), the Court of Appeal is only being asked to affirm the trial court’s order, albeit on additional or alternative grounds, the situation is not that of a cross-appeal.  In VCS v Magmasters [1984] 1 WLR 1208 at p.1209F Sir John (later Lord) Donaldson MR noted that “a respondent’s notice covers three quite different situations” and that the situation under sub-para.(b) merely adds “further arguments to an existing appeal” while the situation under sub-para.(a) and the situation under sub-para.(c) is each “in reality a cross-appeal”.’

5.9.In Thanakharn Kasikorn Thai Chamkat (Mahachon) v Akai Holdings Ltd (No 1) (2010) 13 HKCFAR 283 Bokhary PJ repeated the same view that :

‘ 4.  A cross-appeal is a specie of appeal.  It is therefore an appeal.  And a party who seeks to bring and then brings a cross-appeal assumes the obligations of a would-be appellant and then an appellant.  … I take this view on a purposive and reasonable construction of the scheme created by the Court’s statute and on the nature of a cross-appeal as explained by the Court of Final Appeal in Common Luck Investment Ltd v Director of Legal Aid (2002) 5 HKCFAR 467, 478D-F.’

5.10.In discussing the need for leave to appeal from the District Court, Kwan JA in Ng Hong Ki v Leung Fong Kiu [2012] 1 HKLRD 435 at para 26 held that :

‘ The authorities have established clearly that a cross-appeal given by a respondent’s notice is a separate appeal and the respondent in that situation assumes the obligations of a would-be appellant and then an appellant.  Order 59 r.6(3) is “mere machinery”, and it does not override the requirement of leave provided in s.63(1) of the District Court Ordinance.’    

5.11.This Court plainly has no jurisdiction to hear the complainant’s challenge by way of a cross-appeal as no right of appeal is conferred on the complainant in the underlying legislation. Likewise no jurisdictional power is conferred on this Court.  This being the case there is no need to consider the merits of the complainant’s challenge.

2)  Conclusion

5.12.Accordingly the complainant’s respondent’s notice was also dismissed.

Hon Yuen JA :

6.I agree with Cheung JA’s reasons for judgment.

Mr Eugene Fung S.C. and Mr Adrian Lai, instructed by Wilkinson & Grist, for the 1^st and 2^nd respondents

Mr Peter Duncan S.C. and Ms Christy Wong, instructed by Reed Smith Richards Butler, for the complainant