The Ontario Securities Commission (OSC) is accusing accounting firm Ernst & Young LLP of securities law violations over its auditing of failed emerging market issuer, Zungui Haixi Corp.
The OSC has set July 15 as the date for a hearing amid allegations that the firm failed to comply with auditing standards when signing off on Zungui’s books in advance of its initial public offering, and again in 2010, which the OSC claims “led it to overlook or discount significant issues that called the accuracy of Zungui’s financial statements into question.”
It says that these failures amount to breaches of the securities laws, as did disclosures citing these audits, and that the audit failures also constituted conduct contrary to the public interest. The allegations have not been proven.
In 2009, Zungui raised almost $40 million in total gross proceeds in an IPO. For that deal, E&Y audited Zungui’s consolidated financials and issued an auditors’ report stating that it had performed the audit in accordance with Canadian generally accepted auditing standards. However, the OSC alleges that the IPO audit was not actually conducted in accordance with GAAS, “relying on certain audit results that raised more questions than they answered.”
In particular, it says that the firm “identified a risk that Zungui could use fictitious distributors to fraudulently inflate its revenue – but then disregarded evidence suggesting that the company had grossly exaggerated its sales to purported distributors.”
It also says that the firm “failed to treat multiple red flags about the company’s revenue and earnings with appropriate skepticism; and, that it “failed to conduct a sufficient review of the audit evidence, leaving the review of key evidence in the hands of a staff member with limited experience.” The OSC adds that E&Y’s audit of Zungui’s financial statements for its 2010 fiscal year contained several of the same deficiencies as the IPO audit.
In 2011, E&Y suspended its audit of the firm, and later resigned as its auditor. In 2012, the OSC found Zungui liable for multiple violations of Ontario securities law, including a failure to file audited annual financial statements.
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It also found the firm’s remaining directors liable for multiple violations, including authorizing, permitting or acquiescing in Zungui’s violations. It has since been permanently cease-traded.