The Ontario Securities Commission (OSC) is accusing accounting firm, Ernst & Young LLP, of falling down on the job as the auditor of troubled Chinese timber company, Sino-Forest Corp.

The OSC brought allegations against the firm Monday claiming that it breached securities laws in its work as Sino-Forest’s auditor between August 2007 and April 2012.

“During that time, they audited the annual consolidated financial statements of Sino-Forest and represented to its shareholders that they had performed their audits in accordance with relevant industry standards. Shareholders invested significant sums in Sino-Forest in reliance on these financial statements. Ernst & Young, however, failed to conduct their audits in accordance with relevant industry standards,” the OSC said in a statement of allegations.

Specifically, the commission charges that the firm “failed to perform sufficient audit work to verify Sino-Forest’s ownership of its most significant assets; failed to perform sufficient audit work to verify the existence of Sino-Forest’s most significant assets; and, failed to undertake their audit work on the Sino-Forest engagement with a sufficient level of professional skepticism.”

Among other things, the OSC also says that the firm failed to properly structure its Sino-Forest audit team, noting that many of its source documents were produced only in Chinese, which weren’t translated into English; that several of the senior partners involved in the audits were unable to read or speak Chinese, and that they relied on its Chinese speaking staff to provide informal translations of important source documents. “As a result, the non-Chinese speaking staff were often not aware that important information was missing from some of Sino-Forest’s key documents,” it says.

Ultimately, the OSC alleges that its audit work was not conducted in accordance with Canadian generally accepted auditing standards (GAAS), and that each of these failures to comply with GAAS constitutes a breach of securities law. Additionally, it says that Sino-Forest’s regulatory filings, which contained Ernst & Young’s representation that they had conducted their audits in accordance with GAAS, also represents a breach of the law by the audit firm.
“Ernst & Young’s failures to comply with GAAS… led them to overlook or discount significant flaws in Sino-Forest’s assertions relating to the ownership and existence of the Purported Assets. The Purported Assets constituted the vast majority of Sino-Forest’s assets and produced nearly all of its reported revenue. Ernst & Young’s lack of diligence in these areas therefore resulted in significant negative consequences for Sino-Forest’s shareholders,” it says.

The allegations have not been proven. An initial hearing has been scheduled for January 7, 2013.

Earlier this year, the OSC accused Sino-Forest and former senior executives of fraud. Those allegations have not been proven, and the company is in creditor protection.

The case also sparked a review of emerging market issuers generally, which found a number of weaknesses in the governance and disclosure practices of issuers, listing rules, auditing and underwriting practices, earlier this year. In general, it noted a lack of professional skepticism among auditors, and said their work was hampered by a lack of local knowledge, language barriers, and too much reliance on local firms. As a result, the commission published new guidance for issuers last month, and it is also working with other regulators to improve underwriting standards, auditing and listing processes.

“Our investigation into Sino-Forest is a complex international investigation, and a major focus has been on whether gatekeepers such as auditors and other corporate advisors properly performed their role in protecting investors,” said Tom Atkinson, director of enforcement at the OSC. “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 laws, we will hold them accountable.”