Several Provisions on the Trial of Cases Involving Civil Tort Compensation in Connection with Audit Activities by Accounting Firms

(Promulgated by the Supreme People's Court on June 11 2007 and effective as of June 15 2007.)

SPC Interpretation [2007] No.12

These Provisions have been formulated pursuant to laws such as the PRC General Principles for Civil Law, PRC Certified Public Accountants Law,PRC Company Law and PRC Securities Law and in the light of experiences in previous trials in order to properly try cases involving civil tort compensation in connection with audit activities by accounting firms and to safeguard the public interest and the lawful rights and interests of concerned parties.

Article 1: If a materially interested party institutes a civil tort compensation action in a people's court on the grounds that an accounting firm issued an untruthful report in the course of carrying out any of the audit activities specified in Article 14 of the Certified Public Accountant Law, thereby causing it to incur a loss, the people's court shall accept such case in accordance with the law.

Article 2: A natural person, legal person or other organization that incurred a loss in a transaction with the audited work unit or in carrying out trading activities relating to the shares, bonds, etc., of the audited work unit as a result of reasonably relying on or using a untruthful report issued by an accounting firm shall be deemed a materially interested party as specified in the Certified Public Accountant Law.

If an accounting firm violates laws, regulations, or the practice standards or rules implemented by the Chinese Institute of Certified Public Accountants after formulation by the institute in accordance with the law and approval by the State Council's finance department or the principles of honesty, credibility and impartiality by issuing an audit report that contains false records, misleading statements or material omissions, such report shall be deemed an untruthful report.

Article 3: If a materially interested party does not institute a legal action against the audited work unit but directly institutes a legal action against the accounting firm, the people's court shall inform it to institute a legal action jointly against the accounting firm and the audited work unit. If the materially interested party refuses to institute a legal action against the audited work unit, the people's court shall notify the audited work unit that it shall be a co-defendant in the legal action.

If a materially interested party institutes a legal action against a branch or sub-branch of an accounting firm, the people's court may name the accounting firm as a co-defendant in the legal action.

If the materially interested party accuses an investor of the audited work unit of making a false or untruthful capital contribution or illegally withdrawing its capital contribution and later failing to make up the shortfall, the people's court may name such investor as a third party in the legal action.

Article 4: If an accounting firm causes a materially interested party to incur a loss due to the fact that, in the course of the audit activities, it issued a publicly available untruthful report, it shall be liable for tort compensation, unless it is able to substantiate that it was not at fault.

In substantiating that it was not at fault, the accounting firm may submit to the people's court the relevant practice standards, rules and its audit working drafts, etc.

Article 5: If a certified public accountant is characterized by any of the circumstances set forth below in the course of audit activities and issues an untruthful report, thereby causing a materially interested party to incur a loss, the accounting firm and the audited work unit shall be deemed to be jointly and severally liable:

(1) he/she maliciously colluded with the audited work unit;

(2) he/she was well aware that the accounting treatment of material events by the audited work unit conflicted with relevant state provisions but failed to indicate the same;

(3) he/she was well aware that the accounting treatment by the audited work unit would directly harm the interests of the materially interested party, but concealed the same or reported the same untruthfully;

(4) he/she was well aware that the accounting treatment by the audited work unit would lead to a material misunderstanding by the materially interested party, but failed to indicate the same;

(5) he/she was well aware that the accounting statements of the audited work unit contained untruthful content concerning material events, but failed to indicate the same; or

(6) he/she was instructed by the audited work unit to prepare an untruthful report, and did not refuse to do so.

If the audited work unit committed any of the acts set forth in Items (2) to (5) of the preceding paragraph and the certified public accountant ought, in accordance with practice standards and rules, to have been aware thereof, the people's court shall deem him/her to have been well aware thereof.

Article 6: If an accounting firm, in the course of audit activities, issues an untruthful report due to negligence, thereby causing a materially interested party to incur a loss, the people's court shall determine its liability for compensation based on the degree of its negligence.

If a certified public accountant fails to act with the necessary professional prudence in the course of an audit and is characterized by any of the circumstances set forth below, thereby causing his/her report to be untruthful, the people's court shall deem the accounting firm to be negligent:

(1) he/she violated Item (2) or (3) of Article 20 of the Certified Public Accountant Law;

(2) the certified public accountant in charge of the audit practised at a professional level lower than that which ordinary members of the profession are required to practise;

(3) the audit plan that he/she prepared contained obvious oversights;

(4) he/she failed to carry out necessary audit procedures in accordance with practice standards and rules;

(5) when he/she discovered possible errors or signs of malpractice, he/she failed to add the necessary audit procedures to substantiate or eliminate the same;

(6) he/she failed to reasonably apply the principle of materiality required by the practice standards and rules;

(7) he/she failed to adopt the necessary investigatory means to obtain sufficient audit evidence in accordance with audit requirements;

(8) he/she was well aware that he/she lacked the ability to reach a judgement on a specific audit subject that had a material impact on the overall conclusion, but failed to seek the opinion of an expert and directly produced an audit opinion;

(9) he/she erroneously judged and evaluated audit evidence; or

(10) he/she committed another act that violated the work procedures determined in the practice standards and rules.

Article 7: If an accounting firm is able to substantiate the existence of any of the following circumstances, it shall not be liable for civil compensation;

(1) it complied with the work procedures determined in the practice standards and rules and acted with the necessary professional prudence, but nevertheless failed to discover errors in the audited accounting materials;

(2) a financial institution or other such work unit on which an audit must rely provided false or untruthful supporting documentation and the accounting firm, while acting with the necessary professional prudence, nevertheless failed to discover that it was false or untruthful;

(3) it raised a warning in respect of signs of malpractice by the audited work unit and indicated the same in the audit report;

(4) it complied with the capital verification procedure in conducting the review and issuing the report, but the work unit that commissioned the capital verification illegally withdrew capital after registration; or

(5) it issued an untruthful report for an investor that, at the time of registration, had not made its capital contribution or had not made its capital contribution in full, but after registration made up the shortfall in its capital contribution.

Article 8: If a materially interested party was well aware that the report issued by an accounting firm was untruthful but used it nevertheless, the people's court shall reduce the accounting firm's liability for compensation by taking such circumstance into consideration..

Article 9: Words such as "This report is provided solely for annual inspection purposes", "This report is provided solely for business registration purposes" indicated on a report by an accounting firm may not serve as grounds for exempting it from liability.

Article 10: When a people's court determines in accordance with Article 6 hereof the compensation that an accounting firm shall bear concomitant with its degree of negligence, it shall handle matters as follows:

(1) the loss of the materially interested party shall first be compensated by the audited work unit; if an investor of the audited work unit made a false or untruthful capital contribution or illegally withdrew its capital contribution and failed to make up the shortfall thereafter, and enforcement in accordance with the law against the audited work unit's property is insufficient to compensate for the loss, the investor shall bear liability for making up the compensation to the materially interested party to the extent of its false, untruthful or illegally withdrawn capital contribution;

(2) if enforcement in accordance with the law against the property of the audited work unit and the investor is insufficient to compensate for the loss, the accounting firm shall bear the attendant liability for compensation to the extent of the amount untruthfully audited by it;

(3) the liability for compensation that an accounting firm bears toward one or more materially interested parties shall be limited to the untruthfully audited amount.

Article 11: If an accounting firm and a branch or sub-branch thereof are co-defendants, the accounting firm shall bear joint and several liability for compensation in respect of the portion of the liability borne by its branch or sub-branch.

Article 12: If a tort compensation dispute involving an accounting firm as mentioned herein has not been tried, the people's court may not add the accounting firm as a person against whom a judgment is enforced.

Article 13: These Measures shall be effective as of the date of promulgation. In the event of a conflict between these Provisions and provisions previously issued by this Court concerning the civil liability of accounting firms, such provisions shall cease to apply.

These Provisions shall not apply to civil tort compensation cases involving accounting firms that were tried before the promulgation and implementation hereof and in which a concerned party has filed an appeal or in which a decision for a retrial has been rendered in accordance with trial supervision procedures.

These Provisions shall apply to civil tort compensation cases involving accounting firms that are pending at first instance or second instance at the time of the promulgation and implementation hereof.