Tough on Accountants: The New PRC Accounting Regulations

Article 1 of the Regulations reiterates the tort of misstatement, providing that an “interested person” may file a tortious claim in a People's Court for damages suffered from relying upon an accounting firm's “untruthful report”.

One is deemed to be an “interested party” under Article 2 of the Regulations if it suffers loss due to reasonable reliance upon or use of the untruthful report when dealing with the audited entity, or from participating in the dealings of the stocks or bonds of the audited entity.

Under Article 2, a report is deemed an “untruthful report” if it is made in breach of relevant laws and regulations including the practising guidelines and rules prescribed by the Chinese Institute of Certified Public Accounts and approved by the finance department of the State Council, or if it contains any false record, misleading statement, or serious omission.

The duty of care imposed under the Regulations is stricter than that imposed in most common law jurisdictions. Under English common law, for example, accountants' duty of care is defined in the House of Lords' decision in Caparo v Dickman¹ (Caparo). Lord Bridge of Harwich held that for such duty of care to arise, three elements need to be satisfied: the damage complained of is foreseeable; there is a sufficient proximity of relationship between the parties; and that it is fair, just and reasonable for such a duty to be imposed.

The Regulations contrast sharply with Caparo in several aspects. Under Article 2 of the Regulations, for example, an interested person is defined broadly so as to include any member in the general public who relies on an untruthful report and suffers a corresponding loss. This contrasts sharply with the position under English common law held in Caparo that a requisite proximity did not exist between the auditors and the shareholders who relied on the accounts prepared by the auditors in a takeover bid, unless the auditors knew that their report would be communicated to the shareholders who subsequently relied on it.

The burden of proof for a plaintiff under the Regulations also appears to be easier to discharge. Article 4 of the Regulations provides that an auditor will be held liable in tort if he issues an untruthful report that causes loss to an interested person unless it can prove that he is not negligent . On its face, therefore, so long as the plaintiff has a prima facie case, there is a presumption of negligence that the defendant has to rebut.

As regards available defence, under Article 8 of the Regulations, if the interested person knows that the report is untrue, but nonetheless relies upon it, the claim will not be barred. Instead, the amount of damage would be reduced at the discretion of the court. This differs significantly from the position under English common law, where under the doctrine of Volenti Non Fit Injuria, the plaintiff's voluntary acceptance of the risk would constitute a complete defence to a negligent misstatement claim.

Although the Regulations generally reflect a legislative intent to raise the ethical standards and the credibility of the accounting profession, how the Regulations will be applied in practice remains to be seen. Auditors in Mainland China, however, need to be aware that they face a higher risk of being found liable for their work under the Regulations than their Hong Kong and English counterparts.

Endnotes

1 Caparo Industries plc v Dickman and other [1990] 1 ALL ER 568

2 ibid, page 573-574

3 Article 6 specifies certain facts that would help prove negligence, including, among others, failure to meet the standards of the ordinary person possessing the particular special skill.