Shockwave of the Kangmei case: from the perspective of "bankruptcy in one case", the rights and punishments of intermediary institutions are seen

"The accounting firm and the signatory accountant bear 100% joint and several liability."

The first-instance judgment of the Kangmei Pharmaceutical Securities Misrepresentation Liability Dispute Case (hereinafter referred to as the "Kangmei Case") fell on the hammer, and the shock wave formed on the auditing industry has not subsided.

According to the judgment, 52,037 investors were compensated 2.459 billion yuan. In addition to kangmei pharmaceutical and its actual controllers, directors, supervisors and other relevant responsible persons were held responsible according to law, the audit firm Zhengzhong Zhujiang Accounting Firm (hereinafter referred to as the "Kangmei case") and its partner Yang Wenwei were also sentenced by the court to bear 100% joint and several liquidation liability for Kangmei Pharmaceutical's debts, and Yang Wenwei personally assumed 100% joint and several liability for nearly 2.5 billion yuan of debts.

As China's first special representative litigation case, the Kangmei case not only set a new record for the number of plaintiffs and the amount of compensation, but also set a record for the intermediary institution to bear joint and several liability for financial liability and was implemented for the first time to the individual accountant.

The judgment has left the auditing industry "at risk for everyone".

Wang Yaowu, a senior financial person, told the Economic Observer that the verdict of the Kangmei case for the first time appeared that the accountant personally bears joint and several civil compensation, which has caused a huge shock to the entire auditing industry, and its impact has been revealed. For example, project partners transfer assets before taking over the project, or do not deposit assets in their own name; some even consider responding through divorce.

He also said that the result of "one case bankruptcy" faced by Zhujiang and Yang Wenwei is not harsh, but for the entire audit industry, the judgment of the case will play a role in forcing the industry to self-regulate.

The first-instance judgment in the Kangmei case has aroused the attention and discussion of people in the financial and legal circles. What is the legal boundary of the power and responsibility of an accounting firm that can be called the "gatekeeper" of the capital market? What are the costs of violating the border and how to circumvent them?

"A bankruptcy case"

Among the compensation liabilities of the entities in the Kangmei case determined by the court, the court confirmed that kangmei Pharmaceutical's annual reports for 2016, 2017 and 2018 had false records such as inflated revenue and inflated monetary funds on the basis of the facts determined by the CSRC's Administrative Punishment Decision, and that Zhongzhong Zhujiang issued a standard unqualified audit opinion for the first two financial reports and a qualified opinion for the latter financial report. During the audit of the 2016 and 2017 annual reports, the relevant auditors of Zhongzhong Pearl River learned that the Jieke system was the business management information system of Kangmei Pharmaceutical and the Kingdee EAS system was the financial processing information system, but did not pay attention to whether there were differences between the two systems and did not implement the necessary audit procedures. In addition, Zhongzhong Pearl River was also found to have the fact that there were audit papers "plus plug" letter transaction data and the project manager seriously violated the independence requirements.

The court found that Zhongzhong Zhujiang did not implement the basic audit procedures, resulting in Kangmei Pharmaceutical's serious financial fraud not being discovered by the audit, and Yang Wenwei, as a partner of Zhengzhong Zhujiang and a signatory certified public accountant of Kangmei Pharmaceutical's audit project in 2016 and 2017, was liable for compensation due to gross negligence caused by Zhengzhong Zhujiang in the course of practice. According to the relevant laws, Yang Wenwei shall bear joint and several liability for compensation within the scope of responsibility of The Pearl River.

According to public information, Zhongzhong Pearl River was established in 2000 as a veteran accounting firm in South China, benefiting from the abundant enterprise reserves in Guangdong Province, and the business scale was once comparable to that of national accounting firms. According to the "2020 Comprehensive Evaluation of 100 Accounting Firms Ranking Information" released by the Chinese Institute of Certified Public Accountants, the comprehensive ranking of the Pearl River dropped from 26th in the previous year to 53rd, and the firm's own business income in that year was 176 million yuan, down 59.8% year-on-year.

Zhou Yazhu, a lawyer at Beijing Yingke (Shanghai) Law Firm, told the Economic Observer that the Kangmei case was not the first case of "bankruptcy" of an intermediary institution, and many accounting firms and securities companies and other capital market "gatekeepers" had previously borne joint and several liability for compensation as defendants in securities misrepresentation liability dispute cases. However, the amount of the Kangmei case hit a new high, and the example of the accountant personally bearing huge joint and several liability is indeed rare.

Wang Yaowu told reporters that large accounting firms implement a special general partnership system, and the legal level requires partners with gross negligence to bear joint and several liability, although the precedent of the accountant personally bearing 100% of the joint and several liability for nearly 2.5 billion yuan of debt in the Kangmei case has shaken the industry, but it is not harsh.

He said that domestic accounting firms will withdraw risk reserves proportionally according to income, and individual accountants will also purchase occupational insurance, but considering factors such as the establishment time and income scale of domestic audit institutions, their amount is far from being able to cope with secondary market civil compensation caused by audit failure.

Dr. Ma Junsheng, a senior financial and tax expert, stressed that the proportion of responsibility for financial fraud of listed companies should be borne more by the actual controller and the major shareholder; they are the planners and implementers of financial fraud, and they are also the largest beneficiaries and the strongest motivation. He believes that it is appropriate for listed companies and at-fault intermediaries to bear the liability for compensation, but the listed company should not be the last person to bear the responsibility. If the listed company bears the final liability for compensation, it is equivalent to the later shareholders of the listed company or even the creditors paying for the previous shareholders.

Ma Junsheng suggested that in terms of civil liability, the recovery mechanism for actual controllers and major shareholders needs to be further implemented, and at the same time, the short-selling mechanism is also an effective means to counter financial fraud. Listed companies, securities companies, accounting firms and law firms in the entire capital market chain need to abide by their own soil, shoulder their responsibilities, and receive their own penalties.

The key to the determination of responsibility

After the first-instance judgment in the Kangmei case, whether the accountant can avoid "pouring out his family wealth" through the personal bankruptcy system has become a topic of considerable concern in the auditing industry.

Lawyer Zhou Yazhu said that in August 2020, Shenzhen promulgated the country's first personal bankruptcy regulation, the Shenzhen Special Economic Zone Personal Bankruptcy Regulations, which will be implemented in March 2021. Previously, the Shenzhen Intermediate People's Court had produced the first personal bankruptcy case approved by the court ruling, which only applied to honest and unfortunate people, and Lao Lai was not among the rescued. According to the regulations, if a natural person who resides in the Shenzhen Special Economic Zone and has participated in Shenzhen social insurance for three consecutive years loses the ability to pay off debts due to production, operation, or daily consumption, or whose assets are insufficient to pay off all debts, he may carry out bankruptcy liquidation, reorganization or reconciliation. The court will choose the appropriate type of insolvency proceedings depending on the circumstances of the debtor and creditors.

In addition to the responsibility of accounting firms as intermediary institutions, the determination of the personal liability of accountants is concerned about whether they are "external liabilities" and related exemptions.

Yang Ting, a lawyer at King & Wood Mallesons, pointed out that according to the general principle of joint and several liability and the judicial precedents of Chinese courts, when securities misrepresentation liability dispute cases involve the determination of joint and several liability, only the external liability of the joint and several responsible person is determined in the specific case, but the internal liability division between the responsible persons is not resolved.

Based on this, a noteworthy issue in this case is whether Yang Wenwei's personal liability is external liability as a joint and severally liable person when the first-instance judgment of the Kangmei case has determined that Yang Wenwei is not the civil responsible person for the false statement in the case according to the Securities Law of the times.

Yang Ting pointed out that the judgment result held that Yang Wenwei's personal responsibility was external liability. In this regard, the judgment clearly pointed out that Yang Wenwei "should bear joint and several liability for compensation within the scope of zhengzhong Pearl River's responsibility", rather than directly determining that he should bear joint and several liability for the misrepresentation involved in the Kangmei case.

According to the Partnership Law, a partner shall bear "unlimited liability or unlimited joint and several liability" in the event that the debts of the partnership are caused by intent or gross negligence in the course of their professional activities. She pointed out that this showed that the relationship between the partner with the accounting firm with the accounting firm could be jointly and severally indebted in respect of the external debts of the accounting firm, so its liability was still external and could be resolved in this case.

On the other hand, whether an accountant's failure to sign or not issue an unqualified opinion can become a "gold medal for exoneration" has also attracted market attention.

Xu Feng, a lawyer at Shanghai Jiucheng Law Firm, said that in the past, cases of accounting firms bearing joint and several liability were more common, but there were not many partners and signing accountants who were responsible, and the judgment result of this case may bring great pressure to the responsible club partners and signing accountants, even if there are insurance estimates, it is difficult to cover. He also said that if you follow the necessary auditing standards and practice according to law, keep the working papers and no responsibility certificates, you can still practice normally and give opinions. This kind of joint and several is not unconditional joint and several, if it can be proved that it is not at fault, the club, as well as the partners and the signing accountant, do not need to bear joint and several liability, the core is whether it can prove that it is not at fault.

Lawyer Yang Ting believes that this issue still needs to be specifically grasped according to the circumstances of the case, and ultimately it is still necessary to return to the review of the accountant's diligence and due diligence. Whether the accountant's act of issuing a qualified opinion is sufficient to exempt it from liability must be comprehensively judged in light of the severity of the misrepresentation and the specific opinion issued by the accountant.

She said that the type of audit opinion issued by the accountant is only one of the results of her audit work, and does not fully reflect its working methods and procedures, the degree of attention paid in the audit work, and whether it has fulfilled its duty of diligence and due diligence. It should be noted that the responsibilities of relevant intermediary institutions, including audit institutions, have the nature of "expert responsibility", and it is more appropriate to judge from the perspective of their respective professions and restore to the work background and work scene at that time, rather than "backwards" from the results. On this issue, there may still be a lack of specific and clear measurement standards, which deserve further study and discussion by all walks of life.

Industry self-purification

Accounting firms, securities firms, and law firms, as the "gatekeepers" of the capital market, are also regarded as holding the "golden rice bowl". However, some practitioners said that the auditing industry is also facing the dilemma of talent loss and lack of talent, and more practitioners have self-deprecated as a "labor-intensive" industry. In addition, in recent years, the frequent occurrence of fraud in the capital market and the tightening of supervision have also made the auditing industry risk of being "stigmatized".

A number of financial and accounting sources said that in the current market environment, the auditing industry is fiercely competitive, and if the accountant "does not cooperate" with the intention of the listed company, the customer will most likely change the accounting firm. Therefore, individual accountants will subjectively tend to maintain customer relationships and objectively damage the independence of accounting firms.

Qin Zheng, the plaintiff's lawyer in the Kangmei case, previously said that the accounting firm and the partners who signed the audit report bear full joint and several liability, which is the highlight of the first-instance judgment in this case. The accounting firm was ordered to bear full joint and several liability on the basis that it had not implemented the basic audit procedures and had a very bad impact; as for the signatory partners, the court directly relied on the provisions of the Partnership Law that in a special general partnership, the partners who caused the debts of the partnership due to intent or gross negligence in their professional activities should bear unlimited joint and several liability for the debts. He also said that a rational view of the responsibility of intermediaries is still worth studying. Objectively speaking, the fundamental reason is that the ecological relationship of capital market intermediary service institutions attached to issuers is that it is difficult to ensure their independence. How to build a healthy intermediary service market deserves extensive research and discussion.

Wang Yaowu believes that the landing of the judgment result of the Kangmei case will objectively play a role in forcing the industry to purify itself. After that, accounting firms will pay more attention to customer screening, refuse to endorse dishonest enterprises, accelerate the elimination of dishonest accounting firms and certified public accountants, and promote certified public accountants to improve professional ethics and adhere to practice norms. In addition, the Kangmei case has also raised awareness of the importance of the auditing firm, and the fees charged by the accounting firm in the future should also be increased to meet the consistency of rights and responsibilities.

Economic Observer reporter Liang Ji

Editor/Fan Hongwei