AFRC imposes HK$300 million fine and six-month practice limitation on PricewaterhouseCoopers and HK$10 million in fines on its two former registered responsible persons over the Evergrande Audits

The Accounting and Financial Reporting Council (AFRC) has sanctioned PricewaterhouseCoopers (PwC)¹ and two of its former partners and registered responsible persons, Mr Cheung Siu Cheong (Cheung) and Mr Chow Sai Keung (Chow)², for misconduct in connection with PwC’s audits of the consolidated financial statements of:

(i) China Evergrande Group (in liquidation) (Company) (previous stock code: 03333, delisted) and its subsidiaries (collectively, the Group) for the years ended 31 December 2019 and 2020 (Evergrande Group Audits);

(ii) Evergrande Property Services Group Limited (stock code: 06666) and its subsidiaries for the year ended 31 December 2020; and

(iii) China Evergrande New Energy Vehicle Group Limited (stock code: 00708) and its subsidiaries for the year ended 31 December 2020 (Evergrande Vehicle Audit)

(collectively, the Evergrande Audits).

PwC acted as the reporting accountant for the Company’s listing in 2009 and subsequently served as the Company’s group auditor from listing until early 2023. It conducted each of the Evergrande Audits and expressed unmodified audit opinions on the consolidated financial statements.  At the time of the Evergrande Audits, the Group was a large business group with principal operations in property development and investment, property management, new energy vehicles and other sectors in the Chinese Mainland.  For the financial years ended 31 December 2019 and 2020, the Group reported revenues exceeding RMB477 billion and RMB507 billion respectively, profits exceeding RMB33 billion and RMB31 billion respectively, and total assets exceeding RMB2.2 trillion as at 31 December 2020.

Following investigations and relevant enquiries, the AFRC found that there were numerous serious audit deficiencies by the Auditor³ in the Evergrande Audits, particularly the Evergrande Group Audits.  These included misconduct that facilitated and contributed to management’s inflation of the Group’s reported profits and liquidity; failures to exercise professional scepticism despite elevated audit risks; a significant loss of audit independence; and the issuance of unmodified audit opinions despite not having obtained sufficient appropriate audit evidence (and, in some instances, despite knowing that such evidence was lacking).  By issuing unmodified audit opinions, the Auditor allowed the Group’s material financial misstatements to go unchallenged, thereby enabling the presentation of a misleading and distorted financial position by the Group. The AFRC also identified substantial weaknesses in PwC’s governance and monitoring controls in respect of the Evergrande Group Audits.  

In light of the above, the AFRC has:

(i) issued a public reprimand to each of PwC, Cheung and Chow;

(ii) imposed pecuniary penalties totalling HK$310,000,000, comprising a penalty of HK$300,000,000 on PwC and penalties of HK$5,000,000 each on Cheung and Chow; 

(iii) imposed an immediate practice limitation prohibiting PwC, for a period of six months, from accepting, performing, or issuing reports in respect of any PIE engagements for new clients⁴;  and
 

(iv) directed PwC to provide periodic updates and reports to the AFRC regarding its remedial actions for a period of twelve months (at intervals of no more than three months), and to arrange additional training to ensure that effective remedial measures are implemented to address the regulatory concerns identified by the AFRC in this matter. 

The AFRC’s Key Findings

The AFRC identified multiple audit deficiencies across each of the Evergrande Audits.  Among these, the audit deficiencies in the Evergrande Group Audits were particularly egregious.  The Auditor’s deficiencies fall broadly into five key areas: 

(i) Facilitating and contributing to management’s inflation of the Group’s reported profits and liquidity, by:

• Disregarding clear evidence of premature revenue recognition – i.e., the Auditor disregarded evidence from its own site visits showing that properties were still under construction – while accepting the Group’s records that properties were completed and ready for handover without verification and additional work; and

• Knowingly permitting unsupported consolidation adjustments i.e., unjustified accounting entries, to be recorded – even when the engagement team was aware of management’s intention to manipulate the Group’s financial results to achieve desired net profit targets. 

   

(ii) Failing to exercise professional scepticism despite multiple red flags indicating elevated risks of material misstatements, and failing to design and perform appropriate procedures to obtain sufficient appropriate audit evidence across critical audit areas. These included revenue, properties under development, completed properties held for sale, restricted cash, going concern assessment and debts misclassified as equity.    

(iii) Failing to maintain audit independence, including by:

• Allowing management to influence audit testing by permitting the swapping of samples for site visits that management did not wish to be inspected, and even requesting management to select its own site visit samples for audit testing; and
• Assuming management’s responsibility in preparing financial statements that formed the basis of the Group’s consolidated financial statements, notwithstanding that such responsibility rested with management.  By doing so, the Auditor placed itself in a position where it would be auditing its own work.

(iv) Failing to comply with professional standards when performing audit work, with numerous deficiencies across multiple audit areas and procedures, including tests of controls, walkthrough procedures, and tests of details.

(v) Failing to properly monitor and evaluate the system of quality control of the relevant office of PwC’s network firm (Relevant Office).

These deficiencies ultimately enabled the Group to prematurely recognise revenue, inflate reported profits, as well as materially misstate its properties under development and completed properties held for sale, which were major assets reported at RMB1,327.5 billion and RMB1,406.4 billion representing 60% and 61% of the Group’s total assets for 2019 and 2020 respectively.

Mr Denis Cheng, Head of Investigation and Compliance, said, “The AFRC’s findings reflect serious auditor misconduct, particularly in facilitating manipulation, breaches of audit independence and failures to exercise professional scepticism, which are egregious and wholly unacceptable.  Independence, objectivity and scepticism constitute a non-negotiable foundation of audit practice.  These fundamental breaches fall dramatically below the standards expected of a leading firm in Hong Kong.”

As the group signing auditor, PwC bore ultimate responsibility for audit quality and was required to exercise effective governance and monitoring controls over audit work performed by the Relevant Office.  In the Evergrande Group Audits, PwC relied heavily on the audit work performed by that office without properly monitoring or evaluating the design and operating effectiveness of its system of quality control.  There were pervasive and systemic deficiencies in multiple areas of the system of quality control in the Relevant Office, including:

(i) Insufficient focus on audit quality by partners: The partner performance evaluation framework for engagement partners at the Relevant Office placed disproportionate emphasis on client relationships, business development and revenue generation, with limited focus on audit quality.  This reflects an improper prioritisation of commercial interests over audit quality at that office. 

(ii) Partners’ financial dependence on key client relationship:  More than 80% of the engagement partner’s revenue was generated from engagements for the Group.   Given that engagement finance was a major component of partner performance evaluation, this substantial financial dependence created a significant self-interest and/or intimidation threat.  However, senior management neither assessed the extent of this dependence nor implemented effective safeguards to mitigate the resulting threats.

PwC’s failures to identify and address these and other quality control deficiencies in the Relevant Office materially impaired its ability to ensure audit quality in the Evergrande Group Audits.     

In circumstances where the engagement team heavily relied on the work performed by the Relevant Office, Chow as the PwC South China and Hong Kong Assurance Leader and designated quality control system responsible person (QCSRP) of PwC at the time of the Evergrande Audits, had responsibility for understanding and evaluating the effectiveness of the system of quality control of that office.  In this regard, the AFRC found that Chow breached his statutory obligations in that he failed to use his best endeavours to ensure that PwC established, and complied with, effective policies and procedures for monitoring the quality control system of the Relevant Office.  In addition, Chow had failed to demonstrate professional competence and due care in performing his role as QCSRP.

The AFRC also found that Cheung, as the engagement quality control reviewer (EQCR), failed to adequately evaluate the engagement team’s significant judgments and conclusions in the Evergrande Group Audits and the Evergrande Vehicle Audit, despite being aware of significant risks of fraud in revenue recognition and management override of controls, as well as the significant risk relating to going concern assessment.  

Ms Janey Lai, Chief Executive Officer of the AFRC, said, “This case highlights the need for robust quality management systems and effective oversight, especially for audit engagements involving cross-boundary arrangements.  Audit quality is anchored in the tone at the top set by firm leadership, and reinforced through firm‑wide governance and supervision, to ensure that legitimate regulatory and market expectations placed on public interest entity auditors are translated into high-quality audit work at the engagement level.”  

The AFRC’s Disciplinary Decision

The AFRC is satisfied that PwC, Cheung and Chow failed to discharge their professional responsibilities and did not meet the standard of care expected of a reasonably competent auditor, EQCR and QCSRP, respectively.  Accordingly, the AFRC finds that each of PwC, Cheung and Chow had committed misconduct under the Accounting and Financial Reporting Council Ordinance (Cap. 588).  

In deciding the appropriate disciplinary sanctions, the AFRC has considered all the relevant circumstances, including the nature, seriousness, duration, frequency and impact of the misconduct, as well as the relevant aggravating and mitigating factors.  Among other things: 

• The Auditor demonstrated a significant loss of independence and objectivity, and failed to exercise professional scepticism despite heightened fraud and management override risks.  This misconduct strikes at the core of an independent audit and severely undermines the credibility of the auditor’s work.
• Significant deficiencies were also identified in PwC’s monitoring of the quality control system at the Relevant Office and PwC’s supervision of that office.  The deficiencies identified in that office were systemic and pervasive, yet PwC failed to detect and address such deficiencies, reflecting weaknesses in its governance and monitoring control of its system of quality control.  
• The Auditor’s misconduct in the Evergrande Audits allowed material misstatements in the consolidated financial statements over two financial years to go unchallenged, putting investors’ and stakeholders’ interests at risk, and significantly damaging public trust in the reliability of audited financial information and the integrity of the capital markets.
• Aggravating and mitigating factors: The AFRC took into account PwC’s prior disciplinary history with the Hong Kong Institute of Certified Public Accountants as an aggravating factor.  The AFRC also took into account the remedial measures that PwC has already undertaken and continues to undertake following the incident, as well as the fact that Cheung and Chow each have a clean disciplinary record, as mitigating factors.

Ms Hester Leung, Head of Discipline, said, “This marks the first time the AFRC has imposed a practice limitation on a public interest entity auditor.  The combination of hefty pecuniary penalties and a practice limitation is necessary and appropriate, given the serious and egregious audit failures, the substantial weaknesses in the audit firm’s governance and monitoring controls, and the profound and far-reaching impact on the public interest.  Together, these sanctions send a clear message that serious departures from professional standards will not be tolerated and will be met with robust enforcement action.”
 

Dr David Sun, Chairman of the AFRC, said, “Strong ethics and high-quality audits are fundamental to the integrity of financial reporting and market confidence. While the issues identified in this case are serious, the AFRC remains confident in the credibility and capability of Hong Kong’s audit profession as a whole.  The AFRC has taken note of PwC’s proactive remedial measures, and expects the firm to build on these efforts, demonstrating through its governance, leadership and conduct a sustained commitment to audit quality that meets the expectations placed on it as a leading firm.” 
 

The AFRC expresses its deep appreciation for the unwavering support of the Supervision and Evaluation Bureau of the Ministry of Finance of the People’s Republic of China in this matter, which underscores the importance of strong cross-boundary cooperation in effective regulatory oversight and enforcement.

For details of the decision, please refer to the Statement of Disciplinary Action.