Breaches to the code of ethics: A case study for PAIBs

10/27/2021

A look at how the Code of Ethics for Professional Accountants underpins the importance of professional behaviour and integrity for professional accountants in business



The Code of Ethics for Professional Accountants (code) applies to all Institute members. Chapter A of the code is based on the International Ethics Standards Board for Accountants’ (IESBA) International Code of Ethics for Professional Accountants (Including International Independence Standards). It is underpinned by the five fundamental principles that establish the standard of behaviour expected of a professional accountant. They are:

  • Integrity
  • Objectivity
  • Professional competence and due care
  • Confidentiality
  • Professional behaviour

The code also requires professional accountants in public practice to be independent when performing audits, reviews, or other assurance engagements. Independence is closely linked to the principles of integrity and objectivity and is an important element of serving the public interest.

Paragraph 10 of the preface of the code states that “Council requires members of the Institute to comply with the code. Apparent failures by members of the Institute to comply with the code are liable to be enquired into by the appropriate committee established under the authority of the Institute, and disciplinary action may result...” Disciplinary action may include:

  • Temporary or permanent removal from membership.
  • Temporary or permanent cancellation of a practising certificate issued to a CPA.
  • Reprimand.
  • Penalty of up to HK$500,000.
  • Payment of costs and expenses of proceedings.

This is the first of two case studies in A Plus, developed by the Institute’s Ethics Committee. This case study covers a situation in business, while the next case study, which will be covered in next month’s issue, will cover one in practice. They illustrate breaches to the fundamental principles of the code by professional accountants and are adapted from the real-life cases involving Institute members. These scenarios illustrate the fundamental principles in the code, but are not intended to cover every possible circumstance. Where appropriate, additional case studies would be developed to raise the awareness of certain ethical topics and corresponding requirements in the code.

Case 1: Sales of trust assets

In 2014, Peter became the sole director of ABC Limited. He also became the sole registered shareholder of the company for the benefit of the beneficial owner of ABC Limited who is a separate legal person.

The company held shares in a Hong Kong-listed company, XYZ International Limited. On 18 September 2015, the shares’ market value was HK$140 million. On 18 September 2015:

  • Peter facilitated ABC Limited to sell the shares to a buyer at 40 percent of the closing price on the day immediately before.
  • A HK$5 million cheque was drawn by the buyer to ABC Limited as part of the purchase consideration, but Peter never cashed it. The terms of the sale were to be completed seven days later. There was no security for the payment other than a deposit of HK$5 million.
  • The disposal of shares was without the consent, knowledge or instructions of the beneficial owner of ABC Limited.

Peter claimed that the poor annual results published by XYZ International Limited on 18 September were an impetus for selling the shares. He considered the sale of shares was in the best interest of ABC Limited, the beneficial owner and himself.

Peter signed the “sold notes” of the shares which stated that the sales were for full market value and that the consideration had been received, in the knowledge that this was untrue. These notes would be provided to the Inland Revenue Department for stamp duty purposes.

Consider the following with reference to the code:

1. Which fundamental principles did Peter fail to comply with?

2. Was it appropriate for Peter to sell the shares in the manner described in the case? Why or why not?

3. Peter asserted that there was no breach of the fundamental principles with regard to the sold notes for stamp duty purposes. He argued that there would only be falsity if it involved understating the consideration, but there would not be falsity in overstating the consideration and paying more stamp duty. Do you agree?

Peter failed to comply with the fundamental principles of professional behaviour and integrity.

Professional behaviour

Peter failed to uphold the fiduciary duties to the beneficial owner of ABC Limited under the relevant laws (i.e. the common law) to act in the best interests of the company. He sold the shares at a substantial discount of the market price and executed the sales without security other than a deposit of HK$5 million. Also, he disposed of 100 percent of the shares without any prior consent from the beneficial owner.

The Institute’s Disciplinary Committee, when considering the facts and circumstances in the given scenario, summarized in its disciplinary decision that it is untenable that the respondent (i.e. Peter) would consider that it was in the company’s best interests to sell the shares at a 60 percent discount without first selling the shares on the market; it is unbelievable that the respondent would consider it to be in the company’s best interests to execute the sales without any security other than a deposit for HK$5 million.

Peter made false statements in the sold notes to the shares that the sales were for full market value and that consideration had been received, which was not true. They were false statements regardless of whether the consideration was more or less than the actual amount. The fact that Peter had not defrauded upon the amount of the stamp duty to levy is irrelevant regarding whether there was a breach to the fundamental principles.

Integrity

Peter acted dishonestly and caused ABC Limited to mislead the Inland Revenue Department by signing the sold notes showing incorrect sales proceeds, and by knowingly participating in a transaction which involved the misapplication of trust assets to the detriment of the beneficial owner.

What does the code say?

Paragraph R115.1 in Chapter A requires Institute members to comply with the principle of professional behaviour, i.e. to comply with relevant laws and regulations; behave in a manner consistent with the profession’s responsibility to act in the public interest in all professional activities and business relationships; not perform any action that would discredit the profession.

The code also requires members to act with integrity, i.e. to be straightforward and honest in all professional and business relationships (paragraph R111.1 in Chapter A). The code describes integrity as involving fair dealing, truthfulness and having the strength of character to act appropriately, even when facing pressure to do otherwise or when doing so might create potential adverse personal or organizational consequences (paragraph 111.1 A1 in Chapter A).

What should Peter have done?

Peter should have:

  • Obtained prior consent from the beneficial owner before disposing the shares.
  • Acted in the interest of ABC Limited. This includes but is not limited to assessing threats to compliance with the fundamental principles by exercising professional judgement and taking into account whether a reasonable and informed third party would be likely to conclude that it would be in ABC Limited’s best interests to:

      - Sell the shares at a 60 percent discount instead of selling them on the market; and

      - Execute the sale without any security other than a deposit for HK$5 million


  • Acted honestly, including but not limited to, stating the actual price for the sale of shares in the sold notes. 

This article was contributed by the Institute's Standard Setting Department. This guidance is for general reference only. The Institute, Ethics Committee and the staff of the Institute do not accept any responsibility or liability in respect of the guidance and any consequences that may arise from any person acting or refraining from action as a result of any materials in the guidance. Members of the Institute and other users of this guidance should also read the original text of the code for further reference and seek professional advice where necessary. The Institute’s Standard Setting Department welcomes your comments and feedback on this guidance, which should be sent to commentletters@hkicpa.org.hk.