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* OSC staff allege breach of Ontario Securities Act
* Ernst & Young says its work was up to standard
* Sino-Forest collapsed after short-seller's allegations
* Sino-Forest investors settle for C$117 million
By Allison Martell and Solarina Ho
TORONTO, Dec 3 (Reuters) - Canadian regulators said on Monday Ernst & Young had conducted improper audits of Sino-Forest Corp in the years before fraud allegations brought down its client, and the accounting firm said it reached a settlement in a class-action suit by Sino shareholders.
Dimitri Lascaris, a partner at Siskinds LLP and co-lead counsel for the investor class action, said he believes the auditor settlement, at C$117 million ($118 million), was the biggest of its kind in Canadian history.
The news came on the same day as the Ontario Securities Commission announced formal allegations against the auditor and about a year and a half after short-seller Carson Block first accused Sino-Forest of grossly exaggerating its assets.
Block's report touched off a firestorm that led to the company's delisting and insolvency, as well as a flurry of regulatory actions and lawsuits.
The OSC's staff allege that Ernst & Young's audits for 2007 to 2010 failed to measure up to industry standards in verifying the ownership and existence of Sino-Forest assets, the regulator said. It also said the firm should have applied more professional skepticism to their audits.
"Investors rely on auditors to conduct their audits in accordance with professional standards, particularly when foreign companies are listing on Canadian exchanges," said Tom Atkinson, OSC's director of enforcement. "If auditors fail to abide by Canadian auditing standards and securities laws, we will hold them accountable."
In an emailed response, Ernst & Young Canada denied the allegations, saying it was confident its work on the Sino-Forest audits "met all professional standards." The firm resigned as Sino-Forest's auditor in April.
Separately, U.S. regulators charged the Chinese affiliates of five top accounting firms, including Ernst & Young, with violating U.S. securities law.
The Securities and Exchange Commission alleged that the firms refused to produce audit documents in connection with accounting fraud investigations into some U.S.-listed Chinese companies.
Sino is the most prominent in a series of North American-listed companies with Chinese operations whose accounting or disclosure practices came under suspicion last year. The scandals have hurt investor confidence and led to sharp declines in the equity valuations of many Chinese companies listed in the United States and Canada.
In addition to Ernst & Young, the class-action suit names Sino-Forest itself, company executives, financial institutions and others. The settlement requires court approval.
"We have many defendants left, and we are now going to focus our attentions on ensuring that all of them are held accountable for their role in this matter," he said.
In a separate statement on the class action, Ernst & Young said the settlement did not include any admission of liability, and confirmed that it was for C$117 million.
"Upon approval, the settlement will reduce the uncertainty and future burden on our business, and allow us to focus on our people and our clients," it said.
The Sino-Forest affair has prompted criticism of Canada's regulatory regime as being lax in its oversight of companies listed in Canada.
On Monday, Lascaris, one of the country's leading securities class action lawyers, sounded an optimistic note.
"We finally have a legal regime in Ontario which provides a clear path to recovery against auditors and other experts," he said.
Changes to the Ontario Securities Act that came into effect in late 2005 make it easier to bring securities class actions, including those against auditors. But the lawsuits are still relatively rare in Canada, and the new law has faced few real-world tests.
OSC's Atkinson said in the release that a major focus in the Sino-Forest investigation has been whether auditors and other advisers acted properly.
While the investigation is not over, the regulator is unlikely to take action against any additional parties involved with Sino-Forest, spokeswoman Carolyn Shaw-Rimmington said.
"At this stage and based on the evidence presently available, we do not anticipate initiating proceedings against additional parties," she said.
The OSC said there would be a hearing on its allegations on Jan. 7, 2013. In cases like this one, staff at the regulator argue the case before OSC commissioners, who can choose to impose monetary penalties and other sanctions.
"The evidence we will present to the OSC will show that Ernst & Young Canada did extensive audit work to verify ownership and existence of Sino-Forest's timber assets," said the statement from Ernst & Young.
Trading in shares of Sino-Forest, once the biggest forestry company on the Toronto Stock Exchange, was halted in August 2011. The shares were formally delisted in May 2012, and the company is now insolvent.
Sino-Forest filed for protection under the Companies' Creditors Arrangement Act, the equivalent of U.S. Chapter 11 filing, in March.
On Monday, the company said its creditors had voted to approve its reorganization plan, under which the creditors will acquire all of its forestry assets.