Cloopen closes the book on fraud case, looks to rebuild

The U.S. securities regulator charged the cloud services provider with fraud for falsifying revenue, but didn’t impose any fine due to the company’s cooperation in the investigation

Key Takeaways:

• The SEC charged cloud services provider Cloopen with falsifying revenue, but also praised it for cooperating with its investigation into the matter
• The company announced a major board overhaul in December, but faces a long road in its rebuilding effort due to stiff competition and China’s slowing economy

By Doug Young

It was one of China’s last major IPOs in New York before the current freeze, raising $320 million in a February 2021 New York listing on big hopes for China’s cloud services market. But what started as a drizzle with so-so financial results quickly turned into a downpour onto shares of Cloopen Group Holding Ltd. (RAASY.US) after its May 2022 disclosure of up to 30 million yuan ($4.2 million) in fake sales on its books.

Now, Cloopen is hoping to turn the page on its dubious past following a newly announced settlement of fraud charges leveled against it by the U.S. Securities and Exchange Commission (SEC). The company is hoping to follow in the footsteps of the similarly scandal-tainted Luckin (LKNCY.US), which admitted to even larger fraud in a case that shocked Wall Street in 2020 and was likely a factor behind the SEC’s crackdown on new Chinese IPOs dating from 2021.

Cloopen’s case also has implications for intra-city courier services provider Dada Nexus (DADA.US), which just last month admitted to similarly cooking its books.

All three of these cases are notable because their fraud was uncovered through internal audits, rather than through SEC-initiated probes. That’s at least partly due to the fact that the SEC previously had little or no access to these companies’ internal books because most or all of their accounting records were out of its reach in China. But that changed in 2022 when the SEC got such access through a landmark information-sharing deal with its Chinese counterpart.

All these developments, when considered as a whole, should reassure foreign investors that the financial reports from U.S.-listed Chinese companies are becoming more reliable. But it’s unclear just yet if companies like Cloopen, Luckin and Dada Nexus will eventually be forgiven for their sins and allowed to return to the main exchanges on Wall Street.

Both Luckin and Cloopen are currently in over-the-counter trading purgatory, having been officially booted from their previous listings on the Nasdaq and New York Stock Exchange, respectively. Dada Nexus continues to trade on the Nasdaq, but is likely to come under pressure to delist if it fails to file its annual reports while it sorts through its accounting mess. Luckin has previously stated its desire to relist if the Nasdaq will allow it, though the Nasdaq hasn’t openly commented on the case.

Cloopen’s settlement is probably too fresh to think about a potential relisting just yet, and the company has said it is still determining its next step.

While being charged with fraud by the SEC is obviously never a good thing, the terms of Cloopen’s settlement actually look about as good as the company could have hoped for considering the circumstances. Most notably, the SEC didn’t fine the company for its transgressions due to Cloopen’s full cooperation with the investigation. That contrasts sharply with Luckin, which was fined $180 million in 2020 for overstating its 2019 revenue by as much as 2.2 billion yuan – equal to about 40% of its expected annual sales at the time.

SEC praise

Truth be told, the SEC was quite praiseworthy of Cloopen for its handling of the matter.

“The SEC determined not to impose civil penalties against Cloopen because the company self-reported its accounting issues, cooperated extensively with the staff’s investigation, and undertook prompt remedial measures,” it said in its statement released last Thursday. The SEC said its investigation found that “facing pressure to meet strict quarterly sales targets, two senior managers directed their employees to improperly recognize revenue on numerous contracts for which Cloopen had either not completed work or, in some instances, not even started work.”

The generally positive tone to the SEC’s statement is significant, since the New York Stock Exchange will inevitably take such an attitude into consideration if and when Cloopen tries to relist its shares in the future. The stock currently trades at just $0.0002, and has mostly traded below one cent since last June when it announced it would be delisted.

Since then, the company has been busy not only trying to mend fences with the SEC, but also to steady its ship. The most significant step in that regard came in December when it announced the resignation of five people from its board, including the relinquishing of the chairman’s position by CEO Sun Changxun. Other departing board members included CFO Li Yipeng and chief product officer Xiong Xiegang.

Significantly, however, Sun, Li and Xiong all retained their positions in the company despite leaving the board. That’s quite different from Luckin, whose top two officials were both kicked out of the company after the fraud. Luckin went on to install a new top management team and has embarked on a rapid growth story that has won back investors, who have bid up its shares by more than a factor of 10 from their low point back in 2020.

While the SEC may be open to a Cloopen relisting if the company can show that it has sufficiently reformed, a major obstacle to winning back investors may simply be its stalling growth. The company was hardly a rising star in its last financial report before the scandal, reporting its revenue rose 44.3% year-on-year to 276 million yuan in the third quarter of 2021. The fraud would have reduced that to perhaps around 30% growth, but either way the actual amounts are relatively small.

The reality is that China’s economy is slowing sharply after years of breakneck growth, which is likely to affect companies’ spending on things like cloud services. At the same time, U.S. export restrictions could also affect the sector’s development – a factor that was behind e-commerce giant Alibaba’s (BABA.US; 9988.HK) recent decision to scrap its previously announced plan to spin off its cloud division as a standalone company.

On the whole, the overall picture for Cloopen remains quite cloudy. The SEC’s positive tone could pave the way for an eventual relisting if that’s what the company wants. But first it will need to convince investors that it’s a company with a future, which could be tough in the current economic environment and also with its old management team still in place.

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