Detailed Review: Cloopen Group's Accounting Fraud
- Sarvesh Saxena, Attorney
- Jul 21, 2024
- 4 min read
I. Introduction
The Securities and Exchange Commission (“Commission”) instituted cease-and-desist proceedings against Cloopen Group Holding Limited (“Cloopen” or “Respondent”) pursuant to Section 21C of the Securities Exchange Act of 1934 (“Exchange Act”). This decision was taken in response to an offer of settlement submitted by Cloopen, which the Commission accepted. The proceedings focus on violations of federal securities laws, specifically concerning accounting fraud.
II. Summary of Findings
Fraudulent Revenue Recognition:
1. Nature of Misconduct:
Senior management at Cloopen, specifically the former Operating Management Director and a former Department Head, were found to have engaged in fraudulent activities to prematurely recognise revenue on service contracts.
These actions took place from May 2021 through February 2022, during which the Senior Managers directed their department to recognise revenue on incomplete or unstarted projects.
2. Impact on Financial Statements:
As a result, Cloopen overstated its revenues for Q2 2021 by $1.8 million (approximately 4% of total revenue) and for Q3 2021 by $2.8 million (approximately 6% of total revenue).
The announced revenue guidance for Q4 2021 was also significantly overstated.
3. Market Reaction:
The announcement of an internal investigation led to a 12.7% decline in the price of Cloopen’s American depositary shares.
III. Detailed Findings
Cloopen’s Corporate Structure and Operations:
1. Company Overview:
Cloopen, a Cayman Islands corporation, operates in China through its variable interest entity, Beijing Ronglian Yitong Information Technology Co. Ltd.
Cloopen’s American depositary shares (ADSs) were registered with the SEC and traded on the NYSE under the symbol “RAAS” until delisting in November 2023.
Discovery and Internal Investigation:
1. External Audit and Resignation:
During the audit of Cloopen’s financial statements for FY 2021, the External Auditor identified irregularities in customer transactions, leading to their resignation on April 29, 2022.
Following this, Cloopen announced an internal investigation on May 3, 2022.
2. Internal Investigation Findings:
The internal investigation revealed that the Senior Managers had fraudulently recognised revenue on approximately 25 out of 43 contracts in their department.
The investigation also uncovered similar misconduct in other departments, including improper use of acceptance reports and lack of supporting documentation.
3. Financial Misstatements:
Cloopen overstated revenues for Q2 2021 by $1.8 million and for Q3 2021 by $2.8 million.
The premature recognition of millions of dollars in revenue for Q4 2021 led to overstatement of revenue guidance.
Violations of the Exchange Act:
1. Section 10(b) and Rule 10b-5:
Cloopen engaged in fraudulent conduct related to the purchase or sale of securities.
2. Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B):
Cloopen failed to file accurate and timely reports and did not maintain adequate books, records, and internal accounting controls.
IV. Cloopen’s Remedial Actions and Cooperation
Prompt Reporting and Cooperation:
1. Self-Reporting:
Cloopen promptly self-reported the accounting errors to the SEC in early May 2022, soon after retaining outside counsel.
2. Cooperation with SEC:
Cloopen provided substantial cooperation, including detailed explanations, witness summaries, and key documents.
Remedial Measures:
1. Management and Organisational Changes:
Cloopen formed an independent special committee to investigate the issues.
The company terminated the Senior Managers responsible and disciplined other involved employees.
Departments involved in the misconduct were reorganised or removed.
2. Internal Controls and Training:
Cloopen strengthened internal accounting controls related to customer contracts, payments, and revenue recognition.
Executives, department heads, and employees received retraining on internal controls and company policies.
New finance and accounting personnel with expertise in U.S. GAAP were recruited.
3. Clawback of Bonuses:
Cloopen implemented a clawback policy, reclaiming $228,000 in bonuses from its CEO and CFO.
V. SEC’s Order
Sanctions and Conditions:
1. Cease-and-Desist Order:
Cloopen has been ordereded to cease and desist from committing any future violations of Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and related rules.
2. Conditional Civil Penalty:
The SEC has not imposed a civil penalty at this time, recognising Cloopen’s cooperation. However, if Cloopen is found to have provided materially false information, the SEC reserves the right to seek penalties.
VI. Conclusion
The SEC’s action against Cloopen underscores the critical importance of maintaining robust internal accounting controls and ethical management practices. This case highlights the severe consequences of fraudulent financial reporting and serves as a cautionary tale for corporations.
It is noteworthy that self-reporting can play a crucial role in resolving serious regulatory lapses and fraud issues. Regulators often view self-reporting as a demonstration of good faith and a commitment to compliance, which can result in more favourable outcomes, including reduced penalties and a more collaborative resolution process.
Source: SEC
LEGAL ANALYSIS BY: Sarvesh Saxena, Barrister, Bar of England & Wales. Authorised to conduct unreserved legal services. No Rights of Audience.
Legal Disclaimer:
This article is intended for general informational purposes only and does not constitute legal advice. It may not reflect the most current legal developments and is not guaranteed to be accurate or complete. No attorney-client relationship is established by this article. Readers are advised to seek professional legal counsel from a qualified attorney in their jurisdiction before making any legal decisions.
The author disclaims all liability for any actions taken based on the content of this article. Any views or opinions expressed are those of the author and do not necessarily reflect the official policy or position of any other agency, organisation, employer, or company.
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