Enforcement News: SEC Settles Accounting Fraud Charges with Chinese Company and Declines to Impose Civil Penalties Because of the Company’s Self-Reporting, Cooperation and RemediationPrint Article
- Posted on: Feb 8 2024
By: Jeffrey M. Haber
Self-reporting violations of the federal securities laws is an important part of the Securities and Exchange Commission’s enforcement regimen. For decades, the SEC has credited cooperative behavior that assists the Commission in its mission to protect investors. As such, when businesses self-report and rectify allegedly illegal conduct, and otherwise cooperate with Commission staff, the SEC has shown a willingness to forego the imposition of civil penalties when settling enforcement actions.
What does the Commission consider to be sufficient assistance and cooperation? Actions such as self-policing, self-reporting, remediation, and cooperation, are the primary considerations.1
Self-policing concerns an entity’s governance and compliance programs and their ability to detect potential violations before they come to light.2 Self-reporting involves the disclosure of misconduct to the public, regulatory agencies, and self-regulatory organizations after conducting a thorough investigation into the origins, scope and consequences of the misconduct.3 Remediation refers to actions taken by the entity to correct the violations of law, such as termination of employment, employee discipline, modifying and improving internal controls and procedures to prevent recurrence of the misconduct, and compensating those adversely affected.4 Cooperation refers to the entity providing assistance to regulators and giving regulators access to information relevant to the alleged violations.5
In the Matter of Cloopen Group Holding Limited, the SEC declined to impose civil penalties against the company because of its self-reporting, cooperation and remediation.
Cloopen arose from an alleged accounting fraud perpetrated by the former Operating Management Director and a former Department Head at Cloopen Group Holding Limited (the “Senior Managers”). Cloopen is a Cayman Islands corporation that is headquartered in Beijing, People’s Republic of China (“China”) and operates in China through its variable interest entity, Beijing Ronglian Yitong Information Technology Co. Ltd. Cloopen provides cloud-based communications products and services to enterprises of various sizes located primarily in China. Cloopen’s American depositary shares (“ADSs”) were registered with the Commission pursuant to Section 12(b) of the Exchange Act and traded on the New York Stock Exchange (“NYSE”) under the symbol “RAAS.”
According to the SEC, during Cloopen’s year-end audit for fiscal year 2021, its external auditor (the “External Auditor”) identified potential accounting errors. Following an internal investigation, said the SEC, Cloopen determined that, from May 2021 through February 2022, the two China-based Senior Managers, who headed the department that handled Cloopen’s strategic customers, had orchestrated a fraudulent scheme to prematurely recognize revenue on service contracts for which Cloopen had either not completed work or, in some instances, not even started work. The SEC also said that Cloopen identified additional problematic contracts in other departments that were missing or appeared to have falsified supporting documentation.
As a result of the foregoing, the SEC alleged that Cloopen overstated the unaudited financial results that it announced in its filings with the SEC for the second and third quarters of 2021. Specifically, said the SEC, Cloopen’s revenue for the second quarter of 2021 was overstated by $1.8 million (RMB 11.6 million) (approximately 4% of its total revenue) and its revenue for the third quarter was overstated by $2.8 million (RMB 17.8 million) (approximately 6% of its total revenue).
In addition, noted the SEC, Cloopen’s announced revenue guidance for the fourth quarter of 2021 was significantly overstated. When Cloopen announced the investigation into potential accounting errors, the price of its ADSs declined 12.7% from the prior day’s closing price.
The SEC settled its charges against Cloopen, and declined 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. In this regard, in early May 2022, Cloopen self-reported to the Commission’s staff the accounting errors uncovered by the External Auditor. Cloopen made the self-report within a few days of retaining outside counsel to conduct an internal investigation and before any significant steps had been taken as part of that investigation.
Thereafter, noted the SEC, Cloopen provided substantial cooperation to the Commission’s staff throughout the staff’s investigation, including by providing detailed explanations of the customer transactions at issue and their financial impact; summarizing interviews of witnesses located in China; identifying, translating, and producing certain key documents originally written in Chinese; and providing other relevant information to the staff. The cooperation afforded by Cloopen, said the SEC, substantially advanced the efficiency of the staff’s investigation and conserved Commission resources.
According to the SEC, Cloopen also undertook prompt remedial measures, including: (1) forming an independent special committee of its Board of Directors to investigate the issues raised by the External Auditor; (2) terminating the Senior Managers who orchestrated the early revenue recognition misconduct and also disciplining other employees who were involved; (3) reorganizing or removing the departments involved in the misconduct; (4) strengthening its internal accounting controls surrounding customer contracts, payments, and revenue recognition; (5) retraining company executives, department heads, and employees in the finance, accounting, internal audit, and sales departments on Cloopen’s internal accounting controls and company policies and procedures, including with respect to revenue recognition; (6) recruiting finance and accounting personnel with expertise in U.S. GAAP; and (7) clawing back $228,000 (RMB 1.64 million) of bonus compensation paid to Cloopen’s Chief Executive Officer and Chief Financial Officer for the last nine months of 2021.
The SEC found that Cloopen violated the antifraud provisions of the Securities Exchange Act of 1934, as well as certain reporting, recordkeeping, and internal controls provisions of the federal securities laws. Without admitting or denying the SEC’s findings, Cloopen agreed to cease and desist from further violations of the charged securities laws.
Commenting on the settlement, and in particular Cloopen’s self-help, cooperation and remediation, Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, stated:
This enforcement action demonstrates what we have said repeatedly: there are real benefits to companies that self-report their potential securities law violations, assist during our investigations, and undertake remedial measures. As detailed in our order, Cloopen, a foreign issuer, promptly self-reported accounting errors to Commission staff, provided detailed explanations of the transactions at issue, and cooperated in other ways that substantially advanced the investigation. Cloopen also promptly undertook significant remedial measures, including terminating and disciplining employees involved in the misconduct, strengthening its internal accounting controls, and clawing back compensation from its CEO and CFO. In consideration of Cloopen’s significant cooperation, the Commission determined not to impose a civil penalty against Cloopen.
The press release announcing the settlement of the charges can be found here.
The SEC’s cease and desist order can be found here.
- See SEC, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions (Exchange Act Rel. No. 44969) (Oct. 23, 2001) (here).
- See SEC Enforcement Manual (Nov. 28, 2017), at 6.12 (here).
Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.