Key Points to Note:

• The SEC has charged the cloud services provider Cloopen with falsifying revenue, yet the company is commended for its cooperation with the investigation into the matter
• A major board overhaul was announced by the company in December, but it faces a challenging journey in its rebuilding efforts due to stiff competition and China’s slowing economy

By Doug Young

In February 2021, prior to the current IPO stagnation, Cloopen Group Holding Ltd. RAAS made headlines with a $320 million New York listing, envisioning ample prospects in China’s cloud services market. However, what began as a hopeful drizzle soon intensified into a downpour upon shares of Cloopen after its May 2022 revelation of up to 30 million yuan ($4.2 million) in fabricated sales.

Now, Cloopen seeks to eclipse its checkered past following a newly announced resolution of fraud charges brought by the U.S. Securities and Exchange Commission (SEC). The company aspires to emulate the path of Luckin, which, despite admitting to a larger fraud that rocked Wall Street in 2020, is striving for redemption.

Cloopen’s case is also impactful for a fellow company, Dada Nexus, which recently confessed to similar financial manipulation.

The exposure of fraud in all three cases through internal audits – as opposed to SEC-initiated probes – is noteworthy. Previously, the SEC had limited or no access to the internal records of these companies since their accounting documents were largely beyond its reach in China. However, this changed in 2022 when the SEC gained such access through a landmark information-sharing pact with its Chinese counterpart.

All these developments should offer solace to foreign investors, signifying that the financial reports from U.S.-listed Chinese companies are becoming more dependable. Nevertheless, it remains uncertain whether companies like Cloopen, Luckin, and Dada Nexus will be forgiven for their transgressions and permitted to return to Wall Street’s primary exchanges.

Currently, both Luckin and Cloopen dwell in OTC trading limbo, having been officially ejected from their previous listings on the Nasdaq and New York Stock Exchange, respectively. Dada Nexus continues to trade on the Nasdaq, but could face delisting pressure if it fails to submit its annual reports amidst its accounting predicament. While Luckin has expressed its desire for a relisting if permitted by the Nasdaq, the exchange has not publicly commented on the matter.

Given the freshness of Cloopen’s settlement, concerns about potential relisting are premature, and the company has yet to decide its next course of action.

While facing a fraud charge by the SEC is unequivocally unwelcome, the terms of Cloopen’s settlement appear as favorable as they could be, given the circumstances. Most notably, the SEC refrained from imposing civil penalties on the company owing to Cloopen’s full cooperation with the investigation. This is a stark contrast to the fate of Luckin, which was fined $180 million in 2020 for inflating its 2019 revenue by as much as 2.2 billion yuan – equivalent to approximately 40% of its anticipated annual sales at the time.

Laudatory Remarks from the SEC

Truth be told, the SEC’s commendation of Cloopen is significant. In its statement released last Thursday, the SEC stated, “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.” The SEC’s investigation revealed 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 of the SEC’s statement holds weight, as the New York Stock Exchange will inevitably consider such an attitude if and when Cloopen seeks a relisting of its shares in the future. Currently, the stock trades at just $0.0002, and has mostly hovered below one cent since last June when the delisting was announced.

Subsequently, the company has been diligently engaged in not only reconciling with the SEC but also steadying its course. A pivotal move in this regard was the resignation of five individuals from its board, including CEO Sun Changxun relinquishing the chairman’s position, and CFO Li Yipeng and chief product officer Xiong Xiegang exiting the board.

Notably, Sun, Li, and Xiong retained their positions in the company despite departing from the board. This departs from the aftermath of Luckin’s fraud, where its top two executives were expelled from the company. Following the scandal, Luckin reconstituted its senior management team and embarked on a rapid growth trajectory, inciting investor confidence and driving up its shares by over tenfold from their nadir in 2020.

Although the SEC may be open to a potential Cloopen relisting if the company demonstrates substantial reform, a formidable hurdle to regaining investor faith may be its stagnant growth. The company was far from a rising star in its last financial report before the scandal, reporting a mere 44.3% year-on-year revenue increase to 276 million yuan in the third quarter of 2021. With the fraud, this growth would have been pared down to approximately 30%, irrespective of the actual amounts being relatively modest.

The truth remains that China’s economy is decelerating markedly after years of breakneck expansion, likely impinging on companies’ expenditure on services like cloud computing. Concurrently, U.S. export regulations could also impact the sector’s progression – a factor that prompted e-commerce behemoth Alibaba BABA to rescind its previously announced cloud division spinoff as a standalone entity.

In totality, Cloopen’s landscape remains rather murky. The SEC’s favorable disposition could pave the way for a potential relisting, if that is the company’s intention. However, the company first needs to convince investors of its viability, a task made arduous amid the current economic milieu and with its former management team still at the helm.

This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.