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China Based Issuer Resolves Books And Records And Internal Controls Matter


The Foreign Corrupt Practices Act has always been a law much broader than its name suggests.

Sure, the FCPA contains anti-bribery provisions which concern foreign bribery.

Sure, the FCPA’s books and records and internal controls provisions can be implicated in foreign bribery schemes.

However, the fact remains that most FCPA enforcement actions (that is enforcement actions that charge or find violations of the FCPA’s books and records and internal controls provisions) have nothing to do with foreign bribery. For lack of a better term, these enforcement actions have longed been called non-FCPA, FCPA enforcement actions by this site.

The latest example involves Cloopen Group Holding Limited. Cloopen (a Cayman Islands corporation headquartered in China) is a provider of cloud-based communication products and services. As stated by the SEC: “Cloopen does not operate in the United States and has no employees based in the United States. However, because Cloopen has American depositary shares that traded on the NYSE, it was required to file periodic reports” with the SEC.

In summary fashion, this administrative order finds:

“These proceedings arise from an accounting fraud perpetrated by the former Operating Management Director and a former Department Head at Cloopen (the “Senior Managers”). During Cloopen’s year-end audit for fiscal year 2021, its external auditor (the “External Auditor”) identified potential accounting errors. Following an internal investigation, 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. Cloopen also identified additional problematic contracts in other departments that were missing or appeared to have falsified supporting documentation.

As a result of this misconduct, Cloopen overstated the unaudited financial results that it announced in its filings with the Commission for the second and third quarters of 2021. Specifically, 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).2 In addition, 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 American depositary shares declined 12.7% from the prior day’s closing price.”

Based on the above, the order finds that Cloopen violated, among other things, the FCPA’s books and records and internal controls provisions.

Under the heading “Cloopen’s Cooperation and Remedial Efforts,” the order states:

“In determining to accept the Offer, the Commission considered Cloopen’s prompt self-report of accounting errors to the Commission’s staff, the cooperation provided by Cloopen throughout the Commission’s investigation, and the remedial measures undertaken by Cloopen.

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, 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 substantially advanced the efficiency of the staff’s investigation and conserved Commission resources.

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.”

Without admitting or denying the SEC’s findings, Cloopen agreed to cease and desist from future violations of, among other things, the FCPA’s books and records and internal controls provisions.

In the SEC’s release, Gurbir 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 Cloopen matter is believed to be at least the third non-FCPA, FCPA enforcement action against a China based issuer. (See here for a previous matter involving TAL Education Group and here for a previous matter involving Keyuan Petrochemicals).

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