MANHATTAN (CN) - A failure by Chinese beauty company Jumei to divulge compliance concerns hurt investors, a federal class action alleges, pointing to a 38 percent nosedive in shares.
When Leo Ou Chen's 3-year-old company launched its mobile application in 2012, it had a respectable $21.8 million in sales, the complaint filed Friday states. Shareholder Chao Lu says the number ballooned to $233.2 million the next year, and then to $483 million in 2013.
Unknown to investors before Jumei's May 2014 initial public offering, however, was that Jumei had been benefitting from relatively lax regulation by the Chinese government, according to the complaint.
Lu says this changed in the months leading up to the IPO as China's State Administration of Industry and Commerce (SAIC) instituted new and more stringent "measures for the administration of online commodities trading," and a new consumer-protection law took effect.
The new requirements allegedly meant big changes for Jumei, where "the online distributors (sic) also acts as a marketplace platform that provides service to third-party merchants."
Lu says Jumei told prospective investors in its registration statement that it was "currently in compliance with ... regulations in all material aspects."
While touting its strong base of 1,700 suppliers and third-party merchants, however, Jumei "failed to disclose that certain of those 'third-party merchants' were actually unauthorized 'brand distributors' and/or 'resellers' who Jumei could not continue to do business with once it became a publicly traded company," the complaint states.
Also omitted was the credit for Jumei's past business successes "to purchasing counterfeit or fake product and knockoffs from dubious third-party distributors and resellers, which Jumei then sold at premium prices," the complaint states.
Though Jumei boasted "strong 'steady'growth in China's beauty products industry and rapid growth in online sales in recent years ... in reality the Chinese internet beauty industry was rife with counterfeit and fake product offerings and knockoffs that threatened the nascent industry by damaging the reputation of Chinese internet sellers like Jumei," the complaint continues.
Jumei was "spending tens of thousands of dollars" in early 2014 on special equipment it needed to test for authenticity under the new regulations, but it kept that from shareholders as well, Lu says.
The new regulations required Jumei to eliminate dubious third-party merchants and resellers from its marketplace, but the company concealed that it would thus "be forced to offer significant cash incentives to dump a lot of the dubious inventory," according to the complaint.
In addition to "a reduced product selection" from the pared-down suppliers, Jumei was faced with increasing "product costs going forward, reducing the high gross margins the company had previously been able to achieve pre-IPO through sales of less legitimately sourced product," the complaint states.
In the last full quarter before its IPO, Jumei made $154.9 million in sales, and the $280 proceeds of the IPO cast it as a success, according to the complaint.
But Lu says the impact of the new regulations led to disappointing results thereafter, with the gross profit margin decreasing to 22 percent from 25.9 percent the year before.
Lu says American Depository Shares in Jumei were trading at below $14 at the time of the complaint's filing, "an approximately 38 percent decline from the IPO price."
Lu filed the complaint against Jumei, its executives and its board in Manhattan where the company's shares trade on the New York Stock Exchange.
Also named as defendants are Goldman Sachs and other underwriters that Lu says "shared approximately $19.6 million in fees collectively.
These underwriters, including Credit Suisse Securities (USA) LLC; J.P. Morgan Securities LLC; China Renaissance Securities (Hong Kong) Ltd.; Piper Jaffray & Co.; and Oppenheimer & Co. Inc.; conducted "drafting sessions" with Jumei's lawyers and conducted a roadshow in New York, the complaint states.
Lu is represented by Samuel Rudman with Robbins Geller.
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