August 3, 2020detailedanalysisofcustomerbehavior.Theinvestigatorshad
evenrecordedvideoofsometransactions.Thereportclaimed
thatLuckinwasinflatingthenumberofitemssoldperday
by69%inthethirdquarterof 2019 and88%inthefourth.
Sinceallordersareplacedthroughitsapp,eachhasa sequen-
tialpickupnumber.ButLuckin,thedocumentsaid,seemed
tobeintentionallyskippingnumbersduringthedaytogive
theappearanceofhighervolume.It alsoconcludedthatthe
averagecostofitemssoldwaslowerthanthecompanyhad
reported.Inotherwords,Luckinlookedlikea fraud.
Blockidentifiedtheauthoronlyas“someonewhohasa lot
ofresourcesandwhoI respectinthisspace.”(Accordingto
peoplefamiliarwiththesituation,thedocumentwascreated
bya HongKong-basedfirmcalledSnowLakeCapitalLtd.A
representativeforSnowLakedeclinedtocomment.)
Luckindeniedtheallegations.Itsstockpriceplunged
immediatelyafterthereportcameout,butit recoveredmost
ofthelossinFebruary,evenasthecoronaviruswasspreading.
But beyondthe public’sview,Luckinwasalsounder
scrutiny.AsauditorsfromaccountingfirmEYreviewedLuckin’s
2019 accounts,theyfoundevidencethatsomemanagershad
beenfabricatingtransactions.Ina laterstatement,EYsaidthese
supposedsaleshadinflatedthecompany’sincome,costs,and
expensesforninemonthsin2019.OnApril2,Luckinsaidthat
ChiefOperatingOfficerJianLiuandsomesubordinatesmight
havefakedmorethan$300millioninrevenue,morethana
quarter’sworthofreportedsales.Now,thecompanysaid,a
specialcommitteewouldconductaninternalinvestigation.
Fora briefmoment,it seemedLuckinwouldtrytogrowits
wayoutoftrouble.It continuedopeningstores—asmanyas 10
perday—asco-founderLutriedtomakeamends.Ina May 20
statement,hesaidthat“mystylemayhavebeentooaggressive
andthecompanymayhavegrowntoofast,whichhasledto
manyproblems.”But,hecontinued,“Ibynomeanssetoutto
deceiveinvestors.”Luckindeclinedtocommentbeyonditspre-
viousstatements.Liu,ofJoyCapital,declinedtobeinterviewed.A
ccountingscandalshavebeena featureofChinese
capitalism for decades, many of them attracting little
notice outside the country. Luckin, however, is different. It’snot a huge company, but it’s a prominent one that attracted
ostensibly sophisticated Western investors eager to buy
intowhattheythoughtwasoneofChina’smostrobustcon-
sumerbrands.Anditscollapsecomesata timewhenChina
istrying to make sure its businesses, already hampered by
risingtensionswiththeWest,canstillaccessforeigncapital.
Accordingtopeoplefamiliarwiththematter,whoaskedto
remainanonymous because they aren’t permitted to speak
publicly, Vice Premier Liu He has personally asked for an
investigation into the scandal, expressing concern about its
impact on investor confidence. The national securities regu-
lator did not reply to a request for comment. Chinese media
has reported that Lu could face criminal charges. Beijing reg-
ulators have also offered to cooperate with the U.S. Securities
and Exchange Commission.
If Luckin survives, it will be in greatly diminished form.
Its shares will be delisted from Nasdaq; for now they’re trad-
ing at less than $3 apiece. Shareholder suits are expected.
Qian was fired as CEO in May, and shareholders ousted Lu as
chairman in July. Qian hasn’t spoken publicly and couldn’t be
reached. Lu didn’t respond to requests for comment. Schakel,
who hasn’t been accused of involvement in the fraud, remains
at the company.
The more important consequences could be for the
Chinese economy as a whole, and especially for main-
land companies hoping to tap U.S. capital markets to fund
growth. Luckin “refreshes the story that Chinese equities
are dangerous,” says Paul Gillis, an accounting expert at
Peking University’s Guanghua School of Management. And,
he says, the example of misconduct could make it easier to
kick other Chinese companies off U.S. exchanges. In May the
Senate overwhelmingly approved a bill that would require
Chinese companies with U.S. listings to submit to scrutiny
by the Public Company Accounting Oversight Board, a body
created in response to the collapse of Enron. As California
Representative Brad Sherman, a Democrat, said when he
introduced a corresponding measure in the House: “Had
this legislation already been signed into law, U.S. investors
in Luckin Coffee likely would have avoided billions of dol-
lars in losses.”
A representative for Muddy Waters declined to comment on
itsprofitfromLuckin’sfall.BlockarguesthatuntilU.S.regu-
latorsareabletoenforcerulesforChinesecompanies—which
theChinesegovernmentsayswouldviolateitssovereignty—
high-profilefraudswillcontinue. In China, he says, exagger-
ating performance is often the only way to raise capital, a
consequence of being “the most cutthroat business environ-
ment on Earth.”
But he places much of the blame for scandals like Luckin’s
ontheU.S.investorswhochoosetobelievestoriesofever-
fastergrowth.“Idon’tblamedrugdealersforpeople’s
addictions. I blame people who get caught up in them more,”
Block says. “We have a thirst for fairy tales from China.”
�With Cathy Chan, Jinshan Hong, Melissa Karsh, Crystal Tse,
ZHENGYAO LU: VICTOR J. BLUE/BLOOMBERG Daniela Wei, and Steven Yang
49Lu celebrates in New York
after the company’s IPO