PROBLEM

Luckin Coffee, to allure investors, produced fraudulent assertions and faked its financial success.
Luckin Coffee concealed money by falsifying bank documents and failing to disclose proper revenue and
costs. Luckin reportedly failed to retain exact financial records and maintain effective internal
accounting controls. The company was well aware that its financial statements and reports were
fraudulent and dishonest. Luckin forged expenses and costs with the help of finance businesses,
vendors, and third-party shell companies.

RELEVANT FACTS

Luckin Coffee is a coffeehouse business and café brand based in China. It was launched in 2017
in Beijing. To surpass Starbucks Corp., it offered lower-priced coffee, primarily for takeout and delivery,
with the use of an Application it developed. Because of the business model it adopted and the APP it
promised to use, some investors became interested. Within a year of its founding in 2017, one of the
biggest venture capital (VC) firms in China, Joy Capital, as well as the Singapore sovereign wealth fund
GIC, had put serious money behind Luckin, valuing it at $1 billion

It controlled 4,507 kiosks since around January 2020, surpassing the number of Starbucks
locations in China. It reported sales of as much as $200 million in the first quarter of 2019. This early
success drew in big international investors such as BlackRock Inc. and support from banks including
Credit Suisse Group AG. With such support Luckin went public in the U.S. in May 2019, raising $561
million.

The rapid growth surprised many and aroused suspicions including Joy Capital’s managing
partner, Liu Erhai, whom left a question “So how can they achieve astonishing performance within short
period?” in the Tech conference in Hong Kong in July 2019 according to Bloomberg. And it turns out it
wasn’t just a baseless question as six months later, Luckin was caught in a massive fraud.

Muddy Waters Research, a short-selling business, released an anonymous 89-page document on

Twitter on January 31, 2020, indicating that Luckin Coffee had misrepresented financial and operational
data. According to the survey, the quantity of products sold per shops increased by at least 69 percent in
the third quarter of 2019 and by 88 percent in the fourth quarter.

Luckin’s fabricated sales. Early April 2019, Luckin fabricated coupon sales to inflate its revenue
where employees are involved in three types of fraudulent schemes. Deals were made by creating
coupons and selling them to three types of customers: individual customers, corporate customers, and
sales to third-party shell companies – intermediary agents who resold coupons to individual customers.
This act shows the awareness of Luckin’s management and employees to the schemes and false
accounting.

First scheme, employees and their family members purchases coupons on the Luckin’s app as an
individual customers then redeems the coupons where they create fake orders. Fake orders will then
intentionally and dishonestly increases sales figures. It then become a cycle of purchasing and
redeeming coupons which Luckin recognized the fabricated revenue. The second scheme is similar to
the first scheme, these fake coupon redemption orders artificially enhanced sales performance. The only
difference is it involves corporate customers but they are still related to Luckin employees. The third
fraudulent scheme, sales to third-party shell companies – intermediary agents who resold coupons to
individual customers which made up the largest portion of fabricated revenue, approximately 90% of
the total USD311 million.

Luckin also fabricated expenses and returned funds. In connection to the third scheme, Luckin
returned funds to the funding companies via bank transfers and fabricated expenditure. Payments to
vendors, including suppliers, were recorded as business-related expenses in the financial statements.
These vendors, however, did not provide Luckin with any services or products in exchange. Luckin also
fabricated costs in order to match the overstated revenue. The total fabricated expenses and costs in
2019 were around USD196 million.

Following an investigation, the US Securities and Exchange Commission, China's securities

regulator, and China's State Administration for Market Regulation charged Luckin with providing false
information about revenue, expenses, and net loss from April 2019 to January 2020 in order to deceive
investors about Luckin's financial performance. On December 16, 2020, the SEC completed its
investigation and announced a penalty against Luckin. As a result, Luckin agreed to a settlement which
included permanent injunctions and the payment of USD180 million in monetary penalties. Luckin has
not responded to the allegations, either admitting or denying them.
REFERENCES:

https://en.wikipedia.org/wiki/Luckin_Coffee
https://sevenpillarsinstitute.org/case-study-luckin-coffee-accounting-fraud/
https://www.npr.org/sections/goatsandsoda/2019/05/17/723193259/what-does-chinas-luckin-coffee-
have-that-starbucks-doesnt
https://www.coursehero.com/file/108764531/BUS4301-Ethics-Case-Discriptions-on-Luckin-Coffee-
Scandaldocx/