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China's Luckin Coffee Scandal Renews US Call for Stricter Oversight

FILE - A company executive photographs a Luckin Coffee cup during the company's IPO at the Nasdaq Market site in New York, May 17, 2019.
FILE - A company executive photographs a Luckin Coffee cup during the company's IPO at the Nasdaq Market site in New York, May 17, 2019.

Luckin Coffee Inc., a Chinese coffee retail chain listed on the Nasdaq, confirmed this week it has received notice that it will be delisted from the U.S. stock exchange after it acknowledged falsifying $310 million in sales.

Analysts say the action is a blow to all Chinese companies, and comes as U.S. lawmakers consider imposing new regulations on Chinese companies seeking American investment.

Luckin, an upstart rival to Starbucks Corp. in China, said in a regulatory filing on Tuesday that it has received written notice from Nasdaq's listing qualification staff on May 15 that it would be dropped. The company said the delisting decision was due to "public interest concerns" surrounding "fabricated" transactions, as well as "past failure to disclose material information."

The China-based company said that it planned to request a hearing before a Nasdaq panel to appeal the decision – a meeting that would occur roughly 30 to 45 days after the request.

"This is a such an unfortunate incident, it is a blow to the reputation of Chinese listed companies in the U.S," said Guo Yafu, founder and CEO of TJ Capital Management.

Luckin is the latest in a series of Chinese companies listed in the U.S. that have come under intense scrutiny.

The U.S. Senate on Wednesday passed sweeping legislation that potentially could bar many Chinese companies from listing shares on U.S. exchanges or raising money from American investors without adhering to strict regulatory and auditing regulations.

The so-called "Holding Foreign Companies Accountable Act," overwhelmingly approved by Republican and Democratic senators, would require Chinese companies to demonstrate they are neither owned nor controlled by a foreign government. This would require the companies to submit to an audit that can be reviewed by the Public Company Accounting Oversight Board, a non-profit group that oversees audits of all U.S. companies that want to raise money in public markets.

Who is Luckin?

Luckin Coffee Inc, a coffeehouse chain founded in 2017, joined Nasdaq in 2019 through a $561 million IPO, or initial public offering.

The company rapidly expanded between 2017 and 2019, fueled by an aggressive marketing strategy, in which the company reportedly spent three times as much as it earned to feed its growth. By the beginning of 2020, the company claimed it had 4,500 shops in Mainland China, several hundred more than rival Starbucks.

Yet on April 2, Luckin Coffee announced that an internal investigation found that its chief operating officer, Jian Liu, had fabricated the company's 2019 sales by "around RMB2.2 billion" ($310 million). On April 8, the U.S. stock market halted trading on all Luckin shares as a result of the fraud probe.

Throughout April, the company's stock dropped by over 80%. On May 12, the company fired its CEO Jenny Zhiyq Qian and COO Jian Liu from their positions.

"The cooked books are either from accounting fraud or sales fraud," Guo told VOA.

After the delisting decision by Nasdaq, Luckin Coffee founder Charles Lu Zhengyao said in a statement published on Chinese social media platform WeChat on Wednesday that he "apologizes to all the investors, staff and clients of Luckin for the terrible impact of the incident."

Lack of oversight

Luckin Coffee's announced delisting follows years of tensions between American auditors and Chinese companies over the financial documentation required of companies that list shares on U.S. exchanges.

Congress created the Public Company Accounting Oversight Board (PCAOB) in 2002 to ensure that companies listed on U.S. stock exchanges have accurate financial and corporate records.

It took a few years for PCAOB to negotiate inspection-related agreements with many countries around the world, but eventually nearly all – except China – have come into agreement.

"There may still be one or two small countries without agreements — China is by far the largest without one," said James Peterson, an author and former staff attorney for now defunct Arthur Andersen.

Many Chinese companies have significant government links and claim "state secrets" when asked to disclose financial information to U.S. auditors.

Peterson said that the content of corporate records and audit working papers are no more qualitatively "secret" in China than they are for businesses in any other country.

"China's claim of 'state secrets' is no more than rhetorical cover for the simple position that 'we do not want to,'" Peterson told VOA.

Trump wants to get tough

U.S. President Donald Trump said in a recent interview aired on Fox News that he was looking "very strongly" at setting rules to require Chinese companies to comply with American accounting rules. Federal officials have long demanded compliance with U.S. audit inspections as a condition for listing.

Yet he also suggested that he doesn't want to threaten to delist Chinese companies that don't comply with U.S. regulations if it spurs them to flee to a competing foreign stock exchange.

"Let's say you want to get tough," Trump said, "What do they do? They say, 'OK, well, we'll move to London or we'll go to Hong Kong.'"

Guo said Trump's concern is reasonable, since a lot of Chinese companies have or are preparing to list in Hong Kong.

"If the U.S. wants all Chinese companies [that don't comply with U.S. auditing rule] to leave, they will have to find other places to go. These are all good companies, like Baidu and JD. com," he said.

He added that Alibaba, the e-commerce giant based in China, already has a secondary listing on the Hong Kong Stock exchange.