Postings | China Accounting Blog | Paul Gillis


Luckin Coffee Fraud

Luckin Coffee (Luckin) has taken the spotlight as the largest and perhaps most audacious Chinese fraud yet. On April 2, Luckin said that Chief Operating Officer Jian Liu and some subordinates might have faked more than $300 million in revenue, more than a quarter’s worth of reported sales. Luckin’s NASDAQ traded stock collapsed from $50 per share to $3 per share and faces likely delisting. 

The company says the fraud was in three quarters of 2019. If the fraud extends to 2018 it could mean the original IPO was fraudulent with serious consequences for the company, auditors, and investment bankers.  

Luckin’s auditor is the Chinese member firm of Ernst & Young, Ernst & Young Hua Ming. Normally auditors are silent when their clients are accused of fraud.  EY issued an extraordinary statement regarding Luckin, essentially saying they found the fraud. PCAOB standards formerly included this statement, although it was removed in a later revision: The auditor has an ethical, and in some situations a legal, obligation to maintain the confidentiality of client information. 

Sherman slips in amendment

My friend and old colleague Andy Bishop pointed out that while Senator Kennedy’s attempt to insert the Holding Foreign Companies Accountable Act into the Senate version of the Defense Authorization Act failed, Representative Brad Sherman was successful in introducing an amendment to include it in the house version which has passed. Sherman’s amendment was included in a large batch of amendments that appear unrelated to defense.   

Because the House and Senate versions of the Defense Authorization Act are different, a conference committee will be convened to reconcile the differences. The final version must be pass both the House and Senate and then be signed by the president before it becomes law. 

I speculate that the Sherman amendment gets dropped in the Conference because it is apparent that the issues are not straightforward. I still think the House will take up this legislation, perhaps even before the election.

Defense Bill passes Senate without PCAOB

Senator Kennedy said he would introduce the Holding Foreign Companies Accountable Act  (HFCAA) as an amendment to the Defense Authorization bill, and he did, but the Senate never took up his amendment.   

So the HFCAA bill, which passed the Senate by unanimous consent, still awaits action in the House. Kennedy’s gambit was to attach the bill to must pass legislation like the Defense Authorization Bill, but apparently senate leaders did not think that was a good idea. 

Perhaps Senate Majority Leader Mitch McConnell wanted to wait for the administration’s report that is due on August 3 that will recommend how to deal with China and US securities markets.  Perhaps he delayed because of concerns that the bill hurts Americans more than Chinese. Or perhaps rumored SEC pushback on the bill and recommendations for changes to protect multinationals were a factor. 

I don’t expect the house to take action until after the August 3 report and based on the poor state of relations between the US and China we could see action very quickly after that.  

How will Chinese companies react to HFCAA?

I published a report that I coauthored with Ray Tang Hou of the UVA law school  on the Holding Foreign Companies Accountable Act with GMT Research.  GMT is a Hong Kong based research firm that focuses on accounting analysis.  GMT has generously allowed me to republish the report here

The report was published before the comments by China reported on this blog and the introduction of the bill as an amendment to the defense bill. 

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