Luckin Coffee Inc. has agreed to pay $180 million to settle regulatory claims that it cooked its books to make growth appear more robust and meet earnings targets. The Securities and Exchange Commission announced the penalty on Wednesday, eight months after the Chinese company disclosed that some of its officers fabricated sales in 2019. Luckin neither admitted nor denied the SEC's fraud claims, which were filed in Manhattan federal court. The settlement is subject to a federal judge's approval. Luckin intentionally faked more than $300 million in retail sales from April 2019 to January 2020 by using purported individual customer accounts and related parties and shell companies, the SEC said. The company also fabricated 1.3 billion yuan, or $196 million, of expenses by paying 13 purported suppliers of raw materials, human resources, and delivery services, according to the SEC. The SEC's findings confirmed details of the schemes reported by The Wall Street Journal in May. Luckin, once a high-flying competitor to Starbucks Corp. in China, went public on the Nasdaq Stock Market in 2019. Its disclosure of financial-reporting failures earlier this year caused its shares to plummet 75%. The debacle put a spotlight on U.S. regulators' inability to inspect the audits of American-listed Chinese companies, a compliance gap that gained attention in Congress this year. Luckin's executive officers and senior managers were involved in the fraud, the SEC alleged in its federal court complaint. The Journal reported that some of the companies involved in the sham schemes were linked to Luckin's then-chairman and controlling shareholder, Charles Lu. Mr. Lu stepped down from Luckin's board in July, and the Nasdaq delisted Luckin's shares on July 13. Luckin's shares still trade over the counter. The SEC didn't announce any enforcement claims against individuals on Wednesday but said in a press release that its investigation is continuing. The fraud came to light during the course of Luckin's annual audit, the SEC's court complaint says. In a statement, Luckin said the deal reflected its cooperation and efforts to improve. "The Company's Board of Directors and management are committed to a system of strong internal financial controls, and adhering to best practices for compliance and corporate governance," said Jinyi Guo, Luckin's current chairman and chief executive. Bank records were altered to hide the misconduct and the alleged cheating inflated Luckin's revenue by 45% in one quarter in 2019, the SEC said. The sham sales were part of disclosures that Luckin filed with the SEC in January 2020 as it raised another $418 million from U.S. equity investors and $446 million from bond investors, the SEC said. In September, the Chinese government penalized Luckin Coffee and companies that participated in the fake-sales scheme. Luckin reported at the time of its 2019 initial public offering that it operated 2,370 stores in China and had over 16.8 million customers. The company's tremendous growth—it launched operations in October 2017—drove the story that hooked investors: China was primed for a boom in coffee consumption, and Luckin was positioned to benefit from serving it. But officers of the company engaged in fraud as early as April 2019, the SEC said, when employees and two entities associated with Luckin's officers and directors bought up coupons that were meant to be used for coffee. The coupons were never used, but Luckin "created fake customer orders to 'redeem' the coupons" and justify the recognition of revenue, the SEC's complaint says. In another scheme, which accounted for most of the $311 million in fake sales, certain employees arranged coupon sales to shell companies, which were described within Luckin as agents that would resell the vouchers to individual customers. According to the SEC's complaint, one worker involved in that scam emailed: "We will try to replace the contact persons [of the fictitious agents] with third parties, in order to reduce the number of our internal colleagues that are aware of such issue.

Questions:

1.  The article discusses how the top executives and managers committed the fraud, manipulating financial statements, falsifying transactions, and source documents, such as bank records. Why do you think so many people were involved in the schemes?

2.   What types of "checks and balances," or internal controls, would you implement in Daily Grind to prevent fraud of this magnitude?

Answer rating: 100% (QA)

Solution 1 The involvement of many people in the scheme is attributable to the weaknesses in the internal ... View the full answer