Most China watchers have spent the past three months trying to decide what a Biden Presidency means for U.S.-China relations.
And over the past week, some China watchers also have been watching as mainland Chinese users flocked to discussions on the Clubhouse app, seemingly without sparking concern among Great Firewall monitors. That brief window into the Rest-of-the-World Internet slammed shut for mainlanders on Monday evening Beijing time when Chinese regulators blocked access to the Clubhouse API and started blocking the transmission of access codes to users’ phones. The Clubhouse situation was most interesting for the astonishing level of openness seen in discussions about topics as varied as Uighur detention camps, Tiananmen Square culpability and Taiwanese sovereignty.
Another bit of news news that dropped on Friday should not have been unexpected by regular readers of the China Law Blog: coffee company Luckin Coffee (Luckin) filed for Chapter 15 bankruptcy in the U.S., a little over a month after the company agreed to pay a $180 million fine to the U.S. Securities and Exchange Commission (SEC). Last year, Luckin admitted falsely claiming $310 million worth of revenue in 2019.
Chapter 15 is a section of the United States bankruptcy code that allows cooperation between United States courts and foreign courts in resolving bankruptcy proceedings that involve multiple jurisdictions. Chapter 15 was added to the U.S. Bankruptcy Code in 2005 and it represents U.S. adoption of the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”) in 1997.
For those of you interested in a brief refresher on the Luckin saga, we wrote about it last July in Investing in Chinese Companies is Un-Luckin.
The Luckin story is worth revisiting, though, for two reasons.
One, it serves as a reminder (did you really need one?) of the importance of conducting due diligence on China investments (any investment, really). There can be little doubt Luckin would still be happily defrauding investors if not for Carson Block, founder of Muddy Waters Research, who several months before Luckin went public on NASDAQ in May 2019, published an anonymously authored report exposing the company’s fraud. [You may remember Carson Block from The China Hustle, which if you have not seen, you should do so right this minute.] Luckin denied the report’s validity at the time, but eventually admitted fraud.
And two, it serves as a reminder that short sellers do play an important role in equity markets (looking at you, GameStoppers!), reminding starry-eyed optimists that markets are not designed to increase in value in perpetuity and fund Lamborghinis for every investor, but instead, should bear some relation to underlying asset value.
Due diligence, of course, can look quite a bit like hard work, especially in countries such as China, where access to information is highly regulated, and distribution tightly controlled or prohibited. And of course assets are only “overvalued” if you can’t find a seat when the music stops. After all, if BlackRock and Singapore sovereign wealth fund GIC thought Luckin was a good idea, why not you? This is not just a China problem, of course. The list of big-name investors who lost hundreds of millions on blood testing company Theranos was long and distinguished. And the list of prominent investors that took a pass numbered only one, as far as I know: Google Ventures, which reportedly made an attempt to verify Theranos’s claims in the real world and was unable to satisfy itself they were legitimate.
Back in April of last year, Senators Marco Rubio (R-FL), Bob Menendez (D-NJ), Tom Cotton (R-AR) and Kirsten Gillibrand (D-NY) authored the Ensuring Quality Information and Transparency for Abroad-Based Listings on U.S. Exchanges (EQUITABLE) Act, aimed at increasing oversight of Chinese and other foreign companies listed on American exchanges and at delisting firms that are out of compliance with U.S. regulations for a period of three years.
The bill did not go to a vote, and this will not pass into law, but at the time Rubio said “The Luckin Coffee scandal is just one of many examples of Chinese fraud, and it should be a major wake-up call for policymakers and regulators that the time for action is now. If Chinese companies want access to the U.S. capital markets, they must comply with American laws and regulations for financial transparency and accountability.”
To which we can (and should) say, “Obviously.”
Believe it or not, Luckin has continued to grow steadily through all the drama of the past two years (though at rates far below the 300-500% growth it reported prior to the first allegations of fraud), but the company continues to be a madhouse of fiscal and management misbehavior.