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Luckin Coffee scandal sparks demand from Chinese tech firms for auditors to check online metrics data

Internet companies listed in China and abroad are increasingly asking auditors and consultants to validate data like number of daily active users.

Image credit to Luckin Coffee.

Chinese technology companies are increasingly hiring auditors and consultants to ensure accurate reporting of their operational metrics—information crucial to investors but out of the scope of traditional financial reporting audits—to boost market confidence and strengthen accountability.

Internet companies listed in China and abroad, as well as those seeking an initial public offering, are asking auditors and consultants to validate common metrics data, from the number of daily active users to gross merchandise value, auditors say.

Investors of fast-growing, cash-burning tech firms often rely on these key yardsticks of online traffic and transactions to form judgments about their investments more than conventional financial data like profits and revenue. But these statistics are currently not part of the standard financial statement audit required by regulators, and are thus at higher risk of manipulation and fabrication.

“It’s an untapped space,” said Wilson Chow, global TMT [telecom, media, and technology] industry leader at professional services firm PwC. “I see a growing trend of [companies and regulators] paying more attention to these metrics.”

The adoption, which has been on the rise over the past few years as more tech companies sprang up in fields from e-commerce to video streaming, accelerated after the shocking 2.2 billion yuan (USD 311 million) accounting scandal of Nasdaq-listed Luckin Coffee, previously touted as China’s challenger to Starbucks, according to Chow.

“Because of the recent incident, companies have stepped up their efforts and raised more awareness of adopting formal data reporting practices to global investors. They really want to give more trust and transparency to investors and to protect their brand name,” he said.

Executives at Luckin, best known for its online ordering, steep discounts, and cheap delivery, were found to have inflated turnover between the second quarter and the fourth quarter of 2019.

This could have been achieved by fabricating Luckin’s online order volume, as all orders are placed through its mobile app, according to an anonymous short-seller report released by famous activist investment firm Muddy Waters in January.

The report documented efforts to verify Luckin’s order volume by employing thousands of people to sit in its shops across China to record store traffic. Luckin denied the allegations in the report, before confirming the fabrication in April after an internal investigation.

Read this: Luckin chairman Lu Zhengyao quits from CAR Inc amid escalating coffee chain scandal

More Chinese companies—like their global peers—are also requesting so-called system and organization controls reports from auditors, which include checks on their IT infrastructure such as cloud servers to make sure it’s secure and can protect the integrity of their data, said Steven Kreit, assurance partner at US accounting and advisory firm MGO in New York.

“It does add an extra layer of confidence to the information you are getting,” said Kreit, who leads the firm’s Securities and Exchange Commission (SEC) practice and works with international companies seeking to list in the US. The trend has persisted for a few years, he added.

Experts could also use big data and artificial intelligence technologies to spot anomalies such as an unusual geographical concentration of IP addresses for large transactions, said PwC’s Chow.

He predicts securities regulators in China and beyond will start to build up a set of benchmarks and rules surrounding the reporting of this largely unregulated operating data. In 2017, the China Securities Regulatory Commission published a set of guidelines targeting online gaming companies seeking to go public.

“For example, in the future, they may dictate what sort of operating data to disclose in companies’ prospectuses, and what sort of assurance they need to validate data accuracy for reporting,” he said.

This article was originally published in the South China Morning Post.