What happened

Shares of Luckin Coffee (LKNC.Y -2.88%) plunged more than 70% on Thursday after the Chinese coffee retailer said its board was investigating allegations that a senior executive had fabricated transactions.

So what

Luckin, the so-called "Starbucks of China," was a high-flier following its May 2019 initial public offering, with the shares more than doubling by early 2020. But in late January Muddy Waters Research, a well-known short-seller focused on China stocks, said it had received a report arguing that Luckin was committing fraud by inflating the number of items sold per day.

Two cups of coffee on a table.

Image source: Getty Images.

In a securities filing Thursday, Luckin  said its board had formed a special committee to oversee an internal investigation into certain issues brought to the board's attention. Specifically, the board said it had received information indicating that Luckin chief operating officer Jian Liu and several employees reporting to him had engaged in misconduct including fabricating certain transactions.

The transactions in question occurred last year and totaled about 2.2 billion yuan ($300 million).

Liu and other employees implicated have been suspended while the investigation is being conducted. The board special committee has retained Kirkland & Ellis as outside counsel and is working with FTI Consulting to conduct the investigation.

Luckin said it will release additional information about the investigation in due course, and said it is committed to improving its internal controls.

Now what

Whatever one thought of the initial unattributed report on potential fraud at Luckin, this board action indicates there are significant worries that things were not what they seemed at the company. The company's annualized revenue run rate is about $850 million, so the investigation is already focused on a significant chunk of Luckin's overall business. And history shows that when outside independent auditors open up the books, there is no telling what else they might find.

It's way too soon to know whether these fraud allegations are enough to stop Luckin's long-term momentum. But I can't blame investors for heading for the exits on Thursday instead of waiting around to find out.