In a prelude of things to come for public companies, on December 4 the Securities and Exchange Commission (SEC) sued restaurant operator The Cheesecake Factory Incorporated for making misleading disclosures regarding the impact of the COVID-19 pandemic on its financial conditions and operations. After issuing warnings and guidance to public companies since the early stages of the pandemic, this is the SEC’s first time charging a public company for misleading disclosures relating to the pandemic.
Allegations Against The Cheesecake Factory
The allegations against The Cheesecake Factory are straight forward. Early in the pandemic, The Cheesecake Factory disclosed in SEC filings that its restaurants were “operating sustainably.” The SEC alleged this disclosure contradicted internal company documents, which showed that due to the pandemic the company was losing approximately $6 million in cash per week, was projected to run out of cash in 16 weeks, and had notified its landlords that it would not pay rent in April.
The inadequacy of The Cheesecake Factory’s SEC filings was further confirmed according to the SEC when the company later shared the undisclosed financial information with potential private equity investors and lenders in connection with an effort to seek additional liquidity.
The Cheesecake Factory settled the charges by agreeing to pay a $125,000 penalty and to cease-and-desist from future similar violations. A factor leading to the relatively low penalty amount assuredly was the credit the SEC afforded the company for cooperating with the SEC’s investigation. No details were provided in the settlement order regarding The Cheesecake Factory’s cooperation efforts.
In announcing the settlement, the SEC warned public companies that it will continue to closely scrutinize pandemic-related disclosures and encouraged companies to cooperate with such investigations. Stephanie Avakian, Director of the SEC’s Division of Enforcement, stated in the SEC’s press release that “The Enforcement Division, including the Coronavirus Steering Committee, will continue to scrutinize COVID-related disclosures to ensure that investors receive accurate, timely information, while also giving appropriate credit for prompt and substantial cooperation in investigations.”
Takeaways for Public Companies
Public company disclosures relating to the pandemic should be handled with extra care in light of the SEC’s enforcement focus in this area. Concerning the substance of disclosures, company counsel would be wise to review the guidance issued by Jay Clayton (SEC Chairman) and William Hinman (the now-former Director of the Division of Corporation Finance) on April 8, 2020. The SEC specifically reiterated the importance of this guidance in its press release announcing The Cheesecake Factory settlement.
The Cheesecake Factory settlement serves as a reminder of the need to ensure consistency among all of a public company’s disclosures — written and oral, formal and informal. The SEC alleged that The Cheesecake Factory’s SEC filings were inconsistent with disclosures made to potential investors/lenders and its landlords.
Having a process in place to ensure disclosure consistency is particularly important in the current environment as companies are routinely under pressure to address the business implications of the pandemic and are engaging in business maneuvers to navigate the financial implications of the pandemic. With respect to the latter, for example, many companies applied for government relief under the CARES Act, including through the Paycheck Protection Program. Such government relief programs themselves are under heightened scrutiny and therefore present an added layer of risk that the agencies reviewing those programs will flag inconsistencies between a company’s program applications and certifications and its other public disclosures.
Finally, a company facing SEC scrutiny of its disclosures should (as with any SEC investigation) give careful consideration to how it approaches cooperating with the investigation. As reflected by The Cheesecake Factory settlement, the SEC remains interested in awarding credit to respondents that cooperate to the SEC’s satisfaction. Experienced outside counsel can provide sage advice regarding the SEC’s approach to cooperation credit.
If you have any questions about COVID-19-related disclosures and related SEC investigations, please contact the author.