On December 4, 2020, in what is according to the SEC its first proceeding charging an issuer for misleading investors about the financial effects of the pandemic on company finances and operations, the SEC entered into a settled Cease and Desist Order with The Cheesecake Factory Incorporated based on the agency’s determinations that the company’s late March and early April statements that it was “operating sustainably” were, without further information, misleading to investors. The SEC’s December 4, 2020 Cease-and-Desist Order can be found here, and the agency’s December 4, 2020 press release about the Order can be found here.
The SEC Administrative Proceeding
In March 2020, according to the SEC’s Order, Cheesecake Factory faced “unprecedented challenges” due to the coronavirus outbreak. According to the Order, the company made several disclosures during the period from late March to early April “regarding the effect of, and its response to, the pandemic.” These disclosures, according to the SEC, “failed to adequately inform investors of the extent of the COVID-19’s impact on the company’s operations and financial condition.”
According to the SEC, in late March, the company began to take steps to conserve cash and increase liquidity in the near-term. Among other things, on March 18, 2020, the company sent its landlords a letter saying that it would not be paying April rent. On March 18, 2020, the company drew down the last $90 million available under a revolving line of credit. Beginning on March 23, 2020, the company began efforts to try to raise additional funds. In presentations to potential lenders and private equity investors, the company disclosed, among other things that it had enough cash to support approximately 16 weeks of operations under then-prevailing conditions and that the company was experiencing a negative cash flow of $6 million per week.
The SEC’s Order presents the agency’s determinations that the company’s SEC filings dated March 23, 2020 and April 3, 2020 were materially misleading because the filings and accompanying press releases failed to disclose several of the distinctive impacts that the coronavirus outbreak had had on the company’s operations.
Specifically, though the company said in its filings and press releases that it was “operating sustainably,” the company did not disclose that the company’s internal documents showed it was losing $6 million per week and that its internal projections showed that it had only 16 weeks of cash remaining. In addition, in the March 23 filing and accompanying press release, while the company said that it had undertaken steps to preserve “financial flexibility” during the pandemic, the company did not disclose that it had already informed investors that it would not be paying rent in April due to the impact of the coronavirus outbreak on its business.
The SEC’s order notes that in anticipation of the institution of the cease and desist proceedings, the company had “submitted an Offer of Settlement,” which the Commission had determined to accept. Under the Offer of Settlement, the company consented to the entry of a Cease-and-Desist Order, without, it should be emphasized, “admitting or denying the findings” in the Order.
Pursuant to the Order, the company agreed to cease and desist from causing any violations or future violations of the relevant disclosure requirements; agreed to pay a civil money penalty of $125,000. The Order expressly acknowledges “the cooperation” that the company “afforded the Commission staff.”
According to the SEC’s December 4, 2020 press release, the agency’s administrative proceeding against Cheesecake Factory is “the first charging a public company for misleading investors about the financial effects of the pandemic.”
To be sure, this Cheesecake Factory proceeding is not the agency’s first pandemic-related proceeding. The agency has, by my count, brought five prior enforcement actions related to the pandemic. However, the prior proceedings did not relate to company disclosures about the impact of the pandemic on company operations and finances; rather, the prior proceedings related to company statements about how the companies involved were positioned to be able to profit from the pandemic. (My posts about the five prior enforcement actions can be found here, here, here, and here).
I expect that the reaction of many readers to the allegations and circumstances involved in this proceeding will be that these allegations are really small potatoes. And, indeed, they are. Could it have been news to anyone that that at the outset of the coronavirus outbreak and in the midst of the government shutdown orders that a restaurant chain was experiencing financial disruption and had to enter into discussions with its landlords? However, the fact that his proceeding involves such small potatoes may actually be the point of this proceeding.
The agency’s press release about the proceeding quotes Stephanie Avakian, the Director of the SEC’s Division of Enforcement, as saying that “When public companies describe for investors the impact on their business, they must speak accurately.” The press release also quotes SEC chair Jay Clayton as emphasizing that issuers must “continue their proactive, principles-based approach to disclosure, tailoring these disclosures to the firm and industry-specific effects of the pandemic on their businesses and operations.” Clayton is quoted further as saying that “it is also important that issuers who make materially false or misleading statements regarding the pandemic’s impact on their businesses and operations be held accountable.”
So, in other words, even if the allegations in this proceeding are small potatoes, the proceeding nevertheless is intended to communicate several very important messages to other companies.
First, when companies are disclosing the impact of the coronavirus on company finances and operations, they have to be accurate. Second, the disclosures have to be tailored to the specific company and industry involved. And third, if the statements are not accurate and company-specific, the agency will hold companies accountable – even if the disclosures involved are really small potatoes.
There is one further message here – that is, it doesn’t excuse companies from the obligations to make accurate disclosures to investors that the companies find themselves in extraordinary circumstances. Indeed, the SEC’s order expressly notes that in March, as a result of the coronavirus outbreak, Cheesecake Factory found itself facing “an unprecedent challenge.” Even under those kinds of circumstances, the SEC’s administrative action seems to be saying, companies have an obligation to make sure that their disclosures are accurate and tailored to the specific company and industry. It could be argued that the disclosure obligations are particularly critical in these kinds of circumstances as investors’ needs to have complete and accurate information are particularly critical.
I think it is particularly noteworthy that this proceeding involves statements and circumstances at the very outset of the pandemic, when conditions were particularly chaotic and uncertain. This proceeding underscores the fact that even under those kind of disrupted circumstances, as far as the SEC is concerned, companies are not relieved of their obligations to provide accurate information. And if companies are not going to be cut any slack under those kinds of circumstances, companies certainly are not going to be cut any slack now that they are all operating under the new normal circumstances of chronic and continuing disruption.
The fact that these statements and circumstances involved in this proceeding took place months ago presents its own message, which is that companies should not be comfortable with the passage of time; the SEC will pursue claims based on investor disclosure statements that it does not believe to have been accurate, notwithstanding the passage of time.
The truth is that none of this should come as any surprise to investor companies. The SEC has emphasized from the outset of the pandemic that notwithstanding the disruption from the coronavirus outbreak, the agency continues to believe that full and accurate disclosures to investors are critical. For example, in an April 8, 2020 statement from Clayton and SEC Division of Corporate Finance Director William Hinman, the Commission emphasized the importance of full and robust disclosures to investors, precisely because of the disruption that the pandemic outbreak represents.
One final note. In making observations about COVID-related securities class action lawsuits, I have noted that the cases generally fall into one of three categories.
First, there are the cases against companies that experienced coronavirus outbreaks in their facilities (cruise ship lines, private prison systems). Second, there the cases against companies that made statements about their ability to profit from the coronavirus outbreak (vaccine companies, diagnostic testing companies, manufacturers of person protective equipment, online learning companies). Third, there have been the company’s whose financial performance and business operations who have been disrupted by the coronavirus outbreak (Hotel REITS, residential real estate development companies). The SEC’s prior enforcement actions have all involved cases falling in this second category of cases, but the administrative proceeding against Cheesecake Factory is the first SEC enforcement action to fall in this third category.
Although the Cheesecake Factory proceeding is the first SEC enforcement action to fall in this third category, I don’t think it will be the last. Indeed, if I had to make a prediction, I would say that it is likely that we will be seeing more of these third-category proceedings in the weeks and months ahead. Now that the SEC is just getting around to its first action of this type involving circumstances at the very outbreak of the coronavirus, it seems likely that in the months ahead we will be seeing further proceedings involving various statements about the impact of the coronavirus outbreak on company operations and finances that have been issued in the intervening months, particularly as the public health emergency crisis aspect of the outbreak drags out far longer than anyone anticipated. And just as I think there will be further third-category SEC proceedings filed in the months ahead, so too I think we will be seeing further third-category private securities class action lawsuits as well.