In mid-March 2020, Cheesecake Factory (“company”) faced an unprecedented challenge to its business from the COVID-19 pandemic impact. In that context, the company issued several disclosures regarding the effect of, and its response to, COVID-19. For example, on March 23, 2020, its press release stated that the company was transitioning to an “off-premise model” that was “enabling the company’s restaurants to operate sustainably at present under this current model.”
The disclosures turned out to be misleading because it excluded expenses attributable to corporate operations from its sustainability claim. It even had to draw on the last $90 million of its revolving credit line and was actively seeking additional liquidity through lenders or private equity investors. The company was losing approximately $6 million in cash per week and projected that it had only 16 weeks of cash remaining even after drawing the $90 million. The result was the Securities and Exchange Commission (“SEC”) settled with the company for a paltry civil penalty of $125,000.
Don’t be fooled by the penalty. While the monetary penalty may seem insignificant, I believe the SEC’s message is significant and one all registrants should digest and consider carefully.
In its SEC filings on March 23, 2020, and April 3, 2020, The Cheesecake Factory stated that its restaurants were “operating sustainably” during the COVID-19 pandemic. While The Cheesecake Factory was telling the markets that its restaurants were operating sustainably, it asked its landlords for help. In its March 23 filing, the company described actions undertaken to preserve financial flexibility during the pandemic. However, it failed to disclose that Cheesecake Factory told its landlords that it would not be making its rent payments in April, following a major decline in income due to COVID-19.
CEO David Overton wrote in a letter to the landlords, “Please understand that we do not take this action or make this decision lightly, and while we hope to resume our rent payments as soon as reasonably possible, we simply cannot predict the extent or the duration of the current crisis.”
According to the 8-K filing, “The company fully cooperated with the SEC in connection with the settlement.” The Cheesecake Factory agreed to the SEC’s order to pay a civil money penalty of $125,000 and cease and desist from committing or causing any violations and any future violations of the reporting standards of Section 13(a) of the Securities Exchange Act of 1934 and Rules 12b-20 and 13a-11 thereunder.
SEC Chairman Jay Clayton said in a statement, “During the pandemic, many public companies have discharged their disclosure obligations in a commendable manner, working proactively to keep investors informed of the current and anticipated material impacts of COVID-19 on their operations and financial condition.”
“As our local and national response to the pandemic evolves, it is important that issuers continue their proactive, principles-based approach to disclosure, tailoring these disclosures to the firm and industry-specific effects of the pandemic on their business and operations. It is also important that issuers who make materially false or misleading statements regarding the pandemic [COVID-19’s] impact on their business and operations be held accountable.”
As companies analyze their specific facts and circumstances and consider their disclosure obligations, the SEC is encouraging them to consider a broad range of questions, including:
- What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace? How are the changes impacting, or reasonably likely to impact, your financial condition and short- and long-term liquidity?
- How is your overall liquidity position and outlook evolving? To the extent COVID-19 is adversely impacting your revenues, consider whether such impacts are material to your sources and uses of funds, as well as the materiality of any assumptions you make about the magnitude and duration of COVID-19’s impact on your revenues. Are any decreases in cash flow from operations having a material impact on your liquidity position and outlook?
- Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs? Are your disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity
- Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods? Have you provided additional collateral, guarantees, or equity to obtain funding? Have there been material changes in your cost of capital? How has a change, or a potential change, to your credit rating impacted your ability to access funding? Do your financing arrangements contain terms that limit your ability to obtain additional financing? If so, is the uncertainty of additional funding reasonably likely to result in your liquidity decreasing in a way that would result in you being unable to maintain current operations?
- Are you at material risk of not meeting covenants in your credit and other agreements?
- If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity? Are there estimates or assumptions underlying such metrics, the disclosure of which is necessary for the metric not to be misleading?
- Have you reduced your capital expenditures, and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them? What factors will you consider in deciding to extend or curtail these measures? What is the short- and long-term impact of these reductions on your ability to generate revenues and meet existing and future financial obligations?
- Are you able to timely service your debt and other obligations? Have you taken advantage of available payment deferrals, forbearance periods, or other concessions? What are those concessions, and how long will they last? Do you foresee any liquidity challenges once those accommodations end?
- Have you altered terms with your customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected your financial condition or liquidity? Did you provide concessions or modify the terms of arrangements as a landlord or lender that will have a material impact? Have you modified other contractual arrangements in response to COVID-19 in such a way that the revised terms may materially impact your financial condition, liquidity, and capital resources?
- Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity, and if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?
- Have you assessed the impact material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on your liquidity and capital resources, and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?
Remember, the opposite of transparency is concealment!
This settlement was the first time the SEC charged a public company for misleading investors about the economic effects of COVID-19.
Boards, specifically the Audit and Disclosure Committees, need to be diligent and promote transparency by ensuring the books and records (see below), including disclosures, are at a minimum complete and accurate.
I welcome your thoughts and comments.
Remember, “Anti-fraud tactics and compliance programs are not the enemies of ethics. JTM”
Happy and Safe Holiday Season to All
Bosher – Hunton & Williams
Books and Records
The books and records provision was enacted in 1977 as part of the Foreign Corrupt Practices Act (“FCPA”). It requires issuers—companies that are required to file reports with the SEC or that have securities registered with the SEC—to “make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.”
In one of the few reported decisions discussing the books and records provision, a federal district court described the provision’s three goals:
(1) assure that an issuer’s books and records accurately and fairly reflect its transactions and the disposition of assets,
(2) protect the integrity of the independent audit of issuer financial statements that are required under the Exchange Act, and
(3) promote the reliability and completeness of financial information that issuers are required to file with the Commission or disseminate to investors under the Exchange Act.
The books and records provision was enacted as part of the FCPA but is deceiving. The provision covers practices that may be neither foreign nor corrupt.
In recent years, the SEC has brought enforcement actions for books and records violations in circumstances that had nothing to do with bribery and related to purely domestic transactions—for example, records relating to the value of mortgage-backed securities; round-tripping transactions that led to overstated revenue; options backdating; and miscalculation of tax liabilities.
The SEC generally imposes strict liability for inaccurate or insufficiently detailed books and records because the statute does not explicitly require materiality or scienter. In other words, a company may be held liable for sloppy entries in its books and records, no matter how small, and regardless of whether there was any intent to deceive.