In its first action against a public company for misleading investors about the financial effects of the pandemic, the SEC has announced settled charges against The Cheesecake Factory. In mid-March, the company, which operates a chain of restaurants, was compelled as a result of COVID-19 to temporarily change its business model from dine-in restaurants to “an ‘off-premise model’ (i.e., to-go and delivery).” The company then issued two press releases (furnished to the SEC on Form 8-K) advising of the transition and indicating that the new model was “enabling the Company’s restaurants to operate sustainably at present under this current model,” but failed to disclose that the claim of sustainable operations excluded expenses attributable to corporate operations as well as the weekly loss of $6 million in cash. Those statements, the SEC concluded, were “materially false and misleading.” According to SEC Chair Jay Clayton, “[a]s 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’s impact on their business and operations be held accountable.”
According to the Order, in mid-march, when the pandemic hit and resulted in shutdowns across the country, the company sought to conserve cash and increase near-term liquidity, including by notifying its landlords that it would not be paying April rent due to severe decreases in cash flow resulting from the shutdowns. The company also made a $90 million (and final) drawdown on its revolving line of credit, with the result that, as of April 1, it had only $65 million in cash and cash equivalents. By March 23, 2020, the company was actively seeking at least $100 million in additional liquidity through debt or equity financings. The company was more forthcoming in discussions with potential lenders and investors. Notably, in “presentations shared with lenders and potential private equity investors, Cheesecake Factory disclosed its cash position and projected that the company had cash to support approximately 16 weeks of operations under the prevailing circumstances.” In addition, during this period, “internal Cheesecake Factory documents noted that the company was experiencing a negative cash flow rate of $6 million per week.”
Yet, on March 23, 2020, the company furnished to the SEC a Form 8-K withdrawing previously issued financial guidance as a result of the impact of COVID-19 and including as an exhibit its press release of even date announcing its transition to the “off-premise model” that was “enabling the Company’s restaurants to operate sustainably at present under this current model.” The company also disclosed the $90 million drawdown, that it had curtailed planned unit growth and that it was “evaluating additional measures to further preserve financial flexibility,” but did not disclose the letters to its landlords or the company’s negative cash flow rate that it had disclosed to potential lenders and investors.
However, after press reports of the landlord letters, the company submitted another Form 8-K disclosing its intent not to pay rent in April, negotiations with its landlords regarding ongoing obligations, reductions in executive and board comp and its furlough of approximately 41,000 employees (although they did retain their benefits and receive a daily free meal). On April 3, the company furnished another 8-K attaching a press release that disclosed its preliminary Q1 2020 sales update, claiming again that “the restaurants are operating sustainably at present under this [off-premise] model.” In neither the April nor the March 23 press releases did the company disclose that the sustainability claim excluded expenses attributable to corporate operations, the weekly loss of $6 million in cash or that the company had cash sufficient for only 16 weeks.
In the Order, the SEC concluded that the company’s March 23 and April 3 Forms 8-K were materially false and misleading in violation of “Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20 thereunder, which collectively require every issuer of a security registered pursuant to Section 12 of the Exchange Act to file with the Commission accurate current reports on Form 8-K that contain material information necessary to make the required statements made in the reports not misleading.” The company was ordered to cease and desist and to pay a penalty of $125,000.
Fortunately, on April 20, the company announced a $200 million subscription agreement for the sale of convertible preferred stock to a private equity investor.