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Say Cheese: SEC Charges The Cheesecake Factory In Its First Action Against A Public Company For Improper Disclosure On The Effects Of COVID-19 – Corporate/Commercial Law


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Say Cheese: SEC Charges The Cheesecake Factory In Its First Action Against A Public Company For Improper Disclosure On The Effects Of COVID-19


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On December 4, 2020, the United States Securities and Exchange
Commission (SEC) announced a charge against a public company for
misleading investors about the financial impacts of the COVID-19
pandemic.1 Between March and April 2020, The Cheesecake
Factory Inc. (Cheesecake Factory) made several disclosures which
failed to adequately inform investors of the extent of the impact
of COVID-19 on the company’s operations and financial
condition. This improper disclosure resulted in a $125,000.00
penalty. This is the first instance of the SEC charging a public
company for a misleading disclosure arising from the pandemic.

While we are unaware of any similar regulatory actions in
Canada, Canadian regulators have indicated that they are closely
monitoring potentially misleading disclosure relating to
COVID-19.

The SEC often sets trends that are followed by Canadian
regulators and we anticipate that there may be similar
investigations and charges in Canada in the future. As a result,
public companies should be diligent in disclosing the potential
impacts of COVID-19 on their operations and finances.

Key Takeaways

  • Silence on current cash flow, projected cash flow, and
    steps taken to conserve cash may mislead investors as to
    COVID-19’s impact on a company.
    The Cheesecake Factory
    disclosed that its restaurants were “operating
    sustainably,” but was in fact incurring substantial losses and
    projected having no cash on-hand within a number of months. In
    addition to this misleading disclosure, the Cheesecake Factory
    privately disclosed its financial situation to certain potential
    investors, while keeping all existing shareholders in the
    dark.

  • Securities regulators have maintained, and even
    intensified, their scrutiny of COVID-related disclosure
    obligations
    . Early in the pandemic, the SEC expressed its
    commitment to scrutinize public disclosure on the financial impacts
    of COVID-19. Canadian regulators – and the Canadian Securities
    Administrators (CSA) – have made similar commitments, and we
    anticipate that we will see investigations and charges relating to
    issuers’ COVID-19 disclosures in the future.

  • Canadian issuers should adhere strictly to the
    CSA’s guidelines on adequate disclosure of the effects of
    COVID-19.
    Given the likelihood of COVID-19 disclosure
    cases in Canada, public issuers should exercise diligence in their
    disclosure relating to the pandemic to ensure that they comply
    their applicable disclosure obligations.

Summary and Background

On December 4, 2020, the SEC announced that it had settled
charges made against the Cheesecake Factory for misleading
disclosures relating to the extent of the impact of COVID-19 on the
company’s operations and financial condition. The SEC
determined that the Cheesecake Factory failed to satisfy its
disclosure obligations and, accordingly, ordered the restaurant
group to pay a $125,000.00 fine.2

The Cheesecake Factory’s SEC filings dated March 23 and
April 3, 2020 stated that its restaurants were “operating
sustainably,” when in fact the restaurant chain was losing
approximately $6 million in cash per week and only had a projected
16 weeks of cash remaining from the date of its disclosures.
Similarly, the Cheesecake Factory failed to disclose its financial
concerns and the steps it took to conserve its financial position.
For example, the Cheesecake Factory did not report that the company
notified each of its landlords that it would not be in a position
to pay rent for April 2020. However, the Cheesecake Factory
privately disclosed its actual cash position and projected earnings
with lenders and potential private equity investors.

The SEC found that the Cheesecake Factory violated its
disclosure obligations by omitting material information in its
public filings, which constituted misleading disclosure. In its
press release, SEC Chairman Jay Clayton made the following
comment:

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’s impact on their business and
operations be held accountable.3

What Canadian Issuers Need to Know

The SEC brought the action against the Cheesecake Factory eight
months following the company’s public filings, pursuant to the
SEC’s ongoing commitment to scrutinizing public disclosure on
the impacts of COVID-19. Canadian regulators have voiced similar
commitments to keeping Canada’s capital markets open and
conducting vigilant enforcement of securities law.4

The disclosure principles set out by the SEC mirror the guidance
from the CSA and the International Organization of Securities
Commissions (IOSCO). Accordingly, we expect that Canadian
securities regulators may conduct investigations or commence
proceedings that are similar to those levied against the Cheesecake
Factory. Canadian public issuers should be particularly diligent in
considering how they may be impacted by COVID-19, and what
disclosures need to be made. As described in our earlier article,
COVID-19 Impact: Disclosure Obligations and Risks
for Canadian Public Companies
, and pursuant to the guidelines
published by the CSA and IOSCO, public disclosures relating to COVID-19
should:

  1. Discuss important trends and risks relating to COVID-19 that
    have impacted, or are likely to impact, financial statements;

  2. Provide detailed and specific steps that the issuer has taken
    and will take to mitigate risk with respect to COVID-19;

  3. Inform investors about the quality and potential variability of
    profit, loss, and cash flow, and whether past performance can be
    understood to be indicative of future performance;

  4. Discuss the impact of COVID-19 on the issuer’s operations,
    including changes in total revenue, risks, and uncertainties that
    may materially affect future performance;

  5. Be cautious when sharing forward-looking information and, given
    the uncertainty surrounding the COVID-19 pandemic, only disclose
    that which an issuer has a reasonable basis to disclose;

  6. Keep disclosures up-to-date as new information becomes
    available and changes any judgments and/or estimates contained in
    financial statements; and

  7. Avoid inconsistencies in transparency and detail between an
    issuer’s private disclosure to investors and its required
    public disclosure.

In sum, issuers should be detailed, forward-thinking, and
measured in how they disclose the impacts of COVID-19 on a
company’s operations and finances.

The Upshot

Though the Cheesecake Factory case is the first instance in
North America of a securities regulator holding a public company
accountable for incomplete disclosure relating to COVID-19, we
anticipate that securities regulators will continue to scrutinize
disclosure matters relating to the pandemic for the foreseeable
future. Canadian public companies should be diligent in their
consideration of how they disclose matters relating to COVID-19, to
ensure that they continue to meet all disclosure obligations.

Footnotes

1. https://www.sec.gov/news/press-release/2020-306.

2 .https://www.sec.gov/litigation/admin/2020/34-90565.pdf.

3 .See https://www.sec.gov/news/press-release/2020-306.

4 .CSA COVID-19 Information Hub.

The authors of this article gratefully acknowledge the
contributions of articling student Beth Burnstein.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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