Enforcement News: The Cheesecake Factory Charged For Issuing Misleading Information About The Impact of COVID-19 On Operations

• Posted on: Dec 7 2020

In prior articles, we have examined enforcement actions (and settlements thereof) brought by the Securities and Exchange Commission (“SEC” or “Commission”) involving false statements about the subject companies and COVID-19. (E.g., here.) Those actions involved micro-cap companies and the products they claimed to offer to address the pandemic. As we noted in those articles, there was a common thread between the actions – they involved pump and dump schemes in which the company falsely claimed that its products or services could prevent, detect or cure the coronavirus. 

In today’s article, we examine a COVID-19 related enforcement action against The Cheesecake Factory Incorporated, a Delaware corporation based in Calabasas Hills, California, that operates restaurants across the United States and internationally through licensees. The action represents the first time the SEC has charged a large public company for misleading investors about the financial effects of the pandemic.

On December 4, 2020, the SEC announced (here) that it settled charges against The Cheesecake Factory for making false and misleading statements about the impact of the COVID-19 pandemic on its business operations and financial condition in press releases attached to Forms 8-K that were filed with the SEC on March 23 and April 3, 2020, respectively.

According to the Cease and Desist Order (the “Order”) (here), in mid-March 2020, The Cheesecake Factory faced an unprecedented challenge to its business and operations arising from the impact of the COVID-19 pandemic. The company issued several disclosures regarding the effect of, and its response to, the pandemic. As described in the Order, certain of those disclosures failed to inform investors of the extent of the pandemic’s impact on the company’s operations and financial condition in the period of late-March through mid-April 2020, when the company obtained additional financing.

As explained in the Order, the company began taking steps to conserve cash and increase liquidity in the near-term. Among other things, on March 18, 2020, the company sent a letter to its landlords saying that it would not be paying April rent due to the “severe decrease in restaurant traffic [due to COVID-19 that] ha[d] severely decreased our cash flow and inflicted a tremendous financial blow to our business,” noting that it “hope[d] to resume our rent payments as soon as reasonably possible.”

In addition, on March 23, 2020, the company drew down the last $90 million on a revolving line of credit. As of the start of the second quarter on April 1, 2020, the company had approximately $65 million of cash and cash equivalents.

By at least March 23, 2020, said the SEC, the company was actively seeking additional liquidity through either the incurrence of debt through lenders or the issuance of equity to private equity investors with the goal of raising at least $100 million. In presentations shared with lenders and potential private equity investors, noted the SEC, The Cheesecake Factory disclosed its cash position and projected that the company had cash to support approximately 16 weeks of operations under the prevailing circumstances. According to the SEC, internal documents showed that the company was experiencing a negative cash flow rate of $6 million per week.

On March 23, 2020, The Cheesecake Factory filed a Form 8-K with the Commission disclosing, among other things, that it was withdrawing previously issued financial guidance due to economic conditions caused by COVID-19. The Cheesecake Factory attached, as an exhibit to the Form 8-K, a copy of a press release also dated March 23, 2020, in which it provided a business update regarding the impact of COVID-19. According to the press release, The Cheesecake Factory announced that it was transitioning to an “off-premise model” (i.e., to-go and delivery) that was “enabling the Company’s restaurants to operate sustainably at present under this current model.”

The company also disclosed the $90 million draw down on its revolving credit facility, that it had curtailed planned unit growth, and that it was “evaluating additional measures to further preserve financial flexibility.” The SEC claimed that the March 23, 2020 Form 8-K and the attached press release did not disclose the landlord letters or the company’s negative cash flow rate.

Two days later, on March 25, 2020, the media reported that The Cheesecake Factory had sent a letter to each of its restaurants’ landlords on March 18 stating that it was not going to pay its rent for April 2020, and included a copy of one of the landlord letters.

On March 27, 2020, following media reports of the landlord letter, The Cheesecake Factory provided information in another Form 8-K, disclosing that it was not planning to pay rent in April and that “it was in various stages of discussions with its landlords regarding ongoing rent obligations, including the potential deferral, abatement and/or restructuring of rent otherwise payable during the period of COVID-19 related closure.” The company also disclosed that effective April 1, 2020, it had reduced compensation for executive officers, its Board of Directors, and certain employees. In addition, the company announced that it had furloughed approximately 41,000 employees but allowed them to retain their benefits and insurance until June and provided them with a daily complimentary meal from their restaurant.

On April 3, 2020, The Cheesecake Factory filed a Form 8-K with the Commission that attached a copy of an April 2, 2020 press release as an exhibit. The April 2 press release provided a preliminary first quarter 2020 sales update given the impact of COVID-19. Among other things, The Cheesecake Factory disclosed that “the restaurants are operating sustainably at present under this [off-premise] model.”

The SEC alleged that The Cheesecake Factory’s disclosures on March 23 and April 3 regarding the sustainability of its restaurant operations did not disclose that the company was excluding expenses attributable to corporate operations from its claim of sustainability; that the company was, in fact, losing approximately $6 million in cash per week; and that it had only approximately 16 weeks of cash remaining, even after the $90 million revolving credit facility borrowing.

In addition, claimed the SEC, The Cheesecake Factory’s March 23, 2020 disclosure that it was

“evaluating additional measures to further preserve financial flexibility” did not disclose the March 18, 2020 landlord letters stating that the company would not pay April rent.

Based on the foregoing, the SEC claimed that The Cheesecake Factory’s March 23 and April 3, 2020 Forms 8-K were materially false and misleading.

On April 20, 2020, The Cheesecake Factory announced that it received a $200 million investment from Roark Capital, a private equity firm, thereby enhancing the company’s liquidity position. 

“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,” said SEC Chairman Jay Clayton. “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.”

“When public companies describe for investors the impact of COVID-19 on their business, they must speak accurately,” said Stephanie Avakian, Director of the Division of Enforcement. “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.”

In the Order, the SEC found that The Cheesecake Factory violated reporting provisions of the federal securities laws. Without admitting the findings in the Order, The Cheesecake Factory agreed to pay a $125,000 penalty and to cease-and-desist from further violations of the charged provisions. The company cooperated in the SEC’s investigation – a factor that the Commission considered in determining to accept the settlement.

On Friday, December 4, 2020, the price of the company’s shares fell 2% to $38.62 per share.