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The SEC fires a warning shot about COVID-19 disclosures

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The SEC fires a warning shot about COVID-19 disclosures

Public companies must accurately disclose the current and anticipated material impacts of COVID-19

Tuesday, December 22, 2020
By Erika Kelton for

The recent settlement that Cheesecake Factory paid to the Securities and Exchange Commission was relatively small, but it conveyed a big message: Public companies must accurately disclose the current and anticipated material impacts of COVID-19 on their operations and financial condition.

Cheesecake Factory paid $125,000 in early December (see story) to resolve the charges, a fine that apparently was reduced because of the company’s cooperation with the SEC’s investigation.

This was the first time the SEC brought an enforcement action against a public company for misleading investors about the financial impact of the pandemic, and it is unlikely to be the last. The agency has been keeping a close eye on public disclosures about the impact that COVID-19 is having on operations and revenues.

According to the SEC, in March and April 2020, Cheesecake Factory filed Forms 8K that were materially false and misleading at a time when the company was trying to obtain additional financing of at least $100 million.

In its filings, the company said that its restaurants “are operating sustainably” during the pandemic by offering food to-go and delivery, despite being forced to shut down or cut back indoor dining services.

In reality, the SEC said, Cheesecake Factory was losing about $6 million in cash each week and had only approximately 16 weeks of cash remaining, even after drawing down the last $90 million on a revolving line of credit.

The SEC said Cheesecake Factory failed to disclose that its claim of sustainability excluded expenses attributable to corporate operations. The agency also alleged that the company failed to disclose in the March filing that it was not going to pay April rent for its operations.

Cheesecake Factory was successful in getting the additional financing it sought. On April 20, the company announced a $200 million subscription agreement for the sale of convertible preferred stock to a private equity investor, greatly improving the company’s liquidity position.

The SEC did not reveal how it learned about Cheesecake Factory’s alleged violations, but the number of whistleblower tips filed with the SEC has exploded this year, at least partially because of whistleblower reports of pandemic-related fraud.

In FY 2020, the SEC received over 6,900 whistleblower tips — a huge jump over the previous annual record of 5,200 in FY 2018.

The number of record-setting whistleblower awards in 2020 likely will convince many more whistleblowers to step forward. Half of the 10 largest SEC whistleblower awards so far have been made this year: $114 million (the largest award), $50 million (tied for second largest), $28 million (the eighth-largest), $27 million (the ninth) and $22 million (the tenth).

The Dodd-Frank Act grants SEC whistleblowers 10 percent to 30 percent of the monetary sanctions collected as a result of their information and assistance. The law also provides whistleblowers protection against job retaliation.

Despite the economic uncertainty the pandemic is causing most companies, the SEC has stayed vigilant regarding disclosure requirements. Companies must accurately disclose their financial and operating status, as well as how their operations and financial condition might change as a result of the coronavirus. The SEC has said it would not second-guess good faith efforts to provide “appropriately framed” forward-looking information and noted the safe-harbors for such statements.

“We appreciate that in many cases, actual financial and operational results may differ substantially from what would now appear to be reasonable estimates,” said SEC Chairman Jay Clayton and William Hinman, the director of the SEC Division of Corporation Finance in a statement issued in April about the importance of public disclosure during the pandemic.

However, companies may not privately provide financial information to lenders and potential private equity investors that differs substantially from the information they provide to the SEC and the public, as the SEC alleged Cheesecake Factory did.

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