by T. GormanPosted on Posted in SECActions

Cases tied to issuer accounting questions and disclosures have long been a staple of the Commission’s Enforcement Division. In recent years the agency has launched a number of initiatives focused on these issues. While some cases were generated, eventually the efforts seemed to fade.

There are some recent suggestions that the Division may be about to regenerate earlier trends in the area with a data driven approach. For example, as the fourth quarter of the last government fiscal year ended the Division filed several accounting cases in the blitz of actions initiated before year end. Last week a settled action centered on false statements by an issuer built on a failure to disclose certain accounting data shared with potential lenders but not the public.

This week the agency filed another settled action built on issuer failures to disclose how the company made its numbers in key areas. Stated differently, the company did not disclose changes that permitted the firm to make certain financial goals. In the Matter of General Electric Company, Adm. Proc. File No. 3-2-165 (December 9, 2010).

The action is built on two key omissions: First, GE failed to tell investors how its Power division made the numbers. Second, investors were not told about deteriorating trends in the insurance area and potential losses that eventually resulted in pre-tax charges.

At an investor conference in May 2015 GE detailed future plans for growth. While the firm faced substantial challenges, GE told investors that its framework to grow non-GAAP Industrials and Verticals Operating Earnings per share would yield $1.25 to $1.35 in 2015 to $2 per share in 2018.

GE Power, a significant line of busines that manufactures gas turbines, faced challenges in the marketplace. Business in Power was flat, according to internal documents. A large portion of the segment’s earnings and cash came from very profitable agreements that ran for years.

A plan was developed. The division had a $5 billion “deferred balance” of unbilled revenue reported in GE’s financial statements. Key was to reduce expenses. If costs and estimated costs for the division were reduced, greater revenue would result and Power would hit its financial goals.

In 2016 GE did not tell investors that 25% of Power’s reported profits were generated by reducing estimates of costs to complete the work under the longterm contracts. The next year the same technique was used in the first three quarters to significantly boost profits. Investors were told only that Power generated $1.4 billion in 2016 and $1.1 billion for the first three quarters of 2017. Investor were not told that the revenue increases were generated in part by changing estimates that compromised the cash flow for future years.

The company used a similar approach to report increased industrial cash collections for 2016 and 2017. GE decided to sell or factor long term receivables from the Power service multi-year agreements primarily to GE Capital, a subsidiary of the company. This practice – called “deferred monetization” boosted reported cash flow by over $1.4 billion in 2016 and over $500 million for the first three quarters of 2017.

Finally, there were issues in the insurance area. Beginning in 2004 the firm explored exiting the line of business. Portions of its insurance portfolio were divested. The long-term care insurance policies remained – a sale would generate huge losses.

By 2015 and 2016 costs exceeded revenues. Despite the known trends, GE lowered projected claims costs for the distant future while concluding that it did not have insurance losses. The company did not disclose its rising claim costs and the resulting potential for material insurance losses.

In 2017 and 2018 GE made a series of public announcements. They described the disappointing cash and earnings in GE Power and a $9.5 billion pre-tax insurance charge. The share price dropped about 75%. The Order alleges violations of Securities Act Section 17(a0(2) & (3) and Exchange Act Sections 13(a), 13(b)(2(A) and 13(b)(2)(B).

In resolving the matter, the Commission acknowledged the remedial actions taken by the firm which included replacing key personnel. The company consented to the entry of a cease-and-desist order based on the Sections cited in the Order and agreed to pay a penalty of $200 million. A fair fund will be created.

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by T. GormanPosted on Posted in SECActions

The pandemic continues to have a huge impact on restaurants, among others. The initial lock downs earlier this year shuttered many dining and other establishments. Some establishments closed. Many restaurants morphed into takeout establishments and later added outdoor dining. Recent restrictions in some areas such as California have even closed outdoor dining, but not takeout. There is little doubt that many restaurants will unfortunately not survive.

One nationwide chain tried to survive by taking a series of actions which more than suggested it was suffering from financial difficulties. At the same time the company did not disclose some information that would have added to the bleak picture painted by its disclosures. The omissions were later penned into an Order Instituting Proceedings charging false statements. In the Matter of The Cheesecake Factory Incorporated, Adm. Proc. File No. 3-20158 (December 4, 2020).

Cheesecake Factory is a well-known national restaurant chain based in Calabasas Hills, California. The firm’s shares are traded on Nasdaq Global Select Market under the ticker symbol CAKE.

As the pandemic began to unfold Cheesecake Factory and other restaurant chains effectively had their businesses closed by the initial restrictions imposed which were designed to try and contain the virus. By mid-March 2020 Cheesecake Factory and others faced unprecedented challenges. Over the next month Cheesecake Factory took a series of steps to try and survive. Those included:

· Efforts to conserve cash such as a March 18, 2020 letter sent to landlords saying that it would not be paying April rent due to a severe decrease in restaurant traffic from the virus; the firm hoped to resume payments as soon as “reasonably possible,” according to the letter;

· On March 23, 2020 the firm drew down the last $90 million on a revolving line of credit; at the beginning of the second quarter the company had about $65 million in cash and cash equivalents;

· By March 23 the company was actively seeking additional liquidity through either debt or equity investments with the goal of raising at least $100 million;

· Possible private equity investors were told the company would survive at the current negative cashflow rate for about 16 more weeks – documents reflected a negative cash flow rate of $6 million per week;

· In a March 23 Form 8-K filed with the Commission Cheesecake Factory stated that it was withdrawing prior financial guidance due to the virus; the attached press release stated the company was moving to an “off-premise model” or delivery to permit the firm to operate “sustainably;”

· Two days later each restaurant landlord received a letter stating the April rent would not be paid; the letter was reported in the media;

· A March 27, 2020 Form 8-K stated the company was not planning to pay rent in April and that it was in discussions with landlords regarding its ongoing rent obligations and potential resolutions; in addition, executive officers, board members and certain employees would take a pay cut while 41,000 workers were furloughed but allowed to retain certain benefits;

· An April 3, 2020 Form 8-K filing attached an April 2 press release disclosing preliminary Q1 2020 sales noting that the restaurants were operating sustainably using the off-premises model; and

· On April 20, 2020 Cheesecake Factory announced a $200 million subscription agreement for the sale of convertible preferred stock to a private equity investor.

The Order alleges that the March 23 and April 3 Forms 8-K were false and misleading. The Forms did not disclose that the firm was “excluding expenses attributable to corporate operations” from its discussions of “sustainability;” there was no statement that the negative cash flow was $6 million per week or only 16 weeks of cash remained as was stated to certain potential lenders. The Order alleges violations of Exchange Act Section 13(a).

The firm, whose cooperation was considered by the Commission, resolved the matter, consenting to the entry of a cease-and-desist order based on the sections cited in the Order. The firm also agreed to pay a penalty of $125,000 that was transferred to the U.S. Treasury.

Comment

Clearly an issuer cannot make selective disclosure. Cheesecake Factory selectively disclosed the available facts yet painted a bleak picture of the firm’s finances but not bleak enough.

The Commission acknowledged that Cheesecake Factory cooperated with its investigation.

But just what did Cheesecake Factory get for that cooperation? Reduced charges? A reduced penalty? Stated differently, what is the value of cooperation? If the Commission wants to encourage corporate cooperation – and a recent report suggests it is declining (here) – it would be useful if the agency could add specificity to what is considered.

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