Cheesecake Factory’s SEC Fines Are Latest D&O Liability to Stem from COVID-19 Pandemic
The US Securities and Exchange Commission has levied $125,000 in civil penalties on Cheesecake Factory as part of a settlement to resolve the agency’s allegations that the company made materially misleading statements to investors about the impact of the COVID-19 pandemic on its business. While this is the first such case reported by the SEC, it is only one in a string of recent third-party liabilities companies have faced that implicate directors’ and officers’ liability insurance coverage.
The SEC accepted Cheesecake Factory’s settlement offer, which resolves the investigation without admission of any wrongdoing. The SEC’s order, however, explains that the company “faced an unprecedented challenge to its business arising from the impact of the COVID-19 pandemic” and made “false and misleading” statements about those financial challenges to investors. In particular, the SEC took issue with several disclosures about financial impact of the virus, including statements in 8-K filings that its restaurants were “operating sustainably” during the pandemic, when in reality the company was “losing approximately $6 million in cash per week” and only had 16 weeks of cash remaining.
From cruise lines to molecular diagnostics companies, we have reported at length about the new D&O liabilities companies will face as the novel coronavirus results in a surge of “event-driven” claims alleging that companies and their directors and officers and other executives and employees breached their duties to the company or violated securities laws in the context of COVID-19 exposure.
The Cheesecake Factory settlement is an example of government investigations arising from a company’s activities in response to the pandemic. SEC Chairman Jay Clayton issued a statement regarding the Cheesecake Factory settlement emphasizing the importance the agency is placing on “proactive” disclosures as the local and national response to the pandemic evolves and suggesting that the agency will continue to hold businesses accountable for failing to adequately disclose the pandemic’s impact on their business and operations.
Even in the absence of coverage for a settlement comprised solely of fines or penalties, companies can incur substantial legal fees and expenses in defending against and ultimately resolving such investigations or enforcement actions, all of which may be covered by D&O insurance. Too often, these legal fees and expenses far exceed the amount of the actual settlement. Government investigations (and the parallel securities lawsuits based on the same allegedly false or misleading statements that often accompany them) are only one of many ongoing D&O exposures companies face, which can include, among others, claims by creditors, shareholders, and other stakeholders arising from bankruptcy proceedings; False Claims Act and qui tam claims relating to funds received from government assistance programs; and cyber-related claims from shareholders or customers in the event a breach or other fraud is committed by hackers exploiting COVID-19-reltaed vulnerabilities. As companies continue to react and adapt to the ongoing pandemic and associated impact on their business and operations, they should pay close attention to D&O insurance as an effective risk mitigation tool to address future COVID-19-related losses.