April 14, 2020
April 14, 2020
The Coronavirus Disease 2019, known as COVID-19, has had a significant impact on boards and their enterprises across the globe. The pandemic has resulted in dual crises to our health and the economy, and while such a situation is not unprecedented, it is hitting organizations and testing their resilience like never before. Although the full boardroom is pulling together to address this fast-moving situation, audit committees, who are tasked with financial and risk oversight, are on high alert on a range of urgent issues from adjusting financial projections to addressing immediate liquidity and credit risk.
On March 25, 2020, NACD, KPMG, and Sidley Austin convened a meeting of the NACD Audit Committee Chair Advisory Council—a group of audit committee chairs from Fortune 500 companies—during the COVID-19 crisis for a wide-ranging virtual discussion about audit committee action items in this unprecedented time. Several key themes emerged from the discussion for both audit committees and the full board.
As one delegate stated, “To get through a crisis like this, relationships with stakeholders are key.” Investors are high on the list of important stakeholders, and how companies communicate with them in this moment matters.
“We said we will probably lose money in the first quarter, and said that we didn’t know what the coming year held. We told our truth,” said one delegate, stressing honesty in the face of uncertainty. “We had a lot of communication with investors, and we trusted them to do the right thing when [they were] given the information we had.”
Caution was urged around presenting non-GAAP financial metrics. While useful given the severity and uniqueness of the current situation, adjustments to GAAP metrics should be used reasonably and should not be used to paint a rosier picture of the company’s financial state. A crisis like this challenges the audit committee to critically assess numerous—likely subjective—judgments from management and the auditors on key line items in the financial statements.
Some boards have made the decision to withhold earnings guidance, given the level of uncertainty in the business environment. Perhaps most important to note is that companies don’t have to wait until the earnings release to communicate with investors. “Think through whether the 8-K requirements [have been] triggered. It may be sooner than [at] an earnings release,” said John Rodi, leader of the KPMG Audit Committee Institute.
The group noted that the US Securities and Exchange Commission (SEC) had recently announced an extension to the deadline to file certain disclosure reports that would otherwise have been due between March 1 and July 1, 2020 and disclosure guidance on non-GAAP metrics.
Audit committee chairs should discuss any potential timing issues with external auditors earlier than usual, given the new remote operating environment many companies are facing for the first time. “Ask, ‘What is the timeline for the disclosure of risks that precede or follow the quarter?’” suggested one delegate. “Robust conversation early will lessen future headaches,” confirmed another delegate.
For example, potential changes to both the design and operation of the company’s internal control environment may be necessary due to most employees working remotely. Management and auditors need to work in tandem to ensure the best outcomes for the company. “It’s never been more critical [that there be] open lines of communication between auditors and management teams,” said Rodi.
Decisions made prior to the pandemic, such as stock buybacks, likely warrant a second look. “If the board authorized buybacks, it’s fair to ask if the facts and assumptions are the same as when the decision was made,” stressed one delegate. “Even if you have a legal basis to resume purchases, is the appropriateness there?” cautioned Tom Kim, partner at Sidley Austin.
Capital expenditure decisions should also be reexamined, and given the importance of liquidity in this environment, decisions on matters such as credit drawdowns should be considered carefully, especially with the prospect of government loans being made available to companies, but with conditions. Finally, consider how strategy may need to change. Do underlying assumptions remain valid? Is the worst-case scenario extreme enough?
In this environment, it’s not enough to manage the current crisis. Companies and their boards must also assess and prepare for a wide range of heightened risks that are second- and third-order effects of the crisis. Certain risks, however, should be top of mind for committee and board discussion.
With the rapid move to work from home, cyber risk, for example, takes on additional importance. “We are seeing heightened cyber risk, especially in the phishing area. A lot of phishing is focused on how the virus will affect the employee, and the click rates are going way up,” noted one delegate.
Another risk comes in the form of financial controls with a dispersed workforce. “As people work from home, they may not have the same set of controls. Internal audit is working with the internal-controls group to shore this up,” one delegate pointed out. The board must remain focused on overseeing compliance in an environment where existing systems are stressed.
Other risks include credit and supply-chain risks. And, of course, all are concerned about employee health and safety. As one participant said, “Risk outweighs opportunity at the moment.”
During normal operations, board committees have defined roles and responsibilities that ladder up to the full board. In a crisis of this magnitude, the full board needs to be more actively involved. One delegate stressed, “We are operating as a total board and not as a committee. The issues we are facing reach into every committee, so it hasn’t been helpful to divvy up the workload.”
The board must try to reduce demands on management, as the CEO and management team work through a minefield of crisis-related issues. At the same time, the board must stay abreast of the latest developments in order to make a fully informed decision at a moment’s notice in a rapidly changing environment. “It can be helpful for the lead director to serve as a conduit between the board and management, so that management can focus its attention on managing the crisis and not [on] answering questions from individual directors,” said Claudia Allen, a senior advisor at the KPMG Board Leadership Center. Some boards have increased the frequency of their meetings, while others receive daily reports from the CEO via email. Solid information flow and clear communication are key.
Clearly, planning for any given crisis is difficult. “The crisis that you plan for is rarely the one you have, but muscle memory from dealing with previous crises and preparation for other scenarios remains in place,” said Allen. One delegate stressed the importance of testing your current crisis plan at scale: “That is what’s critical. The plan can break down at scale, so you need to test at scale.”
As difficult as leading may be at the moment, the current pandemic is a chance to learn for the next crisis. One delegate perhaps said it best: “Plan for the worst, but work for the best.”
COVID-19. Uncertainty. Fear. Recession. Fiduciary Duties.
It’s essential that directors know what to focus on and when.
NACD: Tools and resources to help guide you in unpredictable times.