8 Steps For Audit Committees To Navigate The Pandemic

Directors on audit are facing unprecedented challenges, thanks to COVID-19. Here's what they can do to keep the ship righted.

The COVID-19 crisis presents unprecedented challenges for all of us—and everyone has a role to play. Audit committees should consider the following steps to help their companies weather this storm.

1.  Watch the “tone at the top.”

Prioritize the health and safety of employees, customers, vendors and counterparties. This is the right thing to do and also mitigates risk for the company. As the company begins to contemplate re-entry of its work force, health concerns will need to be weighed against business imperatives, and board members can provide an important perspective.

2. Stay on top of operations & risks.

Decisions during crises are often made at “light-speed,” but boards still have oversight duties and must adequately inform themselves about key decisions, all of which can have regulatory, legal or other implications.

Consider requiring more frequent management updates. Document any additional steps taken. Examine action plans and clearly designate who will handle certain challenges. Ask more detailed questions to facilitate learning about issues that may be harder to understand in an extended period of remote meetings. Consider asking for briefings from a broader array of management or external advisors with specialized knowledge. But also know that management has unusual demands at this time, so don’t add to them unnecessarily. Consider, in consultation with management, the enterprise risk management impacts of COVID-19 and its aftermath.

3. Stay in sync with management on reporting.

Audit committees should expect to be exceptionally active this quarter and it is essential that management and the committee (indeed, the full board) are in sync on key reporting issues. The SEC has provided recent guidance to reporting companies to encourage robust reporting in key disclosure areas, including risk factors, MD&A (including liquidity) and forward-looking information and “outlook” sections. If your company previously provided annual earnings guidance, consider withdrawing it or updating with appropriate hedging or cautionary language given the significant uncertainties most companies face in this environment. If necessary, consider taking advantage of a 45-day extension for filing first quarter 10-Qs (for calendar year filers).

First-quarter reporting for most issuers will reflect the pre- and mid-crisis environments, and investors and analysts will especially focus on mid-crisis performance, which for many companies began in March. Audit committees and management teams should also be prepared to expend extra time on key accounting judgments that could be impacted in this environment, such as intangible asset impairments, revenue recognition and A/R and tax reserves, in addition to factors that might bear on the company’s internal control over financial reporting.

4. Make sure disclosures and reporting are consistent.

Plaintiffs’ attorneys are investigating whether COVID-19 disclosure-related issues can support opportunistic securities class actions, with two such cases already filed. Companies that express public confidence about their general prospects or their supply chain sufficiency despite dismal news about the economy and COVID-19’s impacts face heightened risk.

As always, companies should be careful to have support for statements at the time they are made. Watch for changing circumstances and adverse trends, in particular, as those circumstances change rapidly; describe them accurately as new developments. Ensure that public reporting is consistent with what the board is being told privately.

Shareholders also may second guess board-level decisions or inaction. So, consider documenting COVID-19-related considerations and responses to create a diligence record. Shareholders looking to file derivative actions often seek books and records before filing or making demands. Having a record of board considerations and responses can be very protective. Shareholder demands and books and records demands often come by mail, so companies should be alert to incoming mail when personnel are out of office.

5. Be aware of insider trading risks. 

In a rapidly changing environment like this, be especially vigilant about insider trading in company stock. Stock prices are extremely volatile and events are changing quickly – this is an environment in which an insider can be challenged on a trade with benefit of hindsight. The SEC circulated a notice to be especially careful regarding trading windows given heightened sensitivity of inside information, and extra SEC scrutiny will likely be applied. Companies should take extra care in considering their trading policies, including with respect to insiders putting up or taking down 10b5-1 plans.

6. Be prepared for contract breaches. 

COVID-19 likely will cause breaches and attempted avoidance, and your company may be on either side of those disputes. Examine force majeure clauses and common-law doctrines such as frustration, impossibility, and commercial impracticability. Weigh the benefits of performance vs. strategic non-performance. TROs or threatening litigation may shield from aggressive counterparties, but also consider reputational and long-term relationship issues. Audit committees also should consider financial statement implications around uncertainty in resolution of breaches, including potentially material revenue and expense swings.

7. Update crisis management plans

Effective crisis management prevents under- and over-reacting. Consequently, Audit committees should consider whether an up-to-date, effective crisis management plan is in place. Elements may include:

• Cross-functional teams

• Audit or risk committee involvement

• Decisive procedure and resource deployment

• Contingency plans

• Thoughtful communications, including “holding” statements on likely issues.

8. Conduct contingency planning exercises.

Boards should engage with management on 2020 demand/revenue projections under various scenarios and conduct contingency planning exercises to address downside scenarios. Planning elements include:

• Conserving liquidity to preserve flexibility

• Exploring public and private options to enhance flexibility

• Employee and talent disruption

• Need for employee workforce and compensation reductions

• Other expense and cap ex reductions

• Board/governance continuity (including emergency bylaws and management succession planning)

Certain companies may require more extensive restructuring planning, including liability management or full bankruptcy preparedness planning.

 

This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The content therein does not reflect the views of the firm.

 

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Hille Sheppard is co-leader of Sidley’s global securities and shareholder litigation practice. Brian Fahrney is a member of the Sidley’s Executive Committee and is a global co-leader of the M&A and Private Equity group. He also serves on the firm’s COVID-19 Task Force. Dave Gordon is a partner at Sidley and heads the Litigation group in the firm’s Chicago office. He is also the co-leader of the firm’s global Accountants and Professional Liability practice