The recent disruption to business operations around the world has created new challenges for boards and their companies as they enter earnings season. To help provide clarity on the latest SEC guidance and cut through the noise to assist board members in their upcoming reporting, Corporate Board Member spoke with Liz Morgan, partner at King & Spalding, and Jan Babiak, audit chair at Walgreens and Bank of Montreal and senior independent director at Euromoney Institutional Investor PLC, to provide their respective perspectives and experience as we move through this crisis.
On the impact of COVID-19 on corporate filings:
Liz Morgan, partner, King & Spalding: The impact of the current situation is different for every company. That was one of the key themes in the guidance that came out of the Division of Corporation of Finance last week. One of the things we’ve been talking to boards about on the disclosure front is guidance—when is the right time to update, withdraw, revise or refrain from giving guidance. And as we come to the end of the quarter for many companies and they start thinking about what 10-Qs and earnings releases will look like, there’s a focus on what is the board’s responsibility in terms of ensuring, from a risk oversight perspective, that they’re working closely with management to make sure they understand the risks the company faces today and that those risks are disclosed in an accurate and complete way.
Jan Babiak, audit chair, Walgreens and Bank of Montreal: COVID-19 generalizations are problematic. I’m on boards in different countries, in different sectors, and there is no right answer because every company is different, every board is different, every regulatory regime is different—but every company is impacted. For example, even companies considered ‘essential’ that have continuing or even increased revenues will have unexpected costs, such as extra custodial and cleaning bills. And most companies have many people working from home, so it’s adding to the technology costs and cybersecurity protection needs even if revenue is down. Some sectors, like delivery and pharmacy, are hiring like crazy. There are reports of members of management even working the stores and unloading trucks because it’s just all-hands-on-deck. Beyond extra cleaning costs, these companies may be giving hourly team members bonus pay to help cover additional costs such as childcare (given the schools are closed) to help ensure the shifts are staffed. Contrast this with other companies where a portion of the income comes from events, restaurants and hotels, which have widespread cancellations and many of the employees have nothing to do, and that’s a very different situation. So, I think the question about the impact from a board standpoint depends on the company. While there will be a number of common factors, like recognizing the uncertainty, there will be significant differences as well. Every company will have a duty to disclose what this means to them.
On providing guidance in a rapidly changing, unpredictable environment:
Liz Morgan: The rapidity of change is key, and that’s one of the main challenges here. As a practical matter, we’re seeing companies adjust regular timetables and ask for flexibility to make sure that their board, and particularly their audit committees, are available in real time to be briefed on and overseeing decisions, including on to withdraw or update guidance, or to stay silent. And as we come up on the window when companies might pre-release results, companies may think about pre-releasing results for the first quarter and disclosing how the pandemic impacted business over the past few weeks, at the same time as making an announcement to withdraw or revise guidance. One of the challenges there will be balancing how to talk about impacts over the past few weeks with future expectations, given the uncertain and evolving nature of what may be ahead.
Jan Babiak: Forward looking is always challenging, but it’s particularly challenging now. Where companies might’ve been comfortable giving guidance for the next year, a lot of people have completely pulled guidance and just said, ‘We don’t know about the short- and medium-term future.’ You want to be transparent with your shareholders, but, by the same token, if you don’t know, you don’t know. Historically, if a CEO were to say, ‘I don’t know’, the market might think, ‘well, you’re clearly not on top of your business.’ But I think the market understands that everybody’s in a state of uncertainty because no one knows how long this is going to last or what’s going to happen. Recently, I’ve seen examples of companies that have communicated one quarter’s guidance only, ‘We can give you some visibility of the next quarter, but that’s it.’ In the past, you wouldn’t have done that.
On pulling guidance:
Jan Babiak: I think if you are sure your guidance is no longer realistic, you should withdraw your guidance. But if you can actually see a path to still hitting your guidance, which might be viable after consideration of actions taken to mitigate the crisis, it may not be necessary. Good leaders are unlikely to just sit there and watch revenue fall without taking compensating actions. There are so many things that you can do, such as freezing pay increases, stopping all travel, scaling back or canceling projects, and much more. Depending on the scale of the revenue loss, these adjustments may be enough. You may be able to fix the cost side to offset the implications to EBITDA, and you may still make your guidance depending upon the factor on which your guidance is set—earnings per share or otherwise. Even if with a disaster scenario whereby we continue in this state of isolation for another six months, you can still see a path to hitting your guidance, do you need to communicate that before the next scheduled market update? That said, if there is no way you’re going to hit your number, then I think you’ve got a different responsibility as soon as you know.
On the consequences of pulling guidance or communicating uncertainty:
Jan Babiak: As an audit committee chair, I think you have to look at where you are in the cycle and what else is happening. For example, if the company is currently in the market with a securities offering or engaged in stock buybacks, there may be more of an obligation to speak to the market sooner rather than later. However, if you were just in the middle of a normal quarter and you didn’t have securities offerings or stock buybacks or anything like that going on, you probably wouldn’t have an obligation to issue anything early. It’ll come through as part of your normal quarterly reporting. And I think in these truly unprecedented times, the market and, certainly, the regulators do have some understanding if companies say, “We don’t know, but here’s what we’re doing”. Then the market and investors will make their own judgement about what is communicated. Six months ago, if a CEO stood up and said, ‘I don’t know what kind of revenues we’re going to have in two months, and I don’t know our expected cost base,’ the share price would plummet, and the board would be criticized for not firing that incompetent CEO. But that is not the environment we’re in right now. Because we really are all in this together, I think there’s a little bit more acceptance that articulating uncertainty is not a sign of weakness or incompetency.
On the value of honesty and transparency:
Liz Morgan: Companies need to be accurate and complete in their disclosures. They need to make sure that their disclosures are correct and not misleading at the time that they are made. And yes, in addition to strict compliance with legal disclosure requirements, investors are looking for transparency. About a week ago, we heard companies saying, we think our stock has been negatively impacted because we haven’t come out and said anything yet, and our investors are assuming the worst. So, in the interest of transparency and having a dialogue, we want to come out and make a statement, even if it’s not saying much and even if it’s not required. But at this point it’s all we can say, and, in that sense, we think it’s complete and not misleading.
Jan Babiak: As always, you’ve got to follow the usual disclosure rules, and most of that is very clear even as it relates to uncertainties. For example, in February 2018, the SEC issued cybersecurity interpretive guidance, what you need to do in an evolving situation. So, if you have a cyber breach, at what point do you need to report it? Well, this situation has some of that kind of feel to it because it’s evolving by the day. All the boards are having extra board calls and with each, you have to ask, ‘Have we made any decisions that now we need to communicate to the market? Are we at a point where we need to either report something or change something we reported recently?’ I think you just have to stay on top of it. And then, transparency and honesty even where you have uncertainty. It is probably worth noting that investors, regulators and others also have an insight into what is happening based on the social media postings of the company. For example, if you are posting that you are hiring, that is providing some information that the market may consider, even though it does not trigger an SEC reporting requirement.
On regulatory relief:
Liz Morgan: On March 25, the SEC announced that 45-day conditional relief is available for disclosure reports due between March 1 and July 1, 2020 where companies are unable to meet deadlines as a result of COVID-19. The guidance also reminds companies that notwithstanding the relief that’s available, companies are encouraged to provide current and forward-looking information to their investors. If a company is considering relying on this relief, it will need to disclose the reasons arising from the COVID-19 pandemic that prevent the timely filing, and it should still consider how to provide appropriate ongoing disclosures to investors during the extension period..
On investor and regulator expectations
Liz Morgan: The overarching principle of materiality here is an important driver; think about this [situation] in every aspect of your disclosures to reflect not only the way that results and operations were impacted last quarter, but also how you expect them to be impacted going forward based on current information. The SEC has been clear that disclosure requirements can apply even in the absence of a specific line item requirement. One thing to highlight from recent SEC guidance is the idea that companies should be proactively revising, updating disclosures as their facts and circumstances change. The question of how often disclosures need to be updated will depend on whether insiders are trading, whether the company is buying back securities, whether the company is doing an offering, as well as Regulation FD and IR considerations.
Jan Babiak: The companies I’m working with are doing a good job of setting up committees with work streams. I was just on one board call yesterday, the CEO walked us through eleven work streams outlining who was leading each and their respective roles and accountabilities. Examples include taking care of the welfare of employees; technology; short term revenue; future revenue opportunities; government liaison; cost control; financing needs and working capital protections; internal and external communications; etc. This is the sort of crisis management and recovery that you would expect management to have in place. And also, as an investor, when you’re asking questions that’s what you want to hear—the company has a sensible plan and it is being integrated into the fabric of the organization.
