The COVID-19 pandemic poses unique and novel challenges to publicly-traded retailers, particularly with respect to design and testing of both internal controls over financial reporting and disclosure controls and procedures. We recommend that retailers assess what has changed in the current financial reporting environment, consider whether existing controls are sufficient to prepare financial statements and disclosure documents at the reasonable assurance level, and determine what new controls (if any) are necessary to reduce the risk of errors and fraud.

Publicly-traded retailers large and small have begun to deal with a host of financial and operational issues that have adversely impacted their quarterly results and future prospects. In the coming weeks, public companies will face a myriad of novel and often unfamiliar financial reporting issues, including subsequent event disclosure, fair value and impairment measurement, accounting for loss contingencies and exit activities, revenue recognition, tax liabilities, going concern, and potential insurance recoveries, just to name a few. Businesses accepting federal or other stimulus funds will be required to operationalize a variety of limitations on executive compensation, workforce relations, share repurchases and dividends, among other things. Additionally, the pressure on employees to cut corners is often greater in an economic downturn.

The 2008 financial crisis demonstrated how difficult these issues can be to navigate during a period of economic uncertainty accompanied by widespread volatility in the markets. In addition to the reemergence of these stresses, public companies must now also sort them out while their independent audit firms and substantially all of the key company participants in the financial reporting process are working physically apart from one another. Even when shelter-in-place and social distancing protocols become relaxed, many businesses could face a long glide path before one can expect some semblance of normality to return.

We recommend that retailers begin to assess their existing disclosure and internal controls by taking stock of what has changed in the current financial reporting environment. Unique or novel accounting issues should be carefully analyzed, and expert advice sought when internal resources are insufficient. Potential and actual disruptions to a company’s supply chain, customer base, operations, processes, and workforce should be weighed when evaluating the operating effectiveness of legacy controls. As part of this process, retailers should also assess any potential deficiencies in review-type internal controls and the ability of individuals to perform control duties in light of shelter-in-place orders and other company-specific remote-work protocols.

Based on this assessment, retailers should determine whether existing controls are sufficient to prepare financial statements and disclosure documents at the reasonable assurance level. If a legacy control cannot be performed as previously designed, companies should determine what new controls may be necessary to reduce the risk of errors and fraud. In doing so, they should ensure that any changes in design address both the original risks of material misstatement as well as any new risks. We anticipate regular dialogue with counsel, the auditors and audit committees on these topics.

We remind retailers to make sure that their disclosure controls are operating effectively so they can produce thoughtful and robust disclosures for investors. In a series of interviews and public statements, the SEC’s chairman and other senior officials have recently urged public companies to provide timely updates on the current and forward-looking impact of the pandemic on their businesses, including whether a company has applied for or received federal or other stimulus funds.

In the current environment, public companies of all types should expect to find themselves under heightened scrutiny from the news media, putative whistleblowers, agency inspectors general, consumer watchdog groups, members of Congress and other political figures. Businesses accepting stimulus funds may find that scrutiny to be pervasive and relentless. The SEC brought a wide range of enforcement cases after the last financial crisis involving accounting irregularities, deficient controls, insider trading and other forms of securities fraud. These cases are frequently brought with the benefit of hindsight. We fully expect history to repeat itself when the current crisis abates.

The best defense against the prospect of future regulatory inquiries or outright litigation remains a robust control environment. Retailers should not hesitate to change their procedures when circumstances require, and they should retain well-documented support files for all material disclosures.

View our more detailed client alert on these topics.