Cybersecurity Disclosure: The Risks Of Silence

With the rise in targeted, sophisticated, malicious attacks on corporate America’s electronic infrastructure, companies are increasingly focused on their cybersecurity disclosure obligations. There is a growing concern that many companies – fearing reputational harm – are sitting silent, but recent disclosures from a number of companies indicate a shifting approach to cybersecurity disclosure. In addition, pronouncements from the Obama Administration and top regulators reinforce the importance of understanding cybersecurity disclosure obligations. Cybersecurity is critically important to regulators and failure to disclose cybersecurity risks or actual breaches will likely draw significant attention. This OnPoint outlines some of the reasons for companies’ increased focus on managing their cybersecurity risks.

SEC Guidance On Cybersecurity Disclosure

Failure to disclose a data security breach or cybersecurity risk may conflict with specific guidance from the Securities and Exchange Commission's (SEC) Division of Corporation Finance on disclosure obligations relating to cybersecurity risks and cyber incidents. Securities and Exchange Commission, CF Disclosure Guidance, Topic No. 2: Cybersecurity (Oct. 13, 2011). According to the guidance, cyber incidents and the risk of such incidents may give rise to disclosure obligations under current SEC rules. Because of the damage that a cyber incident can cause as well as existing obligations to disclose information that a “reasonable investor would consider important to an investment decision,” corporations may be required to provide information that allows investors to understand the nature of a company’s particular cybersecurity risks.

Regulators Have Identified Cybersecurity As A Top Priority

State and federal regulators have taken notice of the growing cybersecurity threat and made it a top priority. President Obama has declared that the “cyber threat is one of the most serious economic and national security challenges we face as a nation.” The U.S. Attorney for the Southern District of New York, Preet Bharara, similarly has stressed publicly the importance of prompt corporate disclosure of cybersecurity threats. In a New York Times op-ed piece, Bharara stated, “I have come to worry about few things as much as the gathering cyberthreat.” More recently, Norm Champ, Director of the SEC's Division of Investment Management, has echoed the importance of cybersecurity and placed proposing a privacy rule on his division’s “immediate” agenda. The Massachusetts Attorney General’s office has likewise reminded companies that it will pursue failures to disclose data breaches.

Recent Disclosure Trends

As regulators take aim at cybersecurity, more and more companies are coming forward about cybersecurity issues. The past few months have seen revelations that Chinese hackers infiltrated The New York Times computer systems and accessed employees’ passwords and e-mail accounts. Twitter, Facebook and Apple have likewise made similar disclosures. The Wall Street Journal and The Washington Post have also recently made known that they had been attacked. What emerges is a growing concern, and realization, that electronic security systems in corporate America are increasingly vulnerable.

Yet, many companies remain unclear on how to more effectively protect their systems and, in the event of an actual breach or known cybersecurity risk, what needs to be disclosed and how to do so. In this environment, cybersecurity disclosure is an issue that public companies cannot afford to ignore. Indeed, computer security experts estimate that more than a thousand companies have recently suffered cybersecurity attacks. McAfee Inc.’s former vice president for threat research, Dmitri Alperovitch, recently wrote that he is “convinced that every company in every conceivable industry with significant size and valuable intellectual property and trade secrets has been compromised (or will be shortly).” According to Mr. Alperovitch the Fortune Global 2000 firms should be divided up into two categories: “those that know they’ve been compromised and those that don’t yet know it.”

Companies should thus take a realistic approach to data security, analyzing their vulnerabilities, response protocols and current disclosures. Silence in the face of known security risks or data security breaches may result in far greater reputational harm and enforcement costs than making a required disclosure.