Broker-Dealers and Investment Advisers Now Targeted by Both Cyber Intruders and SEC Cybersecurity Examiners

by BakerHostetler

Cybersecurity has increasingly become a critical issue for all types of businesses, few more so than broker-dealers, investment advisers and others in the financial sector. The cyber threat is much broader than customer data privacy as addressed by the Securities and Exchange Commission’s Regulations S-P (regarding privacy of consumer financial information) and S-ID (regarding identity theft). Cybersecurity encompasses risks such as thefts of funds or business information and attacks designed to disable a firm’s operations.

On April 15, 2014, the SEC’s Office of Compliance Inspections and Examinations (OCIE) staff brought heightened attention to such cyber threats with the issuance of a Risk Alert titled “OCIE Cybersecurity Initiative.”[1] The OCIE Risk Alert provides valuable guidance to regulated firms on ways they can go about protecting themselves from cyber risks. It also highlights the regulatory risks firms will encounter if they do not implement adequately robust cybersecurity compliance programs. Broker-dealers and investment advisers should take steps now to ensure they are protected from the looming threats from both cyber criminals and regulatory examiners.

The SEC and FINRA Shine the Spotlight on Cybersecurity in 2014

Technology-related risks have been a focus of the SEC’s rulemaking and examination programs in recent years. For example, as we discussed in our 2013 Mid-Year Report, the SEC and Commodity Futures Trading Commission jointly issued final rules in April 2013 requiring certain regulated entities to implement identity theft programs.[2] As we also discussed in a previous Executive Alert, the SEC, FINRA, and the CFTC issued joint guidance in August of last year on the “best practices and lessons learned” from their review of firms’ business continuity and disaster recovery plans, following the closures of equities and options markets caused by Hurricane Sandy.[3]

In 2014, securities regulators have moved beyond such particularized technology issues, and highlighted the broad spectrum of cybersecurity risks that firms face. Early this year, FINRA announced that it had begun conducting targeted examinations (sweeps) to assess how broker-dealers are managing cybersecurity threats.[4] FINRA’s sweeps letter requested information on over a dozen cybersecurity issues, and asked firms to complete an “impact analysis” regarding the likelihood and potential impact of various kinds of cyber attacks on the firm’s critical systems.[5]

On March 26, 2014, the SEC convened a cybersecurity roundtable, at which four sets of panelists addressed various perspectives on cybersecurity issues faced by both market participants and public companies.[6] Opening the program, SEC Chair Mary Jo White described the roundtable as an aspect of the SEC’s effort to inform itself, the marketplace, other agencies and the private sector as to cyber risks and ways to combat them. OCIE’s April 15 Risk Alert is the next step in the regulators’ drive to enhance procedures and protections in this critical area.

OCIE’s Cybersecurity Initiative

The OCIE staff stated in the Risk Alert that it will examine more than 50 registered broker-dealers and investment advisers to help the SEC determine what additional steps it should take to address cybersecurity threats, and to identify areas where the SEC and the industry can collaborate to protect investors and markets from those threats. While only a relative handful of registered broker-dealers and investment advisers will be directly affected by this wave of examinations, all firms should take heed because it will likely be only a matter of time before they face similar scrutiny.

Fortunately for firms not yet in the SEC staff’s sights, the Risk Alert provides substantial guidance on the types of cybersecurity issues the staff plans to review. Attached as an appendix to the Risk Alert is a sample list of 28 requests for documents and information (with detailed sub-parts) which, while not necessarily exhaustive, to a large extent provides a roadmap of the staff’s current concerns. Legal and compliance personnel of broker-dealers and investment advisers would be well advised to use this list as a baseline for their compliance programs.

Many of the questions outlined by the SEC staff track information addressed in the Framework for Improving Critical Infrastructure Cybersecurity, which was released in February 2014 by the National Institute of Standards and Technology (NIST).[7] Some of the principal areas of inquiry include:

  • Firms’ adoption and internal dissemination of written cybersecurity policies and procedures and documentation of compliance with those policies and procedures;
  • Periodic risk assessments to identify both cybersecurity threats and physical threats that may bear on cybersecurity, identification of persons responsible for conducting the assessments and documentation of findings;
  • Training of employees and vendors, including with respect to network access and use of removable and mobile media;
  • Information technology controls and processes, including network access restrictions, denial of service attack protection, regular system maintenance, software and applications testing, user privilege limitations and encryption;
  • Arrangements with customers and vendors, including online account access and authentication; and
  • Insurance policies specifically covering losses or expenses attributable to cybersecurity incidents

The sample list of questions also asks each firm to (i) describe how it identifies relevant best practices regarding cybersecurity for its business model, (ii) identify its three most serious cybersecurity risks and the basis for this determination, and (iii) describe actual cybersecurity incidents that have occurred (e.g., malware, denial of service attacks, software or hardware malfunctions, network breaches by employees, vendors and other third parties, fraudulent customer emails or remote access, and extortion attempts) and the firm’s responses, including whether it reported the incidents to regulators, law enforcement or industry organizations.

What Firms Should Do Now

Plainly, the vast majority of registered broker-dealers and investment advisers are not yet the subject of an OCIE cybersecurity examination. Yet all firms should focus their attention on the issues spotlighted by the Risk Alert.

The most significant risk for many firms is the cybersecurity risk itself. Many of the speakers at the SEC Roundtable attested to the growing threats firms face, as measured by the frequency and severity of attacks, and the financial and reputational damage these attacks can bring. Highlighting one area of the problem, SEC Commissioner Luis Aguilar cited a 2012 global survey that found that 53 percent of securities exchanges had experienced a cyber-attack in the previous year. Thus, the primary reason firms should establish robust safeguards is to protect their businesses, their customers and other constituencies.

But the OCIE Risk Alert also highlights the regulatory risk faced by firms. As the questions attached to the Risk Alert make clear, cybersecurity examinations will extend substantially beyond prior hot-button areas such as protection of customer information and business continuity plans. Firms’ compliance programs must address all types of cyber risks, whether arising from external (e.g., competitors, nation-states, terrorists, hackers, environment) or internal (e.g., employee, vendor, customer) threats, and risks ranging from misappropriations of information or assets to impairments and even shutdowns of firm operations.

While the new SEC initiative appears focused more on information gathering and information sharing than on regulation and enforcement, it may not be long before cybersecurity examinations turn to deficiency letters and enforcement actions.

Enforcement actions involving violations of Section 30(a) of SEC Regulation S-P (the Safeguards Rule)—which requires broker-dealers and investment advisers to adopt written policies and procedures reasonably designed to protect customer information—are instructive as to the magnitude of these regulatory risks. For example, in 2008, the SEC instituted a settled administrative proceeding in which it found that a broker-dealer had failed to implement adequate security measures and left customer information at the firm’s branch offices vulnerable to unauthorized access during a series of hacking intrusions that took place over several months.[8] Among other sanctions, the firm was fined $275,000 and required to engage and bear the cost of an independent consultant to review and make recommendations concerning firm policies and procedures. As another example, in 2010, FINRA fined a broker-dealer $375,000 for similar violations.[9]

More recently, in October 2013, a settled SEC administrative proceeding imposed a $250,000 fine, independent consultant undertaking, and other sanctions on an investment adviser for various violations of the Investment Advisers Act of 1940.[10] This action arose from the adviser’s failure to implement proper safeguards as a custodian of client assets, which allowed a hacker to engage in fraud with respect to a client’s account.

Therefore, to help protect against both technological and regulatory risks, firms should act now to assess and, if necessary, enhance their cybersecurity compliance and supervisory programs. The issues highlighted in the OCIE Risk Alert—as well as in the FINRA sweeps letter and NIST Framework—are excellent resources on which to base this assessment.

[1] OCIE Cybersecurity Initiative, SEC National Exam Program Risk Alert, Vol. IV, Issue 2 (Apr. 15, 2014).
[2] Identity Theft Red Flags Rules, SEC Release No. 34-69359 (Apr. 10, 2013).
[3] Business Continuity Planning, Joint Guidance from the SEC, FINRA and CFTC (Aug. 16, 2013).
[4] FINRA, Targeted Examination Letters Re: Cybersecurity (Jan. 2014).
[5] Available at:
[6] SEC, Cybersecurity Roundtable (Mar. 26, 2014).
[7] NIST Releases Cybersecurity Framework Version 1.0 (Feb. 2014).
[8] In the Matter of LPL Financial Corp., SEC Exchange Act Rel. No. 58515 (Sept. 11, 2008).
[9] D.A. Davidson & Co., FINRA Letter of Acceptance, Waiver and Consent, No. 20080152998 (Apr. 9. 2010).
[10] In the Matter of GW & Wade, LLC, SEC Investment Advisers Act Rel. No. 3706 (Oct. 28, 2013)


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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