Cybersecurity liability: Delaware has good news for directors

by Thompson Coburn LLP

Thompson Coburn LLP

The Delaware Chancery Court just issued an opinion that will have directors breathing a sigh of relief in connection with cybersecurity risks. In its opinion – Reiter v Fairbank, C.A. No. 11693-CB (Del. Ch. Oct. 18, 2016) – the Chancery Court articulated the standards of “bad faith” that must exist in order for directors to be held liable for failing to exercise oversight with regard to the corporation’s compliance with law in a risky area.

Duty of oversight

The duty of oversight was first articulated in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). This duty arises from a director’s duty of loyalty to the corporation. This breach involves a conscious disregard by the director of his or her responsibilities; that the director “utterly failed” to implement a system of reporting of controls; or the director consciously failed to monitor operations and thereby was disabled from being informed of risks requiring the director’s attention.

In Reiter, the plaintiffs alleged that the corporation’s directors failed to implement an adequate compliance program to assure compliance with certain anti-money laundering laws. The corporation conducted the relevant business in traditionally underbanked urban areas involving “high risk products and services” for a “high risk customer base” that was well-known to present a risk of money laundering and was therefore subject to extensive regulation.

The Reiter Court emphasized two key elements that are prerequisites to finding liability:

  1. The director must have acted with scienter and must know that his or her actions are inconsistent with applicable fiduciary duties; and
  2. There must be a causal connection between the harm to the corporation and the board’s conduct. This connection may be demonstrated if the directors knew “red flags” suggesting misconduct but consciously failed to address the problem

The evidence in Reiter showed that the Board’s Audit and Risk Committees received numerous reports explaining compliance risks related to the regulated cashing business and management’s plans to address the risk. Plaintiffs contended that these reports were “red flags” that should have motivated the directors to impose greater internal controls. The Court disagreed, holding that none of the reports showed that the corporation’s controls and procedures violated statutory requirements or that anyone at the corporation engaged in illegal conduct, nor was management indifferent to the compliance challenges. Rather, these reports show that the company was taking significant steps to deal with the issue and keep the directors informed, eventually deciding to exit the regulated business altogether.

Relevance to cybersecurity

What can this corporation’s experience with money laundering regulation teach us about cybersecurity? The Reiter Court gives directors of Delaware corporations (both public and privately held) critical guidance on how to discharge their fiduciary duties when operating in an environment fraught with legal risk.

Virtually all modern business enterprises are, to an extent, in the data business and often data is one of the business’ most valuable assets. To paraphrase bank robber Willie Sutton, hackers go after data because “that’s where the money is.” This is true for large public companies, as well as smaller privately held companies (in fact, smaller companies are at even greater risk in view of the more limited resources they are typically able to devote to cybersecurity).

Data security is more than just business risk; the protection of data from theft or misuse is the subject of extensive legal requirements at the state, federal and international levels. The duty of oversight requires that directors make sure there are appropriate controls and systems in place to provide reasonable assurance that the company complies with applicable law regarding the use and protection of information, and to address red flags indicative of violations of law.

Investors pay close attention to corporate liability resulting from data security. Although stockholder derivative claims against directors were dismissed by courts in two recent cases (involving Wyndham Worldwide and Target), derivative suits against directors are likely to increase as the regulatory environment becomes more complex and the threats become more sophisticated. Companies issuing securities must also take into consideration their cybersecurity risk when making disclosure to investors. For example, they should consider taking steps to ensure financial statements adequately reflect loss contingencies and compliance expense, as well as securities offering documents and in periodic reporting, such as the “managements’ discussion and analysis” section of certain SEC filings.

Directors should also consider the nature of the data, where it is stored, and who else may come in contact with the company’s data. So, for example, the board would take into account contractors and others in the supply chain (and depending on the circumstances, even the subcontractors of the contractors). Considerations would also include developing and enforcing policies and procedures, implementing training programs, conducting audits of information technology infrastructure, and assessing geopolitical issues (such as local country or regional laws and treaties, the prevalence of cybersecurity threats, the viability of the local courts and enforcement tools, and the like). 

Key takeaways from the Reiter decision

  • When the Delaware courts review directors’ decisions, the focus is not on business risk (where the courts typically defer to management’s judgment) but rather risks related to legal compliance.
  • Directors are expected to cause the company to implement a system of reporting or controls to assure legal compliance and address compliance problems when they occur. The key is that directors do not ignore red flags indicating violation of law or fraudulent or criminal conduct. “Good faith, not a good result, is what is required of the board.”
  • The prevalence of cybersecurity risks and laws dealing with data usage and protection requires directors to at least consider their company’s profile for compliance risk.
  • Directors should consider their company’s supply chain and take into account where business operations occur, where the data originated and where it is stored. 
  • Directors should make a clear contemporaneous record of their ongoing attention to compliance with data security laws so there is a strong argument in support of their good faith efforts to implement appropriate systems and controls.
  • If directors have made a good faith effort to carry out fiduciary duties but a compliance problem nonetheless occurs, the directors’ conduct would be evaluated under the deferential business judgment rule. For situations where directors may have liability for gross negligence (but still not a conscious disregard for duties that amounts to bad faith), most corporate charters have an exculpation provision protecting directors from personal liability.

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.

© Thompson Coburn LLP | Attorney Advertising

Written by:

Thompson Coburn LLP

Thompson Coburn LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.