SEC Penalizes Yahoo $35 Million For Massive, Undisclosed Cyber Theft

by Dorsey & Whitney LLP

Cyber security has evolved into a key issue for every company. Media reports continue to chronicle new breaches. Many firms list cyber security as a significant risk factor in their periodic filings. While those factors may caution the public, many wonder if anyone reads what is often viewed as nothing but legalize. The more important question, however, may be does the company read them, particularly in the wake of the Commission’s recent action centered on a massive cyber breach – In the Matter of Altaba Inc., f/d/b/a Yahoo! Inc., Adm. Proc. File No. 3-18448 (April 24, 2018).

Yahoo was one of the largest internet media firms in the world. Its shares were traded on the NASDAQ Global Select Market. Following the sale of its operating business in July 2017 to Verizon Communications Inc., the firm changed its name to Altaba Inc. Its shares continued to be registered for trading with the Commission but as a publicly traded non-diversified, closed-ended management investment company. Altaba’s shares are traded on the NASDAQ Global Select Market.

In late 2014 Yahoo suffered a massive breach of its user database. It resulted in the theft, unauthorized access, or acquisition of hundreds of millions of its users’ personal data. The firm’s internal information security team learned that the company information technology networks and systems suffered a widespread intrusion by hackers associated with the Russian Federation.

By December 2014 the security team, as well as the Chief Information Security Officer, determined that the hackers had stolen copies of user database files containing the personal data of at least 108 million users. This included information called the “crown jewels” – email addresses, telephone numbers, dates of birth, hashed passwords, and security questions and answers. The hackers also accessed a separate data source – 26 Yahoo customer accounts connected to Russia.

Senior management and the internal legal team received reports from the CISO within days. The firm did not disclose the information until the fall of 2017. The outside auditors were not informed. Outside counsel was not consulted. Only the 26 users whose email accounts were tied to Russia were informed.

At the time the data breach was discovered the risk factors in Yahoo’s periodic filings stated in part: “If our security measures are breached, our products and services may be perceived as not being secure, users and customers may curtail or stop using our products and services, and we may incur significant legal and financial exposure.” Thus a significant data breach could “exposure us to a risk of loss of this information, litigation, remediation costs, increased costs for security measures, loss of revenue, damage to our reputation and potential liability,” according to the disclosures.

No mention of the breach was made in the firm’s filings. The MD&A sections, for example, was supposed to discuss known trends and uncertainties. No mention was made of the data breach. The firm’s disclosure controls did not mandate disclosure.

In the summer of 2016 Yahoo began negotiations with Verizon regarding the sale of its internet business. During the negotiations Yahoo created a spreadsheet that represented the firm was only aware of four minor breaches in which user’s personal identifying information was exposed. In a June 27, 2016 telephone call requested by Verizon to discuss the chart, the representations were reiterated.

On July 23, 2016 Yahoo entered into a stock purchase agreement with Verizon. Under the terms of the agreement Yahoo sold all of the outstanding shares of Yahoo Holdings to Verizon for over $4.8 billion in cash. The agreement contained a representation regarding data breaches that essentially reiterated the representations which had been made during the negotiations. The agreement was attached to a filing Yahoo made with the Commission.

On September 22, 2016, Yahoo disclosed the 2014 breach and the resulting theft of data involving 500 million of its user accounts in a press release. Disclosure was also made to Verizon. The firm’s market cap fell by almost $1.3 billion resulting from a 3% stock price drop. Verizon renegotiated the purchase agreement, reducing the price by $350 million, a 7.25% discount. Later the firm corrected its disclosure documents.

In resolving the proceedings the firm agreed to continue cooperating with the Commission’s investigation and any litigation.

The Order alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act section 13(a) and related rules. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay a $35 million penalty.

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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