SEC Playing Bigger Role in Cybersecurity

Dorsey & Whitney LLP

Besides clarifying disclosure requirements, the agency is prompting companies to take proactive steps.

Cybersecurity threats have reached a point where they cannot  go ignored  by any  government agency, even the U.S. Securities and Exchange Commission.  Although an agency that is tasked with protecting investors is not one that typically comes to mind in the battle against cyber threats, the  SEC does maintain jurisdiction over cybersecurity issues for public companies, broker dealers and  investment advisers, due to its responsibilities for ensuring the disclosure of material information, integrity of market  systems and customer data protection.

The SEC began focusing on cybersecurity issues in October 2011 by issuing guidance for public companies on disclosing risks and incidents within the already existing framework of public company disclosure requirements. The SEC’s guidance clarified the material information regarding cybersecurity risks and incidents that requires disclosure. Since then, the number of disclosures about data breach incidents, risk factors, trends and uncertainties, and legal proceedings related to cybersecurity threats has grown.

Although requiring this enhanced disclosure regarding cybersecurity issues is intended to protect investors and provide greater information  to  those  with  national  security responsibilities, it is providing collateral  benefits  as well.  In order to avoid securities law liability for material omissions or misstatements in their public filings, public companies  are  finding  that  they  must pay closer attention to their policies, procedures  and  compliance  systems in  the  area  ofcybersecurity.  One area public companies should revisit is their  disclosure controls  and  procedures to ensure that those procedures  adequately  address  reporting up cybersecurity risks and incidents. In edition, many public company boards of directors are starting to rethink  risk oversight  in this  area and, as companies seek new directors to join their boards,experience in  overseeing cybersecurity risks may become a highly sought attribute.  Companies that want to ensure   better  cybersecurity  risk oversight at the board level should consider revising their annual board evaluations and director questionnaires in this regard.

The SEC rules, like many other federal and state laws, mandate the disclosure of past  failures to  protect data.  Forty-seven states require notification  to consumers if there  is a reason to believe that their personal information has been the subject of an unauthorized breach. The federal Health Information Technology for Economic and Clinical Health  (HITECH) Act requires similar notifications for the breach of personal health related information.  The trend,  however, has moved  away  from the  emphasis on the reactive  response to data breaches to proactive measures to protect data in the first instance. This proactive  approach  is embodied in a compliance program consistent with the Federal Sentencing Guidelines requiring computer security policies, the appointment of a security coordinator, training the workforce on protecting company data, periodic auditing of the viability of the program, enforcing its policies,and promptly responding  to policy violations.

Compliance  programs,  if designed properly, can be used to protect shareholder value.  The loss of competitively sensitive data can obviously have an adverse impact on shareholder value. The  breach  of personal  customer information that can be used to perpetrate identity theft can be just as harmful.  Press reports surrounding the theft of personal data, as recently occurred with Target Corp., can result in devastating publicity undermining customer and shareholder confidence.

The trend is clearly in the direction of making data protection an integral part of a company compliance program.  For example,  in 2010 Massachusetts began requiring any company that owns, licenses, stores or maintains personal information of a Massachusetts  resident to implement  a comprehensive written security program for personal information.  While  there is no foolproof means of stopping cyberattacks, a well-designed compliance program can minimize the potential risks.

Cyberattacks on the infrastructure underlying capital markets have been on the rise too and, as a result, the  SEC is paying  close attention to cybersecurity for self-regulated organizations  and  large  alternative trading  systems.  The SEC has issued proposed rules on regulation systems, compliance and integrity, which would require stock exchanges and the like to test their automated systems for vulnerabilities, test their  business continuity  and  disaster recovery  plans, notify the  SEC of computer intrusions and recover their clearing and trading operations within specified time frames.

Stock exchanges also have begun taking their own steps to ensure listed companies have cybersecurity protections in place.  The New York Stock Exchange has compliance rules that require  listed companies to “adopt and disclose a code of business conduct” that includes the protection  of confidential information “that might be of use to competitors, or harmful to the company or its customers, if disclosed.”

As cyberattacks on financial institutions   have  become  more  frequent  and  sophisticated,  the  SEC also has focused on cybersecurity risk issues for broker dealers and investment advisors.  In April 2013, the  SEC adopted Regulation  S-ID, which requires certain regulated financial  institutions and creditors to adopt and implement identity theft programs and which builds upon the SEC’s existing rules for protecting customer data such as Regulation S-P.

In light of the risks posed by cyberthreats, all public companies should do the following:  Review the  corporate  compliance  program to ensure it adequately covers the prevention and detection of cyberthreats;  if one  doesn’t  exist,  create a compliance program for the protection  of data; update company policies and agreements to adequately protect competitively sensitive and personal data; and institute procedures for effectively reporting to the public cybersecurity risks and breaches.


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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