Reed Smith Client Alerts

Starting with the Securities and Exchange Commission's January 2014 announcement that cybersecurity is a priority in its National Examination Program, SEC Chair Mary Jo White and others at the SEC have continued to stress the significance of the cybersecurity threat in speeches and in congressional testimony. Recently, the Commission hosted a Cybersecurity Roundtable to discuss the issues and challenges that cybersecurity presents for market participants and public companies, as well as for regulators. Panelists from government, financial institutions and public companies participated in four panels on the cybersecurity risk landscape—public company disclosure, resilience of market systems, and issues affecting broker-dealers, investment advisors, and transfer agents. Each panel was moderated by an SEC director with responsibility in that area. As Chair White observed in her opening remarks, the threat of a cybersecurity breach is global, and the public and private sectors must work together to address these threats. Thereafter, she actively participated throughout all of the sessions, and was joined by her fellow commissioners at various times during the almost day-long forum. In his prepared remarks, Commissioner Aguilar called for the establishment of a cross-division Cybersecurity Task Force within the SEC, acknowledging that the Commission “has much to learn about the specific risks that our regulated entities and public companies are facing.”

Much of the discussion was familiar territory to those following cybersecurity issues, particularly in the financial services industry. The panels on cybersecurity risk, market systems and SEC-regulated advisors included discussions related to such issues as:

  • The need for the public and private sectors to exchange information and clarity around what can be shared.
  • The role that Regulations S-ID (Identity Theft Red Flags rule released in coordination with the Commodity Futures Trading Commission) and S-CI (Systems Compliance and Integrity) can play in addressing cybersecurity threats and aiding resiliency of financial markets.
  • The impact of the presidential executive order that was issued last year, and the recent publication by the National Institute of Standards and Technology of a Cybersecurity Framework after consultation with all sectors and industries.
  • The concern about the market’s ability to withstand and recover from a concerted cyber attack. Such an event could impact the confidentiality and integrity of trading information, as well as the infrastructure connecting the various trading platforms. Several panelists observed that there is no common “reset” point to which all systems could uniformly return in the event of market shutdown.

The panel on disclosures perhaps provided the best insight into the Commission’s direction on cybersecurity. The consensus from the public company and market participant panelists was that the SEC’s Cybersecurity Disclosure Guidance, which was issued in October 2011, does not appear to have resulted in the release of significant, substantive information by public companies that would inform the investing public. Both Chair White and Commissioner Aguilar asked the panelists if the guidance had been helpful and contributed to more sharing of information. Panelists noted the disincentive to provide information about privacy breaches, the fact that reputation risk does not always result in long-term impact on stock price, and the lack of significant disclosure regarding the exposure of intellectual property or business information—the loss of which arguably has a greater impact on business operations. There was also discussion of other disclosure requirements, such as state data breach notice statutes and how much information is enough. From the various discussions on disclosures, which permeated all of the panels, the thread that emerged was that fuller guidance that is not unduly prescriptive or inflexible would assist companies in their disclosure process.

Consistent with the SEC’s emphasis on cybersecurity, the Financial Industry Regulatory Authority (FINRA), in its January 2, 2014 Annual Regulatory and Examination Priorities Letter, underscored that cybersecurity remains a top priority, stressing the need to ensure that broker-dealers have up-to-date securities policies and procedures in place in order to protect sensitive customer data from increasingly frequent—and sophisticated—attacks cutting across all industries. In February, FINRA announced a cybersecurity “sweep” aimed at assessing broker-dealers’ approaches to managing cybersecurity “in light of the critical role information technology (IT) plays in the securities industry, the increasing threat to firms’ IT systems from a variety of sources, and the potential harm to investors, firms, and the financial system as a whole that these threats pose.” In conjunction with the announcement, FINRA issued targeted examination sweep letters to 20 broker-dealer firms aimed at gathering information on their cybersecurity practices and risk concerns. Speaking at the Roundtable, a senior FINRA official gave a brief review of the “very preliminary” information obtained from the sweep letters, stating that broker-dealers reported their self-assessment of the risks they face from a cyber attack as being greatest in three key areas:

  • Operational risks from outside events and persons outside the firm with access to their systems, as their top concern
  • Risks from the inside by employees of the firms
  • Risks from hackers

One other theme that emerged from the Roundtable is the increased awareness of—and attention to—the cybersecurity threat at the public company board level. Panelists stressed that while cybersecurity used to be the province of the Audit Committee, today it is a major focus of the entire board. Recently announced public company data breaches quickly spawned shareholder litigation in addition to regulatory interest. We can expect that the conjunction of increased regulatory attention, particularly in the area of disclosure, and public company board of director oversight of cybersecurity risks, will be watched with interest by shareholders of public companies.

There is no doubt that cybersecurity issues have the attention of the SEC. This is consistent with the trend among financial services regulators that was most recently reflected in guidance from the CFTC describing the data security requirements for covered financial institutions. Given the fact that the SEC has not undertaken an update to its principal privacy and security regulation (Regulation S-P) since an interim rule was issued in 2008, the Commission has work to do on that regulation, in addition to considering issuance of supplemental disclosure guidance. Whether the SEC’s heightened interest in cybersecurity will result in concrete action remains to be seen. In the meantime, firms and companies regulated by the SEC that have not implemented a cybersecurity program should begin the process. Those that have a program in place should review it in light of SEC’s demonstrated interest and the guidance already issued by other financial regulators—and all should be ready for more to come.


Client Alert 2014-109