SideBar

In 2018, the SEC announced that it had adopted long-awaited new guidance on cybersecurity disclosure. With the increasing importance of cybersecurity and the increasing incidence of cyber threats and breaches, the guidance cautioned, companies needed to review the adequacy of their disclosures regarding cybersecurity and consider how to augment their policies and procedures to ensure that information regarding cybersecurity risks and incidents is effectively communicated to management to allow timely decisions regarding required disclosure and compliance with insider trading policies. The guidance highlighted the pervasiveness of, and increasing reliance by companies on, digital technology to conduct their operations and engage with customers and others. That made companies in all industries vulnerable to the threat of cybersecurity incidents, such as stolen access credentials, malware, ransomware, phishing, structured query language injection attacks and distributed denial-of-service attacks. Whether these incidents were a consequence of unintentional events or deliberate attacks, the SEC cautioned that they represented a continuous risk to the capital markets and to companies, their customers and business partners, a risk that called for more timely and transparent disclosure.

The guidance built on Corp Fin’s  2011 guidance on this topic (see this Cooley News Brief).   In addition to a discussion of disclosure obligations under existing laws and regulations, the 2018 guidance added in new discussions of cybersecurity policies and procedures, particularly with respect to disclosure controls and procedures, and insider trading and selective disclosure prohibitions. The guidance urged companies to assess whether their disclosure controls and procedures captured information about cybersecurity risks and incidents and ensured that it was reported up the corporate ladder to enable senior management to make decisions about whether disclosure was required and whether other actions should be taken. According to the guidance, “[c]ontrols and procedures should enable companies to identify cybersecurity risks and incidents, assess and analyze their impact on a company’s business, evaluate the significance associated with such risks and incidents, provide for open communications between technical experts and disclosure advisors, and make timely disclosures regarding such risks and incidents. The controls should also ensure that information is communicated to appropriate personnel to facilitate compliance with insider trading policies.”  (See this Cooley Alert and this PubCo post.) 

In 2018, the SEC also issued an investigative report under Section 21(a) that advised public companies subject to the internal accounting controls requirements of Exchange Act Section 13(b)(2)(B) of the need to consider cyber threats when implementing internal accounting controls. The report investigated whether a number of defrauded public companies “may have violated the federal securities laws by failing to have a sufficient system of internal accounting controls.” As described in the 21(a) report, Enforcement conducted investigations of nine listed public companies in a range of industries that experienced cyber fraud in the form of “business email compromises,” which involved perps sending spoofed or otherwise compromised electronic communications that purported to be from company executives or vendors.  The perps then deceived company personnel into wiring substantial sums into the perps’ own bank accounts.  In these instances, each company lost at least $1 million, and two lost more than $30 million for an aggregate (mostly unrecovered) loss of almost $100 million. And these weren’t one-time only scams: in one case, the company made 14 wire payments over several weeks for an aggregate loss of over $45 million, and another company paid eight invoices totaling $1.5 million over several months.

Although the SEC decided not to take any enforcement action against the nine companies investigated, the SEC determined to issue the report “to make issuers and other market participants aware that these cyber-related threats of spoofed or manipulated electronic communications exist and should be considered when devising and maintaining a system of internal accounting controls as required by the federal securities laws. Having sufficient internal accounting controls plays an important role in an issuer’s risk management approach to external cyber-related threats, and, ultimately, in the protection of investors.” Given our expanding reliance on electronic communications and digital technology for economic activity, the report advised companies to “pay particular attention to the obligations imposed by Section 13(b)(2)(B) to devise and maintain internal accounting controls that reasonably safeguard company and, ultimately, investor assets from cyber-related frauds.” In particular, the report focused on the requirements of  Section 13(b)(2)(B)(i) and (iii) to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management’s general or specific authorization,” and that “(iii) access to assets is permitted only in accordance with management’s general or specific authorization.” (See this PubCo post.)