UK: UK ICO Cites Inadequate M&A Data Protection Due Diligence As A Factor In Proposing $125M Breach Fine

Last Updated: 25 July 2019
Article by Andrew Lustig, Randy Sabett, Aaron Binstock, David Navetta and Boris Segalis

On July 9, 2019, the UK Information Commissioner's Office (ICO) publicly announced its intent to impose a £99M (approximately $123M) GDPR fine on Marriott in connection with the discovery and notification of a data breach at Starwood. Among its justifications for the record fine, the ICO cited inadequate data protection due diligence by Marriott in its acquisition of Starwood as a factor that delayed the discovery of the breach until 2018, even though the breach occurred at Starwood in 2014, and the acquisition of Starwood by Marriott took place in 2016.

Whether or not the ICO's view of acquirer data protection due diligence responsibilities is reasonable, the record Marriott fine should serve as a reminder of the importance of thorough data protection due diligence in M&A transactions that involve targets that handle significant amounts of personal data.

ICO's View

In an interesting twist, news of the proposed fine did not originate from the ICO. As a result of SEC cyber guidance from 2011 and 2018, which specifies that cyber risks and cyber incidents could trigger general SEC reporting obligations, Marriott disclosed the breach in a statement on its website to coincide with a filing of its 8-K.

The breach occurred at Starwood in 2014 and affected the personal information of almost 400 million Starwood guests, of which about 30 million were in the European Economic Area (EEA), including seven million in the UK. Marriott acquired Starwood in 2016 and discovered the breach in November 2018. In explaining the fine, the ICO alleged that its "investigation found that Marriott failed to undertake sufficient due diligence when it bought Starwood ...." The UK Information Commissioner Elizabeth Denham added that she viewed GDPR's requirement for accountability for personal data to "include carrying out proper due diligence when making a corporate acquisition" including measures to assess "what personal data has been acquired" and "how it is protected."

Realities of Discovering Breaches

The ICO appears to place the responsibility for discovering a target's breach on the acquirer even though acquirers are at a disadvantage when they seek to examine a target's cybersecurity on extremely tight time lines, and need to rely on the representations of the target, which has the benefit of being familiar with its own systems and cybersecurity practices. Hindsight in a data breach is usually 20/20 and leads to pronouncements of things that could have been done to discover a breach or avoid it in the first place. The reality is that it is entirely possible that at the time of the Starwood acquisition any reasonably thorough cybersecurity evaluation would not have led to the discovery of the breach. To this point, one of the leading cybersecurity reporters – Brian Krebs – observed that in the Starwood breach "the intruders encrypted information from the hacked database (likely to avoid detection by any data-loss prevention tools when removing the stolen information from the company's network)."

Deal Documents

In what might be a focus for the ICO, the Marriott/Starwood deal documents, however, do not offer evidence of a robust data protection due diligence effort. While stock purchase agreements or merger agreements often contain at least one provision addressing privacy and security, the Marriott/Starwood Agreement and Plan of Merger did not. The documents included traditional IP representations and warranties, but no reps and warranties around privacy or cybersecurity.

Next Steps

Next steps in the ICO enforcement action, including a likely appeal of the proposed fine by Marriott, may see a detailed examination of at least some of the considerations in the ICO's fine determination. In arguing against the fine, Marriott could argue that the company took immediate steps to mitigate the attack, cooperated with the investigation and complied with industry cybersecurity standards (such as PCI DSS). To the extent the ICO asserts that the extent of the data protection due diligence triggered a GDPR violation, Marriott could argue the diligence was reasonable despite the terms of the merger agreement, and the company used best practices to contain the damage once the breach was discovered. It will be interesting to see how the ICO reacts to those (and any other) arguments Marriott will make.

Lessons Learned – Cybersecurity Diligence in M&A

Data protection attorneys and cybersecurity consultants increasingly get called in to perform detailed diligence on privacy and cybersecurity matters in M&A. Cybersecurity has become an important part of the M&A due diligence process for many (if not most) transactions, particularly those that involve targets that handle significant amounts of personal data. In light of the ICO's apparent focus on data protection due diligence, acquirers (and parties aligned with the acquirers) will want to take reasonable steps to help determine whether the target has taken appropriate steps to protect the data with which it has been entrusted. This due diligence is key irrespective of whether the personal information comes directly from consumers, is transferred in a B2B arrangement and in practice should encompass the security of trade secrets or other confidential or proprietary information.

Exposure of trade secrets and confidential information that does not contain personal information is also of great concern – in certain situations, it can subject a target to even greater liability than personal information breaches. For example, ransomware and business email compromises are becoming increasingly common and can lead to the direct loss of assets ($1.2 billion in losses in 2018), business interruption (Aluminum maker, Norsko Hydro loses $55 million) and data asset loss.

The ICO's rationale for the Marriott fine, depending on the circumstances, should prompt acquirers to evaluate more closely the cybersecurity exposure brought on by the acquisition. An overall cyber risk assessment early in the process can help calibrate the cyber maturity of a target. In addition to a diligence review of the target's cyber documentation (e.g., security policy, incident response policy, access control policy, etc.) by the acquirer's legal team, something as simple as a cyber questionnaire could provide some perspective on the cyber aspects of the target. Alternatively, the acquirer's legal team can bring in a technical team for a more thorough (and technical) analysis that could range from a static analysis of the network defenses from inside the network to an active attempt to break into the network from the outside, known as a penetration test. Acquirers may also leverage cybersecurity assessment tools that can provide an ostensibly objective score and rating of the target. For software, a combination of a security audit and vulnerability tests can help reveal various coding issues that could lead to security incidents. Finally, if a target has gone through a PCI audit, an ISO 27001 assessment, a SSAE 16 audit or any other of an assortment of security compliance-related processes, the acquirer can examine the results to help determine the target's security posture.

Outcomes of Cybersecurity Diligence

In the event that any of the above techniques reveal issues the acquirer finds unacceptable, provisions of the acquisition agreement could be used to terminate the deal and allow the parties to walk away. For example, the acquirer, upon finding a very serious cybersecurity problem with the target, might be able to invoke a material adverse change (MAC) clause if drafted with cybersecurity breaches in mind. Typically, if a party to a transaction experiences a MAC in the party's business, operations, financial or other condition, a MAC clause could allow the other party to withdraw from the transaction.

For the target company, performing its own risk assessment could offer several useful benefits (particularly if performed before any particular transaction were to commence). For example, if a target conducts a risk assessment, the resulting gap analysis can be used to begin addressing any significant issues before they arise in the context of the transaction. Such foresight could ultimately result in a higher valuation of the target and reduced risk that major issues arise later that could derail a potential transaction. Further, any resulting certification or compliance assessment can be used as described above to demonstrate the security posture of the target to defend against regulatory investigations and potentially save millions on fines or other penalties. In the event a transaction moves forward before all deficient elements of a cybersecurity audit are met, a target will want to carefully evaluate which elements to disclose and how to disclose them. Having a plan for addressing such deficient elements can often ease concerns that might be raised by the acquirer.

These outcomes should be based on several broad areas of analysis:

  • Determination of the type, amount and sensitivity of the data being acquired, stored and processed by the target
  • Evaluation of exposure based on regulatory (e.g., GDPR or CCPA) or industry standard-based (e.g., PCI DSS) requirements
  • Identification of past breaches, the response undertaken by the target to such breaches and any kinds of resulting penalties, fines or legal actions
  • Analysis of the preparation undertaken by the target, including the state of its policies and procedures and level of preparedness based on those policies and procedures (e.g., does the company have an incident response plan and do they conduct practice efforts, such as tabletop exercises)
  • Evaluation of the resiliency of the target (e.g., does it conduct penetration (or pen) tests or regular security scanning)
  • Identification of security or industry-based certification (e.g., ISO 27001 certification, Privacy Shield registration, independent HIPAA certification, to name a few)

Finally, if a transaction involves the use of representation and warranty or other transactional insurance that has become common, parties should carefully consider whether the policy includes exclusions for cybersecurity events and the impact of cybersecurity due diligence (or lack thereof) on coverage available under the policy.

What's Next?

Data protection, including cybersecurity, continues to be an issue at the top of the list of concerns for companies in acquisition mode. As acquirers become more sophisticated and better understand the data protection and cyber liabilities they could be inheriting as a result of an M&A transaction, the greater the scrutiny will be paid to the target companies. The use of data protection and cybersecurity questionnaires, tailored M&A questions and related non-technical mechanisms can offer a good starting point for an acquirer to understand the target's approach to privacy and cybersecurity. More detailed (and intrusive) technical mechanisms can be employed when greater detail or more significant concerns exist. Ultimately, the attention given to data protection and cybersecurity issues is only likely to increase.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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