United States: Broker-Dealer Cybersecurity: Protect Yourself Or Pay The Price

Last Updated: January 15 2014
Article by Daniel Nathan and Ana-Maria Ignat

In its recently issued 2014 Regulatory and Examination Priorities Letter, FINRA stated that cybersecurity remains a priority given the ongoing cybersecurity issues reported across the financial services industry, including the increasing frequency and sophistication of attacks targeting the nation's largest financial institutions. The securities industry watchdog continues to be concerned with the integrity of firms' infrastructure and the safety and security of sensitive customer data. Broker-dealers are well-advised to ensure that their data security systems and procedures are up-to-date, since the financial and, more important, reputational impacts of adverse examination findings or enforcement actions can be devastating.

THE REGULATION

The applicable regulatory framework governing broker-dealer cybersecurity includes the SEC's Regulation S-P (Privacy of Consumer Financial Information).1 Specifically, Rule 30 (the so-called Safeguards Rule) requires brokers, dealers, investment companies and investment advisers registered with the Commission to:

  • adopt reasonably designed written policies and procedures addressing administrative, technical and physical safeguards for the protection of customer information and records; and
  • protect against any anticipated threats or hazards to the security or integrity of customer records and information, and against unauthorized access to or use of customer records or information. 2

THE EXAM FOCUS

Over the past six years, FINRA's examination priorities have consistently included cybersecurity, data integrity and customer information protection issues. FINRA's examination program looks for potential deficiencies in broker-dealers' procedures in the cybersecurity area, and when an actual breach occurs, FINRA's enforcement program has taken formal disciplinary action, requiring remediation and imposing severe penalties. This year, as in 2013, broker-dealers should expect that FINRA's examiners will focus on the integrity of firms' policies, procedures and controls to protect sensitive customer data, and that findings of significant gaps could lead to investigations or enforcement action.

Since 2010, FINRA has conducted thematic reviews in the areas of technology and cybersecurity, and identified these examples of strong controls:

  • structured governance over application risk classification and controls;
  • robust IT organizations interacting with all areas and facets of the firm;
  • full encryption policies and practices for all devices, including those utilized outside the firm;
  • independent reviews and testing of operating systems and security; and
  • strong user credential requirements and management.

On May 22, 2012, a session of FINRA's annual conference was dedicated to customer protection issues, including a discussion of applicable requirements, recent enforcement activity and industry practices. At the February 25, 2013, meeting of the SRO Subcommittee of the ABA Securities Litigation Committee, FINRA's senior officials Susan Axelrod and Michael Rufino observed that, in the cybersecurity area, FINRA is especially concerned about smaller firms, as exams have shown particular vulnerability in technology systems, with problems that include expired or ineffective anti-viral software. In addition, in the event of a successful cyber-attack, the financial constraints of a small firm may be significant and impair the firm's ability to compensate the victims. In June 2013, during an event hosted by the Insured Retirement Institute, FINRA senior official Daniel Sibears reported that FINRA had seen a proliferation of complaints about cybersecurity breaches at broker-dealer firms, which makes cybersecurity a big issue for FINRA.

Of even greater concern than the potential regulatory penalties and other sanctions that FINRA or the SEC may impose is the potential damage to a broker-dealer's reputation and the loss of client confidence as a result of a data breach.

FINRA ENFORCEMENT ACTIONS

Although FINRA has brought relatively few enforcement actions in the cybersecurity and customer information protection area, the matters it chose to pursue illustrate the focus of its inquiries. FINRA's enforcement actions have found violations in the following areas:

  • Policies and procedures
    • The failure of a broker-dealer to adopt written procedures setting forth an information security program designed to respond to intrusions;
    • The failure to establish procedures mandating that employees install anti-virus software and other protection on their computers; and
    • The failure to implement procedures for the encryption of laptops or data stored on laptops.
  • Encryption, password protection, and anti-virus and security software
    • The failure to use a properly configured computer firewall;
    • The failure to audit employee computers to confirm the installation of security software;
    • The failure to monitor for potential or actual breaches;
    • The failure to enforce the mandated use of strong passwords through validation or periodic password changes and a forced password expiration;
    • The failures to employ effective usernames and passwords, or to place controls and procedures on the use and dissemination of the usernames and passwords;
    • The failure to review web server logs revealing intrusions;
    • The failure to implement appropriate encryption measures;
    • Allowing employees to share computer sign-on credentials to access files which contained confidential customer information; and
    • Storing a database containing customer information on a computer with a persistently open Internet connection which left the information in the database exposed to the internet.
  • Training, audits and consultant recommendations
    • The failure to perform sufficiently broad periodic audits to protect customer records and other sensitive information from unauthorized access;
    • The failure of a firm to carry out the security recommendations of independent auditors and outside security consultants for an intrusion detection system; and
    • The failure to provide adequate training to employees regarding customer breaches, leading to the failure of certain employees to recognize that an unauthorized customer account data breach had occurred and that the breach had to be reported to the firm's compliance department and privacy officer.
  • Customer notifications
    • The failure to provide customers with an opt-out notice prior to disclosing their information to the nonaffiliated third party; and
    • Sending misleading notification letters to affected customers and their brokers.

Significantly, in all of these cases, FINRA imposed relatively high penalties – between $150,000 and $450,000 – and required extensive and often expensive remedial measures, including making needed hardware and software upgrades, revising written supervisory procedures, implementing data security policies and various related protocols, engaging third-party consultants to review information security systems, providing notifications to customers, offering customers the services of a nationally-recognized credit monitoring service free of charge, and resolving related class action litigation.

Some of these cases are instructive.

In one case, a firm used a public-facing computer web server that also housed a database containing confidential customer information. The database was stored in a computer with a persistent Internet connection, which left the customer information in the database exposed to the internet. In addition, the firm failed to encrypt the database or activate a password, and the lack of encryption in the database exacerbated the vulnerability of the confidential customer information. The firm's failure to adequately secure customer information ultimately led to actual customer harm when a third party downloaded the confidential customer information through a sophisticated network intrusion. The firm only learned of the breach through an email sent by the hacker. Although the attacks were visible on web server logs, the firm failed to review those logs. The firm did not have any written procedures for the review of web server logs, nor an intrusion detection system. Even if it had detected the intrusion, the firm did not have written procedures setting forth an information security program designed to respond to intrusions. The firm also failed to carry out the recommendation of independent auditors and outside security consultants that it implement an intrusion detection system. FINRA concluded that the firm's systems and procedures were not reasonably designed to safeguard customer records and information, in contravention of Regulation S-P, supervisory deficiencies which ultimately contributed to the hacker's ability to obtain the confidential customer information of approximately 92,000 firm customers. FINRA required the firm to take numerous remedial steps after the intrusion, including taking down its website, reporting the incident to law enforcement, providing written notice to affected customers and voluntarily offering affected customers a subscription to a credit-monitoring service for two years at a cost of $1.3 million to the firm. The firm also paid a $375,000 fine.

In another case, FINRA found that for seven years a broker-dealer failed to adequately protect customer records and information in the firm's electronic portfolio management system by allowing certain employees to share computer sign-on credentials to access files which contained confidential customer information. The firm failed to place controls and procedures on the use and dissemination of the usernames and passwords, thus allowing potential access to the customer information outside of its control and management. The firm was also unable to determine which or how many employees had been given access to the common usernames and passwords, and did not have procedures to disable or change usernames and passwords on a recurring basis, or even after a home office employee was terminated or otherwise no longer associated with the firm. The firm also failed to establish procedures mandating that its representatives in the field install anti-virus software and other protection on their computers used to conduct LFS-related business away from the home office, and to audit the representative-owned computers to confirm the installation of security software or to monitor for potential or actual breaches. The firm was found to have violated Rule 30 of Regulation S-P and failed to adequately supervise its personnel, and paid a $450,000 fine.

SEC ENFORCEMENT

The SEC has also been fairly active in enforcing the Safeguards Rule in the cybersecurity area. Deficiencies identified by the SEC at firms included:

  • The failure of a firm to have customer information policies and procedures for its employees and branch-registered representatives describing its overall program that was reasonably designed to protect customer records and information as required by the Safeguards Rule;
  • The distribution of limited and insufficient written materials, which included suggestions rather than mandates, regarding safeguarding customer information;
  • The lack of written procedures to follow up on potential computer security issues uncovered during branch audits, reported by registered representatives to the help desk, or identified as a result of breaches or potential breaches of customer information;
  • The failure to mandate that the firm's registered representatives maintain antivirus software on their computers used to access customer account information on the firm's intranet and trading platform, thus leaving the information vulnerable to unauthorized access; and
  • The failure to implement adequate controls, including some security measures, to safeguard customer information maintained in a proprietary trading platform, thus leaving the information vulnerable to unauthorized access.
  • In these cases, the SEC imposed substantial penalties from $100,000 to $275,000.

RECOMMENDATIONS

  • Broker-dealers should be mindful of FINRA's focus on cybersecurity issues, and should ensure that their policies, procedures and practices are compliant with existing guidance and teachings stemming from FINRA and SEC's enforcement efforts in the area. Attorneys and consultants expert in customer data security and privacy can assist broker-dealers in identifying gaps in their policies and procedures and, should a firm encounter a data breach or account intrusion, they can assist in damage control and mitigate the reputational impact of such an event.

Footnotes

1. Regulation S-P became effective in November 2000, and compliance with the rules and regulations has been mandatory since July 1, 2001. The requirement that policies and procedures be written has been in place since 2005.

2. In July 2005, the National Association of Securities Dealers ("NASD"), FINRA's predecessor, reminded its members of their obligations relating to the protection of customer information: www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p014772.pdf. FINRA has also published a list of steps a firm may need to take when it learns that its customers' accounts may have been compromised: http://www.finra.org/industry/issues/customerinformationprotection/p117443

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.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Daniel Nathan
Similar Articles
Relevancy Powered by MondaqAI
Carlton Fields
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Carlton Fields
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions