United States: SEC Adopts Rules To Improve Systems Compliance And Integrity

On November 19, 2014, the Securities and Exchange Commission (SEC) unanimously voted to adopt Regulation Systems Compliance and Integrity (Reg SCI), which will govern the technology infrastructure of the U.S.'s securities exchanges and certain other trading platforms and market participants.1 Reg SCI will supersede and replace the SEC's current Automation Review Policy (ARP). The new regulations are intended, according to the SEC, to reduce the occurrence of systems issues and improve resiliency when systems problems do occur.

Under Reg SCI, self-regulatory organizations, certain alternative trading systems (ATSs), plan processors, and certain exempt clearing agencies will be required to have comprehensive policies and procedures in place for their technological systems. Reg SCI also provide a framework for these entities to, among other things, take appropriate corrective action when systems issues occur; provide notifications and reports to the SEC regarding systems problems and systems changes; inform members and participants about systems issues; conduct business continuity testing; and conduct annual reviews of their automated systems.

Key Definitions

  • SCI Entity. Reg SCI imposes requirements on entities meeting the definition of an "SCI entity" under the rule, which is defined as an "SCI self-regulatory organization, SCI alternative trading system, plan processor, or exempt clearing agency subject to ARP."
  • SCI Systems. The adopted definition of "SCI systems" includes "all computer, network, electronic, technical, automated, or similar systems of, or operated by or on behalf of, an SCI entity that, with respect to securities, directly support trading, clearance and settlement, order routing, market data, market regulation, or market surveillance." SCI systems are subject to all provisions of Reg SCI, except for certain requirements applicable only to critical SCI systems.
  • Critical SCI Systems. The Commission has defined "critical SCI systems" as "any SCI systems of, or operated by or on behalf of, an SCI entity that: (a) directly support functionality relating to: (1) clearance and settlement systems of clearing agencies; (2) openings, reopenings, and closings on the primary listing market; (3) trading halts; (4) initial public offerings; (5) the provision of consolidated market data; or (6) exclusively listed securities; or (b) provide functionality to the securities markets for which the availability of alternatives is significantly limited or nonexistent and without which there would be a material impact on fair and orderly markets." Systems in this category are those that, if they were to experience systems issues, the Commission believes would be most likely to have a widespread and significant impact on the securities markets. As a subset of "SCI systems," "critical SCI systems" are subject to the same provisions as "SCI systems," except that critical SCI systems are subject to certain heightened resilience and information dissemination provisions.
  • Indirect SCI Systems. The term "indirect SCI systems" is defined to mean "any systems of, or operated by or on behalf of, an SCI entity that, if breached, would be reasonably likely to pose a security threat to SCI systems." Systems that are adequately physically or logically separated (i.e., isolated from SCI systems such that they do not provide vulnerable points of entry into SCI systems) will not fall within the definition of indirect SCI systems. To the extent that non-SCI systems are sufficiently walled off from SCI systems using appropriate security measures, and thus are not reasonably likely to pose a security threat to SCI systems if breached, they would not be included in the definition of indirect SCI systems, and thus would be outside of the scope of Reg SCI. "Indirect SCI systems" are subject only to the provisions of Reg SCI relating to security and intrusions.
  • SCI Event. The term "SCI event" is defined as "an event at an SCI entity that constitutes: (1) a systems disruption; (2) a systems compliance issue; or (3) a systems intrusion." "Systems disruption" is defined to mean "an event in an SCI entity's SCI systems that disrupts, or significantly degrades, the normal operation of an SCI system." "Systems compliance issue" is defined as "an event at an SCI entity that has caused any SCI system of such entity to operate in a manner that does not comply with the [Exchange] Act and the rules and regulations thereunder or the entity's rules or governing documents, as applicable." "Systems intrusion" is defined to mean "any unauthorized entry into the SCI systems or indirect SCI systems of an SCI entity."
  • Major SCI Event. The term "major SCI event" means "an SCI event that has had, or the SCI entity reasonably estimates would have: (a) [a]ny impact on a critical SCI system; or (b) [a] significant impact on the SCI entity's operations or on market participants."
  • Responsible SCI Personnel. The term "responsible SCI personnel" means, "for a particular SCI system or indirect SCI system impacted by an SCI event, such senior manager(s) of the SCI entity having responsibility for such system and their designee(s)."

Key Provisions

  • Obligations Related To Policies and Procedures of SCI entities. The rules require "[e]ach SCI entity to establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its SCI systems and, for purposes of security standards, indirect SCI systems, have levels of capacity, integrity, resiliency, availability, and security adequate to maintain the SCI entity's operational capability and promote the maintenance of fair and orderly markets."

The policies and procedures must include, at a minimum: (i) the establishment of reasonable current and future technological infrastructure capacity planning estimates; (ii) periodic capacity stress tests of such systems to determine their ability to process transactions in an accurate, timely, and efficient manner; (iii) a program to review and keep current systems development and testing methodology for such systems; (iv) regular reviews and testing, as applicable, of such systems, including backup systems, to identify vulnerabilities pertaining to internal and external threats, physical hazards, and natural or man-made disasters; (v) business continuity and disaster recovery plans that include maintaining backup and recovery capabilities sufficiently resilient and geographically diverse and that are reasonably designed to achieve next-business-day resumption of trading and two-hour resumption of critical SCI systems following a wide-scale disruption; (vi) standards that result in such systems being designed, developed, tested, maintained, operated, and surveilled in a manner that facilitates the successful collection, processing, and dissemination of market data; and (vii) monitoring of such systems to identify potential SCI events. Such policies and procedures are deemed to be reasonably designed if they are consistent with current SCI standards, which shall be comprised of information technology practices that are widely available to information technology professionals in the financial sector and issued by an authoritative body that is a U.S. governmental entity or agency, association of U.S. governmental entities or agencies, or widely recognized organization. SCI standards were released concurrently with the Adopting Release.2

The rules also require that "[e]ach SCI entity shall establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its SCI systems operate in a manner that complies with the Act and the rules and regulations thereunder and the entity's rules and governing documents, as applicable." The policies and procedures must include, at a minimum: (i) testing of all SCI systems and any changes to SCI systems prior to implementation; (ii) a system of internal controls over changes to SCI systems; (iii) a plan for assessments of the functionality of SCI systems designed to detect systems compliance issues, including by responsible SCI personnel and by personnel familiar with applicable provisions of the Act and the rules and regulations thereunder and the SCI entity's rules and governing documents; and (iv) a plan of coordination and communication between regulatory and other personnel of the SCI entity, including by responsible SCI personnel, regarding SCI systems design, changes, testing, and controls designed to detect and prevent systems compliance issues.

The rules further require that "[e]ach SCI entity shall establish, maintain, and enforce reasonably designed written policies and procedures that include the criteria for identifying responsible SCI personnel, the designation and documentation of responsible SCI personnel, and escalation procedures to quickly inform responsible SCI personnel of potential SCI events."

An SCI entity is required to periodically review the effectiveness of its policies and procedures and take prompt action to remedy any deficiencies.

  • Obligations Related to SCI Events.
  • Corrective Action. The rules require that "[u]pon any responsible SCI personnel having a reasonable basis to conclude that an SCI event has occurred, each SCI entity shall begin to take appropriate corrective action, which shall include at a minimum, mitigating potential harm to investors and market integrity resulting from the SCI event and devoting adequate resources to remedy the SCI event as soon as reasonably practicable."
  • Notification to the Commission. An SCI entity must notify the Commission of an SCI event immediately upon any responsible SCI personnel having a reasonable basis to conclude that an SCI event has occurred. An SCI entity is required to, within 24 hours of any responsible SCI personnel having a reasonable basis to conclude that the SCI event has occurred, submit a written notification pertaining to such SCI event to the Commission, which shall be made on a good faith, best efforts basis and include: (i) a description of the SCI event (including system(s) affected); and (ii) to the extent available: the SCI entity's current assessment of the types and number of market participants potentially affected by the SCI event; the potential impact of the SCI event on the market; a description of the steps the SCI entity has taken, is taking, or plans to take, with respect to the SCI event; the time the SCI event was resolved or timeframe within which the SCI event is expected to be resolved; and any other pertinent information known by the SCI entity about the SCI event. The rules require an ongoing obligation to update the Commission on a regular basis until the SCI event is closed.

If the SCI event is resolved and the SCI entity's investigation is closed within 30 days of its occurrence, then within five business days after the resolution of the SCI event and closure of the investigation regarding the SCI event, an SCI entity is required to submit a final written notification to the Commission. If an SCI event is not resolved or the SCI entity's investigation of the SCI event is not closed within 30 calendar days of the occurrence of the SCI event, then an SCI entity must submit an interim written notification pertaining to such SCI event to the Commission within 30 calendar days after the occurrence of the SCI event. Thereafter, within five business days after the resolution of such SCI event and closure of the investigation regarding such SCI event, an SCI entity must submit a final written notification pertaining to such SCI event to the Commission. The final written notification must include: (i) a detailed description of the SCI entity's assessment of the types and number of market participants affected by the SCI event; the SCI entity's assessment of the impact of the SCI event on the market; the steps the SCI entity has taken, is taking, or plans to take, with respect to the SCI event; the time the SCI event was resolved; the SCI entity's rule(s) and/or governing document(s), as applicable, that relate to the SCI event; and any other pertinent information known by the SCI entity about the SCI event; (ii) a copy of any information disseminated to any affected members or participants; and (iii) an analysis of parties that may have experienced a loss, whether monetary or otherwise, due to the SCI event, the number of such parties, and an estimate of the aggregate amount of such loss.

These reporting requirements do not apply to any SCI event that has had, or the SCI entity reasonably estimates would have, no or a de minimis impact on the SCI entity's operations or on market participants. For these types of events, an SCI entity must preserve records relating to the SCI event and submit to the Commission within 30 calendar days after the end of each calendar quarter, a summary description of such systems disruptions and systems intrusions, including the SCI systems and, for systems intrusions, indirect SCI systems, affected by such systems disruptions and systems intrusions during the applicable calendar quarter.

  • Notification to Members or Participants. An SCI entity, after any responsible SCI personnel has a reasonable basis to conclude that an SCI event has occurred, is required to promptly notify those members or participants of the SCI entity that any responsible SCI personnel has reasonably estimated may have been affected by the SCI event; provided, however, that for major SCI events, the SCI entity is required to promptly notify all of its members or participants. The notification must include the system(s) affected by the SCI event and a summary description of the SCI event. When known, the notification must also include the SCI entity's current assessment of the types and number of market participants potentially affected by the SCI event and a description of the progress of its corrective action for the SCI event and when the SCI event has been or is expected to be resolved. There is an ongoing obligation to provide regular updates.
  • Obligations Related to Systems Changes. Reg SCI requires, for systems changes, the SCI entity to file a quarterly report with the Commission describing completed, ongoing, and planned material changes to its SCIsystems and the security of indirect SCI systems, during the prior, current, and subsequentcalendar quarters, including the dates or expected dates of commencement and completion. There is an obligation to promptly submit a supplemental report notifying the Commission of a material error in or material omission in any previously provided quarterly report. An SCI entity is also required to conduct an SCI review of the SCI entity's compliance with Reg SCI not less than once each calendar year. The report needs to be provided to senior management of the SCI entity no more than 30 calendar days after completion of the SCI review. The report also needs to be provided to the Commission and the board of directors of the SCI entity within 60 calendar days after its submission to senior management of the SCI entity.
  • SCI entity business continuity and disaster recovery plans testing requirements for members or participants. Reg SCI requires SCI entities to mandate participation by designated members or participants in scheduled testing of the operation of their business continuity and disaster recovery plans, including backup systems, and to coordinate such testing on an industry- or sector-wide basis with other SCI entities.

The new rules become effective 60 days after publication in the Federal Register. SCI entities generally must comply with the requirements nine months after the effective date. ATSs newly meeting the volume thresholds in the rules for the first time will be provided an additional six months from the time that the ATS first meets the applicable thresholds to comply. Further, SCI entities will have 21 months from the effective date to comply with the industry- or sector-wide coordinated testing requirement.

The unanimous adoption of Reg SCI shows the SEC's clear commitment to requiring the entities that it regulates to account for the significant risk that cybersecurity attacks pose to the financial markets and market infrastructure today and the need to effectively manage that risk through measures such as testing, risk assessments, adoption of consistent best practices and standards, and information sharing.

Footnotes

1. The 742-page adopting release – Release No. 34-73639 – is available at http://www.sec.gov/rules/final/2014/34-73639.pdf.

2. http://www.sec.gov/rules/final/2014/staff-guidance-current-sci-industry-standards.pdf.

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