United States: SEC And FINRA Cybersecurity Reports Highlight Cybersecurity As A New Compliance Priority

Last Updated: February 25 2015
Article by Michael R. Manley, Michael J. Rivera, D.E. Wilson, Jr. and Andrew E. Bigart

On February 3, 2015, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) released reports summarizing observations on the state of cybersecurity in the brokerage and investment industries based on separate supervisory sweeps that each entity performed in 2014. The reports underscore the increased emphasis that the financial regulators are placing on cybersecurity as a bedrock compliance priority.

To assist firms in reviewing their cybersecurity policies and procedures, we highlight below the key takeaways from the SEC and FINRA reports. First, however, we note two broader concepts that brokers and investment advisers should keep in mind when reviewing their cybersecurity programs.

While the SEC and FINRA reports are excellent resources, they cannot be understood in a vacuum. The legal and regulatory frameworks for cybersecurity are evolving in response to changes in technology and the government's increased emphasis in this area. The White House and Congress continue to explore cybersecurity reform, which will lead to future executive orders or legislation on information sharing and/or data breach remediation, such as the President's recent executive order on Promoting Private Sector Cybersecurity Information Sharing (Feb. 13, 2015). At the same time, the National Institute of Standards and Technology (NIST) issued a Cybersecurity Framework in early 2014 that regulators will likely look to for guidance on cybersecurity best practices. Similarly, a number of public and private entities, such as the Financial Services – Information Sharing and Analysis Center (FS-ISAC), have been established to serve as additional resources on cyber threats and compliance best practices.

We also note that the compliance approach suggested in the SEC and FINRA reports is reminiscent of the anti-money laundering (AML) guidance that the regulators have been publishing for years. In this regard, the SEC and FINRA (and the banking agencies) have aggressively challenged perceived AML failures, including, recently, taking action against individual compliance officers. The AML world may foreshadow the enforcement approach that the regulators will take for cybersecurity, meaning that firms should review their cybersecurity function on a regular basis to confirm that they have the right people, with the right resources and technology, to address cybersecurity risks. Both the SEC and FINRA have identified cybersecurity as an examination priority for 2015.

SEC Risk Alert

The SEC's Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert summarizing cybersecurity observations from recent examinations of 57 registered broker-dealers and 49 registered investment advisers. The key observations included:

  • Most examined broker-dealers (93%) and advisers (83%) have adopted written information security policies.
  • The examined firms' cybersecurity policies for vendors varied between brokers and advisers.
  • Most examined firms conduct periodic risk assessments to identify cybersecurity threats, etc.
  • Most examined broker-dealers (98%) and advisers (91%) make use of encryption in some form.
  • Most examined firms reported having been the subject of a cyber-related incident.
  • Many examined firms provide their clients with suggestions for protecting their sensitive information.
  • Many examined firms identify best practices through information-sharing networks.
  • The designation of a Chief Information Security Officer varied by examined firm business model.
  • Most examined firms have conducted a review of their technology resources.
  • The use of cybersecurity insurance varied by examined firm.

FINRA Report on Cybersecurity Practices

FINRA's Report on Cybersecurity Practices provides firms with a risk-based approach to cybersecurity based on observations from a 2014 sweep of brokerage firms. According to FINRA, brokers and investment advisors face a multi-threat cybersecurity landscape, with the most common threats identified as hackers penetrating firm systems; insiders compromising firm or client data; and operational risks (e.g., power failures). The FINRA report highlights the following best practices for establishing a cybersecurity compliance program to address these and other potential cyber risks:

Governance and Risk Management for Cybersecurity

Firms should establish and implement a cybersecurity governance framework that includes risk management policies, processes, and structures coupled with relevant controls tailored to the firm's risk profile and available resources (see discussion below on cybersecurity risk assessments). In particular, FINRA advised firms to ensure that a firm's compliance function incorporates "multiple views—including from the business, information technology, risk management and internal audit—in conjunction with senior management and board oversight to implement an effective cybersecurity program."

Cybersecurity Risk Assessment

Firms should conduct regular assessments to identify cybersecurity risks associated with firm assets and vendors. The information developed through an initial (and periodic) assessment can help a firm identify its potential vulnerabilities and design its compliance function to prioritize resources to minimize risk. Although not mentioned in the FINRA report, firms looking for additional information on risk assessments should review the Federal Financial Institutions Examination Council Bank Secrecy Act/Anti-Money Laundering Examination Manual. The manual sets forth detailed guidance on conducting risk assessments in the AML world that could prove useful to firms looking to establish their cybersecurity risk assessment procedures.

Technical Controls

Firms should implement technical controls to protect firm software and hardware from cyber-attack. This is an area, in particular, where we suggest it is important for a firm's information technology department to work closely with other parts of a firm's business so that technical controls can be tailored to a firm's internal and outward facing operations.

Incident Response Planning

In addition to implementing preventative measures, firms should establish policies and procedures for escalating and responding to cybersecurity incidents. The primary objective of an incident response plan is to ensure that a firm can react quickly in the event of a cybersecurity incident to minimize internal and external damage. And if an incident does occur, a firm should investigate the incident to identify the root causes and take steps to restore customer confidence (such as reimbursing customers for any financial losses), as appropriate.

Vendor Management

Firms should implement a risk-based approach to manage cybersecurity risk that can arise from vendor relationships. Common steps to minimize such risk include pre-contract and ongoing due diligence of vendors and the use of contractual provisions to assign responsibility in the event of a cybersecurity incident.

Staff Training

Firms should provide regular cybersecurity training for staff. As explained by FINRA, the most effective cybersecurity training is developed in conjunction with a firm's cybersecurity program so that lessons learned across the compliance function can be shared with staff.

Cyber Intelligence and Information Sharing

Firms should use cyber threat intelligence to improve their ability to identify, detect and respond to cybersecurity threats. As noted, participation in industry threat-sharing initiatives (such as FS-ISAC) is recommended to help firms stay abreast of threats and best practices.

Cyber Insurance

Firms should evaluate the utility of cyber insurance as a way to transfer some risk as part of their risk management processes. In our experience, cybersecurity insurance can be purchased as a standalone policy, as a rider to an existing policy, or may even be addressed to some extent in existing policies. Cyber insurance can be purchased to cover a number of different costs, including legal and public relations expenses arising from a breach, business interruption, liability, website defacement, and extortion, among others. To be eligible for cyber insurance, an interested entity must be able to demonstrate that its cybersecurity practices are sufficiently robust. Firms should therefore perform a cybersecurity self-assessment to determine whether any improvements are needed prior to approaching a potential insurer.


The SEC and FINRA cybersecurity reports start the second phase of an initiative begun last year to emphasis the importance of cybersecurity for the brokerage and investment industries. We interpret the reports as having two, complementary themes. First is the importance of establishing a culture of compliance from the C-suite down. The second is on holding individuals accountable for lapses in compliance. Speeches such as the one given by SEC Commissioner Aguilar at the New York Stock Exchange in June 2014, connect Board and senior management activity with effective compliance. The February releases by the SEC and FINRA further highlight the importance of robust compliance programs.

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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