United States: Cybersecurity Liability: Delaware Has Good News For Directors

The Delaware Chancery Court just issued an opinion that will have directors breathing a sigh of relief in connection with cybersecurity risks. In its opinion – Reiter v Fairbank, C.A. No. 11693-CB (Del. Ch. Oct. 18, 2016) – the Chancery Court articulated the standards of "bad faith" that must exist in order for directors to be held liable for failing to exercise oversight with regard to the corporation's compliance with law in a risky area.

Duty of oversight

The duty of oversight was first articulated in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). This duty arises from a director's duty of loyalty to the corporation. This breach involves a conscious disregard by the director of his or her responsibilities; that the director "utterly failed" to implement a system of reporting of controls; or the director consciously failed to monitor operations and thereby was disabled from being informed of risks requiring the director's attention.

In Reiter, the plaintiffs alleged that the corporation's directors failed to implement an adequate compliance program to assure compliance with certain anti-money laundering laws. The corporation conducted the relevant business in traditionally underbanked urban areas involving "high risk products and services" for a "high risk customer base" that was well-known to present a risk of money laundering and was therefore subject to extensive regulation.

The Reiter Court emphasized two key elements that are prerequisites to finding liability:

  1. The director must have acted with scienter and must know that his or her actions are inconsistent with applicable fiduciary duties; and 
  2. There must be a causal connection between the harm to the corporation and the board's conduct. This connection may be demonstrated if the directors knew "red flags" suggesting misconduct but consciously failed to address the problem

The evidence in Reiter showed that the Board's Audit and Risk Committees received numerous reports explaining compliance risks related to the regulated cashing business and management's plans to address the risk. Plaintiffs contended that these reports were "red flags" that should have motivated the directors to impose greater internal controls. The Court disagreed, holding that none of the reports showed that the corporation's controls and procedures violated statutory requirements or that anyone at the corporation engaged in illegal conduct, nor was management indifferent to the compliance challenges. Rather, these reports show that the company was taking significant steps to deal with the issue and keep the directors informed, eventually deciding to exit the regulated business altogether.

Relevance to cybersecurity

What can this corporation's experience with money laundering regulation teach us about cybersecurity? The Reiter Court gives directors of Delaware corporations (both public and privately held) critical guidance on how to discharge their fiduciary duties when operating in an environment fraught with legal risk.

Virtually all modern business enterprises are, to an extent, in the data business and often data is one of the business' most valuable assets. To paraphrase bank robber Willie Sutton, hackers go after data because "that's where the money is." This is true for large public companies, as well as smaller privately held companies (in fact, smaller companies are at even greater risk in view of the more limited resources they are typically able to devote to cybersecurity).

Data security is more than just business risk; the protection of data from theft or misuse is the subject of extensive legal requirements at the state, federal and international levels. The duty of oversight requires that directors make sure there are appropriate controls and systems in place to provide reasonable assurance that the company complies with applicable law regarding the use and protection of information, and to address red flags indicative of violations of law.

Investors pay close attention to corporate liability resulting from data security. Although stockholder derivative claims against directors were dismissed by courts in two recent cases (involving Wyndham Worldwide and Target), derivative suits against directors are likely to increase as the regulatory environment becomes more complex and the threats become more sophisticated. Companies issuing securities must also take into consideration their cybersecurity risk when making disclosure to investors. For example, they should consider taking steps to ensure financial statements adequately reflect loss contingencies and compliance expense, as well as securities offering documents and in periodic reporting, such as the "managements' discussion and analysis" section of certain SEC filings.

Directors should also consider the nature of the data, where it is stored, and who else may come in contact with the company's data. So, for example, the board would take into account contractors and others in the supply chain (and depending on the circumstances, even the subcontractors of the contractors). Considerations would also include developing and enforcing policies and procedures, implementing training programs, conducting audits of information technology infrastructure, and assessing geopolitical issues (such as local country or regional laws and treaties, the prevalence of cybersecurity threats, the viability of the local courts and enforcement tools, and the like). 

Key takeaways from the Reiter decision

  • When the Delaware courts review directors' decisions, the focus is not on business risk (where the courts typically defer to management's judgment) but rather risks related to legal compliance
  • Directors are expected to cause the company to implement a system of reporting or controls to assure legal compliance and address compliance problems when they occur. The key is that directors do not ignore red flags indicating violation of law or fraudulent or criminal conduct. "Good faith, not a good result, is what is required of the board."
  • The prevalence of cybersecurity risks and laws dealing with data usage and protection requires directors to at least consider their company's profile for compliance risk. 
  • Directors should consider their company's supply chain and take into account where business operations occur, where the data originated and where it is stored.  
  • Directors should make a clear contemporaneous record of their ongoing attention to compliance with data security laws so there is a strong argument in support of their good faith efforts to implement appropriate systems and controls.
  • If directors have made a good faith effort to carry out fiduciary duties but a compliance problem nonetheless occurs, the directors' conduct would be evaluated under the deferential business judgment rule. For situations where directors may have liability for gross negligence (but still not a conscious disregard for duties that amounts to bad faith), most corporate charters have an exculpation provision protecting directors from personal liability. 

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.

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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.