In response to the evolving landscape of cybersecurity threats, and the negative and potentially substantial consequences for companies that fall victim to cybersecurity incidents, on February 21, 2018, the SEC published interpretive guidance (Guidance) to assist public companies in preparing disclosures about cybersecurity risks and incidents.1 The Guidance applies the customary disclosure concepts that apply to material risks to cybersecurity risks, and reinforces and expands prior guidance issued by the SEC’s Division of Corporation Finance in October of 2011. In addition, the Guidance addresses the importance of maintaining comprehensive policies and procedures related to cybersecurity risks and incidents, the application of insider trading prohibitions in the cybersecurity context, and the need for companies and their insiders to refrain from making selective disclosures of material nonpublic information about cybersecurity risks or incidents.
Overall, the Guidance does not represent a departure from generally applicable securities law disclosure requirements. It does, however, suggest that registrants should expect increased Staff focus on cybersecurity disclosures.
Disclosure Framework
The Guidance instructs companies to consider the materiality of cybersecurity risks and incidents when preparing their registration statements, and periodic and current reports.2 Although current disclosure rules don’t explicitly refer to cybersecurity risks and incidents, disclosures may be required as they would be in the case of other material risks and incidents.
Periodic reports require timely and ongoing information regarding a company’s business and operations, risk factors, legal proceedings, financial statements, disclosure controls and procedures (DCPs) and corporate governance, and are required to include management’s discussion and analysis of financial condition and results of operations (MD+A), all of which may require disclosure of cybersecurity risks and incidents. Registration statements must include all material facts necessary to make the statements therein not misleading.3 The Guidance instructs companies to consider the adequacy of their cybersecurity-related disclosure in this context. Companies can use current reports on Forms 8-K and 6-K to maintain the accuracy and completeness of effective shelf registration statements with respect to the costs and other consequences of material cybersecurity incidents. The Guidance encourages companies to use such forms to disclose cybersecurity matters (noting that this practice reduces the risk of selective disclosure and trading in their securities on the basis of material non-public information). The Guidance also urges companies to avoid generic cybersecurity-related disclosure, and to provide specific information that is useful to investors.
Factors to be considered in determining disclosure obligations regarding cybersecurity risks and incidents include the potential materiality of any identified risk and, in the case of incidents, the importance of any compromised information and the impact of the incident on the company’s operations.4 Although the Guidance states that detailed disclosures that could compromise a company’s cybersecurity efforts are not required, companies are expected to disclose cybersecurity risks and incidents that are material to investors, including associated financial, legal, or reputational consequences.
Although the SEC recognizes that all facts may not be initially available, and that ongoing investigations (including cooperation with law enforcement) may affect the scope of disclosure, this alone would not permit avoidance of disclosure. The Guidance also reminds companies that they may have a duty to correct prior disclosure determined to have been untrue (or to have omitted a material fact necessary to make the disclosure not misleading) at the time it was made, and a duty to update disclosure that becomes materially inaccurate after it is made.
Specific Rules
Risk Factors
Item 503(c) of Regulation S-K and Item 3.D of Form 20-F require companies to disclose the most significant factors that make investments in their securities speculative or risky. Companies should disclose cybersecurity risks if they are among such factors, including risks that arise in connection with acquisitions. Issues to consider in evaluating cybersecurity risk factor disclosure include: the severity and frequency of any prior cybersecurity incidents; the probability and potential magnitude of cybersecurity incidents; the adequacy and cost of preventative actions; limits on the ability to prevent or mitigate certain cybersecurity risks; aspects of the company’s business that give rise to material cybersecurity risks; costs associated with maintaining cybersecurity protections; the potential for reputational harm; regulations that may affect requirements relating to cybersecurity and associated costs; and litigation, regulatory investigation, and remediation costs associated with cybersecurity incidents. Companies may need to disclose previous or ongoing cybersecurity incidents or other past events (including those involving suppliers, customers, or competitors) in order to place these discussions in the appropriate context.
MD+A
Item 303 of Regulation S-K and Item 5 of Form 20-F require companies to discuss their financial condition, changes in financial condition and results of operations, including events, trends, or uncertainties that are reasonably likely to have a material effect on their results of operations, liquidity, or financial condition, or that would cause reported financial information not to be necessarily indicative of future operating results or financial condition, and such other information that the company believes to be necessary to an understanding of the foregoing. Factors to consider with respect to MD+A disclosure include the costs related to ongoing cybersecurity efforts and cybersecurity incidents, and the risk of potential cybersecurity incidents. In addition to immediate costs of a cybersecurity incident, a host of other costs may also be relevant to the analysis, including costs related to: the loss of intellectual property; preventative measures; insurance; litigation and/or regulatory investigations; compliance with legislation; remediation; reputational harm; and the loss of competitive advantage. Companies are also instructed to consider the impact of cyber incidents on each of their reportable segments.
Description of Business
Item 101 of Regulation S-K and Item 4.B of Form 20-F require companies to discuss their products, services, relationships with customers and suppliers, and competitive conditions. Disclosure is required where cybersecurity incidents or risks materially affect any of these items.
Legal Proceedings
Item 103 of Regulation S-K requires companies to disclose information relating to material pending legal proceedings to which they or their subsidiaries are a party. This includes any such proceedings relating to cybersecurity issues.
Financial Statement Disclosures
Cybersecurity risks and incidents may affect a company’s financial statements. Relevant examples in the Guidance include: expenses related to investigation, breach notification, remediation and litigation; loss of revenue; warranty or other claims; insurance premium increases; diminished future cash flows; asset impairments; recognition of liabilities; or increased financing costs. Financial reporting and control systems are expected to be designed to provide reasonable assurance that information about the financial range and magnitude of cybersecurity incidents would be incorporated into the financial statements on a timely basis.
Board Risk Oversight
Item 407(h) of Regulation S-K and Item 7 of Schedule 14A require disclosure of the role of a company’s board of directors in risk oversight. If cybersecurity risks are material to a company’s business, this discussion should include the nature of the board’s role in overseeing the management of such risk, including disclosures regarding the company’s cybersecurity risk management program, and how the board engages with management on cybersecurity issues.
DCPs
The Guidance encourages companies to adopt comprehensive policies and procedures related to cybersecurity and to assess their compliance regularly, including whether sufficient DCPs are in place to ensure that relevant information about cybersecurity risks and incidents is processed and reported to allow timely decisions regarding required disclosure. DCPs should enable companies to identify cybersecurity risks and incidents, assess and analyze their impact, evaluate their significance, provide for open communication between technical experts and disclosure advisors, and make timely related disclosures.
Exchange Act Rules 13a-14 and 15d-14 require a company’s principal executive officer and principal financial officer to make certifications regarding the design and effectiveness of DCPs, and Item 307 of Regulation S-K and Item 15(a) of Form 20-F require companies to disclose conclusions on the effectiveness of DCPs. These items should consider the adequacy of controls and procedures for identifying and assessing cybersecurity risks and incidents, and require management to consider whether there are deficiencies in the DCPs that render them ineffective.
Insider Trading
Information about a company’s cybersecurity risks and incidents may constitute material nonpublic information. Accordingly, directors, officers, and other corporate insiders would violate the antifraud provisions of federal securities laws if they trade in the company’s securities in breach of their duty of trust or confidence while in possession of that material nonpublic information.
The Guidance also encourages companies to consider how their codes of ethics and insider trading policies address trading on the basis of material nonpublic information related to cybersecurity risks and incidents. Companies are instructed to consider implementing restrictions on insider trading during an investigation and assessment of significant cybersecurity incidents.
Regulation FD and Selective Disclosure
Companies are expected to have policies and procedures in place to ensure that any disclosures of material nonpublic information related to cybersecurity risks and incidents are not made selectively, and that any Regulation FD required public disclosure is made in accordance with that regulation.
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Footnotes
1 The Guidance pertains to public operating companies, and does not address the specific implications of cybersecurity to other regulated entities under the federal securities laws, such as registered investment companies, investment advisers, brokers, dealers, exchanges, and self-regulatory organizations.
2 Listed companies are also reminded of obligations to make prompt public disclosure of material information that may be imposed by stock exchange listing requirements.
3 Omitted information is considered to be material if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or that disclosure of the omitted information would have been viewed by the reasonable investor as having significantly altered the total mix of information available.
4 A traditional materiality analysis requires consideration of the probability that an event will occur and the anticipated magnitude of the event in light of the totality of company activity.
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