United States: U.S. Securities And Exchange Commission Issues Guidance On Cybersecurity Risks And Incidents

On February 21, 2018, the U.S. Securities and Exchange Commission (the "Commission") issued guidance in a report titled "Commission Statement and Guidance on Public Company Cybersecurity Disclosures"1 to assist public companies in preparing disclosures on cybersecurity risks and incidents. The Commission notes that its 2011 guidance led to increased general disclosures, typically in the form of risk factors. Considering the increasing significance of cybersecurity incidents however, the Commission believes it is important to provide further guidance to public companies. In addition to reinforcing and expanding upon the Commission's 2011 guidance on cybersecurity disclosures, the Commission addressed new topics, including the importance of cybersecurity policies and procedures and the application of insider trading prohibitions in the context of cybersecurity. A close analysis of the new guidance shows that the Commission is becoming increasingly aggressive regarding cybersecurity risks and the potential for significant incidents to occur.

Material Disclosures

The Commission's guidance requires public companies to consider the materiality of cybersecurity risks and incidents when preparing disclosures under the Securities Act of 1933, as amended (the "Securities Act") and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Commission indicates that cybersecurity risks and events may require timely and ongoing disclosure in periodic reports, including annual reports on Form 10-K and quarterly reports on Form 10-Q. Additionally, because Securities Act and Exchange Act registration statements and Exchange Act periodic reports must disclose all material facts required to be stated therein or necessary to make the statements therein not misleading, public companies should consider the adequacy of their cybersecurity-related disclosures. To maintain the accuracy and completeness of shelf registration statements with respect to the consequences and costs of material cybersecurity incidents, public companies that are active public market participants may wish to consider providing disclosures related to cybersecurity risks and incidents in current reports on Form 8-K. The Commission Statement urges public companies to continue to use these forms to disclose material information pertaining to cybersecurity matters promptly.

In determining disclosure obligations regarding cybersecurity risks and incidents, public companies generally must weigh the potential materiality of any identified risk and, if an incident occurs, the importance of any compromised information and the impact of the incident on ongoing operations. The materiality of cybersecurity risks or incidents depends upon the scope of potential or actual harm to a public company's reputation, financial performance, and customer and vendor relationships, as well as the possibility of litigation or domestic or foreign regulatory investigations or actions. Although the Commission indicates that it understands that public companies may require time to discern the implications of a cybersecurity incident and that companies may need to cooperate with law enforcement, such ongoing internal or external investigations would not provide a basis for avoiding disclosure of a material cybersecurity event. If a prior disclosure is incomplete or inaccurate, the Commission suggests that public companies consider making an update or correction.

The Commission's guidance also discusses risk factor disclosures, which require public companies to disclose the most significant factors that make investments in their securities speculative or risky. Notably, the Commission suggests that public companies should consider the following issues in evaluating cybersecurity risk factor disclosures: (i) the occurrence of prior cybersecurity incidents, including their severity and frequency; (ii) the probability of the occurrence and potential magnitude of such incidents; (iii) the adequacy of preventative measures undertaken to reduce cybersecurity risks and costs (including limits or the ability to prevent or mitigate cybersecurity risks); (iv) the aspects of business and operational functions that contribute to material cybersecurity risks and the potential costs of such risks; (v) the costs of cybersecurity protections (including any insurance coverage relating to cybersecurity incidents and payments to third-party service providers); (vi) the potential for reputational harm; (vii) existing or pending laws and regulations relating to cybersecurity that may affect the requirements to which public companies are subject and their associated costs; and (viii) litigation, regulatory investigation, and remediation costs associated with cybersecurity incidents.

Importantly, the Commission clarified that general discussions of these topics in risk factors alone may not be sufficient, stating that public companies should consider disclosing previous or ongoing cybersecurity incidents or other past events to place discussions of these risks in the appropriate context.

Board Risk Oversight

The Commission also discussed how disclosure of a board's involvement in the oversight of the risk management process should provide important information to investors about how a public company perceives the role of its board and the relationship between the board and senior management in managing the material risks facing the company.2 To the extent that cybersecurity risks are material to the business, these disclosures should include the board's role in overseeing and managing material cybersecurity risks and a description of how the board administers its risk oversight function. Disclosures regarding a public company's cybersecurity risk management program and how the board engages with management allow investors to assess how a board is discharging its risk oversight responsibility.

Management's Discussion and Analysis of Financial Conditions and Results of Operations ("MD&A")

The Commission's guidance also discusses MD&A disclosures. The Commission's guidance provides that the cost of ongoing cybersecurity efforts, the costs and other consequences of cybersecurity incidents, and the risks of potential cybersecurity incidents could inform a public company's analysis of the events, trends or uncertainties that are reasonably likely to have a material effect on such company's results of operations, liquidity or financial condition. In addition, the Commission states that public companies should consider the array of costs associated with cybersecurity issues, including loss of intellectual property, immediate costs of the incident, as well as the costs associated with implementing preventative measures, maintaining insurance, responding to litigation and regulatory investigations, and preparing for and complying with proposed and current legislation.

Description of Business and Legal Proceedings

Public companies are required in their periodic reports and registration statements to discuss their products, services, relationships with customers and suppliers, and competitive conditions. If cybersecurity incidents or risks materially affect any of these factors, a public company must provide appropriate disclosure of such incidents or risks. With respect to required disclosures of material pending legal proceedings, the Commission's guidance notes that this requirement includes any material pending legal proceedings related to cybersecurity issues, such as a customer lawsuit due to the theft of customer intellectual property related to a cybersecurity event.

Disclosure Controls and Procedures

The Commission's guidance encourages public companies to adopt comprehensive policies and procedures related to cybersecurity and to assess their compliance regularly. A public company must assess whether it has sufficient disclosure controls and procedures in place to ensure that relevant information about cybersecurity risks and incidents is processed and reported to the appropriate company personnel. When making the required certifications and disclosures regarding the design and effectiveness of disclosure controls and procedures, a company's principal executive officer and principal financial officer should consider the adequacy of controls and procedures for identifying cybersecurity risks or incidents and assessing and analyzing their impact.

Insider Trading

As noted above, information about a public company's cybersecurity risks and incidents may be material non-public information for which directors, officers and other corporate insiders would violate the antifraud provisions of Rule 10b-5 of the Exchange Act if they make transactions in a company's securities while in possession of that material non-public information. The Commission's guidance encourages public companies to consider how their code of ethics and insider trading policies take into account and prevent trading based on material nonpublic information related to cybersecurity risks and incidents.

Regulation FD and Selective Disclosure

The Commission's guidance notes that companies may have disclosure obligations under Regulation FD in connection with cybersecurity matters. In cases of selective disclosure of material non-public information related to cybersecurity, public companies should ensure compliance with Regulation FD, and the Commission expects public companies to have policies and procedures to ensure that any disclosures of material non-public information related to cybersecurity risks and incidents are not made selectively. Accordingly, public companies may wish to review their Regulation FD policies to determine whether they appropriately address information relating to cybersecurity risks and incidents.


1 17 CFR 229 and 249; SEC Release No. 33-10459; 34-82746, available at: https://www.sec.gov/rules/interp/2018/33-10459.pdf.

2 Final Rule: Proxy Disclosure Enhancements, Release No. 33- 9089 (Dec. 16, 2009) [74 FR 68334 (Dec. 23, 2009]

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