What is "the Cloud"? That depends on whom you ask. Answers currently run from Apple and its competitors offering storage and music and file synchronization to customers who are individuals, to very large vendors at a global scale servicing very large enterprises as customers. This is a frontier in many ways, and if you are going to embark on a Cloud transaction, you will be well advised to ask many questions, some of which may seem basic. While this article is focused on the laws in the United States, the risk management suggestions highlighted here are applicable anywhere on earth.

Fundamentally, moving to the Cloud is an outsourcing transaction, i.e., a company engages a third party to perform a function that the company would otherwise have performed for itself. Cloud computing is a business model that enables organizations to achieve potentially significant cost savings by sharing services, software and platforms in a third party's data center, instead of operating in the company's own data center.

Often Cloud providers will dazzle the prospective client with the potential for very significant cost savings, which is very alluring in this economic climate. The mode of operation used by some important name brands in the Cloud space is to put a "standard form contract" in a prospective client's hand accompanied by a smile and a request that you "sign here." Don't do it! Don't sign a standard form for something as important as a data center, which is the heartbeat of your operation. Go directly to your lawyer. This warning is especially relevant to regulated financial services institutions. If you sign the standard form and you are subject to any type of risk management governance-related obligations, which is the duty of every Board of Directors, you may not be able to demonstrate that the company has adequately managed its risks. Risk management functions for financial institutions after Dodd-Frank are especially highlighted. For example, FINRA has a list of examination priorities for 2012, and cybersecurity and outsourcing are on that list. It is unlikely that the vendor's standard form, drafted for its purposes, will provide the company with the control and assurances that it will need when FINRA examiners arrive.

Not intending to alarm, but if a data center is being replaced by a Cloud provider, it is a "bet the farm" transaction.

Remember: great deals begin with great due diligence. Conduct your due diligence assiduously, and negotiate carefully, especially if you are in the financial services industry.

What follows is focused on financial services companies, but many issues of control over data and processes and the ability to have continuity of business functions are applicable to any company considering Cloud services.

In financial services, you must take account of the important macro-regulatory compliance themes for U.S. financial services companies, which include:

  • Dodd-Frank Act and related Bank & Securities Financial Stability Outsourcing Regulations;
  • Sarbanes-Oxley Section 404;
  • Laws pertaining to Cybersecurity and Data Privacy; and
  • Record Retention.

Here are a few starting points.

1. Performance First

Can the Cloud provider actually do the job that you need done? Getting an answer will require a great deal of conversation with the prospective vendor. Consequently, all discussions with a Cloud provider should begin with a Non-Disclosure Agreement. Your company will want to protect its proprietary information during the conversation. In order to determine whether the Cloud provider can actually provide what you need to run your business, you will necessarily be sharing a lot of information. During the early days of the conversation, your company will need to disclose to the Cloud provider a fair amount of information about procedures and processes and data that may be competitively sensitive.

Also during the initial stages, probe how quickly the Cloud provider recovers services and data if there is a failure of the technology for any reason. Almost perfect uptime for on-line capabilities, and very well devised and operated data protection are fundamentals in your own data centers, and they must be present in the company's Cloud arrangement. A relationship with your Cloud provider relies on trust – once they are hired, they are not easily fired. Verify capabilities in advance, and write a contract that allows you to continue to monitor and react if things change during the contract's term. The company should be comfortable with the Cloud provider they select and this aspect of due diligence will go a long way to ensure that comfort.

Importantly, you should ensure that the Cloud provider understands what it is getting into. Depending on the substance of the service being provided – for example, support of a consumer banking application – the Cloud provider needs to understand that bank regulators may examine the Cloud provider as if it is a regulated entity.

The post Dodd-Frank outsourcing regulations – effective and proposed – are clear that when a company outsources a function, the company is not off the hook for regulatory compliance. Do a careful inventory of the regulations that pertain to the service(s) that you propose to move to the Cloud, validate that the Cloud provider can perform the functions and clearly document your needs in the Cloud agreement. Be sure that you have contractual and actual capabilities to audit and require corrective actions and even terminate if necessary so that your company's obligations to regulators can be satisfied, and the Company's own internal operational risk management requirements are met.

Cloud providers that understand the culture of regulatory compliance will likely be a better fit for a financial services company. Having a Cloud provider that is learning on the job isn't a good idea.

2. Cybersecurity and Data Privacy

Two areas of very intense focus by financial services regulators at present are cybersecurity and data privacy. When thinking about these issues in the Cloud, the Company really does need to create an inventory at the data element level to understand the kind, character, and privacy/cybersecurity implications of the information the Company will entrust to the Cloud provider. Is it information that relates to a person that may be sensitive like social security numbers, financial account identifiers and balances, or employee health information? Identifying the location of the servicer of the data (your Cloud provider may have locations in multiple jurisdictions), where will it be housed, where in the world it might be sent or reside? Do the involved jurisdictions have laws and regulations that impact your business, or your obligations to manage the data? For example, is personal information coming from a country that has data protection legislation/regulations that requires notification of the individual as to how that information is being used? Do you or does the Cloud provider have the necessary capability to make such notifications? Which of you will absorb the costs in the event the data is lost or stolen, if any? Is the information entrusted to the Cloud proprietary or otherwise valuable intellectual property such as trading algorithms or a database of corporate client information? If so, evaluate the information according to its criticality to your business – will the loss or corruption or misappropriation of the information create an operational or legal problem, or perhaps do reputational harm or cause you direct economic loss or enable a competition?

After the company understands its own position, it can begin to evaluate the security of the Cloud provider. Often a map or diagram of the flow of information from the company to the Cloud provider and back, or to and from other destinations, and can help you to understand how and where the data moves, and what procedures, processes and technologies are in place to keep the data safe and protected at each step.

Bad actors in cyberspace are increasing both in number and sophistication. The Company should ascertain that your Cloud provider has a dedicated, highly competent Cybersecurity staff that has high visibility and respect in its own organization. During conversations find out whether the Company focuses on dealing with the continuous evolution of "hacker" incursions into on-line operations. Some additional things to look for in a Cloud provider are background checks for employees, qualification and standards for those employees, and a culture sensitive to security issues. Important basic questions include: Is the company's data encrypted during transmission? While it is in storage? Is their employees' access to data restricted to people assigned to your account? Do those people also work on your competitors' accounts? Are there sub-Cloud providers? If so, have the Cloud – sub-Cloud relationships and interactions been subject to the same scrutiny as you are applying to your contract with the Cloud provider? What is the Cloud provider's process for removing data ("scrubbing" the disks and the memory) when equipment is replaced or upgraded? What happens to your company's data when the contract expires? Are transition services back to the company or to another Cloud provider carefully considered and documented? What provisions are in place in the event that the contract with the Cloud provider is terminated?

If your company is a public company, the Securities and Exchange Commission, Division of Corporate Finance, CF Disclosure Guidance: Topic 2 – Cybersecurity, October 13, 2011, requires your company to disclose risks specifically associated with outsourcing transactions. Will your contract with a Cloud provider support you in documenting the existence of risks (and the approaches in place to mitigate them)?

Cloud services agreements, like any other outsourcing arrangement, need to fit into the company's overarching rubric for risk management. The company needs to assure itself, and to be able to assure its Board, its shareholders and its clients if called upon to do so, that the Cloud provider is secure, safe, and well managed, before contract execution. Furthermore, the company needs to be in a position contractually to ensure that the Cloud provider stays that way for the life of the contract. Think through what your contingency plan will be if there is a degradation in the service provided during the contract term, or there is a problem in the region where the services are provided.

3. Disaster Recovery Capability

Here again, you should think about what you would expect from your own data center operators, and this will give you a base line to this important consideration when managing operational risks. Be sure you have reviewed and are satisfied with the Cloud provider's approach to disaster recovery.

4. Record Retention (and Retrieval)

Once you have begun to operate in the Cloud, your company is no longer in direct command of its data. Record Retention and the ability to preserve and retrieve records comprehensively and quickly for company business, investigations, examinations and litigation is important. Make sure that the company's contract with the Cloud provider is consistent with the regulations and the required procedures in the event of a litigation (e.g., can the Cloud provider perform the steps necessary for a litigation hold on the records or email in their custody?) Jurisdiction in the Cloud is not necessarily intuitive. A useful step is to designate a jurisdiction in your contracts.

Be careful that arrangements for Record Retention, which often involve third parties, are modified to give you control of your data during and after the contract.

5. Other Issues

While we have addressed many questions here. The list is comprehensive, but not exhaustive. Your business will have its own related considerations. Another area that will be of concern to most companies pertains to tax issues depending on the location(s) of the service provider and the company, and related factors implicating permanent establishment or transfer pricing.

Moving to the Cloud, which sounds easy, is anything but easy from a legal point of view. Nevertheless, the level of care suggested here is needed. At the end of the day, the Company will want to actually realize its anticipated savings, and not be unhappily surprised months or years into the relationship

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.