The Evolving Obligations of Public Companies to Disclose Cyber-Intrusions

by Cadwalader, Wickersham & Taft LLP

Public companies have struggled with the question of whether a cyber-intrusion triggers an obligation under the federal securities laws to disclose the intrusion to investors in a public filing. While the SEC has provided staff guidance on this issue, such guidance does not represent the official view of the SEC and the federal securities laws do not otherwise address cyber-intrusions specifically. Thus, companies remain uncertain about when, in the SEC’s view and under existing federal securities law, a cyber-intrusion triggers a disclosure obligation.

This issue has gone from academic to very real in the wake of several high-profile cyber attacks against companies and governments, and the rising threat of attacks in the United States. For example, FBI Director Robert Mueller warned in March 2012 that “in the not too-distant-future . . . the cyber threat will pose the greatest threat to our country.”

In response to such cyber attacks and concerns, according to recent press reports, some members of Congress are considering legislation to require the SEC to provide improved and official guidance on the obligations to disclose cyber-intrusions. For example, Senator Jay Rockefeller, Chairman of the United States Senate Commerce, Science and Transportation Committee, has recently indicated that – as soon as this month – he will propose adding a provision to pending cyber-security legislation directing the SEC to issue formal, clearer guidance concerning when a cyber-intrusion is subject to disclosure. Such guidance would replace the existing non-binding SEC staff guidance on this subject.

Existing Cyber-Intrusion Disclosure Guidance

There is no obligation to disclose information merely because it is material. Indeed, companies constantly possess material, nonpublic information about their businesses. Instead, the federal securities laws require publicly traded companies to disclose information only where (a) there is a statutory or rule requirement to do so, or (b) where disclosure is required to correct prior statements of material fact that were false or misleading at the time they were made.

In light of these requirements and because the securities laws do not specifically address when a cyber-intrusion must be disclosed, on October 31, 2011, the SEC’s Division of Corporation Finance issued its “views regarding disclosure obligations relating to cyber-security risks and cyber-incidents” (the “Corp Fin Staff Release”).1 As with any staff release, the Corp Fin Staff Release only represents “the views of the Division of Corporation Finance,” is not “a rule, regulation, or statement of the [SEC],” and the “Commission has neither approved nor disapproved its content.”

The Corp Fin Staff Release states, among other things, that public companies should:

  • Review, on an ongoing basis, the adequacy of their disclosures relating to cyber-security risks and cyber-incidents.
  • Disclose the risk of cyber-incidents if these issues are among the most significant factors that make an investment in the company speculative or risky.
  • Disclose known or threatened cyber incidents to place the discussion of cyber-security risks in context.
  • Address cyber-security risks and cyber incidents in their Management’s Discussion and Analysis if the “costs or other consequences associated with one or more known incidents or the risk of potential incidents represent a material event, trend, or uncertainty that is reasonably likely to have a material effect on the registrant’s results of operations, liquidity, or financial condition or would cause reported financial information not to be necessarily indicative of future operating results or financial condition.”
  • Disclose a cyber-incident in the “Description of Business” if one or more cyber-incidents materially affect a registrant’s products, services, relationships with customers or suppliers, or competitive conditions.

The Corp Fin Staff recognized that federal securities laws may conflict with the security of a company. As a result, the Corp Fin Staff Release states that the federal securities laws do not require disclosure that itself would compromise the integrity or security of a company’s computer networks. Instead, the Corp Fin Staff Release was simply intended to help investors appreciate the nature of the risks faced by companies in a manner that would not have that consequence.

Potential Cyber-Intrusion Disclosure Legislation

Especially in light of the non-binding nature of the Corp Fin Staff Release, Senator Rockefeller intends to add a provision to pending cyber legislation that would require the SEC to issue formal, binding guidance regarding when a cyber-intrusion is a reportable, event.

Speaking at the German European Security Association Conference on Cyber-security on April 26, 2012, Senator Rockefeller explained that he would seek to add the provision to the Cyber-security Act of 2012 (the “Act”), and that the provision would:

“require the Commission itself, through a vote of the Commissioners, to issue formal interpretive guidance on these issues. This formal SEC guidance will build on the staff guidance, further clarifying and highlighting the need to inform the market of material risks pertaining to cyber-security.”

Introduced with bipartisan and White House support on February 14, 2012, the Act also calls for the Secretary of Homeland Security to assess, among other things, the cyber-security risk to federal and private entities, and establish procedures to designate systems that, if breached, could result in mass casualties, mass evacuations, or catastrophic economic damage such as market and transportation disruption, and severe degradation of national security.

The Act is one of several pieces of bipartisan cyber-security legislation pending in Congress. Although Congress is on the verge of a recess, the Senate leadership has indicated that the legislation is likely to proceed to a vote on the Senate floor this month.

Considerations for a Public Company

Still, with the election season in full swing, and limited floor time available in the Senate and House, it is unclear whether the Act or other cyber-security legislation will be passed this year. Even if the pending legislation is not passed with a provision directing the SEC to issue guidance, however, the SEC may, sua sponte, issue formal guidance in this area.

No matter the outcome of the legislation, companies still must ensure that they are in compliance with existing federal securities laws with respect to cyber events. Under existing laws, a public company should:

  • Ensure that it has policies in place to address and respond to a data breach, including, at a minimum:

• An incident response team; • A plan of action to identify its cause and correct the breach; and • A communications plan.

  • Examine existing federal securities statutes and regulations, potentially applicable state and other laws and rules, and the Corp Fin Staff Release2 to promptly and thoroughly assess whether any cyber intrusion or threat constitutes an event subject to potential disclosure. To help make this assessment, a company should consider, among other things:

• The size and scope of the incident; • The business affected by the incident; • Whether the incident exposed a significant weakness in a company’s security system; • The type of data affected by the intrusion; • The potential impact of the intrusion on the company’s reputation; • The company’s potential liability under existing computer security, identity theft, and data protection laws; • The potential impact of the intrusion on the company’s existing relationships and business opportunities; and • Whether the company’s internal controls identified the intrusion.

  • Examine the adequacy of its internal controls and cyber defenses, and make sure it is in a position to discuss these controls and defenses publicly to the extent necessary to help assure shareholders, clients, business partners, and other potentially interested constituencies.
  • Be prepared to defend any decision not to disclose to regulators, the Department of Justice, and even to Congress, given its high level of interest in this issue.

1 See

2 At last count, 46 states have law enforcement and/or customer notification requirements in the event of a data breach involving personal identifying information. In addition, provisions of HIPAA and guidance issued by banking regulators pursuant to the Graham-Leach-Biley Act have significant data breach notification requirements, as well as enumerated penalties for non-compliance with notification requirements. Moreover, the securities exchanges, such as the New York Stock Exchange (NYSE) and NASDAQ (NASDAQ), generally require their listed companies to disclose material information about the company to the public.

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