Investment advisers and broker-dealers can expect more scrutiny of their data security from the Securities and Exchange Commission. Our Cybersecurity Preparedness & Response and Investment Management, Trading & Markets teams explore how multiple SEC divisions will be assessing capital market participants’ cybersecurity risk management.
- Be sure to inform your investors of cyber risks
- Practical considerations
- The GDPR and global reach of regulators
In the first half of 2018, the Securities and Exchange Commission (SEC) has reaffirmed its focus on data security and the importance of cybersecurity preparedness through its draft Strategic Plan for fiscal years 2018 through 2022 and interpretative guidance for public company disclosures. Taken together with preexisting guidance, it is clear that the SEC expects more mature cybersecurity programs from its registrants and that it will continue to prioritize data security as fundamental to the U.S. capital markets and market participants.
Multiple divisions and offices of the SEC have now provided guidance and a series of risk alerts regarding its cybersecurity regulations, including the Office of Compliance Inspections and Examinations (OCIE), Division of Investment Management, and, most recently, Division of Corporation Finance. In addition to numerous speeches by commissioners and division directors and an enhanced website, the SEC’s approach to cybersecurity risk management and compliance continues to leverage existing regulations and statutes to police market participants’ preparedness and responses to new and emerging cyber threats.
Because of the importance of “data collection, storage, analysis, availability, and protection,” market participants can expect the SEC to continue to use all tools at its disposal to ensure that market participants “are actively and effectively engaged in managing cybersecurity risks” for the foreseeable future. In addition, the SEC will seek to ensure that market participants as well as public companies “are appropriately informing investors and other market participants of these risks and incidents.” For instance, public companies are expected to disclose material risks and material cybersecurity events, a process that usually depends on internal procedures and controls for assessing materiality and disclosure thresholds. For public companies not otherwise subject to OCIE examination, the SEC has limited its activities to the oversight of disclosures via enforcement action in cases where it has deemed the disclosure of a material cybersecurity event to have been inadequate.
Investment Advisers and Broker-Dealers Under Scrutiny
Written guidance, OCIE examinations of investment advisers and broker-dealers, and the increasingly active Division of Enforcement’s Cyber Unit are the key ways the SEC is addressing cybersecurity preparedness for its registrants. In recent remarks, SEC Chairman Jay Clayton reiterated the work of the Division of Enforcement’s Cyber Unit, and in particular noted that intrusions into online retail brokerage accounts are an area of focus for the specialized unit. Coupled with the FBI’s recent release of its 2017 Internet Crime Report, it is clear that both regulators and law enforcement are focused on cybersecurity threats that rely on investment services platforms and resources to target or harm the investing public. For registered investment advisers and broker-dealers, the primary implication of this focus is that the SEC will continue to expect more mature cybersecurity programs that adapt to the changing threat environment and appropriately manage and communicate risks to investors and other market participants, as discussed below.
Over the last three years, the SEC has sanctioned firms for a range of specific alleged cybersecurity-related violations. These have included the reliance on ineffective limitations on access rights that failed to prevent a firm employee from inappropriately accessing confidential customer data and for failing to audit or test those limitations to access rights. Other allegations have included the failure to conduct periodic risk assessments, employ firewalls to protect servers that contain sensitive personally identifiable information (PII), encrypt PII at rest, and establish procedures for responding to a cybersecurity incident. The SEC has also brought an action alleging that an adviser’s policies and procedures failed to designate a responsible supervisor and address how customer records and information are to be handled when transmitted, were incomplete, and were not tailored to the actual practices of a firm.
The SEC continues to be focused on technology-based market disruptions as well. In June 2016, the Division of Investment Management released guidance following an August 2015 market disruption caused by a systems malfunction at a financial institution that affected hundreds of mutual funds and exchange-traded funds. The SEC guidance noted that “some funds could have been better prepared for the possibility that one of their critical service providers would suffer an extended outage.” The guidance suggested that advisers of fund complexes, CCOs, and fund boards should reexamine their oversight of critical service providers as they strengthen their business continuity and disaster recovery plans, with a particular focus on communications protocols across the fund complex, with the board, and externally with the affected service provider and other stakeholders. The guidance highlighted the importance of understanding how the business continuity plans of the critical service providers relate to the fund and how that impacts the fund’s backup procedures. Finally, the guidance suggested that funds consider how a variety of critical service provider disruptions could impact fund operations and investors and to be prepared to manage the response, whether the disruption occurs at a critical service provider or at the fund itself.