With No Police Exemption, SEC Data Breach Rules Shaking Up Retail

Written by Mark Rasch
February 15th, 2012

Attorney Mark D. Rasch is the former head of the U.S. Justice Department’s computer crime unit and today serves as Director of Cybersecurity and Privacy Consulting at CSC in Virginia.

In almost all U.S. state and federal data breach disclosure laws, a loophole lets a retailer avoid disclosure if law enforcement says it would help the investigation to keep the breach secret. The U.S. Security and Exchange Commission (SEC), however, now has no such exemption.

This is huge. It means that if the Secret Service or FBI tells a chain to keep an incident secret or else risk disrupting an active investigation, a company that complies—and keeps word of the breach out of SEC filings—may be guilty of SEC fraud. In this federal agency versus federal/state agency tug of war, the retailer victim may be victimized again.

The SEC guidance recognizes that significant cybersecurity incidents should be reported promptly. This suggests that if a regulated company discovers an incident “after the balance sheet date but before the issuance of financial statements,” it should consider going to the extraordinary length of issuing a separate disclosure just of the incident itself, along with an estimate of its financial impact.

Thus, companies may be in the unusual position of not disclosing an attack to affected customers, because the FBI or Secret Service has asked them not to, but having to then issue an SEC disclosure of a “material nonrecognized subsequent event” to the investing public.

Moreover, it is unlikely that law enforcement could even ask a company to refrain from a disclosure, because failing to disclose a material fact (like a major cyber breach) would constitute “fraud in connection with the purchase or sale of securities,” and it is unlikely that the cops could tell a company, “go ahead, defraud your shareholders and the investing public.” Yet another conundrum for regulated entities.

Other problems with SEC disclosure are both timing and detail. To make a meaningful disclosure might expose the company to even more attacks. If you say, for example, “we completed an audit of our PCI payment systems, found them completely vulnerable to attacks and there is nothing we can do about it,” not only would shareholders rightfully panic, but cyberthieves would rejoice. The more detailed (and meaningful) the disclosure, the more it exposes the company to further attack and, therefore, further diminution of share value. Is that really what investors want?

It doesn’t seem to be what companies want. Last week, a report by Reuters indicated people were shocked, shocked to find out that most companies were not reporting cybersecurity incidents. The Reuters report quoted President Obama’s former cybersecurity policy advisor, Melissa Hathaway, and Stu Baker, a former top DHS official, as wondering why companies are mostly not reporting these attacks to shareholders. This follows an Oct. 11, 2011, guidance by the SEC that publicly traded or regulated entities should disclose such attacks where they would materially affect the value of the company. The key word here is “materiality.”

In the movie Apollo 13, there’s a debate about whether or not to tell the astronauts in the crippled craft that their trajectory may be too shallow and that they might just bounce off the Earth’s atmosphere into space. The flight director asks if there is anything the astronauts can do about it and is told, “not now.” He replies: “Then they don’t need to know, do they?” The same is true for cybersecurity events.

Ask yourself the question: “If a company I invested in had a cybersecurity incident, would I want to know?” If the company is a retailer or payment processor, and the incident involved PCI cardmember data, then the odds are very good that a disclosure would already have been made—at least to the affected parties, if not to shareholders. The same is true if the incident involved health data from a provider, payer or business associate.


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Most Recent Comments

Why Did Gonzales Hackers Like European Cards So Much Better?

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