Boards of Directors, Corporate Governance and Cyber-Risks: Sharpening the Focus

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the recent “Cyber Risks and the Boardroom” Conference; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I am pleased to be here and to have the opportunity to speak about cyber-risks and the boardroom, a topic that is both timely and extremely important. Over just a relatively short period of time, cybersecurity has become a top concern of American companies, financial institutions, law enforcement, and many regulators. I suspect that not too long ago, we would have been hard-pressed to find many individuals who had even heard of cybersecurity, let alone known what it meant. Yet, in the past few years, there can be no doubt that the focus on this issue has dramatically increased.

Cybersecurity has become an important topic in both the private and public sectors, and for good reason. Law enforcement and financial regulators have stated publicly that cyber-attacks are becoming both more frequent and more sophisticated. Indeed, according to one survey, U.S. companies experienced a 42% increase between 2011 and 2012 in the number of successful cyber-attacks they experienced per week. As I am sure you have heard, recently there have also been a series of well-publicized cyber-attacks that have generated considerable media attention and raised public awareness of this issue. A few of the more well-known examples include:

  • The October 2013 cyber-attack on the software company Adobe Systems, Inc., in which data from more than 38 million customer accounts was obtained improperly;
  • The December 2013 cyber-attack on Target Corporation, in which the payment card data of approximately 40 million Target customers and the personal data of up to 70 million Target customers was accessed without authorization;
  • The January 2014 cyber-attack on Snapchat, a mobile messaging service, in which a reported 4.6 million user names and phone numbers were exposed;
  • The sustained and repeated cyber-attacks against several large U.S. banks, in which their public websites have been knocked offline for hours at a time; and
  • The numerous cyber-attacks on the infrastructure underlying the capital markets, including quite a few on securities exchanges.

In addition to becoming more frequent, there are reports indicating that cyber-attacks have become increasingly costly to companies that are attacked. According to one 2013 survey, the average annualized cost of cyber-crime to a sample of U.S. companies was $11.6 million per year, representing a 78% increase since 2009. In addition, the aftermath of the 2013 Target data breach demonstrates that the impact of cyber-attacks may extend far beyond the direct costs associated with the immediate response to an attack. Beyond the unacceptable damage to consumers, these secondary effects include reputational harm that significantly affects a company’s bottom line. In sum, the capital markets and their critical participants, including public companies, are under a continuous and serious threat of cyber-attack, and this threat cannot be ignored.

As an SEC Commissioner, the threats are a particular concern because of the widespread and severe impact that cyber-attacks could have on the integrity of the capital markets infrastructure and on public companies and investors. The concern is not new. For example, in 2011, staff in the SEC’s Division of Corporation Finance issued guidance to public companies regarding their disclosure obligations with respect to cybersecurity risks and cyber-incidents. More recently, because of the escalation of cyber-attacks, I helped organize the Commission’s March 26, 2014 roundtable to discuss the cyber-risks facing public companies and critical market participants like exchanges, broker-dealers, and transfer agents.

Today, I would like to focus my remarks on what boards of directors can, and should, do to ensure that their organizations are appropriately considering and addressing cyber-risks. Effective board oversight of management’s efforts to address these issues is critical to preventing and effectively responding to successful cyber-attacks and, ultimately, to protecting companies and their consumers, as well as protecting investors and the integrity of the capital markets.

The Role of the Boards of Directors in Overseeing Cyber-Risk Management

Background on the Role of Boards of Directors

When considering the board’s role in addressing cybersecurity issues, it is useful to keep in mind the broad duties that the board owes to the corporation and, more specifically, the board’s role in corporate governance and overseeing risk management. It has long been the accepted model, both here and around the world, that corporations are managed under the direction of their boards of directors. This model arises from a central tenet of the modern corporation—the separation of ownership and control of the corporation. Under this structure, those who manage a corporation must answer to the true owners of the company—the shareholders.

It would be neither possible nor desirable, however, for the many, widely-dispersed shareholders of any public company to come together and manage, or direct the management of, that company’s business and affairs. Clearly, effective full-time management is essential for public companies to function. But management without accountability can lead to self-interested decision-making that may not benefit the company or its shareholders. As a result, shareholders elect a board of directors to represent their interests, and, in turn, the board of directors, through effective corporate governance, makes sure that management effectively serves the corporation and its shareholders.

Corporate Boards and Risk Management Generally

Although boards have long been responsible for overseeing multiple aspects of management’s activities, since the financial crisis, there has been an increased focus on what boards of directors are doing to address risk management. Indeed, many have noted that, leading up to the financial crisis, boards of directors may not have been doing enough to oversee risk management within their companies, and that this failure contributed to the unreasonably risky behavior that resulted in the destruction of untold billions in shareholder value and plunged the country and the global economy into recession. Although primary responsibility for risk management has historically belonged to management, the boards are responsible for overseeing that the corporation has established appropriate risk management programs and for overseeing how management implements those programs.

The importance of this oversight was highlighted when, in 2009, the Commission amended its rules to require disclosure about, among other things, the board’s role in risk oversight, including a description of whether and how the board administers its oversight function, such as through the whole board, a separate risk committee, or the audit committee. The Commission did not mandate any particular structure, but noted that “risk oversight is a key competence of the board” and that “disclosure about the board’s involvement in the oversight of the risk management process should provide important information to investors about how a company perceives the role of its board and the relationship between the board and senior management in managing the material risks facing the company.”

The evidence suggests that boards of directors have begun to assume greater responsibility for overseeing the risk management efforts of their companies. For example, according to a recent survey of 2013 proxy filings by companies comprising the S&P 200, the full boards of these companies are increasingly, and nearly universally, taking responsibility for the risk oversight of the company.

Clearly, boards must take seriously their responsibility to ensure that management has implemented effective risk management protocols. Boards of directors are already responsible for overseeing the management of all types of risk, including credit risk, liquidity risk, and operational risk—and there can be little doubt that cyber-risk also must be considered as part of board’s overall risk oversight. The recent announcement that a prominent proxy advisory firm is urging the ouster of most of the Target Corporation directors because of the perceived “failure…to ensure appropriate management of [the] risks” as to Target’s December 2013 cyber-attack is another driver that should put directors on notice to proactively address the risks associated with cyber-attacks.

What Boards of Directors Can and Should Be Doing to Oversee Cyber-Risk

Given the significant cyber-attacks that are occurring with disturbing frequency, and the mounting evidence that companies of all shapes and sizes are increasingly under a constant threat of potentially disastrous cyber-attacks, ensuring the adequacy of a company’s cybersecurity measures needs to be a critical part of a board of director’s risk oversight responsibilities.

In addition to the threat of significant business disruptions, substantial response costs, negative publicity, and lasting reputational harm, there is also the threat of litigation and potential liability for failing to implement adequate steps to protect the company from cyber-threats. Perhaps unsurprisingly, there has recently been a series of derivative lawsuits brought against companies and their officers and directors relating to data breaches resulting from cyber-attacks. Thus, boards that choose to ignore, or minimize, the importance of cybersecurity oversight responsibility, do so at their own peril.

Given the known risks posed by cyber-attacks, one would expect that corporate boards and senior management universally would be proactively taking steps to confront these cyber-risks. Yet, evidence suggests that there may be a gap that exists between the magnitude of the exposure presented by cyber-risks and the steps, or lack thereof, that many corporate boards have taken to address these risks. Some have noted that boards are not spending enough time or devoting sufficient corporate resources to addressing cybersecurity issues. According to one survey, boards were not undertaking key oversight activities related to cyber-risks, such as reviewing annual budgets for privacy and IT security programs, assigning roles and responsibilities for privacy and security, and receiving regular reports on breaches and IT risks. Even when boards do pay attention to these risks, some have questioned the extent to which boards rely too much on the very personnel who implement those measures. In light of these observations, directors should be asking themselves what they can, and should, be doing to effectively oversee cyber-risk management.

NIST Cybersecurity Framework

In considering where to begin to assess a company’s possible cybersecurity measures, one conceptual roadmap boards should consider is the Framework for Improving Critical Infrastructure Cybersecurity, released by the National Institute of Standards and Technology (“NIST”) in February 2014. The NIST Cybersecurity Framework is intended to provide companies with a set of industry standards and best practices for managing their cybersecurity risks. In essence, the Framework encourages companies to be proactive and to think about these difficult issues in advance of the occurrence of a possibly devastating cyber-event. While the Framework is voluntary guidance for any company, some commentators have already suggested that it will likely become a baseline for best practices by companies, including in assessing legal or regulatory exposure to these issues or for insurance purposes. At a minimum, boards should work with management to assess their corporate policies to ensure how they match-up to the Framework’s guidelines—and whether more may be needed.

Board Structural Changes to Focus on Appropriate Cyber-Risk Management

The NIST Cybersecurity Framework, however, is a bible without a preacher if there is no one at the company who is able to translate its concepts into action plans. Frequently, the board’s risk oversight function lies either with the full board or is delegated to the board’s audit committee. Unfortunately, many boards lack the technical expertise necessary to be able to evaluate whether management is taking appropriate steps to address cybersecurity issues. Moreover, the board’s audit committee may not have the expertise, support, or skills necessary to add oversight of a company’s cyber-risk management to their already full agenda. As a result, some have recommended mandatory cyber-risk education for directors. Others have suggested that boards be at least adequately represented by members with a good understanding of information technology issues that pose risks to the company.

Another way that has been identified to help curtail the knowledge gap and focus director attention on known cyber-risks is to create a separate enterprise risk committee on the board. It is believed that such committees can foster a “big picture” approach to company-wide risk that not only may result in improved risk reporting and monitoring for both management and the board, but also can provide a greater focus—at the board level—on the adequacy of resources and overall support provided to company executives responsible for risk management. The Dodd-Frank Act already requires large financial institutions to establish independent risk committees on their boards. Beyond the financial institutions required to do so, some public companies have chosen to proactively create such risk committees on their boards. Research suggests that 48% of corporations currently have board-level risk committees that are responsible for privacy and security risks, which represents a dramatic increase from the 8% that reported having such a committee in 2008.

Clearly, there are various mechanisms that boards can employ to close the gap in addressing cybersecurity concerns—but it is equally clear that boards need to be proactive in doing so. Put simply, boards that lack an adequate understanding of cyber-risks are unlikely to be able to effectively oversee cyber-risk management.

I commend the boards that are proactively addressing these new risks of the 21st Century. However, while enhancing board knowledge and board involvement is a good business practice, it is not necessarily a panacea to comprehensive cybersecurity oversight.

Internal Roles and Responsibilities Focused on Cyber-Risk

In addition to proactive boards, a company must also have the appropriate personnel to carry out effective cyber-risk management and to provide regular reports to the board. One 2012 survey reported that less than two-thirds of responding companies had full-time personnel in key roles responsible for privacy and security, in a manner that was consistent with internationally accepted best practices and standards. In addition, a 2013 survey found that the companies that detected more security incidents and reported lower average financial losses per incident shared key attributes, including that they employed a full-time chief information security officer (or equivalent) who reported directly to senior management.

At a minimum, boards should have a clear understanding of who at the company has primary responsibility for cybersecurity risk oversight and for ensuring the adequacy of the company’s cyber-risk management practices. In addition, as the evidence shows, devoting full-time personnel to cybersecurity issues may help prevent and mitigate the effects of cyber-attacks.

Board Preparedness

Although different companies may choose different paths, ultimately, the goal is the same: to prepare the company for the inevitable cyber-attack and the resulting fallout from such an event. As it has been noted, the primary distinction between a cyber-attack and other crises that a company may face is the speed with which the company must respond to contain the rapid spread of damage. Companies need to be prepared to respond within hours, if not minutes, of a cyber-event to detect the cyber-event, analyze the event, prevent further damage from being done, and prepare a response to the event.

While there is no “one-size-fits-all” way to properly prepare for the various ways a cyber-attack can unfold, and what responses may be appropriate, it can be just as damaging to have a poorly-implemented response to a cyber-event. As others have observed, an “ill-thought-out response can be far more damaging than the attack itself.” Accordingly, boards should put time and resources into making sure that management has developed a well-constructed and deliberate response plan that is consistent with best practices for a company in the same industry.

These plans should include, among other things, whether, and how, the cyber-attack will need to be disclosed internally and externally (both to customers and to investors). In deciding the nature and extent of the disclosures, I would encourage companies to go beyond the impact on the company and to also consider the impact on others. It is possible that a cyber-attack may not have a direct material adverse impact on the company itself, but that a loss of customers’ personal and financial data could have devastating effects on the lives of the company’s customers and many Americans. In such cases, the right thing to do is to give these victims a heads-up so that they can protect themselves.


Let me conclude my remarks by reaffirming the significance of the role of good corporate governance. Corporate governance performed properly, results in the protection of shareholder assets. Fortunately, many boards take on this difficult and challenging role and perform it well. They do so by, among other things, being active, informed, independent, involved, and focused on the interests of shareholders.

Good boards also recognize the need to adapt to new circumstances—such as the increasing risks of cyber-attacks. To that end, board oversight of cyber-risk management is critical to ensuring that companies are taking adequate steps to prevent, and prepare for, the harms that can result from such attacks. There is no substitution for proper preparation, deliberation, and engagement on cybersecurity issues. Given the heightened awareness of these rapidly evolving risks, directors should take seriously their obligation to make sure that companies are appropriately addressing those risks.

Those of you who have taken the time and effort to be here today clearly recognize the risks, and I commend you for being proactive in dealing with the issue.

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