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For a number of years, SEC registrants have migrated toward increasing dependence on digital technologies to conduct their operations. As this dependence has increased, the risks to registrants associated with cybersecurity have also increased, resulting in more frequent and severe cyber incidents. Recently, there has been increased focus by SEC registrants and members of the legal and accounting professions on how these risks and their related impact on the operations of a registrant should be described within the framework of the disclosure obligations imposed by the federal securities laws. As a result, the SEC staff has provided guidance that assists registrants in assessing what, if any, disclosures should be provided about cybersecurity matters in light of each registrant’s specific facts and circumstances.

The SEC staff has prepared this guidance to be consistent with the relevant disclosure considerations that arise in connection with any business risk. The staff says it is mindful of potential concerns that detailed disclosures could compromise cybersecurity efforts — for example, by providing a “roadmap” for those who seek to infiltrate a registrant’s network security — and the SEC staff emphasizes that disclosures of that nature are not required under the federal securities laws.

The federal securities laws, in part, are designed to elicit disclosure of timely, comprehensive, and accurate information about risks and events that a reasonable investor would consider important to an investment decision.  Although no existing disclosure requirement explicitly refers to cybersecurity risks and cyber incidents, the SEC believes a number of disclosure requirements may impose an obligation on registrants to disclose such risks and incidents. In addition, the SEC believes material information regarding cybersecurity risks and cyber incidents is required to be disclosed when necessary in order to make other required disclosures, in light of the circumstances under which they are made, not misleading.

The SEC believes registrants should consider the following areas when considering cybersecurity risks:

  • Risk factors
  • MD&A
  • Business description
  • Legal proceedings
  • Financial statement disclosures

Registrants may seek to mitigate damages from a cyber incident by providing customers with incentives to maintain the business relationship. Registrants should consider ASC 605-50, Customer Payments and Incentives, to ensure appropriate recognition, measurement, and classification of these incentives.

Cyber incidents may result in losses from asserted and unasserted claims, including those related to warranties, breach of contract, product recall and replacement, and indemnification of counterparty losses from their remediation efforts. Registrants should refer to ASC 450-20, Loss Contingencies, to determine when to recognize a liability if those losses are probable and reasonably estimable. In addition, registrants must provide certain disclosures of losses that are at least reasonably possible.

Cyber incidents may also result in diminished future cash flows, thereby requiring consideration of impairment of certain assets including goodwill, customer-related intangible assets, trademarks, patents, capitalized software or other long-lived assets associated with hardware or software, and inventory. Registrants may not immediately know the impact of a cyber incident and may be required to develop estimates to account for the various financial implications. The SEC believes registrants should subsequently reassess the assumptions that underlie the estimates made in preparing the financial statements. According to the SEC, a registrant must explain any risk or uncertainty of a reasonably possible change in its estimates in the near-term that would be material to the financial statements.  Examples of estimates that may be affected by cyber incidents include estimates of warranty liability, allowances for product returns, capitalized software costs, inventory, litigation, and deferred revenue.

The SEC also states that to the extent a cyber incident is discovered after the balance sheet date but before the issuance of financial statements, registrants should consider whether disclosure of a recognized or nonrecognized subsequent event is necessary. According to the SEC, if the incident constitutes a material nonrecognized subsequent event, the financial statements should disclose the nature of the incident and an estimate of its financial effect, or a statement that such an estimate cannot be made.

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