With the economy in overdrive and the bull market continuing to run, it is difficult to envision, let alone discuss, a storm ahead. The S&P 500 and NASDAQ each recently closed at record highs; unemployment is low; and the gross domestic product report is strong. The administration and Congress have taken steps to lessen regulatory burdens, and the Supreme Court has been issuing rulings favorable to businesses. Securities class action litigation against the Fortune 500 is down as stocks generally are rising. So why speak of a brewing storm—and what type of storm?
As the old adage goes, all good things come to an end. The bull market cannot last forever and there already are warning signs that suggest a slowing economy in 2020. Regardless of who will be in the White House after next year's election, the regulatory pendulum is already swinging toward more enforcement, particularly in new areas such as cybersecurity, consumer protection, and antitrust—at both the federal and state levels. State Attorneys General have increased enforcement efforts in areas traditionally reserved for the Securities and Exchange Commission (SEC). Plaintiff-lawyers are getting more creative in bringing new, innovative lawsuits against directors and officers, and class actions will increase as soon as stocks take a negative turn.
There are five steps that boards should be taking now, even when times are good. These steps are critical to fortifying a company against the inevitable threats on the road ahead.
1.Conducting a Cybersecurity Audit
Stephanie Avakian, co-director of the SEC's Division of Enforcement, has stated that "[c]yber-related threats and misconduct are among the greatest risks facing investors and the securities industry." Threats have become more sophisticated, and not even federal agencies, including the SEC, are immune to hacking. Odds are the protections that exist at your company already have become antiquated as the threats evolve.
Cybersecurity is no longer solely the responsibility of a company's head of information technology. Regulators are increasingly looking to hold officers and directors responsible, and company fines for improper oversight or failing to report have increased. For example, Altaba, formerly known as Yahoo!, agreed to pay $35 million to the SEC to settle charges that it failed to disclose a security breach. Yahoo's management allegedly learned in 2014 that hackers had breached its system and stolen personal and account information for millions of its users, but Yahoo did not disclose the breach for almost two years. The SEC's co-director of enforcement, Steven Peikin, said that while the SEC will not "second-guess good faith" responses to a cyberincident, he cautioned that "a company's response to such an event could be so lacking that an enforcement action would be warranted."
Responses to cyber intrusions are not limited to regulatory actions. In 2014, hackers stole 56 million credit and debit card numbers from Home Depot. Shortly after the breach, dozens of banks and credit unions brought class action lawsuits against Home Depot for its alleged data security weaknesses, contending that it "had ignored red flags, expert opinions, employee warnings and industry standards." To settle these claims, Home Depot agreed to pay $25 million to plaintiffs and to improve its data security practices. Altaba and Home Depot are not alone in facing adverse actions following a cyberincident; for these companies, proactive actions surely would have been less expensive than the large settlements they paid.
Directors can minimize both the risk of a cyberattack and also their own individual liability by hiring outside counsel and technical advisors to conduct a cybersecurity audit. Although perhaps not intuitive, outside board counsel is essential to ensuring that the review is protected by the appropriate privilege. Moreover, outside counsel can advise not only on vulnerability but also on the processes and steps it would be necessary for the board to take if there were a cyber intrusion. Understanding and confirming that the appropriate processes are in place now is imperative to being ready should an incident occur. And, importantly, merely undertaking this type of review can help to reduce liability for directors if that time should come.
2.Reviewing and Enhancing Compliance Programs
Best practices dictate that at least once every three to five years directors should independently engage outside counsel to review the compliance and anticorruption programs at their companies to ensure that they are state of the art. In recent years, for example, the SEC has mandated new procedures for dealing with whistleblowers and the Department of Justice (DOJ) has issued new guidance for dealing with matters related to the Foreign Corrupt Practices Act. It is also worth noting that within the past month, the Treasury Department released new OFAC guidance. These developments should be incorporated into every compliance and anticorruption program in order to stay relevant. This low-cost process of independently reviewing compliance programs can significantly decrease the potential liability of directors.
3.Evaluating D&O Insurance
Good times are the best times to evaluate director and officer insurance. Insurance coverage is evolving and new insurance products in the area of government investigations and cybersecurity are available for both companies and their directors and officers. Boards should engage a broker to evaluate on at least an annual basis the existing insurance coverage and to recommend any enhancements. This evaluation of insurance coverage is particularly important in the cybersecurity area because insurers regularly revise policy language for cyber-attacks.
4.Considering Stress Testing and Enhancements to Enterprise Risk Management
Enterprise risk management (ERM) became a household phrase following the last financial crisis. Businesses should accompany ERM with stress testing the balance sheet, income statement, and statement of cash flows. Boards should consider pressing management to present contingency plans in the event that significant downturns occur in the stock price, asset values, or liquidity. Laying out the worst-case scenarios can help prepare a company and its board for the next crisis—whether it be macroeconomic or company-specific in nature.
5.Evaluating Succession Planning
Although succession planning is always important, it is particularly important during good times. Boards should evaluate key personnel, formulate a process of identifying new candidates, and pin down potential interim replacements in the event of a departure. Too often companies are caught flat-footed when a key officer unexpectedly leaves for whatever reason.
It is anyone's bet when the next storm will hit, but history teaches us that it will happen. Boards should consider taking these steps now to prepare for the inevitable storm whenever and wherever it may disturb the present calm.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
