Shareholders kept in the dark on data breaches

It happened more than three and a half years ago. So it presumably would be old news that Chinese hackers broke into soft drink behemoth Coca-Cola's computer systems and stole confidential files relating to its effort to acquire the China Huiyuan Juice Group for $2.4 billion.

But it is just coming to light now, through a report earlier this week in Bloomberg Businessweek. The story said the FBI contacted Coke executives on March 15, 2009, and told them hackers had been inside their system for a month. The attempted deal for Huiyuan collapsed three days later.

The U.S. Securities and Exchange Commission (SEC) requires companies to report to its shareholders any "material losses" from attacks, plus any information, "a reasonable investor would consider important to an investment decision."

Meredith Cross, director of the SEC's division of corporation finance, told Businessweek, "We think reasonable investors could care, depending on the specific facts and circumstances."

But Coca-Cola never disclosed the breach to its investors. Most companies don't. Bloomberg reported on breaches of the British energy company BG Group, the Chesapeake Energy and others that were never disclosed to investors.

When questioned about it, most company officials or representatives either declined to comment, or declared that they were in full compliance with all applicable laws.

The response of Coca-Cola spokesman Kent Landers was typical. "We make disclosures in our public filings when we believe they are appropriate and in accordance with the requirements of the federal securities laws," he told Businessweek.

One reason for the lack of transparency may be that Coca-Cola didn't discover the breach itself. It took notification from the FBI. That is common. Security experts regularly point out that many companies don't know they have been hacked until a third party tells them.

Breach victims also frequently don't know what was taken, who took it and how it is being used. So, since it is difficult to put a value on the loss, they argue that it is not a material event, and therefore not subject to that SEC regulation.

David C. Vladeck, director of the Federal Trade Commission's (FTC) Bureau of Consumer Protection, made that point at a recent press conference, saying that the question of when major data breaches should be reported is "difficult. We don't necessarily have the right answers."

Stewart Baker, a partner at Steptoe & Johnson LLP and former assistant secretary for policy at the Department of Homeland Security, told Businessweek, "All of the ambiguities stack the deck against disclosure."

[See related: EPA data breach highlights worrying trend]

The SEC did not respond to questions about whether its regulations need to be less ambiguous. The agency does have a page on its website with "disclosure guidelines" from its Division of Corporate Finance.

Among those guidelines are that:

Companies should disclose the risk of cyber incidents, "if these issues are among the most significant factors that make an investment in the company speculative or risky.

If a company has been attacked, it "may" need to, "discuss the occurrence of the specific attack and its known and potential costs and other consequences ... (including) describing the property that was stolen and the effect of the attack on its results of operations, liquidity, and financial condition and whether the attack would cause reported financial information not to be indicative of future operating results or financial condition."

If a company increases its cybersecurity expenditures, it should "note those increased expenditures," to current and potential shareholders.

But all that comes with a disclaimer."This guidance is not a rule, regulation, or statement of the Securities and Exchange Commission." In other words, none of it is mandatory.

Jacob Olcott, a principal at Good Harbor Consulting and a former cyber policy adviser to the U.S. Congress, noted that there are rules in place. "Companies that don't disclose material breaches are violating longstanding securities law," he said.

He said companies may also risk shareholder lawsuits for "failing to protect sensitive business information or trade secrets. I think negligence cases based on the breach of fiduciary duty are the most likely."

Dan Berger, CEO and president of the IT security firm Redspin, said the issue is complex, but that "it needs to be addressed."

His fix: Regulations that demand rapid disclosure. "The worse thing [breached companies] can do is disclose too early with insufficient information at hand," he said.

"Sometimes they get goaded ... an organized hacker group makes it public first, which immediately puts the company on the defensive. Almost anything the company says at that point looks bad, because from a PR perspective they try to accentuate the positive -- 'there was a breach but we know of no harm done' while investors assume the worst -- 'the company either doesn't know or is minimizing the issue,'" he said.

But once there has been time to quantify the loss, the investing public has a right to know, Berger said. "Regarding the SEC requirements to disclose material losses, public companies must comply or face investigation or investor lawsuits."

'[The SEC should] set some specific ground rules, provide for a time period for internal assessment and establish thresholds of harm, and corresponding required disclosures actions based on those severity levels," Berger said.

Bu that should be balanced by law enforcement assisting companies, he added. "We shouldn't forget that the companies are victims of crime."

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