The Chief Compliance Officer has extraordinary (and in some cases, unwarranted) access to employee records in addition to other confidential information such as executive meetings and emails. Firms should pursue enhanced background due diligence on potential CCO candidates, create information barriers so that the CCO does not have access to non-regulatory information, and implement a supervisory structure that ensures CCO accountability. Alternatively, consider outsourcing to a third-party firm that has limited access to firm systems as well as direct legal liability for breaches of confidentiality.
Firms can (and probably should) outsource their network and data storage to qualified vendors, but they cannot abdicate their responsibilities to ensure the data is protected from unauthorized intrusion. The compli-pros must work with the IT folks to assess the cloud provider’s ongoing compliance.
SEC’s Office of Compliance Inspections and Examinations has published a Risk
Alert calling out advisers and broker-dealers for their failures to protect personal
information. Based on deficiencies
identified over the last 2 years, the SEC found failures related to privacy
notices, policies and procedures, and physical safeguards. The SEC faulted registrants for failing to
deliver initial and annual privacy notices or for delivering notices that did
not accurately reflect policies and procedures.
The SEC found firms that completely failed to adopt policies and
procedures by simply restating the Safeguards Rule. Other firms either adopted weak policies and procedures
or failed to properly implement them. Some
common deficiencies included unsecure laptops, unencrypted emails, inadequate
training, insufficient control of third-party vendors, inadequate incident
response plans, and shared login credentials.
OCIE states that the Risk Alert is intended “to assist advisers and
broker-dealers in providing compliant privacy and opt-out notices, and in
adopting and implementing effective policies and procedures for safeguarding
customer records and information.”
Compli-pros should ensure the annual testing program includes the privacy notice process and the implementation of policies and procedures to avoid the highlighted issues. It may make sense to combine the testing with the required cybersecurity assessment.
A large BD/IA agreed to pay a $1 Million fine and retain an independent compliance consultant as a result of a third-party intrusion into its customer system. Outside hackers impersonated independent consultant registered representatives and tricked internal IT personnel to change passwords over the phone. Although there was no unauthorized transfer of funds, the impersonators were able to access personally identifiable information of over 5000 customers. The SEC charges the firm with violating the Safeguards Rule and with failing to implement an effective Identity Theft Prevention Program. The SEC faults the firm for allowing outside contractors to use their own equipment, which often had security and encryption problems, and with failures to follow remote session termination procedures.
OUR TAKE: This is the nightmare scenario for retail BD/IAs. The desire to make life easier for the producing reps creates IT vulnerabilities exploited by bad actors. Our recommendation is to retain an outside firm that can conduct an honest vulnerability assessment.
OUR TAKE: It appears that the firm failed to implement a monitoring system to ensure that the trading desks observed information barriers. How firms ensure the protection of material nonpublic information should be part of the annual testing program.
FINRA fined 12 firms a total of $14.4 Million (including individual fines of $4 Million, $3.5 Million and $2 Million) for failing to retain electronic records in the proper format. FINRA charges that, over extended time periods, the firms failed to maintain required broker-dealer and customer records in “write once, read many” (aka WORM) format as required by Rule 17a-4(f)(2)(ii)(a) (BD records must be preserved “exclusively in a non-rewriteable, non-erasable format”). FINRA asserts that retaining records in WORM format protects such records from cyber-crimes. FINRA maintains that the failures affected hundreds of millions of records “spanning multiple systems and categories.” FINRA’s Enforcement Chief empasized “FINRA’s focus on ensuring that firms maintain accurate, complete and adequately protected electronic records.”
OUR TAKE: These are significant fines for IT breakdowns in the absence of further allegations of customer harm or a specific hacking incident. Operations professionals should work with their IT teams and compli-pros to ensure that records retention follows regulatory requirements.
A broker-dealer agreed to pay a $650,000 fine because an OSJ’s cloud server vendor failed to protect customer information. FINRA asserts that foreign hackers penetrated the cloud-based servers and had access to customers’ nonpublic personal information. FINRA faults the firm for failing to monitor or test the third party vendor’s information security. FINRA also alleges that the BD failed to adopt reasonable data security policies that included specific firewall policies and related testing. FINRA cites violations of Rule 30 of Regulation S-P, which requires the protection of customer records and information.
OUR TAKE: Firms must go the extra mile to protect customer information and not just rely on hiring a third party. FINRA will hold BDs strictly liable for data breaches, even those occurring at the vendor.