Why the Duty of Cybersecurity is the Next Evolution for Fiduciary Duties
Bank directors know they can be personally liable for breaches of their fiduciary duties.
Through cases like In re Caremark International Inc. Derivative Litigation 698 A.2d 959 (Del. Ch. 1996), Stone v. Ritter, 911 A.2d 362 (Del. 2006), and Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), Delaware courts have held boards responsible for failing to implement systems to monitor, oversee and ensure compliance with the law.
Recently, the Delaware Court of Chancery formally expanded those rules in In re McDonald’s Corporation Stockholder Derivative Litigation, Del. Ch. Ca. No. 2021-0324-JTL. The ruling established that the fiduciary duties of the officers of a Delaware corporation include a duty of oversight that is comparable to the responsibility of directors. These cases make clear that when the duty of oversight meets with the immense cybersecurity responsibilities of financial institutions, a duty of cybersecurity is added to the fiduciary responsibilities of directors and officers.
The lawsuit by 25 former McDonald’s employees alleged that corporate executives failed to address systemic harassment, leading to a hostile work environment. By allowing failure to oversee and monitor claims against the officers in that case, all corporate executives are now forced to take a leadership role in monitoring and addressing company-wide issues.
Given prior rulings in Delaware courts concerning the duty of oversight and officer fiduciary duties, the McDonald’s decision reiterates the importance of implementing robust compliance programs. It also clarifies that officers and directors must actively address compliance.
Cybersecurity is paramount among the myriad of compliance issues that all corporate officers and directors must address. For example, in 2019, In re Google Inc. Shareholder Derivative Litigation, the proceedings against Google’s parent company involved claims that the company’s board of directors and officers failed to discharge their oversight duties related to the 2018 Google+ security vulnerability. That suit settled for $7.5 million and the company agreed to implement significant governance reforms to address data privacy issues. Similarly, In re Yahoo! Inc. Shareholder Derivative Litigation, multiple cybersecurity breaches between 2013 and 2016 led to a shareholder derivative lawsuit, which settled for $29 million in 2019.
And, in the past year, multiple financial institutions, including Wells Fargo & Co., JPMorgan Chase & Co., and Bank of America Corp., faced lawsuits also seeking to hold their officers and directors personally liable for, amongst other things, failing to:
1. Protect customer data adequately.
2. Oversee the bank’s cybersecurity practices.
3. Prevent data breaches that exposed customer personal information.
In these cases, and many others, cybersecurity and data breaches have caused reputational damage for officers and directors and damaged the corporation’s relationships with customers and partners. In addition, these corporate leaders risk:
• Breach of fiduciary duty claims. If directors or officers do not take reasonable steps to protect the corporation from a data breach, they risk breaching their fiduciary duties and could be held personally liable for the damages caused by the breach.
• Accusations of Negligence. Directors and officers can be accused of negligence for failing to implement appropriate security measures, train employees on cybersecurity best practices and respond to a breach in a timely and effective manner.
• Criminal prosecution. If directors and officers intentionally or recklessly cause a breach or fail to report it to the authorities, they may face criminal prosecution.
• Regulatory penalties. Government or financial regulators can impose significant fines for cybersecurity failures.
And, just as the risks for directors and officers explode, they face an insurance whipsaw. First, directors’ and officers’ (D&O) insurance policies may include specific exclusions for cyber-related claims or require separate cyber insurance to cover these risks. Next, increased personal exposure for officers and directors will increase the likelihood facing lawsuits, increasing the premiums for D&O insurance.To protect themselves, directors and officers should insist on increased corporate governance protection, including:
• The prioritization by boards of cybersecurity and data privacy as crucial risk management areas, including putting proper reporting and monitoring systems into place.
• Requiring directors and officers to actively understand the evolving landscape of cybersecurity and data privacy risks and regulations.
• Corporate investment in appropriate cybersecurity measures and employee training to minimize the risk of data breaches as well as the associated legal and reputational risks.
To mitigate their risk of personal liability, corporate officers and directors must understand, implement and monitor the cybersecurity safeguards their financial institutions need. And, the courts have sent a clear message to bank directors and officers: To discharge your duty of cybersecurity, you must actively oversee and monitor institutional cybersecurity and data privacy programs.