OECD calls for increased focus on Outsourcing, IT and Supplier Risk

Posted
By Tim Wright

At a recent conference, the Twelfth Annual Corporate Accountability Conference, 12 June 2014, Cercle National Des Armées, Paris, Pierre Poret, Counsellor, Directorate for Financial and Enterprise Affairs at the The Organisation for Economic Co-operation and Development, told the audience, referring to the OECD's Risk Management and Corporate Governance report, that "too often, in the enterprise, there was little or no board-level responsibility, with the burden (and oversight responsibility) [for risk management] effectively stopping at the level of the line manager".  According to Monsieur Poret, the OECD's findings showed that companies' boards often played only a very limited role in risk management and that risk management standards were often set at too high a level, with outsourcing and supplier-related risk a key but much overlooked risk.

The report is the output of the OECD's peer review process which is designed to facilitate effective implementation of the OECD Principles and to assist market participants, regulators and policy makers.  The process covers the corporate governance framework and practices relating to corporate risk management of the 26 jurisdictions that participate in the OECD Corporate Governance Committee.  Its findings are based on general survey responses from participating jurisdictions as well as an in-depth review of corporate risk management practices in Norway, Singapore and Switzerland.  

The report, which analysed both private sector and state-owned enterprises, found that "while risk-taking is a fundamental driving force in business and entrepreneurship, the cost of risk management failures is still often underestimated, both externally and internally, including the cost in terms of management time needed to rectify the situation."  Risk governance standards tend to be very high-level.  This limits their practical usefulness, says the OECD, as they should be more operational.  And in the nonfinancial sectors, risk management is less prevalent.  "Outsourcing- and supplier-related risks ...deserve attention in both the financial and the nonfinancial sector." 

The effectiveness of an enterprise's risk management culture can be critical to an organisation's success (or failure).   The OECD lists accounting frauds (Olympus, Enron, WorldCom, Satyam, Parmalat), foreign bribery cases (Siemens) and environmental catastrophes (Deep Water Horizon, Fukushima) to demonstrate that the headlines are not restricted to the financial sector; cases where wrong-doing was compounded by corporate governance failure and deficient risk management systems, with company boards which failed to fully appreciate the risks that the companies were taking (if they were not engaging in reckless risk-taking themselves).

 

The typical modern enterprise has a complex supply chain with a multitude of third party and outsourced relationships.   In the absence of an adequate risk management and assurance framework, says the OECD, reliance on these outsourced and third party relationships can quickly contaminate the organisation, especially if "only lip service only is paid to important parts of the company's value chain that are outsourced".  A risk management framework should address all dependence on key suppliers or joint venture partners, with particular sensitivity to suppliers or other third parties located in countries that may follow different standards from the home country.  Companies with diverse, global supply chains should operationalise strategies to cope with the risks which result from a lack of control over their suppliers and contractors spread out across various parts of the world. 

 

Given high profile supplier failures such as Satyam Computer Services (subsequently rescued by Mahindra Group although not before several significant customers including Merrill Lynch (now a part of Bank of America) and State Farm Insurance terminated their contracts with Satyam), as well as headline hitting events such as factory fires and a building collapse in Bangladesh, companies should ensure that third party supplier risk management is given adequate resource and attention, including examining available insurance and other mitigation strategies such as dual sourcing, supplier assessments, contract compliance reviews, exit strategies and stress testing contractual remedies, where these have been negotiated, such as step-in rights and exit plans. 

FCA Chief announces Project Innovate: Helping Firms Meet the Technological and Regulatory Challenge

Posted
By Tim Wright

The head of the UK's Financial Conduct Authority, Chief Executive Martin Wheatley, used a speech at Bloomberg, London given on 3 June 2014 to promote the FCA's Project Innovate (the drafted text of Martin Wheatley's speech can be read at http://www.fca.org.uk/news/making-innovation-work).  The FCA is the regulatory body that, following reforms introduced by the Financial Services Act 2012, succeeded the Financial Services Authority. It has supervisory powers over the conduct of over 50,000 financial services firms in the UK, and authority to regulate the prudential standards of those firms not covered by the Prudential Regulation Authority. The PRA regulates deposit takers, insurers and significant investment firms.

Project Innovate is intended to allow financial services firms to develop innovative products for consumers.  This has been generally well received, with Wheatley describing Innovate as "an agreement to grant waivers to products that do not necessarily follow FCA guidance to the letter" where firms can show better outcomes for consumers.  Part of the driving force behind Innovate, which will resonate with business leaders across the UK, is to prevent good products from drowning in the "overwhelming red tape that is inevitable as we introduce more regulation, not just at UK but at a European level."

Describing the need for regulators to keep pace with new technologies, rather than - as present - running to catch up, and a desire for a regulatory environment that supports innovation rather than acting as an entry barrier, Wheatley singled out mobile banking, online investment and money transfer as priority areas, and the emergence of London-based innovative companies such as WorldRemit, Monitise, TransferWise and Nutmeg. Wheatley went on to cite digitalisation, big data analytics, venture capital, virtual currencies, crowd funding and peer-to-peer as important, transformational areas.

Smaller firms and start-ups can, in particular, be expected to benefit from the Innovate approach which will encourage collaboration with the FCA in order to develop new technologies that are compliant from day one, with a regulatory environment that, instead of acting as a "drag anchor" supports innovation and encourages the "brightest and most innovative companies to enter the sector". Whether this marks a shift in the FCA's approach to digital currencies, such as bitcoin, remains to be seen, with the regulator so far having kept a wide berth.

It's probably too early to call a trend (more evolution than revolution) but this initiative shows promising signs, with Wheatley recognising, and taking steps to bolster, London's leading position in the European market in financial technology (Wheatley cites growth of global investment in financial technology having tripled over the 5 years to 2013 up to $2.9bn, with UK and Ireland the fastest growing incubators, developing at an annual rate of 74% since 2008, compared with 23% in Silicon Valley).  A single paper and a wider FCA consultation on potential handbook changes are due later this year.  In the meantime, the FCA has started to engage with business including a number of start-ups and organisations such as Tech City and Level 39. It has "opened a hub" in its policy team to pull together expertise and provide support to advise firms developing new models or products on compliance and how to navigate the regulatory system, and by "looking for areas where the system itself needs to adapt to new technology or broader change - rather than the other way round". Wheatley also foreshadowed that a single paper combining all of these initiatives, and wider FCA consultation on potential handbook changes, are due later this year. 

The UDAAP Trap: How Financial Institutions can Avoid Penalties when Using Third Party Services

Posted
By James W. McPhillips and Vipul Nishawala

In Part 1, we noted that financial institutions could find themselves potentially liable for committing an alleged Unfair, Deceptive, or Abusive Act or Practice (UDAAP) as a result of the actions of certain types of external service providers, particularly those that interface directly with customers.  In this Part 2, we will discuss how financial institutions can mitigate the risk of UDAAP enforcement actions through their contracting strategies with their service providers.

A New Wrinkle of Risk

In some ways, the CFPB's UDAAP authority resembles other regulatory regimes in that it places compliance obligations on both the issuer of the product as well as the third-party service provider that helps effectuate a transaction involving such a product.  For example, export control laws place Office of Foreign Assets Control compliance obligations on both parties to a transaction.  Data protection laws apply both to the controller as well as the processor of data.  HIPAA protections for health information apply to the covered entity and its business associates.

In other ways, however, the CFPB's UDAAP authority differs from other regulatory regimes because it expressly imposes upon a financial institution an affirmative obligation to supervise closely the behavior of its service providers.  While some other regulators may also impose express obligations (e.g., Office of the Comptroller of the Currency), in many other regulatory contexts, any required supervisory role is typically either less onerous and/or only implied by the regulatory agency. 

Of course, it is an outsourcing best practice for a customer to have good management and oversight over its service providers, but the CFPB's requirements go further.  Indeed, this supervisory obligation may even undercut a financial institution's rationale to outsource certain functions in the first place and lead an institution to forego pursuing the outsourcing relationship during an initial risk assessment if the institution believes the potential service provider could expose the institution to UDAAP liability.

All outsourcing relationships involve some level of risk.  Depending on the nature of the services, a bank may be handing over sensitive data, management of key processing functions, or responsibility to keep IT infrastructure safe and secure.

The CFPB, however, appears to have added a new wrinkle of risk to what would otherwise be considered a "standard" level of outsourcing risk - for certain services related to consumer financial products or services, if a financial institution's service provider engages in behavior that the CFPB finds unlawful under its UDAAP authority, then the financial institution itself is potentially liable for the conduct of its service providers and could be subject to substantial penalties.

A Delicate Balance

But this risk is not insurmountable.  A thoughtful vendor management/contracting strategy can mitigate a financial institution's risk by incorporating UDAAP obligations into its service provider contracts and sensibly allocating the risk between the parties.  In addition to addressing the risk responsibility in the contract, the financial institution should consider establishing a service provider monitoring and governance framework that expressly addresses UDAAP risk. 

Financial institutions will want to implement specific solutions (which may even vary service provider to service provider) to ensure that it sufficiently protects itself while at the same time not being too heavy handed with its business partner.  A financial institution and its counsel will need to maintain that delicate balance between seeking the necessary protection and creating obligations that can get in the way of doing business.

With this balance in mind, there are two high-level procedural approaches a financial institution's counsel may want to consider.

Single Purpose Agreement

One method a financial institution could employ is to execute single purpose "UDAAP Agreements" with all of the relevant service providers across the enterprise.  This approach is analogous to a company requiring its service providers to enter into NDAs or (for HIPAA covered entities) Business Associate Agreements.

Such an initiative will likely take a fair amount of effort, but it could also bring significant benefits.  First, the institution is starting out with standard terms.  Assuming counsel is successful in limiting negotiation, then all the relevant service providers are signing up to more or less the same obligations, which creates consistency with respect to meeting the CFPB's duty to supervise.

Second, this approach gives the institution room to be specific about what is required.  Some service providers may not know their precise obligations with respect to the prohibition on UDAAP, and having such clear obligations may be beneficial to the financial institution in showing the CFPB that the institution is taking its affirmative obligations seriously.

Finally, with respect to those agreements already in place, a single purpose approach avoids having to reopen and amend the existing terms.  With respect to new agreements being negotiated, the single purpose approach allows the institution to segregate the risk terms (e.g., liability and indemnities) from the underlying commercial transaction, which may result in more efficient negotiations.

Integrate the Terms

Another approach is to integrate the UDAAP obligations into the underlying service provider contract.  Integrating the terms into an underlying agreement may enhance the institution's leverage because each party has the "let's get a deal done now" mentality if it is a new contract.

Integration of the terms into the underlying transaction is also similar to the way many outsourcing contracts deal with other regulatory issues like data protection and export controls, so the approach is unlikely to surprise the service provider.  Taking this approach may result in negotiating "fewer words" because some aspects of compliance (e.g., reporting and audit rights) may already be captured by other portions of the contract.

For those outsourcing transactions that, in the grand scheme of things, present a comparatively lower risk to the financial institution, a single purpose agreement may be too much when simpler integrated terms would suffice.  Compliance obligations with such low-risk transactions may simply be handled in a standard "compliance with laws" section in the agreement.

With respect to medium-risk to high-risk transactions, however, an institution will want to guard against taking a simplistic approach to integration.  In other words, the institution should resist trying to address UDAAP by simply inserting a "compliance with Dodd-Frank" obligation or "compliance with bank policies" obligation into the contract.  Although the service provider may be more agreeable to closing the issue this way, the actual obligations to prevent UDAAP violations are not spelled out.  If CFPB examiners come looking for UDAAP violations, the bank may not have a good story to tell about its good faith effort to mitigate risky UDAAP behavior with that service provider.

Key Negotiation Points

In addition to deciding on the best approach as described above, the financial institution will need to able to negotiate the substantive UDAAP terms.  Of course, a bank's negotiation strategy is highly dependent on the nature of the deal, the leverage each party has, and whether the particular relationship is high or low risk.

The financial institution should focus on the following key areas of risk when negotiating UDAAP terms.

1.             Liability.  As we noted in Part 1, CFPB enforcement actions to date have resulted in fines and restitution obligations that could run into the hundreds of millions of dollars.  Such penalties likely would vastly exceed an agreement's standard liability cap on direct damages.  Therefore, a bank's counsel should attempt to exclude such regulatory fines from any liability caps. 

2.             Indemnities.  A full indemnity from the service provider for regulatory fines may also be appropriate depending on the nature of the services, particularly for high-risk services that directly interface with an institution's consumers. 

3.             Termination.  An institution should also negotiate flexible termination rights with the service provider, so that the institution can exit a relationship in case the service provider engages in prohibited UDAAP activity.  CFPB examiners will likely look favorably upon an institution with such flexible termination rights.

4.             Operational Oversight.  In addition to the traditional risk terms described above, other business and operational terms warrant consideration as well.  To ensure that the institution is able to exercise its heightened obligations to monitor and supervise, it should seek frequent reporting and good recordkeeping practices from its service providers.  Strong audit rights on behalf of the institution are also recommended by the CFPB.  A robust governance framework with the service provider may also be an important part of the financial institution's ongoing monitoring and compliance efforts.

5.             Performance Incentives.  In its guidance documents, the CFPB has noted that consumer complaints can serve as a leading indicator as to whether a UDAAP has occurred.  Not only should an institution look to implement a process for how customer complaints get analyzed and reported up to the bank, but also the institution should consider tailor-made service levels for incentivizing the service provider to limit such complaints in the first place.  Implementing such proactive performance measures will likely show CFPB examiners that the institution is looking to curb violations before they occur. 

Conclusion

Implementing such a contracting strategy is an essential component of any financial institution compliance program.  Among other things, it likely will go a long way in showing the CFPB that a good faith effort has been made to comply with UDAAP rules and ultimately help the financial institution avoid enforcement actions.

The Internet of Things--Avoid Getting Eaten by the Wolf in Sheep's Clothing

Posted
By Joshua Konvisser

With the number of (internet) connected devices rapidly surpassing the number of internet people (actually, all people whether or not connected), we take this opportunity to explore some of the legal complexity brought about by all of this connectivity.
First, some background:

This means that with the current population, we have the ability to address over 47,000 addresses/devices per person

The Sheep's Clothing
The Internet of Things has some wonderful benefits. For example:


  • You can now remotely control your thermostat to save energy;

  • You can monitor systems in your house when away to protect its physical security;

  • Companies can monitor the flow of goods and inventory through their systems;

  • Utilities can manage the flow of resources based on supply and demand through smart metering;

  • Distributers can monitor the movement of their fleets;

  • Municipalities can monitor flow of traffic on streets and availability of parking spaces;

  • And the list goes on as far as our imagination

The Wolf
But . . . the Internet of Things also creates huge amounts of information. And with that information, come all of the risks and challenges of having information.
Companies or other entities collecting or processing information need to protect the confidentiality of that information. Information about the things of individuals can disclose significant information about that individual.

For example, the GPS tracking on a cell phone may be used to tell the owner of an App where the person is going which could disclose private, or even Protected Health Information--imagine, if you will, a company that uses the GPS tracking to monitor the movement of its distributed sales force and learns that one of the sales personnel has been frequenting a certain kind of medical establishment.

Entities need to understand what information they may obtain, and need to develop clear policies and manage expectations of the users. In some countries, even having employees consent to such monitoring may not be enforceable given the "coerced" nature of employee "consent."

This gets even more concerning when companies are monitoring their customers rather than their employees. Although the monitoring may be for the most well-intentioned purposes, the company still possesses sensitive data. For example, the App on smartphones that tracks where people exercise using GPS also knows when people are exercising far from home. If someone was able to hack into that data, they would know when was a good time to break into the home or harm the user's family.

In addition to privacy concerns, there are also more direct employment concerns. Internet connected devices make it easier for employees to work whenever and wherever. This sounds great, but this also means that hourly employees may be encouraged to work outside of their normal work hours. Not only does the device facilitate this extra work, it also reports on it. There are reported cases where this has led to companies incurring unanticipated overtime liability for hourly employees responding to emails from their smartphones.

The Internet of Things also facilitates more direct monitoring--both by private companies and by the government.

Having this data also makes an entity subject to inquiries from law enforcement and in litigation. This volume of data compounds the classic eDiscovery problems which can drive huge costs in terms of gathering, reviewing, and providing data. In addition, a company may be faced with a decision of incurring the legal expense of defending a request for information to protect the privacy of its customers, or sharing the information and affecting its reputation with the customer-base.

Don't Get Eaten
So, what is the purpose of this blog post? The move to the Internet of Things is both unavoidable and, by-in-large, beneficial. By all means, get on board, or be left behind. But entities should be thoughtful and understand some of the associated risks so that they can be built into the decision-making process. By understanding the legal risks, systems can be designed to generate great benefits while accommodating legitimate legal concerns. Advanced awareness and planning can empower those who embrace the Internet of Things, rather than allowing them to be blindsided when it is too late.

Database Marketing Outsourcing

Posted
By Jeffrey D. Hutchings

Database marketing outsourcing is a strategic transaction for retailers. This type of outsourcing can facilitate the integration of diverse marketing channels e.g., web, social media, catalog and in-store sales) and enable more targeted and effective marketing to consumers.

Database marketing encompasses a potentially broad array of services, including:

  • Implementation and hosting of a CRM database marketing solution;
  • Data cleansing, matching, updating and enrichment;
  • Data licensing;
  • Data mining and analytics/reporting; and
  • Campaign management and analysis.

This is the second of two articles highlighting some key business and legal considerations in these transactions. In the first article I discussed scope, sizing and pricing considerations. In this article I will discuss performance and data considerations in connection with database marketing outsourcing.

Performance Considerations

There are a variety of different measures of supplier performance depending on the specific services to be provided by the supplier and the supplier's solution for providing those services. Typical service level measures include the following:

Solution Availability - This service level measures the availability of the components of the supplier's database marketing solution that are to be accessed and used by the customer in connection with the services, such as reporting datamarts. Similar to traditional IT measures of system availability, this service level holds the supplier accountable for the solution being available to the customer's authorized users without material degradation in performance during scheduled hours of operation (excluding scheduled maintenance windows). The supplier is responsible for the application, infrastructure and network elements of the solution managed by or on behalf of the supplier. Availability is normally in the 99.0 - 99.5% range.

Database Update Processing - Database marketing services typically involve the supplier updating customer data through cleansing, appends, enrichment and refreshes in accordance with a defined schedule. As a result, there should be one or more service levels that measure the supplier's successful completion of the scheduled updates in a timely manner. This service level is typically measured either as the percentage of scheduled updates that are completed on time during the measurement period (e.g., monthly or quarterly) or in terms of a permitted number of misses over the course of a contract year. This service level is important in ensuring that the most up-to-date information about consumers is used in designing and implementing marketing campaigns and strategies.

System Response Times - This service level measures the response time of the supplier's system to queries executed by the customer's marketing department or other users. Because queries can vary considerably in terms of complexity, it is necessary to either classify queries by their complexity level (e.g., high, medium and low) with different response times for each classification or pre-define a limited set of common queries that the customer wants to measure (e.g., shopped in the past 12 months, generation of do not mail list) with a specified response time for each query. Failure to meet the required response times for a specified percentage of queries can trigger a service level failure or, alternatively, trigger a severity 1 or 2 incident which needs to be resolved within the required resolution time.

Marketing Campaign Execution - If the services include marketing campaign support, customers may want to include service levels that measure the supplier's timely completion of its responsibilities in connection with the campaigns. For example, the service level could measure the delivery of fulfillment files to direct mail or email vendors in a timely manner. The service level measure will need to be defined based on the specific roles and responsibilities of the supplier and customer in executing marketing campaigns.

Incident Management - In addition to the measures described above, there should be a set of incident management service levels that measure the supplier's effectiveness in responding to and resolving issues that adversely impact the services. Similar to tradition IT measures, incidents are classified by severity level based on the impact to the customer's business and the services.

Key Stakeholder Satisfaction Survey - While the quantitative measures of supplier performance described above address many important aspects of the supplier's performance, they do not capture all aspects of performance that are critical to a successful relationship such as the quality of individuals assigned to the customer's account and the flexibility and customer-focus of the supplier in addressing service and change requests. It is not uncommon for a customer to be unhappy with the supplier's performance even though the supplier is consistently meeting the quantitative measures of performance. As a result, we recommend that customers negotiate a service level that provides for a quarterly evaluation by key customer stakeholders (e.g., CMO, CIO) of the supplier's performance. A modest portion of the supplier's fees should be at risk each quarter if it fails to achieve an acceptable score. Because stakeholder satisfaction is a subjective measure, the first reaction of many suppliers is to resist such a measure. With some effort, however, suppliers can often be persuaded that this is a rationale contract management tool which if used correctly can also benefit them by providing frequent and candid feedback on their customer's perception of their performance.

Data Considerations

Database marketing services involve suppliers managing sensitive consumer data on behalf of the customer. Data typically comes from two sources: (1) the customer's database containing consumer contact, demographic and transactional information which is to be hosted and maintained by the supplier and (2) the supplier's (and/or a third party's) databases of consumer contact and demographic information that are to be used to improve the accuracy and enrich the customer's database. As a result, there are several dimensions to addressing data related issues ranging from data license rights to data protection to the return of customer data at the end of the outsourcing contract.

Licensing of Supplier Data - Customers should give careful consideration to the terms of any data licensed by the supplier in connection with database marketing services. If customers anticipate using any supplier furnished data in connection with co-branding or joint marketing with business partners, they will need to secure express license rights for those activities. In addition, suppliers typically license their data for specified terms (e.g., annual) that expire at the end of the services relationship. However, portions of the data licensed from the supplier may include updated consumer contact information (e.g., new postal or email address, new telephone number) that will be integrated into the customer's consumer records. This information cannot readily be removed from those records and it is not realistic to expect customers to revert to a consumer database with outdated information. As a result, customers should secure unlimited perpetual licenses to such data. To the extent that the customer's license to any data furnished by the supplier will terminate at the end of the services relationship, the supplier should be required to remove such data at no additional charge to the customer without adverse impact to the returned data.

Supplier Use of Customer Data - The outsourcing contract for database marketing services should include appropriate restrictions on the supplier's use of the customer's data. As a general matter, suppliers should agree to use customer data solely for the purpose of providing services to the customer. Suppliers may request the right to use de-identified, aggregated data for various purposes such as making improvements to their services generally and for research and publishing on industry trends. Before granting this right, Customers are advised to carefully consider whether any of the proposed uses of this data could potentially reveal sensitive competitive information and to prohibit those uses. For example, if customer is dominant in a particular industry segment, the supplier's publication of trends in that segment could provide competitors valuable information about the customer's performance.

Protection of Customer Data - The consumer data hosted and stored by the supplier in a database marketing service contain highly sensitive personally identifiable information. As a result, customers should secure strong contractual commitments from the supplier regarding the protection of that information. These commitments should include:

  • a comprehensive security program that complies with all applicable data privacy / security laws and regulations and satisfies the customer's internal security policies;
  • ISO 27001 certification;
  • annual SOC 2, Type 2 reports, including prompt remediation of deficiencies indicated in the reports;
  • data encryption;
  • customer approval of supplier facilities used in delivering the services; and
  • prompt notice and full cooperation in addressing any security events.

If the supplier will not agree to unlimited liability for breach of its security commitments, the limitations on liability should provide for a significantly higher cap on liability than the normal cap for performance failures. In addition, the supplier should be responsible for all reasonable costs incurred by customer in addressing security breaches, including investigation, forensics and legal costs; regulatory fines and penalties; and call center and credit monitoring costs.

Return of Customer Data - When the outsourcing contract with the supplier comes to an end, the customer will need to migrate the consumer data hosted by the supplier to another database marketing solution. The outsourcing contract should include commitments from the supplier to assist the customer with this transition. This should include a commitment by the supplier to return all of the customer's data in an industry standard format (e.g., delimited ASCII), together with configuration descriptions and other documentation relating to the data. Absent these commitments, the customer may find that there are significant operational and financial hurdles in attempting to terminate its relationship with the supplier or negotiate favorable renewal terms.

How Organizations Can Benefit from "Cybersecurity as a Service"

Posted
By Roger C. Roy Jr.

Join two of our SourcingSpeak bloggers, Joe Nash and Meighan O'Reardon, as they explore "Cybersecurity as a Service," an emerging concept that allows companies to more centrally manage cybersecurity. They will highlight how these services may be leveraged by corporations looking to mature their cybersecurity capabilities and address cybersecurity risk from a legal, operational and management standpoint. Topics that they will cover include:

  • How can these cybersecurity services be leveraged by an organization?
  • How should organizations be structuring themselves to best manage cybersecurity, and ultimately to limit their cybersecurity risk profile?
  • What is the preferable approach to create a comprehensive program for cybersecurity management? In-house, third-party sources or both?
  • What are some of the legal ramifications companies must keep in mind?

Tuesday, June 3, 2014
noon - 1:00pm ET/ 9:00 - 10:00am PT/ 5pm - 6pm GMT

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Enterprise Infrastructure Management Is Not a Part-Time Job

Posted
By Joseph E. Nash and Roger C. Roy Jr.

We recently completed a major renegotiation of a very large, longstanding infrastructure outsourcing contract. As is typical with renegotiations, there were areas of the contract that required changes and areas the client wanted to leave alone. In this case, scope (and the presumed current solution) was to be left alone as the focus of concern was thought to be on other areas of the relationship. However, the need to update a seemingly simple exhibit - the Key Supplier Personnel list - told the client they had reason to be a lot more concerned about the supplier's current solution.

CONTINUE READING

How Significant is the Wyndham Case to the US Cybersecurity Legal Landscape?

Posted
By Meighan E. O'Reardon

The security community has been abuzz this week with the US. District Court of New Jersey's April 7 ruling in Federal Trade Commission v. Wyndham Worldwide Corporation, et al. (see http://www.adlawaccess.com/wp-content/uploads/sites/137/2014/04/Opinion.pdf). Wyndham had asserted in a motion to dismiss that the Federal Trade Commission ("FTC") did not have the authority to pursue enforcement actions against the hotelier related to data security. The District Court denied the motion and held that the FTC may in fact pursue claims related to data security under Section 5(a) of the FTC Act's prohibition on unfair or deceptive acts or practices affecting commerce (see 15 U.S.C. 45(a)). While the significance of the holding is being debated in the legal community, this week's decision highlights the Federal Government's increasing emphasis on requiring certain baseline cybersecurity practices by the private sector.
The background facts of the case are fairly straightforward. The FTC brought suit against Wyndham Worldwide, Corp. in the wake of three separate security breaches that occurred between 2008 and 2011 and resulted in the theft of guests' personal information (e.g., payment card account numbers, expiration dates, and security codes). The FTC alleges that after the initial two security incidents, Wyndham failed to implement reasonable and appropriate security measures which exposed consumers' personal information to unauthorized access and resulted in consumer injury. Specifically, the FTC alleges that there were several problems with the Wyndham's information security practices including wrongly configured software, weak passwords, and insecure computer servers.
So what does the Court's holding mean for the private sector? Since, up until this case, the FTC's data security actions have been settled out of court, this case marks the first time that the courts have ruled on the merits of the FTC's authority related to data security actions. Fundamentally, the decision affirms that the FTC has the power to pursue enforcement actions for unreasonable cybersecurity practices under existing laws. The Court, however, cautioned that "this decision does not give the FTC a blank check to sustain a lawsuit against every business that has been hacked." It is also important to note that the Court's decision did not include a verdict on Wyndham's liability in the matter (interested parties should continue to watch as the matter continues).
One significant question that remains unresolved is what constitutes "reasonable" security in this context. It seems possible that we may be starting to see an intersection with cases like this and wider US cybersecurity policy...does "reasonable" equate to adopting a risk mitigation strategy akin to the NIST Cybersecurity Framework? Or, does it mean something even more? Ultimately, this ruling on the FTC's enforcement authority adds to the already dynamic cybersecurity legal landscape and should cause companies to take pause to examine whether their cybersecurity practices are defensible with regulators and in court.

Why Indemnities Matter

Posted
By Lisa C. Earl

Most business clients would rather be in the dentist's chair than sit through negotiation of the indemnity and liability provisions of their agreement. Admit it: your eyes glaze over, time appears to visibly slow down, and you wonder at how the lawyers can find this stuff interesting enough to argue about.

As dull as they appear to be, there are some significant issues that can arise from the indemnity clause. One issue that I see more often than not is that suppliers try to put a financial limit on their indemnification obligations. Sometimes the supplier will agree to remove the limitation, but not always. What are the consequences of having a limitation on an indemnification obligation, and why should you be interested?

Let's consider a software license agreement, which includes an obligation by the software owner (the licensor) to indemnify you (the licensee) for third party claims that the software infringes the third party's intellectual property. If that happens, the licensor will conduct the defense of the claim - that is, they will be the one to hire the attorneys, go to court, and argue why there is no infringement.

The agreement also includes a limitation of liability that limits each party's liability to the annual software license and maintenance fees. The liability provisions could be drafted so that the limit applies to the indemnity obligation. Assume that you are paying $200,000 annually to the licensor, and so that becomes the limit of the licensor's indemnity obligations.

$200,000 can be used up pretty quickly in litigation. There will significant costs to investigate and build a case to rebut the claim - reviewing IP registrations and other documents, interviewing witnesses, researching related lawsuits etc. Legal fees, and the fees of experts and consultants that may need to be retained, quickly build. Then comes the discovery and interrogatory phases.   You may not even be at the point of a court hearing or close to settlement discussions when the amount spent has exhausted the $200,000 maximum.

So what will happen? Based on your agreement, the licensor could simply walk away and leave you holding the baby. From a practical perspective, it would be foolish for them to do that, as it's their software that is allegedly infringing, and you have no reason to defend their product. The only thing that you will want to do at that point is get out of the litigation as quickly and cheaply as possible, and so handing the defense over to you would be commercial suicide for the licensor. But in negotiating the indemnity clauses, many suppliers and licensors don't consider the practicalities of dealing with the litigation - they are only looking at the total risk profile of the agreement that they are entering into.

If the licensor wanted to enforce the terms of the agreement, they could do so, leaving you in the position where you have to step into their role in defending the case, or pay them to continue to do so. Doing either would be at significant cost to you, not to mention the disruption defending the claim may have on your business.

If you are not able to negotiate out the limitation of liability from the indemnity obligations, then you should do two things:  First, try to exclude the costs of defense from the liability cap.  Second, pay extra attention to the indemnification procedures.  For example, how will the parties handle the situation where the expected liability exceeds the liability cap? Are you free to defend and seek contribution from the licensor up to the value of the cap?  And what if the licensor takes responsibility for defending the claim and it later appears that the cap will be exceeded?  You should avoid that scenario by negotiating a requirement for the licensor to waive its limitation of liability in return for assuming full defense of the claim; the alternative (short of having the licensee write a blank check) would be to give you some level of involvement and/or control over defense and settlement, which would quickly become unworkable.

There's no simple answer to this issue, but there are certainly some options that can be explored in negotiations.  

Court of Appeal confirms that information is not property

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By Tim Wright

In a recent judgement, the Court of Appeal of England and Wales held that an electronic database was not a chose in possession or a chattel but a chose in action (see our earlier blog regarding the grant of leave to appeal in this case). In other words, a database is intangible property, not goods which can be possessed. This means that when the parties to a database hosting contract are silent about what happens to the database when the contract ends, the service provider cannot exercise a common law lien over the database so as to force full payment of its fees, and must return the database to its customer.

In giving the lead judgement in the Court of Appeal, Lord Justice Moore-Bick, quoted extensively from the judgment of Lord Justice Diplock in Tappenden v Artus (Tappenden v Artus [1964] 2 Q.B. 185). Tappenden is a case with which most first year law students in the UK will be familiar. In that case, a van owner allowed a customer to use the van pending the completion of a hire-purchase agreement. The van then broke down and was repaired by the defendant garage, but the price of the repairs was not paid. The question arose whether the garage could exercise a lien over the van against the owner. In finding that it could, Diplock L.J emphasised "actual possession of goods" as necessary for the self-help remedy of possessory lien to arise under the common law.

Referring to another leading case, Moore-Bick LJ went on to state that "[a]s OBG v Allan makes clear... the common law draws a sharp distinction between tangible and intangible property...", which leads to the conclusion that "it is [not] possible to have actual possession of an intangible thing ...[and that] it is [not] open to this court to recognise the existence of a possessory lien over intangible property ..."

So, in sharp distinction to the common law as it applies to tangible property (such as the van in Tappenden) a database service provider has no common law right which can be used to stop a customer from accessing its database until the service provider's fees are paid. Of course, there is nothing to stop the parties including such right in the database hosting contract.

2014 Sees The First Fines For Violations Of EU Cookie Laws

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By Steven P. Farmer

Much has been said about the EU "Cookie" laws introduced by an amendment to the Privacy and Electronic Communications Directive in 2011.  Companies with European customers (including those in the US) have grappled with the law's requirement to obtain informed consent from visitors to their websites before cookies can be used.

Not only being the subject of much academic debate, European regulators have also issued a series of guidance papers on the issue, including recent publications from the UK's Information Commissioner's Office and from the Article 29 Working Party, the group made up of representatives from the various EU privacy regulators.  These provide layers of at times arguably conflicting commentary on how to comply with the law.

Whilst question marks hang over key issues (e.g. what constitutes valid consent before cookies can be placed?), with the various EU data protection authorities mooting and often disagreeing on the same, the regulators across the EU appeared to be approaching enforcement actions for breach of the new laws rather gingerly, no doubt a reflection of the wider debates taking place.

Now, four years since the adoption of the Cookie laws, we have now have the first examples of companies being fined by a European regulator for non-compliance. The Spanish regulator fined two companies for failing to provide clear and comprehensive information about the cookies they used.  The two decisions can be found here: http://www.agpd.es/portalwebAGPD/resoluciones/procedimientos_sancionadores/ps_2014/common/pdfs/PS-00321-2013_Resolucion-de-fecha-14-01-2014_Art-ii-culo-5.1-LOPD-22.2-LSSI.pdf

Whilst the fines were not exactly earth-shattering (3,500 Euros a piece) the fact that the cookies used were rather commonplace and not particularly intrusive to individuals' privacy makes these cases more worthy of note and acts as a stark warning to those who have taken a similar relaxed attitude to compliance so far. 

Furthermore, it's not as if the websites in question didn't take any action after the new law was introduced.  To the contrary, they reportedly made attempts to comply with the law, but their measures didn't go far enough - which should make those companies who have buried their heads in the sand even more nervous.

The key point for business is not just the fact we are seeing more enforcement now, nor the level of fine, but rather the fact that cookie law breach is a highly visible "marker" that can draw the attention of the regulators and increase the chances of a deeper audit, which can potentially expose wider breaches and more serious enforcement action. This is the greater consequence of these recent developments and more reason to get one's compliance right

These cases underline how EU member states, driven by cultural sensitivities, consider the use of cookies to be intrusive.  Companies doing business in Europe have had time since the passing of the Cookie law to take action.  We expect to see a significant ramp up in enforcement action across the EU; we hear reports of numerous warning letters coming from regulators across the EU.  For companies that have not yet reviewed their cookie policies and procedures, compliance should move to the top of the corporate agenda. 

Important Announcement of a Key New Data Privacy Initiative

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By Rafi Azim-Khan

Rafi Azim-Khan, Partner and Head of Data Privacy, Europe at Pillsbury and Chair of the British American Business' Law Forum, was in Washington, DC yesterday to hear the important announcement of a key new data privacy initiative, blessed by regulators across the North America, Europe and Asia Pacific regions.

The initiative is aimed at assisting international businesses struggling to come to terms with increasingly complex global data privacy laws and increasing enforcement risks.

FTC Chairwoman Edith Ramirez and new EU Article 29 Working Party Chair Isabelle Falque-Pierrotin of CNIL were joined by UK Commissioner Christopher Graham, Ted Dean of the US Department of Commerce and Canadian APEC lead Daniele Chatelois in announcing publicly for the first time a new "Checklist" tool known as the "Referential", designed to assist companies who have to deal with and transfer consumer and other types of data internationally. It applies to all businesses and all sectors.

Azim-Khan, who discussed with the Commissioners the goals behind the initiative, commented, "Whether a social media company or a car manufacturer marketing via its website, businesses of all shapes and sizes have been crying out for some practical help and guidance regarding their use of data and what is or is not likely to land them in hot water. Many feel recent changes to the laws in the EU and beyond, as well as significantly increased fine levels and scrutiny, are making day to day operations much more difficult and risky."

"Given the world is becoming more connected, business more global and data use increasing, literally by the day, current laws and enforcement are proving very difficult to navigate without detailed analysis and a very careful approach. It can be time intensive and costly to get things right, and equally so if there is a breach, so anything which can help business deal with complex issues such as international data transfers and data use in multiple countries is to be welcomed. That said, this is very much just a first additional step and we will have to see what happens in terms of consultations and feedback."

"This new initiative is also not a "silver bullet," i.e. an "adequacy finding" nor "mutual recognition", for example of Asia's laws by the EU. Rather, it is one new tool worth exploring in the bigger scheme of compliance and given all the upheaval in the past year or so companies with significant global reach would still be advised to urgently audit what they are currently doing and seriously consider steps needed to bring their compliance up to date, for example considering the benefits of updated schemes such as Binding Corporate Rules".

Note: The EU and the US have locked horns in recent months over criticisms the US is not doing enough to enforce Safe Harbor breaches by large US companies and the EU is proposing new "atomic weapon" fines of 2 or 5% of global revenue fines for non-compliance as part of new Regulation proposals.

Asia is presenting a problem for international companies as the laws are hugely varied and some are also now adopting tougher EU-style laws which US companies do not like.

This initiative is the first time the differing parties have tried to put aside differences in such a joined up way.

Remain Vigilant: Managing Cybersecurity Risks in Third-Party Outsourcing Relationships

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By Meighan E. O'Reardon and Aaron M. Oser

This article was originally published on February 27, 2014 and is reprinted with permission from Corporate Compliance Insight.
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Managing third-party suppliers presents significant compliance challenges that often span an organization, raising legal, insurance, human resources and technology concerns, to name just a few. Corporations will continue to wrestle with these risks in the year ahead, but the convergence of external threats, abundance of valuable corporate data and the current regulatory environment has highlighted the importance of corporate cybersecurity practices. Cybersecurity is perhaps one of the hottest topics being discussed in boardrooms today.  The Cybersecurity Framework, anticipated legislation and litany of high-profile data breaches have resulted in even more heightened scrutiny.

The landscape for corporate cybersecurity is rapidly changing and outsourced services, including IT and business process services, all stand to be impacted.  Corporate stakeholders, particularly in the legal, information security and information technology departments, should be keenly focused on the current cybersecurity climate and the state of cybersecurity across third-party outsourcing agreements.

A significant aspect of this heightened attention on cybersecurity is not only how third-party outsourcing partners are managing security as part of the service they deliver, but also the risk and cybersecurity exposure to an organization from these third-party relationships.  Attackers increasingly exploit weaknesses in third-party suppliers' networks to access data and assets from target companies. As a result, having in place the appropriate contractual and governance safeguards with your third-party suppliers is paramount.

Efforts to integrate and manage cybersecurity in outsourcing arrangements should start early. Detailed security assessments and internal cybersecurity stakeholders should be included as part of initial due diligence efforts with selected suppliers. It is important to understand the security processes and tools that proposed suppliers will use as part of the outsourced service, the supplier's vulnerabilities and plans to remediate gaps during the term of the proposed agreement and the plan for the supplier to integrate with existing corporate cybersecurity programs.  Also, understanding how the supplier has previously responded to past incidents and improved its operations as a result is crucial.

Contract documentation should include meaningful cybersecurity provisions related to liability and indemnification for incidents and identify the security policies and procedures that the supplier will be expected to comply with during the term.  Ideally, contracts should support liability and indemnification provisions that align with the value of the data exposed to the third-party supplier, not simply derivatives of the contract value.  Including adequate audit and risk assessment provisions for regular risk assessments and remediation plans (annual at a minimum), of the supplier's operations is also highly recommended.

It is important to remain mindful of proposed cybersecurity legislation - at both the federal and state levels - that may need to be accounted for in outsourcing agreements. Compliance professionals should continue to monitor the proposed landscape of legislative and regulatory changes.  Accounting for requirements in third-party agreements to accommodate new cybersecurity laws will be critical.

Finally, and perhaps most importantly, governance models that allow corporations to manage the security functions of individual suppliers as well as the full portfolio of suppliers in a holistic fashion will become increasingly important over the next year.  The ability to respond quickly to incidents but also make the appropriate strategic risk management decisions related to cybersecurity will be a defining characteristic of a strong corporate cybersecurity program.

Compliance managers and in-house counsel should remain keenly focused on cybersecurity during the next year when negotiating new agreements, amending existing contracts or participating in ongoing governance activities with current service providers. Proactively addressing cybersecurity risks by incorporating security considerations early in the contracting process and defining more appropriate services descriptions, service levels and interaction/governance frameworks can help limit cybersecurity exposures in the first place.

Pillsbury Bloggers in the News: 8 Tips to Deal With Liability When Outsourcing to Multiple IT Vendors

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By Michael Murphy

Mario Dottori is quoted in Stephanie Overby's recent CIO.com article discussing 8 Tips to Deal With Liability When Outsourcing to Multiple IT Vendors.

"In theory, a multi-provider service delivery environment should not create additional complexities in terms of liability. The contracts -- entered into separately between the customer and each supplier -- should, if well constructed, clearly delineate the liabilities between the parties," says Mario Dottori, leader of the global sourcing practice in Pillsbury's Washington, D.C. office.

One tip offered is to create operation level agreements, "OLAs state how particular parties involved in the process of delivering IT services will interact with each other in order to maintain performance, and can help all parties 'see the forest for the trees,' says Dottori.  'These arrangements offer the opportunity for enhanced visibility of the service regime as a whole and helps to reduce -- or better arm the parties with solutions for -- missed hand-offs and finger pointing.' One caveat: Most providers will not agree to take on additional liability in OLAs. But such an agreement can be an effective preventative measure."

For the full article and all 8 tips, please see Stephanie Overby's article on CIO.com.

National Cybersecurity Framework Released - Has Your Organization Considered the Implications?

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By Meighan E. O'Reardon

On February 12, 2014, the National Institute of Standards and Technology ("NIST") released the final version of its Framework for Improving Critical Infrastructure Cybersecurity (the "Cybersecurity Framework" or "Framework") and the companion NIST Roadmap for Improving Critical Infrastructure Cybersecurity (the "Roadmap"). The final version is the result of a year-long development process which included the release of multiple iterations for public comment and working sessions with the private sector and security stakeholders. The most significant change from previous working versions is the removal of a separate privacy appendix criticized as being overly prescriptive and costly to implement in favor of a more general set of recommended privacy practices that should be "considered" by companies.

The Cybersecurity Framework marks an important step for U.S. cybersecurity policy after an Executive Order from the Obama Administration called for its creation in February 2013 (see Executive Order 13636 "Improving Critical Infrastructure Cybersecurity", February 12, 2013). While use of the Cybersecurity Framework is voluntary, the Federal government has been actively exploring various measures to incentivize participation both universally and on a sector-by-sector basis (see http://m.whitehouse.gov/blog/2013/08/06/incentives-support-adoption-cybersecurity-framework. See also Incentives Study Analytic Report, Department of Homeland Security, June 12, 2013 available at https://www.dhs.gov/sites/default/files/publications/dhs-eo13636-analytic-report-cybersecurity-incentives-study.pdf). While the Framework is focused on the 16 sectors identified as critical infrastructure (the 16 critical infrastructure sectors are chemical, commercial facilities, communications, critical manufacturing, dams, defense, emergency services, energy, financial services, food and agriculture, government facilities, health, information technology, nuclear, transportation, and water), companies outside those areas can use the Framework in their risk assessment and enterprise security planning.

What is the Cybersecurity Framework?
The Cybersecurity Framework is a risk management tool to assist companies with assessing the risk of cyber-attack, protecting against attack, and detecting intrusions as they occur. According to NIST, it complements, but does not replace, an organization's existing risk management processes and cybersecurity program. It is organized into three parts - the Framework Core, the Framework Implementation Tiers, and the Framework Profile. The Framework was developed by leveraging existing cybersecurity standards, guidelines and practices. Organizations are encouraged to use it as a tool to continuously assess and improve (where appropriate) cybersecurity practices.

The Framework Core is comprised of five key functions: Identify, Protect, Prevent, Respond, and Recover. These functions are intended to organize companies' basic cybersecurity activities at the highest level and represent a lifecycle for managing cybersecurity across an organization. Each function is further broken down into categories and subcategories that highlight the more detailed processes and activities associated with managing cybersecurity. As set forth in the Cybersecurity Framework, examples of the categories under each function include:

Identify: Asset Management, Business Environment; Governance; and Risk Assessment
Protect: Access Control; Awareness and Training; Data Security; Information Protection Processes and Procedures; Maintenance; and Protective Technology
Detect: Anomalies and Events; Security Continuous Monitoring; and Detection Processes
Response: Response Planning; Communications; Analysis; Mitigation; and Improvements
Recover: Recovery Planning; Improvements; and Communications

The Cybersecurity Framework includes a maturity model that is characterized by implementation "Tiers" for companies to use to assess their progress and development across the various functions. The tiers involve characterizing an organization's development as Partial, Risk-Informed, Repeatable, or Adaptive behavior. Partial maturity is characterized by informal and occasional implementation of the Framework, meaning that the organization is unlikely to have processes in place to utilize cybersecurity information. Risk-Informed entities will have formal, risk-aware processes defined and implemented. An organization that has achieved the Repeatable stage of maturity will have validated processes that are responsive to larger enterprise requirements and needs. Finally, entities that are considered Adaptive will be able to anticipate challenges, adapt rapidly and manage risk in conjunction with changes.

Under the Cybersecurity Framework, assessing an organization's functions in relation to the maturity or implementation Tiers and risk tolerance results in its Profile. NIST encourages companies to use the profile to identify gaps and develop action plans to improve cybersecurity.

Criticisms
The Cybersecurity Framework has been criticized as being overly broad and toothless. Some security professionals note that the Framework is not that different from the checklists that chief security officers already regularly implement. Most large organizations have already implemented a risk management process similar to the Cybersecurity Framework to manage their cybersecurity activities. And, in practice medium and smaller sized organizations may benefit most significantly from this first version of the Cybersecurity Framework. However, additional sector-specific iterations are anticipated and many government analysts note that the Cybersecurity Framework has the potential to become the de facto standard for managing cybersecurity risk.

What's next for U.S. Cybersecurity Policy?
The companion Roadmap to the Cybersecurity Framework outlines several planned follow on activities. In the near term, NIST will continue to oversee and coordinate the ongoing development of the Cybersecurity Framework including by accepting informal comments on the recent release. Additionally, a workshop will be held in the next six months for stakeholders to share feedback on their use of the Cybersecurity Framework. Options for long term governance including identifying the appropriate responsible partners(s) for overseeing the Cybersecurity Framework are also being solicited. Finally, the Roadmap identifies nine cybersecurity disciplines marked for further development and discussion including: (i) authentication; (ii) automated indicator sharing; (iii) conforming cybersecurity assessments; (iv) preparation of a skilled cybersecurity workforce; (v) use of data analytics in cybersecurity; (vi) Federal agency cybersecurity alignment; (vii) international coordination; (viii) supply chain risk management; and (ix) technical privacy standards.

How Can Your Organization Use the Cybersecurity Framework?
Regardless of whether your company falls within one of the defined critical infrastructure sectors, the Framework can be a valuable tool for cross-checking and testing your existing cybersecurity risk management programs. The Framework provides granularity that can be useful in each phase of your program.

Financial services businesses covered by the Gramm-Leach -Bliley Act have guidance in the form of the Standards for Safeguarding Customer Information (Safeguarding Rule) and the Interagency Guidance on Response Programs that require implementation of an information security program including conducting an annual risk assessment, assess the sufficiency of any safeguards in place to control the identified risks, training employees, reviewing information systems (network and software as well as processing, storage, transmission and disposal), detecting, preventing and responding to intrusions or system failures, and overseeing vendors and service providers.

Similarly, companies that are covered entities under the Health Insurance Portability and Accountability Act (HIPAA) have fairly specific regulations governing security of protected health information.

Companies outside financial services and healthcare that comply with the Massachusetts Standards for the Protection of Personal Information of Residents of the Commonwealth (201 Mass. Code Regs. § 17.00) will have implemented a written data security plan that meets the requirements of that regulation, including designating a responsible employee, conducting a risk assessment, implementing an employee security policy, enforcing the policies, addressing issues surrounding terminated employees, overseeing and requiring compliance by service providers, limiting the amount of information collected, limiting retention of data, data mapping, restricting access to records, monitoring performance, reviewing the program annually and implementing an incident response plan.

For each of these businesses, the Cybersecurity Framework addresses additional areas where threats may exist and additional specific steps that can be taken to better protect the business. While the Framework is not designed to replace an information security program, certain aspects of the Framework may trigger improvements in a company's program that help meet the business' strategic priorities: protecting assets and business viability against loss, achieving the appropriate level of security commensurate with the security and scope of the company's data, protecting company systems and data against threats to the network structure and security, anticipating evolving threats to the company's systems and meeting the company's regulatory compliance obligations.