New York Department of Financial Services Issues Final Cybersecurity Regulations

On February 16, 2017, the New York Department of Financial Services (DFS) released final cybersecurity regulations to be codified under 23 N.Y.C.R.R. Part 500 (the Final Rule). The Final Rule contains few substantive revisions from the proposed rule issued by the DFS in late December 2016 (the Revised Proposal), which superseded the original proposed rule issued by the DFS in September 2016.

New York State-chartered or licensed banks, insurance companies, licensed lenders, check cashers, money transmitters, and their holding companies, and other firms that are licensed by, operating under approval orders of, or otherwise subject to regulation by the DFS are subject to the Final Rule (Covered Entities). The Final Rule does not purport to treat federally-chartered banks or federal branches of non-US banks licensed by the Office of the Comptroller of the Currency (OCC) as Covered Entities. The Final Rule directly regulates Covered Entities that operate under DFS licenses or approvals, and also has an indirect impact on their internal and third-party vendors and service providers, as well as affiliates that support or share data platforms and systems with DFS-regulated firms.

The Final Rule is believed to be the first state effort of its kind regulating cybersecurity of financial services firms. Although in some ways the Final Rule is similar to federal requirements and guidance on cybersecurity for banks and securities firms, it differs in details and imposes reporting obligations to the DFS.

The Final Rule will become effective on March 1, 2017 and provides for staggered transition periods for compliance with various aspects of the regulations. Covered Entities must comply with most of the requirements of the Final Rule by August 28, 2017. The Final Rule includes longer transition periods for select requirements. Covered Entities are given one year to comply with the Final Rule's requirements relating to penetration testing and vulnerability assessments, periodic risk assessments, multi-factor authentication and certain training and monitoring provisions. The first annual certification of compliance to the DFS is required on February 15, 2018. Covered Entities are given 18 months to comply with requirements relating to an audit trail, application security, data retention, encryption, and certain training and monitoring provisions and two years to comply with third party service provider requirements.

We have also prepared a comparison of the Revised Proposal and the Final Rule.

The Final Rule retains the vast majority of the provisions of the Revised Proposal, which are discussed in detail in our January 9, 2017 client advisory titled New York Department of Financial Services Revised Proposed Cybersecurity Regulations. The most substantive revisions in the Final Rule include new exemptions for certain insurance companies, namely captive insurance companies, out-of-state risk retention groups, and charitable annuity societies.

• Under Section 500.19(e) of the Final Rule, certain captive insurance companies are now exempted from the majority of the Rule's requirements. Specifically, captive insurance companies that are Covered Entities (i.e., those operating under or required to operate under a license, registration, charter, certificate, permit, accreditation or similar authorization under the New York Banking Law, Insurance Law or Financial Services Law) and are not required to access or utilize nonpublic information (NPI), other than information relating to its corporate parent company, are now only required to conduct a periodic risk assessment (Section 500.09), implement third party service provider security policies and procedures (Section 500.11), maintain policies and procedures governing limitations on data retention (Section 500.13), and comply with notification and certification requirements (Section 500.17).
• Under Section 500.19(f), permitted charitable annuity societies, risk retention groups not chartered or licensed in New York, and accredited reinsurers or certified reinsurers accredited under 11 N.Y.C.R.R. Part 125, each of which must not otherwise qualify as a Covered Entity, are exempt from all of the requirements under the Final Rule.

In addition, the Final Rule relaxes to three years the record retention requirements relating to audit trails designed to detect and respond to cybersecurity events, as described in Section 500.06(a)(2). The record retention period of five years remains unchanged for records relating to systems designed to reconstruct material financial transactions to support normal operations and obligations of the Covered Entity, as described in Section 500.06(a)(1).

Finally, the Final Rule revises certain proposed provisions under Section 500.19(a) to clarify that the quantitative operational standards relating to exemptions for smaller entities are based on the New York operations of the entities, although the New York staffing and revenues of affiliates are included in certain aspects of these de minimis exemptions. Specifically, under Section 500.19(a)(2), entities with fewer than 10 New York employees, including New York staff of the Covered Entity, its affiliates and any independent contractors, are subject only to select provisions of the Final Rule (specifically, Sections 500.02, 500.03, 500.07, 500.09, 500.11, 500.13 and 500.17). Under Section 500.19(a)(2), entities with less than $5 million in gross annual revenue (including revenues of the Covered Entity and its affiliates) in each of the last three fiscal years from their New York business operations are granted the same limited exemption from the Final Rule. Smaller entities that are eligible for a limited exemption will therefore remain subject to the Final Rule's core requirements to maintain a cybersecurity program, policies and procedures, and a third-party service provider security policy, and will be required to certify compliance to the DFS. For an entity to avail itself of any exemption under Section 500.19, it must file with the DFS a Notice of Exemption, as provided in Appendix B of the Final Rule, within 30 days of determining that it is exempt.

Despite concerns voiced by commenters during the two rounds of notice-and-comment that preceded the Final Rule, certain proposed provisions that created confusion or which may subject firms to significant compliance costs remain unchanged in the Final Rule. For example, regarding key points that we mentioned in our analyses of the proposed regulations:

• It is unclear to what extent firms with multi-state enterprise-wide operations, but with only limited ties to New York state, could be deemed to be Covered Entities. The enterprise-wide activities of such institutions could be made subject to the Final Rule, possibly through affiliated DFS-regulated insurance entities and other financial services firms, even if the activities that occur within the DFS's jurisdiction or involve the NPI of New York residents are minimal.
• Completion of an annual certification of compliance is likely to be costly for Covered Entities and will require senior officer(s) of such Entities to obtain actual, perhaps extensive knowledge of compliance systems and controls. Prior DFS statements in connection with the issuance of the Revised Proposal suggest that a Covered Entity's certifying senior officer(s) and/or directors could be held personally liable for perceived compliance shortcomings.
• Although by its terms the Final Rule does not treat national banks, federal savings banks or federally-licensed branches of non-US banks as Covered Entities, the use of common computer and communications platforms among affiliated financial services firms, their interrelated cybersecurity efforts, and the inclusion of "affiliates" of Covered Entities into the measurement of the de minimis exemptions, and certain other aspects of the Final Rule might indirectly, as a practical matter, effectively regulate national banks, federal savings banks, and federally-chartered branches of non-US banks that are affiliated with Covered Entities. However, some aspects of the Final Rule may be preempted by federal law as applied to national banks, and in any event, enforcement of the regulations by the DFS against national banks  is likely precluded by federal law, which vests with the OCC exclusive visitorial authority regarding the content and conduct of activities authorized for national banks under federal law.
• Similarly, although the DFS is not the licensing or regulatory authority for broker-dealers or investment advisers in New York and those entities are not directly subject to the Final Rule, the use of common computer and communications platforms among affiliated financial services firms may as a practical matter regulate the operations of broker-dealer and investment adviser firms that are affiliated with Covered Entities. Section 15(i) of the Securities Exchange Act (the Exchange Act) and Section 203A(b) of the Investment Advisers Act (the Advisers Act) limit the application of state laws, which establish certain functional and reporting requirements upon broker-dealers and investment advisers that differ from or add to requirements established by the Exchange Act, the Advisers Act or regulations issued thereunder by the Securities and Exchange Commission.
• The definition of NPI subject to the Final Rule's cybersecurity provisions and controls remains broad, and Covered Entities need to quickly identify all of the business data and information systems that will fall under the multi-factor authentication, risk-based authentication, and encryption requirements of the Final Rule and create plans for (i) meeting applicable requirements for this data and these networks, and (ii) determining and documenting any choice to use alternative compensating controls.  
• Covered Entities may wish to consider various strategic alternatives for managing institutional and personal regulatory risk, including charter conversion (to a new home state or a national bank charter), relocation and reorganization.

In conclusion, the Final Rule provides little relief or clarification for Covered Entities relative to the Revised Proposal. The implementation of compliance systems that conform to the Final Rule likely will be a challenging and costly exercise—and the Final Rule poses ongoing liability risks for firms and their individual officers and direct