Brent J. Arnold
Partner
Article
11
As derivative actions against the principals of corporate targets of cyber attacks are in their infancy in Canada, there is relatively little to guide an understanding of the magnitude of threat they pose to Canadian directors and officers. Recent case law in the U.S. may well provide Canadian companies-and courts-with a glimpse of the future. For example, in early July 2016 a U.S. derivative action against Target Corporation was dismissed, joining a short list of failed U.S. actions against directors and officers for breaches of corporate cybersecurity.1 In addition to highlighting the difficulty of advancing derivative actions for such breaches, the Target case offers some interesting insights into how companies, directors and officers should behave in anticipating and responding to probably-inevitable cyber breaches.
Target shareholders brought a derivative action in Minnesota following a massive data breach in 2013 that resulted in the theft of up to 40 million customers' personally identifiable information including names, addresses, email addresses, and phone numbers. The Target breach fits the typical profile of such attacks in many respects: it went undetected for weeks; the company found out only because it was brought to its attention by outside sources (the Secret Service, in this case), and the hackers were foreign nationals (Eastern Europeans).2
Derivative actions for cyber breaches are virtually unknown in Canada. In the U.S., derivative actions have often been launched in tandem with class proceedings in cases where there is a clear drop in share price following a misrepresentation, to name just one example. Derivative actions have often piggy-backed on class actions because each has certain procedural advantages. A derivative action has more relaxed pleadings standards (making them less vulnerable to motions to dismiss), and allows plaintiffs to get to the discovery phase more quickly than in class actions. In Canada, however, the use of derivative actions in tandem with direct class actions has not become common practice. The strict pleading standards that exist in the U.S. for class actions are not present in the Canadian context, so the need to buttress the class action with a companion derivative action is absent.
However, in cyber breach cases, derivative actions may become a more attractive option for plaintiff-side counsel in Canada, for much the same reason as it has in the U.S. Namely, cyber breaches have become so common place, U.S. companies' share prices are relatively unaffected by breaches; this makes proving damages or even losses in a class proceeding difficult.3
The Target action has now been dispensed with via a brief court order following several unopposed motions by the defendants.4
The defendants' motions5 were premised on the recommendations of Target's Special Litigation Committee ("SLC").6 Pursuant to Minnesota law, the SLC was struck for the purpose of making a recommendation to Target as to whether it should pursue the plaintiff's derivative action. The SLC's Report considered myriad factors in arriving at its recommendation not to pursue the action. These included the following very revealing factors:7
Many of these factors could have easily been cribbed from headings in a robust cyber security or cyber breach response plan. The complete list highlights the importance of, among other things:
Directors and officers will take comfort in the Target SLC Report's nod to the business judgment rule and to the principle-now widely accepted in the data security industry-that a company can do everything right and still fall victim to a cyber attack.
It is important to recall that the factors considered by the Target's SLC were chosen by the SLC, not the court, and that the court's order is a consent dismissal. As Target's lawyers note in their filings, Minnesota courts defer to SLC recommendations so long as they are satisfied that the SLC is independent and carried out its investigation in good faith.10
The Target SLC Report-and the plaintiffs' consent to the dismissal of their actions in light of the report-highlight the difficulty of addressing consumer complaints regarding cyber breaches via derivative action. In the face of evidence of adequate pre-and post-breach diligence by a Board and officers, the business judgment rule, and a weak business case for a lawsuit,11 Canadian shareholders and other stakeholders will have trouble recovering against directors and officers of targeted companies.
1 Kevin M. LaCroix, "Target Corporation Cybersecurity-Related Derivative Litigation Dismissed," The D&O Diary, July 9, 2016.
2 Elizabeth A. Harris, Nicole Perlroth et al., "A Sneak Path into Target Customers' Wallets," The New York Times, January 17, 2014.
3 In M. LaCroix, "Target Corporation Cybersecurity-Related Derivative Litigation Dismissed," The D&O Diary, July 9, 2016.
5 The Memorandum of Law filed in the case by the defendant Target's Special Litigation Committee.
7 These are only a few of the listed factors, reproduced verbatim. For the complete list, see pp.88-90 of Target Corporation: Report of the Special Litigation Committee, March 30, 2016.
8 PDI DSS stands for the "Payment Card Industry Data Security Standard," a proprietary information security standard administered by the Payment Card Industry Security Standards Council, consisting of various global payment organizations (e.g. American Express, MasterCard and Visa). For more information, visit the PCI Security Standards Council's website.
9 FTC stands for "Federal Trade Commission," the U.S. federal body tasked with protecting consumers and handling consumer data security complaints.
10 See p.2, Memorandum of Law of the Special Litigation Committee of the Board of Directors of Target Corporation in Support of its Motion for Approval and Dismissal, May 6, 2016.
11 Target's SLC considered the "disruption and distraction" to Target an action would create, the actual financial impact of the breach, and the effect the suit would have on employee and morale: pp.88 and 90 of Target Corporation: Report of the Special Litigation Committee, March 30, 2016.
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