The SOC 2 update — how will it affect you?

Read this if you are responsible for cybersecurity at your organization.

Cybersecurity threats aren’t just increasing in number—they’re also becoming more dangerous and expensive. Cyberattacks affect organizations around the globe, but the most expensive attacks occur in the US, where the average cost of a data breach is $9.44 million, according to IBM’s 2022 Cost of a Data Breach Report. The same report shows that the cost of a breach is $10.10 million in the healthcare industry, $5.97 million in the financial industry, $5.01 million in the pharmaceuticals industry, and $4.97 million in the technology industry.

Cyber threat actors are a serious danger to your company, and your customers, stakeholders, and shareholders know this. They expect you to be prepared to defend against and manage cybersecurity threats. How can you demonstrate your cybersecurity controls are up to par? By obtaining a SOC for cybersecurity report.

What is a SOC for cybersecurity report?

It provides an independent assessment of an organization’s cybersecurity risk management program. Specifically, it determines how effectively the organization’s internal controls monitor, prevent, and address cybersecurity threats.

What’s included in a SOC for cybersecurity report?

The report is made up of three key components:

1. Management’s description of their cybersecurity risk management program, aligned with a control framework (more on that below) and 19 description criteria laid out by the AICPA.
2. Management’s assertion that controls are effective to achieve cybersecurity objectives.
3. Service auditor’s opinion on both management’s description and management’s assertion.

Why should you consider a SOC for cybersecurity report?

A SOC for cybersecurity report offers several important benefits for your organization, which include:

• Align with evolving regulatory requirements. The cybersecurity regulatory environment is constantly evolving. In particular, the SEC’s cybersecurity guidelines are becoming stricter over time. A SOC for cybersecurity report can demonstrate you’re aligned with these guidelines. If you’re a public company or are considering going public in the future, you need to be prepared to meet not just the SEC’s guidelines of today, but their evolved guidelines in the future.
• Keep your board of directors informed. Your board is responsible for ensuring the business is effectively addressing and mitigating risks—and that includes cyber risk. A SOC for cybersecurity report offers your board a clear and practical illustration of your organization’s cybersecurity risk management controls.
• Attract and retain more customers. It’s becoming increasingly common for companies to require that their vendors have a SOC for cybersecurity report. Even for companies that don’t require such a report, it’s important to know their vendors are keeping their data safe. Having this report differentiates you from vendors who have not prepared one.
• Improve your cybersecurity posture. A SOC for cybersecurity report can identify current gaps in your cybersecurity risk management program. Once you’ve addressed these gaps, you can show your customers, stakeholders, and shareholders that you’re continuously improving and evolving your cybersecurity risk management approach.

How do I prepare for my SOC for cybersecurity assessment?

There are several steps you should take to prepare for your assessment.

1. Choose your control framework. You have several options, including the NIST Cybersecurity Framework, ISO 27002, and the Secure Controls Framework (SCF). There are multiple online resources to help you choose the framework that’s right for your organization.
2. Determine who your key internal stakeholders are for your cybersecurity risk management program. You’ll need to select a point person to be responsible for ensuring the independent services auditor has all the documentation they need to complete their assessment and act as liaison across internal and external stakeholders.
3. Collect all cybersecurity-related documentation in one location. Make sure you have an organizational system that makes sense to your point person so it’s easy for them to pull the appropriate materials to give to the independent services auditor.
4. Conduct a readiness assessment. You can work with an independent services auditor to conduct such an assessment which will identify gaps you can address before performing the attestation.
5. Select an independent services auditor to perform the attestation. SOC for cybersecurity services are provided by independent CPAs approved by the AICPA. Ideally, you’ll want to select a firm that is experienced in your industry, has a diverse and robust team of cybersecurity professionals, and is accessible when and where you need them.

As always, if you have questions about your specific situation or would like more information about SOC for cybersecurity services, please contact our IT security experts. We’re here to help.

Read this if you have a cybersecurity program.

This week President Joe Biden warned Americans about intelligence that indicated Russia may be preparing to conduct cyberattacks on our private sector businesses and infrastructure as retaliation for sanctions applied to the Russian government (and the oligarchs) as punishment for the invasion of Ukraine. Though there is no specific threat at this time, President Biden’s warning has been an ongoing message since the invasion began. There is no need to panic, but this is a great time to re-visit your current security controls. Focusing on basic IT controls goes can make a big difference in the event of an attack, as hackers tend to go after the easy, low hanging fruit. 

1. Access controls
   Review and understand how all access to your networks is obtained by on-site employees, remote employees, and vendors and guests. Make sure that users are maintaining strong passwords and that no user is connecting remotely to any of your systems without some form of multi-factor authentication (MFA). MFA can come in the form of a token (in hand or built-in) or as one of those numerical codes you have delivered to your phone or email. Poor access controls are simply the difference between leaving your house unlocked versus locked when you leave to go somewhere. 
2. Patching
   One of the most common audit findings we have to date and one of the biggest reasons behind successful attacks is related to unpatched systems. Software patches are issued by software providers to address vulnerabilities in systems that act as an unlocked door to a hacker, and allow hackers to leverage the vulnerability as a way to get into your systems. Ensuring your organization has a robust patch management program in place and that systems are up-to-date on needed patches is critical to your security operations. Think of an unpatched system like a car with a broken window—sure the door is locked, but any thief can reach through the broken window and unlock the car. 
3. Logging 
   Account activity, network traffic, system changes—these are all things that can be easily logged and with the right tools, configured to alert you to suspicious activity. Logging that is done correctly can alert management to suspicious activity occurring on your network and notifies your security team to investigate the issue. Consider logging and alerting like your home’s security camera. It may alert you to the activity outside, but someone still needs to review the footage and react to it to mitigate the threat.  
4. Test backups and more
   Making sure that your systems are successful backed up and kept separate from your production systems is a control we are all familiar with. Organizations should do more than just make sure their backups are performed nightly and maintained, but need to make sure that those data backups can be restored back to a useable state on a regular basis. More so than backups, we also often hear in the work we do that our client’s test only parts of their disaster recovery and failover plans—but have never tested a full-scale fail-over to their backup systems to determine if the failover would be successful in the event of an event or disaster. Organizations shouldn’t be scared to do a full-scale failover test, because when the time comes, you may not have the option to do a partial failover and just hope that it occurs successfully. Not testing your backups is like not test driving a car before you buy it. Sure it looks nice in the lot, but does it actually run? 
5. Incident Management Plan 
   We often review Incident Management Plans as part of the work we do, and often note that the plans are outdated and contain incorrect information. This is an ideal time to make sure your plans are current and reflect changes that may have occurred, like your increasingly remote work force, or that systems have changed. An outdated Incident Management Plan is like being sick and trying to call your doctor for help only to find out your doctor has retired. 
6. Training—phishing attacks
   Hackers’ most common approach to gain access to systems and deploy crippling ransomware attacks is through phishing campaigns via email. Phishing campaigns trick a user into either providing the hacker with credentials to log into systems or to download malware that could turn into ransomware through what appears to be legitimate business correspondence. Training end-users on what to look for in verifying an email’s authenticity is critical and should be seen as an opportunity that benefits the entire organization. Testing users is also critical so management understands the current risk and what is needed for additional training. Security teams should also have other supporting controls to help prevent phishing emails and detection tools in place in case a user does fall for an email. Not training your employees on security is like not coaching your little league team on how to play baseball and then being surprised you didn’t win the game because no one knew what to do. 

In the current environment, information security is an asset to any organization and needs to be supported so that you can protect your organization from cyberattacks of all kinds. While we can never guarantee that having controls in place will prevent an attack from occurring, they make it a lot more challenging for the hacker. One more analogy, and then I’m done, I promise. Basic IT controls are like speedbumps in a neighborhood. While they keep most people from speeding (and if you hit them too fast they do a number on your car), you can still get over them with enough motivation. 

If you have questions about your cybersecurity controls, or would like more information, please contact our IT security experts. We’re here to help.

Read this if you are responsible for cybersecurity at your organization. 

During the financial audit process auditors are required to develop and confirm their understanding of Information Technology (IT) and cybersecurity practices as it relates to financial reporting to better understand risks and because of auditors’ heavy reliance on data pulled from accounting information systems. As auditors, we have seen a significant increase in the amount of impactful incidents affecting not-for-profit organizations and our IT security experts often share valuable advisory comments in annual audit communications with our clients. With recent incidents and a very rapidly changing business environment, here are the three most important from the last six months that impact all not-for-profits. 

Board oversight of cybersecurity 

Cybersecurity gaps within an organization’s systems may lead to risk exposure and have material impacts on all aspects of operations. Responsibility for cybersecurity controls and for establishing a culture of awareness and security should come from the Board and senior leadership. Board members and senior leaders should stay apprised of cybersecurity efforts on a regular basis and incidents should be summarized and reported on a quarterly basis. 

The Board should also consider adding a member who is a professional with IT and cybersecurity experience to help manage and understand the specific risks to the organization and help drive and support cybersecurity efforts.

Ransomware threats and preventive controls

The use of ransomware as a profitable attack on organizations by hackers continues to rapidly increase. Within the last year there have been multiple high-profile incidents that illustrate the impact of a successful attack. These impacts fall into two main areas. One impact may be financial, as millions of dollars are paid to the bad actors as ransom in hopes of being able to regain control of systems. The second impact is operational, resulting in a loss of control of systems and data during the event. Potentially, an unsuccessful data restoration could result in the total loss of information and data maintained on your networks. 

Though no organization may be able to prevent a ransomware attack from occurring entirely, there are basic cybersecurity controls that help reduce the likelihood and impact of an attack. Preventive controls may include: 

• Security awareness training on phishing emails and overall IT security practices for all organization users
• Multi-factor authentication 
• Access controls that prevent users from installing unapproved software onto organization-owned workstations and networks
• Anti-malware software installed on devices that connect to organization systems 
• Use of Zero Trust data management tools for backups
• Disabling macros in emails (prevents back-end processes from automatically running) 

In addition to including these preventive controls to your cybersecurity program, your organization should assess current corrective controls already in place to react to a ransomware event if one is detected or reported. Corrective controls may include:

• Disaster recovery plans/business continuity plans 
• Incident response plans
• Backup controls and restoration tests 

As the risk of ransomware continues to increase and the types of attacks continue to increase in sophistication, your organization should consider regular assessments of IT controls and cybersecurity practices on a regular basis. Such assessments may be performed in conjunction with annual financial statement audits as an expanded scope and/or as a separate annual IT assessment. 

COVID-19 IT considerations 

The global COVID-19 pandemic significantly impacted nearly every aspect of modern life, including the way we work. As personnel were sent home and literally became a remote workforce overnight, changes to IT systems and controls rapidly adjusted to accommodate this new way of business. 

Where controls and procedures were adjusted, if not suspended, your organization should review those changes and determine if controls should revert back to the pre-pandemic process—or be formally changed and documented as policy. 

Guidance from the American Institute of Certified Public Accountants (AICPA) dictates that a gap in controls associated with the pandemic is not a legitimate reason for not completing a control and that any changes must be documented and properly managed.  

Well over a year into the pandemic, the concept of a hybrid workforce has emerged as the predominant way employees and businesses want to work. Your organization should review current policies and procedures that may pre-date the pandemic to ensure that the updates both document and consider the current business environment. 

Additionally, with personnel working remotely or in a hybrid model, or a combination of both, you should assess practices for managing remote access and a hybrid workforce and, where needed, implement industry best-practice tools and procedures to accommodate a remote workforce while maintaining security controls. If you have questions regarding you cybersecurity procedures or want to learn more, please contact our team. We’re here to help. 
 

A version of this article was previously published on the Massachusetts Nonprofit Network. 

Editor’s note: While this article is not technical in nature, you should read it if you are involved in IT security, auditing, and management of organizations that may participate in strategic planning and business activities where considerations of compliance and controls is required.

As we find ourselves in a fast-moving, strong business growth environment, there is no better time to consider the controls needed to enhance your IT security as you implement new, high-demand technology and software to allow your organization to thrive and grow. Here are five risks you need to take care of if you want to build or maintain strong IT security.

1. Third-party risk management―It’s still your fault

We rely daily on our business partners and vendors to make the work we do happen. With a focus on IT, third-party vendors are a potential weak link in the information security chain and may expose your organization to risk. However, though a data breach may be the fault of a third-party, you are still responsible for it. Potential data breaches and exposure of customer information may occur, leaving you to explain to customers and clients answers and explanations you may not have. 

Though software as a service (SaaS) providers, along with other IT third-party services, have been around for well over a decade now, we still neglect our businesses by not considering and addressing third-party risk. These third-party providers likely store, maintain, and access company data, which could potentially contain personally identifiable information (names, social security numbers, dates of birth, addresses), financial information (credit cards or banking information), and healthcare information of your customers. 

While many of the third-party providers have comprehensive security programs in place to protect that sensitive information, a study in 2017 found that 30% of data breaches were caused by employee error or while under the control of third-party vendors.¹  This study reemphasizes that when data leaves your control, it is at risk of exposure. 

In many cases, procurement and contracting policies likely have language in contracts that already establish requirements for third-parties related to IT security; however the enforcement of such requirements and awareness of what is written in the contract is not enforced or is collected, put in a file, and not reviewed. What can you do about it?

Improved vendor management

It is paramount that all organizations (no matter their size) have a comprehensive vendor management program that goes beyond contracting requirements in place to defend themselves against third-party risk which includes:

1. An inventory of all third-parties used and their criticality and risk ranking. Criticality should be assigned using a “critical, high, medium or low” scoring matrix. 
2. At time of onboarding or RFP, develop a standardized approach for evaluating if potential vendors have sufficient IT security controls in place. This may be done through an IT questionnaire, review of a Systems and Organization Controls (SOC report) or other audit/certifications, and/or policy review. Additional research may be conducted that focuses on management and the company’s financial stability. 
3. As a result of the steps in #2, develop a vendor risk assessment using a high, medium and low scoring approach. Higher risk vendors should have specific concerns addressed in contracts and are subject to more in depth annual due diligence procedures. 
4. Reporting to senior management and/or the board annually on the vendors used by the organization, the services they perform, their risk, and ways the organization monitors the vendors. 

2. Regulation and privacy laws―They are coming 

2018 saw the implementation of the European Union’s General Data Privacy Regulation (GDPR) which was the first major data privacy law pushed onto any organization that possesses, handles, or has access to any citizen of EU’s personal information. Enforcement has started and the Information Commissioner’s Office has begun fining some of the world’s most famous companies, including substantial fines to Marriott International and British Airways of $125 million and $183 million Euros, respectively.²  Gone are the days where regulations lacked the teeth to force companies into compliance. 

With thanks to other major data breaches where hundreds of millions’ consumers private information was lost or obtained (e.g., Experian), more regulation is coming. Although there is little expectation of an American federal requirement for data protection, individual states and other regulating organizations are introducing requirements. Each new regulation seeks to protect consumer privacy but the specifics and enforcement of each differ. 

Expected to be most impactful in 2019 is the California Consumer Privacy Act,  which applies to organizations that handle, collect, or process consumer information and do business in the state of California (you do not have to be located in CA to be under the umbrella of enforcement).

In 2018, Maine passed the toughest law on telecommunications providers for selling consumer information. Massachusetts’ long standing privacy and data breach laws were amended with stronger requirements in January of 2019. Additional privacy and breach laws are in discussion or on the table for many states including Colorado, Delaware, Ohio, Oregon, Ohio, Vermont, and Washington, amongst others.      

Preparation and awareness are key

All organizations, no matter your line of business must be aware of and understand current laws and proposed legislation. New laws are expected to not only address the protection of customer data, but also employee information. All organizations should monitor proposed legislation and be aware of the potential enforceable requirements. The good news is that there are a lot of resources out there and, in most cases, legislative requirements allow for grace periods to allow organizations to develop a complete understanding of proposed laws and implement needed controls. 

3. Data management―Time to cut through the clutter 

We all work with people who have thousands of emails in their inbox (in some cases, dating back several years). Those users’ biggest fears may start to come to fruition―that their “organizational” approach of not deleting anything may come to an end with a simple email and data retention policy put in place by their employer. 

The amount of data we generate in a day is massive. Forbes estimates that we generate 2.5 quintillion bytes of data each day and that 90% of all the world’s data was generated in the last two years alone.³ While data is a gold mine for analytics and market research, it is also an increasing liability and security risk. 

Inc. Magazine says that 73% of the data we have available to us is not used.⁴ Within that data could be personally identifiable information (such as social security numbers, names, addresses, etc.); financial information (bank accounts, credit cards etc.); and/or confidential business data. That data is valuable to hackers and corporate spies and in many cases data’s existence and location is unknown by the organizations that have it. 

In addition to the security risk that all this data poses, it also may expose an organization to liability in the event of a lawsuit of investigation. Emails and other communications are a favorite target of subpoenas and investigations and should be deleted within 90 days (including deleted items folders). 

Take an inventory before you act

Organizations should first complete a full data inventory and understand what types of data they maintain and handle, and where and how they store that data. Next, organizations can develop a data retention policy that meets their needs. Utilizing backup storage media may be a solution that helps reduce the need to store and maintain a large amount of data on internal systems. 

4. Doing the basics right―The simple things work 

Across industries and regardless of organization size, the most common problem we see is the absence of basic controls for IT security. Every organization, no matter their size, should work to ensure they have controls in place. Some must-haves:

• Established IT security policies
• Routine, monitored patch management practices (for all servers and workstations)
• Change management controls (for both software and hardware changes)
• Anti-virus/malware on all servers and workstations
• Specific IT security risk assessments 
• User access reviews
• System logging and monitoring 
• Employee security training

Go back to the basics 

We often see organizations that focus on new and emerging technologies, but have not taken the time to put basic security controls in place. Simple deterrents will help thwarting hackers. I often tell my clients a locked car scares away most ill-willed people, but a thief can still smash the window.  

Smaller organizations can consider using third-party security providers, if they are not able to implement basic IT security measures. From our experience, small organizations are being held to the same data security and privacy expectations by their customers as larger competitors and need to be able to provide assurance that controls are in place.  

5. Employee retention and training 

Unemployment rates are at an all-time low, and the demand for IT security experts at an all-time high. In fact, Monster.com reported that in 2019 the unemployment rate for IT security professionals is 0%.⁵ 

Organizations should be highly focused on employee retention and training to keep current employees up-to-speed on technology and security trends. One study found that only 15% of IT security professionals were not looking to switch jobs within one year.⁶  

Surprisingly, money is not the top factor for turnover―68% of respondents prioritized working for a company that takes their opinions seriously.⁶ 

For years we have told our clients they need to create and foster a culture of security from the top down, and that IT security must be considered more than just an overhead cost. It needs to align with overall business strategy and goals. Organizations need to create designated roles and responsibilities for security that provide your security personnel with a sense of direction―and the ability to truly protect the organization, their people, and the data. 

Training and support goes a long way

Offering training to security personnel allows them to stay abreast of current topics, but it also shows those employees you value their knowledge and the work they do. You need to train technology workers to be aware of new threats, and on techniques to best defend and protect from such risks. 

Reducing turnover rate of IT personnel is critical to IT security success. Continuously having to retrain and onboard employees is both costly and time-consuming. High turnover impacts your culture and also hampers your ability to grow and expand a security program. 

Making the effort to empower and train all employees is a powerful way to demonstrate your appreciation and support of the employees within your organization—and keep your data more secure.  

Our IT security consultants can help

Ensuring that you have a stable and established IT security program in place by considering the above risks will help your organization adapt to technology changes and create more than just an IT security program, but a culture of security minded employees. 

Our team of IT security and control experts can help your organization create and implement controls needed to consider emerging IT risks. For more information, contact the team. 
 

Sources:
[1] https://iapp.org/news/a/surprising-stats-on-third-party-vendor-risk-and-breach-likelihood/  
[2] https://resources.infosecinstitute.com/first-big-gdpr-fines/
[3] https://www.forbes.com/sites/bernardmarr/2018/05/21/how-much-data-do-we-create-every-day-the-mind-blowing-stats-everyone-should-read/#458b58860ba9
[4] https://www.inc.com/jeff-barrett/misusing-data-could-be-costing-your-business-heres-how.html
[5] https://www.monster.com/career-advice/article/tech-cybersecurity-zero-percent-unemployment-1016
[6] https://www.securitymagazine.com/articles/88833-what-will-improve-cyber-talent-retention

As the technology we use for work and at home becomes increasingly intertwined, security issues that affect one also affect the other and we must address security risks at both levels.

This year’s top security risks are the first in our series that are both prevalent to us as consumers of technology and to us as business owners and security administrators. Our homes and offices connect to devices, referred to the Internet of Things (IoT), that make our lives and jobs easier and more efficient, but securing those devices from outside access is becoming paramount to IT security.

Many of this year’s risks focus on deception. Through deception, hackers can get information and access to systems, which can harm our wallets and our businesses.

In our 2017 Top 10 IT Security Risks e-book we share with you how to understand these emerging risks, the consequences and impacts these risks may have on your business, and approaches to help mitigate the risks and their impact. Some of the key ways to address these risks are:           

1. Do your homework — change your default passwords (the one that came with your wireless router, for instance), and also make sure that your Amazon Alexa, Google Home, or other smart devices have complex passwords. In addition, turning off devices when they are not in use, or when you are gone, helps secure your home.

2. If you work from home, or have employees who do, set up and use secure connections with dual authentication methods to help protect your networks. Remote employees should be required to use the same security measures as on-site employees.

3. Protect your smartphone at work and at play—smartphones have become one of our most important possessions, and we use the same device for both work and personal applications, yet we don’t protect them as well we should. Password protection is step one. Consider uploading new antivirus software to corporate smartphones and using container apps for corporate emails and documents. These apps allow users to securely connect to a company’s server and reduce the possible exposure of data.

4. Train, inform, repeat. Create a vigilant workforce—through continuous and consistent training and information sharing, you can reduce the occurrence of phishing, hacking and other attacks against your systems.

5. Conduct IT security risk assessments annually to help you identify gaps, fix them, and prepare for any incidents that may occur.

6. Monitor and protect your reputation through tools to identify news on your company and understand the sources of the information.

Our 2017 Top 10 IT Security Risks takes a deeper look at the IoT and other risk issues that pose a threat this year, and what you can do to minimize your own and your organization’s IT security risks.

During my lunch in sunny Florida while traveling for business, enjoying a nice reprieve from another cold Maine winter, I checked my social media account. I noticed several postings about people having nothing to do at work because their company’s systems were down, the result of a major outage at one of three Amazon Web Services (AWS)’ Data Centers and web hosting operations. Company sites were down directly or indirectly through a software as a service (SaaS) provider hosted at the AWS data center.

The crash lasted for four hours and affected hundreds of thousands sites, including Airbnb, Expedia, Netflix, Quora, Slack, and others. The impact of such crashes can be devastating to organizations that rely on their website for revenue, such as online retailers and users of SaaS providers that may rely on a hosted system to conduct day-to-day business.

We advise our clients who consider hosting services in the cloud to weigh the option seriously and understand potential challenges in doing so. Here are some steps you can take to prevent future outages and loss of valuable uptime:

1. Know the risks and weigh them against the benefits.  Ask questions about the system you are thinking of having hosted. Is the system critical to business? Without the system, do you lose revenue and productivity? Is the company providing the SaaS service hosting their own systems, or are they hosted at a data center like AWS? Does the SaaS provider have failover sites at other, separate data centers that are geographically distant from another?
2. Have a backup plan. If your business conducts e-commerce or needs SaaS service to function, consider hosting your web servers and other data at two different providers. Though costly, the downtime impact is highly reduced.
3. Consider hosting yourself. In some cases, we advise against relying on a third-party hosted data center. We do this when the criticality of the function is so high that having your own full-time dedicated support personnel, with multiple internet service providers available, allows you to address outages in-house and reduce the risk of outages.
4. Have a service level agreement. Having a service level agreement with the hosted third party establishes expectations for uptime and downtime. In many instances where uptime is critical, you may consider incorporating liquidated damage clauses (fines and penalties) for downtime. Often when revenue is involved, the hosted party will take deeper measures to ensure uptime.

These types of outages are rare, but significant and while most organizations should not be scrambling to host their own systems and cancel all hosted agreements, it’s a good idea to take a hard look at your cyber security and IT risk management plan. Then, like me, when the clouds clear and you are in warm and sunny Florida, you can take a long lunch and enjoy the day.

Read this if you are a plan sponsor of employee benefit plans.

This article is the eleventh in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. You can read the previous articles here.

Most employee benefit plans have outsourced a significant portion of the internal controls to a service organization, such as a third-party administrator. The plan administrator has a fiduciary responsibility to monitor the internal controls of the service organization and to determine if the outsourced controls are suitably designed and effective.

SOC 1 reports: Internal controls and financial reporting

Generally, the most efficient way to obtain an understanding of the outsourced controls is to obtain a report on controls issued by the service organization’s auditor. Commonly referred to as a System and Organization Controls (SOC) report, the SOC report should be based on the American Institute of Certified Public Accountants’ (AICPA) attestation standards and should cover internal controls relevant to financial reporting, also known as a SOC 1 report (the “1” indicating it covers internal controls over financial reporting).

Plan sponsors should perform a documented review of the SOC 1 report for each of the plan’s significant service organizations. The documented review should include the plan sponsor’s assessment of the complementary user entity controls outlined in the SOC 1 report. The complementary user entity controls are internal control activities that should be in place at the plan sponsor to provide reasonable assurance that the controls tested at the service organization are operating effectively at your plan. If a service organization’s internal controls are operating effectively, but complementary user entity controls are not in place at your organization, the effectiveness of the service organization’s internal controls may not transfer to your plan’s operations.

Creditability and CPA firms: Considerations

Creditability of the CPA firm completing the SOC 1 report examination may impact the reliability of the CPA firm’s opinion and thus your reliability on the service organization’s internal controls. Unfamiliarity with the service auditor’s qualifications may be mitigated through additional research. Items to consider are: 

• The firm’s expertise in SOC 1 reporting
  • Are they familiar with the service organization’s industry?
  • How many professionals do they have that perform SOC 1 examination services?
• The evaluation of AICPA peer reviews 
  Audit firms are required to have a periodic peer review conducted. The results of the peer review are public knowledge and can be found on the AICPA’s website.
  • Did the service auditor receive a “pass” rating during their most recent peer review?
  • Did the peer review cover SOC 1 examination services?
• Evaluation of the service organization’s due diligence procedures surrounding the selection of an auditor

Some of this information may be readily available via the service auditor’s website, while other information may need to be gathered through direct communication with the service organization. A qualified service auditor should be able to provide a SOC 1 report that contains sufficient detail, relevant transactional activity, relevant control objectives, and a timely reporting period.

SOC 1 reports may contain an unqualified, qualified, adverse, or disclaimer of opinion. The report determines if the controls in place are adequate for complete and accurate financial reporting. Report qualifications may affect the risk of relying on the service organization and may result in the need for additional procedures or safeguards to help ensure the plan’s financial statements are presented fairly. Even if the SOC 1 report received an unqualified opinion, you should review the controls tested by the service auditor and the results of such testing for any exceptions. Exceptions, even if they don’t result in a qualified opinion, may have an impact on the plan’s control environment. 

You should also review the scope of the audit to check that all significant transaction cycles, processes, and IT applications were properly assessed for their impact on the plan’s financial statements. Areas outside the scope of the SOC 1 report may require additional consideration, including the possibility of obtaining more than one SOC 1 report for subservice organizations whose functions were carved out from the service organization’s SOC 1 report.

Subservice organizations

Subservice organizations are frequently utilized to process certain transactions or perform certain functions at the service organization. Management of the service organization may identify certain transaction cycles and processes that are performed by a subservice organization and choose to exclude relevant control objectives and related controls from the SOC 1 report description and the scope of the auditor’s engagement. In such cases, multiple SOC 1 reports may need to be acquired to gain adequate coverage of all controls and objectives relevant to your plan. 

Furthermore, you need to consider the time period the SOC 1 report covers. Coverage should be obtained for your plan’s full fiscal year. For SOC 1 reports that lack coverage of your plan’s full fiscal year, a bridge letter should be obtained to help ensure that no significant changes in controls occurred between the SOC 1 report examination period and the end of your plan’s fiscal year.

Although plans commonly outsource a significant portion of their day-to-day operations to service organizations, plan fiduciaries cannot outsource their responsibilities surrounding the maintenance of a sound control environment. SOC 1 reports are a great resource to assess the control environments of service organizations. However, such reports can be lengthy and daunting to review. We hope this article provides some best practices in reviewing SOC 1 reports. If you have any questions, or would like to receive a copy of our SOC 1 report review template, please don’t hesitate to reach out to our Employee Benefits Audit team.

LIBOR is leaving—is your financial institution ready to make the most of it?

In July 2017, the UK’s Financial Conduct Authority announced the phasing out of the London Interbank Offered Rate, commonly known as LIBOR, by the end of 2021¹. With less than two years to go, US federal regulators are urging financial institutions to start assessing their LIBOR exposure and planning their transition. Here we offer some general impacts of the phasing out, some specific actions your institution can take to prepare, and, finally, background on how we got here (see Background at right).

How will the phase-out impact financial institutions?

The Federal Reserve estimates roughly $200 trillion in LIBOR-indexed notional value transactions in the cash and derivatives market². LIBOR is used to help price a variety of financial services products,  including $3.4 trillion in business loans and $1.3 trillion in consumer loans, as well as derivatives, swaps, and other credit instruments. Even excluding loans and financial instruments set to mature before 2021—estimated by the FDIC at 82% of the above $200 trillion—LIBOR exposure is still significant³.

A financial institution’s ability to lend money is largely dependent on the relative stability of its capital position, or lack thereof. For institutions with a significant amount of LIBOR-indexed assets and liabilities, that means less certainty in expected future cash flows and a less stable capital position, which could prompt institutions to deny loans they might otherwise have approved. A change in expected cash flows could also have several indirect consequences. Criticized assets, assessed for impairment based on their expected future cash flows, could require a specific reserve due to lower present value of expected future cash flows.

The importance of fallback language in loan agreements

Fallback language in loan agreements plays a pivotal role in financial institutions’ ability to manage their LIBOR-related financial results. Most loan agreements include language that provides guidance for determining an alternate reference rate to “fall back” on in the event the loan’s original reference rate is discontinued. However, if this language is non-existent, contains fallbacks that are no longer adequate, or lacks certain key provisions, it can create unexpected issues when it comes time for financial institutions to reprice their LIBOR loans. Here are some examples:

• Non-existent or inadequate fallbacks
  According to the Alternative Reference Rates Committee, a group of private-market participants convened by the Federal Reserve to help ensure a successful LIBOR transition, "Most contracts referencing LIBOR do not appear to have envisioned a permanent or indefinite cessation of LIBOR and have fallbacks that would not be economically appropriate"⁴.
  
  For instance, industry regulators have warned that without updated fallback language, the discontinuation of LIBOR could prompt some variable-rate loans to become fixed-rate², causing unanticipated changes in interest rate risk for financial institutions. In a declining rate environment, this may prove beneficial as loans at variable rates become fixed. But in a rising rate environment, the resulting shrink in net interest margins would have a direct and adverse impact on the bottom line.

• No spread adjustment
  Once LIBOR is discontinued, LIBOR-indexed loans will need to be repriced at a new reference rate, which could be well above or below LIBOR. If loan agreements don’t provide for an adjustment of the spread between LIBOR and the new rate, that could prompt unexpected changes in the financial position of both borrowers and lenders³. Take, for instance, a loan made at the Secured Overnight Financing Rate (SOFR), generally considered the likely replacement for USD LIBOR. Since SOFR tends to be lower than three-month LIBOR, a loan agreement using it that does not allow for a spread adjustment would generate lower loan payments for the borrower, which means less interest income for the lender.
  
  Not allowing for a spread adjustment on reference rates lower than LIBOR could also cause a change in expected prepayments—say, for instance, if borrowers with fixed-rate loans decide to refinance at adjustable rates—which would impact post-CECL allowance calculations like the weighted-average remaining maturity (WARM) method, which uses estimated prepayments as an input.

What can your financial institution do to prepare?

The Federal Reserve and the SEC have urged financial institutions to immediately evaluate their LIBOR exposure and expedite their transition. Though the FDIC has expressed no intent to examine financial institutions for the status of LIBOR planning or critique loans based on use of LIBOR³, Federal Reserve supervisory teams have been including LIBOR transitions in their regular monitoring of large financial institutions⁵. The SEC has also encouraged companies to provide investors with robust disclosures regarding their LIBOR transition, which may include a notional value of LIBOR exposure².

Financial institutions should start by analyzing their LIBOR exposure beyond 2021. If you don’t expect significant exposure, further analysis may be unnecessary. However, if you do expect significant future LIBOR exposure, your institution should conduct stress testing using LIBOR as an isolated variable by running hypothetical transition scenarios and assessing the potential financial impact.

Closely examine and assess fallback language in loan agreements. For existing loan agreements, you may need to make amendments, which could require consent from counterparties². For new loan agreements maturing beyond 2021, lenders should consider selecting an alternate reference rate. New contract language for financial instruments and residential mortgages is currently being drafted by the International Securities Dealers Association and the Federal Housing Finance Authority, respectively³—both of which may prove helpful in updating loan agreements.

Lenders should also consider their underwriting policies. Loan underwriters will need to adjust the spread on new loans to accurately reflect the price of risk, because volatility and market tendencies of alternate loan reference rates may not mirror LIBOR’s. What’s more, SOFR lacks abundant historical data for use in analyzing volatility and market tendencies, making accurate loan pricing more difficult.

Conclusion: Start assessing your LIBOR risk soon

The cessation of LIBOR brings challenges and opportunities that will require in-depth analysis and making difficult decisions. Financial institutions and consumers should heed the advice of regulators and start assessing their LIBOR risk now. Those that do will not only be better prepared―but also better positioned―to capitalize on the opportunities it presents.

Need help assessing your LIBOR risk and preparing to transition? Contact BerryDunn’s financial services specialists.

¹ https://www.washingtonpost.com/business/2017/07/27/acdd411c-72bc-11e7-8c17-533c52b2f014_story.html?utm_term=.856137e72385
² Thomson Reuters Checkpoint Newsstand April 10, 2019
³ https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin18/si-winter-2018.pdf
^{4 https://bankingjournal.aba.com/2019/04/libor-transition-panel-recommends-fallback-language-for-key-instruments/
5} https://www.reuters.com/article/us-usa-fed-libor/fed-urges-u-s-financial-industry-to-accelerate-libor-transition-idUSKCN1RM25T