Navigating changes to the SOC 2 guide

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

Is your organization a service provider that hosts or supports sensitive customer data, (e.g., personal health information (PHI), personally identifiable information (PII))? If so, you need to be aware of a recent decision by the American Institute of Certified Public Accountants that may affect how your organization manages its systems and data.

In April, the AICPA’s Assurance Executive Committee decided to replace the five Trust Service Principles (TSPs) with Trust Services Criteria (TSC), requiring service organizations to completely rework their internal controls, and present SOC 2 findings in a revised format. This switch may sound frustrating or intimidating, but we can help you understand the difference between the principles and the criteria.

The SOC 2 Today
Service providers design and implement internal controls to protect customer data and comply with certain regulations. Typically, a service provider hires an independent auditor to conduct an annual Service Organization Control (SOC) 2 examination to help ensure that controls work as intended. Among other things, the resulting SOC 2 report assures stakeholders (customers and business partners) the organization is reducing data risk and exposure.

Currently, SOC 2 reports focus on five Trust Services Principles (TSP):

• Security: Information and systems are protected against unauthorized access, unauthorized disclosure of information, and damage to systems that can compromise the availability, integrity, confidentiality, and privacy of information or systems — and affect the entity's ability to meet its objectives.

• Availability: Information and systems are available for operation and use to meet the entity's objectives.

• Processing Integrity: System processing is complete, valid, accurate, timely, and authorized to meet the entity's objectives.

• Confidentiality: Information designated as confidential is protected to meet the entity's objectives.

• Privacy: Personal information is collected, used, retained, disclosed, and disposed of to meet the entity's objectives.

New SOC 2 Format
The TSC directly relate to the 17 principles found in the Committee of Sponsoring Organization (COSO)’s 2013 Framework for evaluating internal controls, and include additional criteria related to COSO Principle 12. The new TSC are:

• Control Environment: emphasis on ethical values, board oversight, authority and responsibilities, workforce competence, and accountability.

• Risk Assessment: emphasis on the risk assessment process, how to identify and analyze risks, fraud-related risks, and how changes in risk impact internal controls.

• Control Activities: Emphasis on how you develop controls to mitigate risk, how you develop technology controls, and how you deploy controls to an organization through the use of policies and procedures.

• Information and Communication: Emphasis on how you communicate internal of the organization to internal and external parties.

• Monitoring: Emphasis on how you evaluate internal controls and how you communicate and address any control deficiencies.

The AICPA has provided nearly 300 Points of Focus (POF), supporting controls that organizations should consider when addressing the TSC. The POF offer guidance and considerations for controls that address the specifics of the TSC, but they are not required.

Points of Focus
Organizations now have some work to do to meet the guidelines. The good news: there’s still plenty of time to make necessary changes. You can use the current TSP format before December 15, 2018. Any SOC 2 report presented after December 15, 2018, must incorporate the new TSC format. The AICPA has provided a mapping spreadsheet to help service organizations move from TSP to the TSC format.

Contact Chris Ellingwood to learn more about how we can help you gain control of your SOC 2 reporting efforts. 
 

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.

Do you know what would happen to your company if your CEO suddenly had to resign immediately for personal reasons? Or got seriously ill? Or worse, died? These scenarios, while rare, do happen, and many companies are not prepared. In fact, 45% of US companies do not have a contingency plan for CEO succession, according to a 2020 Harvard Business Review study.  

Do you have a plan for CEO succession? As a business owner, you may have an exit strategy in place for your company, but do you have a plan to bridge the leadership gap for you and each member of your leadership team? Does the plan include the kind of crises listed above? What would you do if your next-in-line left suddenly? 

Whether yours is a family-owned business, a company of equity partners, or a private company with a governing body, here are things to consider when you’re faced with a situation where your CEO has abruptly departed or has decided to step down.  

1. Get a plan in place. First, assess the situation and figure out your priorities. If there is already a plan for these types of circumstances, evaluate how much of it is applicable to this particular circumstance. For example, if the plan is for the stepping down or announced retirement of your CEO, but some other catastrophic event occurs, you may need to adjust key components and focus on immediate messaging rather than future positioning. If there is no plan, assign a small team to create one immediately. 

Make sure management, team leaders, and employees are aware and informed of your progress; this will help keep you organized and streamline communications. Management needs to take the lead and select a point person to document the process. Management also needs to take the lead in demeanor. Model your actions so employees can see the situation is being handled with care. Once a strategy is identified based on your priorities, draft a plan that includes what happens now, in the immediate future, and beyond. Include timetables so people know when decisions will be made.  

2. Communicate clearly, and often. In times of uncertainty, your employees will need as much specific information as you can give them. Knowing when they will hear from you, even if it is “we have nothing new to report” builds trust and keeps them vested and involved. By letting them know what your plan is, when they’ll receive another update, what to tell clients, and even what specifics you can give them (e.g., who will take over which CEO responsibility and for how long), you make them feel that they are important stakeholders, and not just bystanders. Stakeholders are more likely to be strong supporters during and after any transition that needs to take place. 

3. Pull in professional help. Depending on your resources, we recommend bringing in a professional to help you handle the situation at hand. At the very least, call in an objective opinion. You’ll need someone who can help you make decisions when emotions are running high. Bringing someone on board that can help you decipher what you have to work with and what your legal and other obligations may be, help rally your team, deal with the media, and manage emotions can be invaluable during a challenging time. Even if it’s temporary. 

4. Develop a timeline. Figure out how much time you have for the transition. For example, if your CEO is ill and will be stepping down in six months, you have time to update any existing exit strategy or succession plan you have in place. Things to include in the timeline: 

• Who is taking over what responsibilities? 
• How and what will be communicated to your company and stakeholders? 
• How and what will be communicated to the market? 
• How will you bring in the CEO's replacement, while helping the current CEO transition out of the organization? 

If you are in a crisis situation (e.g., your CEO has been suddenly forced out or asked to leave without a public explanation), you won’t have the luxury of time.  

Find out what other arrangements have been made in the past and update them as needed. Work with your PR firm to help with your change management and do the right things for all involved to salvage the company’s reputation. When handled correctly, crises don’t have to have a lasting negative impact on your business.   

5. Manage change effectively. When you’re under the gun to quickly make significant changes at the top, you need to understand how the changes may affect various parts of your company. While instinct may tell you to focus externally, don’t neglect your employees. Be as transparent as you possibly can be, present an action plan, ask for support, and get them involved in keeping the environment positive. Whether you bring in professionals or not, make sure you allow for questions, feedback, and even discord if challenging information is being revealed.  

6. Handle the media. Crisis rule #1 is making it clear who can, and who cannot, speak to the media. Assign a point person for all external inquiries and instruct employees to refer all reporter requests for comment to that point person. You absolutely do not want employees leaking sensitive information to the media. 
 
With your employees on board with the change management action plan, you can now focus on external communications and how you will present what is happening to the media. This is not completely under your control. Technology and social media changed the game in terms of speed and access to information to the public and transparency when it comes to corporate leadership. Present a message to the media quickly that coincides with your values as a company. If you are dealing with a scandal where public trust is involved and your CEO is stepping down, handling this effectively will take tact and most likely a team of professionals to help. 

Exit strategies are planning tools. Uncontrollable events occur and we don’t always get to follow our plan as we would have liked. Your organization can still be prepared and know what to do in an emergency situation or sudden crisis.  Executives move out of their roles every day, but how companies respond to these changes is reflective of the strategy in place to handle unexpected situations. Be as prepared as possible. Own your challenges. Stay accountable. 

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

Read this if your CFO has recently departed, or if you're looking for a replacement.

With the post-Covid labor shortage, “the Great Resignation,” an aging workforce, and ongoing staffing concerns, almost every industry is facing challenges in hiring talented staff. To address these challenges, many organizations are hiring temporary or interim help—even for C-suite positions such as Chief Financial Officers (CFOs).

You may be thinking, “The CFO is a key business partner in advising and collaborating with the CEO and developing a long-term strategy for the organization; why would I hire a contractor to fill this most-important role?” Hiring an interim CFO may be a good option to consider in certain circumstances. Here are three situations where temporary help might be the best solution for your organization.

Your organization has grown

If your company has grown since you created your finance department, or your controller isn’t ready or suited for a promotion, bringing on an interim CFO can be a natural next step in your company’s evolution, without having to make a long-term commitment. It can allow you to take the time and fully understand what you need from the role — and what kind of person is the best fit for your company’s future.

BerryDunn's Kathy Parker, leader of the Boston-based Outsourced Accounting group, has worked with many companies to help them through periods of transition. "As companies grow, many need team members at various skill levels, which requires more money to pay for multiple full-time roles," she shared. "Obtaining interim CFO services allows a company to access different skill levels while paying a fraction of the cost. As the company grows, they can always scale its resources; the beauty of this model is the flexibility."

If your company is looking for greater financial skill or advice to expand into a new market, or turn around an underperforming division, you may want to bring on an outsourced CFO with a specific set of objectives and timeline in mind. You can bring someone on board to develop growth strategies, make course corrections, bring in new financing, and update operational processes, without necessarily needing to keep those skills in the organization once they finish their assignment. Your company benefits from this very specific skill set without the expense of having a talented but expensive resource on your permanent payroll.

Your CFO has resigned

The best-laid succession plans often go astray. If that’s the case when your CFO departs, your organization may need to outsource the CFO function to fill the gap. When your company loses the leader of company-wide financial functions, you may need to find someone who can come in with those skills and get right to work. While they may need guidance and support on specifics to your company, they should be able to adapt quickly and keep financial operations running smoothly. Articulating short-term goals and setting deadlines for naming a new CFO can help lay the foundation for a successful engagement.

You don’t have the budget for a full-time CFO

If your company is the right size to have a part-time CFO, outsourcing CFO functions can be less expensive than bringing on a full-time in-house CFO. Depending on your operational and financial rhythms, you may need the CFO role full-time in parts of the year, and not in others. Initially, an interim CFO can bring a new perspective from a professional who is coming in with fresh eyes and experience outside of your company.

After the immediate need or initial crisis passes, you can review your options. Once the temporary CFO’s agreement expires, you can bring someone new in depending on your needs, or keep the contract CFO in place by extending their assignment.

Considerations for hiring an interim CFO

Making the decision between hiring someone full-time or bringing in temporary contract help can be difficult. Although it oversimplifies the decision a bit, a good rule of thumb is: the more strategic the role will be, the more important it is that you have a long-term person in the job. CFOs can have a wide range of duties, including, but not limited to:

• Financial risk management, including planning and record-keeping
• Management of compliance and regulatory requirements
• Creating and monitoring reliable control systems
• Debt and equity financing
• Financial reporting to the Board of Directors

If the focus is primarily overseeing the financial functions of the organization and/or developing a skilled finance department, you can rely — at least initially — on a CFO for hire.

Regardless of what you choose to do, your decision will have an impact on the financial health of your organization — from avoiding finance department dissatisfaction or turnover to capitalizing on new market opportunities. Getting outside advice or a more objective view may be an important part of making the right choice for your company.

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

Read this if your company is seeking assistance under the PPP.

The rules surrounding PPP continue to rapidly evolve. As of June 22, 2020, we are anticipating some additional clarifications in the form of an interim final rule (or IFR) and additional answers to frequently asked questions (FAQ). The FAQs were last updated on May 27, 2020. For the latest information, please be sure to check our website or the Treasury website.

A few important changes:

1. The loan forgiveness application, and instructions, have been updated.
2. There is a new EZ form, designed to streamline the forgiveness process, if borrowers meet certain criteria.
3. Changes now allow for businesses to use 60% of the PPP loan proceeds on payroll costs, down from 75%.
4. Businesses now have 24 weeks to use the loan proceeds, rather than the original eight-week period (or by December 31, 2020, whichever comes earlier).
5. The rules around what is a full-time equivalent (FTE) employee and the safe harbors with respect to employment levels and forgiveness have been clarified.
6. Entities can defer payroll taxes through the ERC program, even if forgiveness is granted.

These changes are designed to make it easier to qualify for loan forgiveness. In the event you do not qualify for loan forgiveness, you may be able to extend the loan to five years, as opposed to the original two years.

The relaxation on FTE reductions is significant. The reductions will NOT count against you when calculating forgiveness, even if you haven’t restored the same employment level, if you can document that:

• you offered employment to people and they refused to come back, or
• HHS, CDC, OSHA or other government intervention causes an inability to “return to the same level of business activity” as of 2/15/2020.

As of June 20, 2020, there was still an additional $128 billion in available funds. The program is intended to fund new loans through June 30, 2020. 

We’re here to help.
If you have questions about the PPP, contact a BerryDunn professional.

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