Just weeks after publishing guidance on cybersecurity, the Securities and Exchange Commission (SEC) assessed a $35 million penalty against Yahoo! Inc. for allegedly misleading investors concerning a major data breach.

The entity—which did not admit or deny the SEC’s findings—knew within days that hackers had stolen usernames, email addresses, phone numbers and birth dates, among other data, for hundreds of millions of user accounts, but waited more than two years to share that information, the Commission said.

What happened

In late 2014, the Internet media company then known as Yahoo (and today doing business as Altaba Inc.) learned of a massive data breach of its user database that resulted in the theft, unauthorized access and acquisition of hundreds of millions of its users’ data, including usernames, email addresses, phone numbers, birth dates, hashed passwords, and security questions and answers. At the time, the breach was the largest known theft of user data. By December 2014, the information security team had determined that the files containing personal data of at least 108 million users (and perhaps all Yahoo users) had been stolen.

Despite its knowledge of the breach, Yahoo did not disclose the data breach in its public filings. Senior management and legal teams did not share information regarding the breach with auditors or outside counsel in order to assess the company’s disclosure obligations in its public filings, and the company engaged in negotiations for a stock purchase agreement with Verizon, reaching a deal in July 2016 for $4.825 billion. In its agreement with Verizon, Yahoo affirmatively represented and warranted that it had no knowledge of any significant data security breaches. Because Yahoo attached its agreement with Verizon to a Form 8-K it filed with the SEC in July 2016, its false representations were publicly available.

Finally, in September 2016, in a press release attached to a Form 8-K, Yahoo disclosed that the 2014 breach had resulted in the theft of the data of 500 million of its users. Yahoo also amended its risk factor disclosures and MD&A to address the 2014 data breach in subsequent public filings and corrected prior statements that its disclosure controls and procedures were effective. It notified Verizon of the information at that time as well.

In its 2016 Form 10-K, filed with the SEC on March 1, 2017, Yahoo disclosed that its principal executive officer and principal financial officer had concluded that “due exclusively to deficiencies in the Company’s existing security incident response protocols related to the 2014 Security Incident, the Company’s disclosure controls and procedures for each of the annual and quarterly periods ended December 31, 2014 through September 30, 2016 were not effective at the end of each such period.”

As a result of this conduct, the SEC said Yahoo had violated Sections 17(a)(2) and (3) of the Securities Act, which makes it unlawful for any person in the offer or sale of securities to obtain money by means of an untrue statement of a material fact or any omission. In addition, the company ran afoul of Section 13(a) of the Exchange Act and related rules, which require the filing with the SEC of annual, quarterly and current reports to maintain disclosure controls and procedures designed to ensure that information is not misleading.

The SEC noted that Yahoo cooperated fully with the Commission in its investigation and promised to continue to do so if necessary. In addition, the company agreed to cease and desist from committing any future violations of the Securities Act and the Exchange Act and to pay a $35 million penalty.

“Yahoo’s risk factor disclosures in its annual and quarterly reports from 2014 through 2016 were materially misleading in that they claimed the company only faced the risk of potential future data breaches that might expose the company to loss of its users’ personal information stored in its information systems, as well as potential future litigation, remediation, increased costs for security measures, loss of revenue, damage to its reputation, and liability, without disclosing that a massive data breach had in fact already occurred,” according to the SEC’s cease and desist order. “Yahoo’s management’s discussion and analysis of financial condition and results of operations (MD&A) in those reports was also misleading to the extent it omitted known trends or uncertainties with regard to liquidity or net revenue presented by the 2014 data breach.”

To read the cease and desist order in In re Altaba, Inc., click here.

Why it matters

Particularly coming on the heels of the SEC’s recently released cybersecurity guidance, the first-of-its-kind $35 million penalty was clearly intended to send a message that the Commission is serious about cybersecurity. While the SEC has a slightly different perspective—protecting investors instead of consumers, like the Federal Trade Commission or a state attorney general—the Commission has clearly signaled that public companies should be on notice that cybersecurity is a priority. “We do not second-guess good faith exercises of judgment about cyber-incident disclosures,” Steven Perkin, co-director of the SEC Enforcement Division, said in a statement about the action. “But we have also cautioned that a company’s response to such an event could be so lacking that an enforcement action would be warranted. This is clearly such a case.”