Friday, September 24, 2010

OUTSOURCED – FUNNY BUT TWISTED.

NBC’s new Thursday evening comedy series, “Outsourced,” has been edited for Hollywood, but it’s charming, farcical and at least spares the viewer the horrible canned laughter of the evening soap operas.

Unemployed American Twentysomething (a throwback to the “Ugly American” dumb idiot of the 1950’s and 1960’s) finds employment in India as call center “manager.” The cast of characters includes an obsequious and overambitious Rajiv, an alienated American managing another call center, a drop-dead gorgeous fun-loving Aussie chick (of mysterious background) managing a third call center, a silent Sikh skilled in the art of the walk-out political protest, a lower caste pariah likely to blossom during the course of the season and other stereotypes reminiscent of “The Office.”In fact, it’s “Outsourced Office,” with cultural training that highlights the worst of both American and Indian stereotypes. But it’s cute, contains enough truth to be half-credible, and is an introduction to the real India. Of course, we have to suspend reality, by ignoring the 10 ½ (to 13 ½) hour time zone differences and assuming phone calls during the day in India are coming from some place in America during some daylight hours.

If you like “Outsourced” and actually want to learn more twisted truths, you need to buy my book, tentatively titled “Twisted Truths in Global Sourcing.”

To contribute to www.outsourcing-law.com or to receive a copy of my book please contact publisher@outsourcing-law.com.

Tuesday, September 14, 2010

Government Procurement: Civil Fraud and Debarment for Non-Disclosure of [Offshore] “Outsourcing”

Many companies provide services to the U.S. government. Directly and indirectly, government contractors must disclose extensive information in their bid documents. Under a draft U.S. law, such bids would need to disclose whether the bidder has a history of “the laying off of a United States worker from a job, and the hiring or contracting for the same job to be performed in a foreign country.”

Under the draft “Stop Outsourcing and Create American Jobs Act of 2010”, introduced by Rep. Jerry Cranwell (D., Calif.) on June 29, 2010, all Federal government departments and agencies would be required to request each bidder for a Federal contract to provide information regarding whether the offeror engaged in “outsourcing” during the fiscal year preceding the fiscal year in which the contract is to be awarded. The bill attacks the restructuring of government suppliers who terminate the employment of a United States worker from a job and hire (or contract for) the same job to be performed in a foreign country.

The bill would punish bidders by debarment from future Federal government contracts and impose criminal fraud penalties under 18 U.S.C. 1001 (false statements to the Government).

Analysis. This bill requires disclosure and imposes civil debarment and criminal liability for non-disclosure. The disclosure relates to a lawful act of laying off a U.S. worker followed by a lawful act of hiring a foreign worker.

Comity and Reciprocity. Public International Law is built upon reciprocity and “comity.” “Comity” represents a respect in one country for the reasonable internal actions in another country for matters that have potential dual impact in both countries. This draft legislation is patently nationalistic, protectionist and xenophobic. On a reciprocal basis, an American worker would have no chance of replacing a foreign worker employed by a foreign employer where the foreign employer provides goods or services to a foreign government. Such legislation risks serious harm to American workers by foreign adoption of similar laws where foreign labor is replaced by American labor.

Multilateral and Bilateral Commitments. As a legal matter, a law that violates U.S. international commitments may be valid under local law but engage the international responsibility of the United States under a prior binding international convention. This law would punish American government contractors for practices that are protected under the WTO General Agreement on Trade in Services (“GATS”) and possibly the WTO Agreement on Trade-Related Investment Measures. Similarly, the U.S. would be in breach of its bilateral duties under NAFTA.

Bill of Attainder. This faces U.S. Constitutional challenge as a Bill of Attainder under Article I, Section 9. A “bill of attainder” was a law that banned a person because of some inherent status or the exercise of some freedom, right or privilege that is generally available to all citizens. It is a legislative declaration that a person or group of persons is guilty of some crime and punishing them without benefit of a trial. In such, the draft law would have the same effect as debarring contractors who fire U.S. workers for any lawful reason, such as a shortage of work, or such as the employee’s abuse of the employer’s computer system or use of office equipment for conducting a sideline business during off-hours.

Business Process Transformation. The draft legislation does not define what is the “same work” that is being done offshore. In many cases, globalization occurs because the functions and roles are changing to use new technologies, to access new markets and to obtain new skills. As in other cases of “follow the work,” the question is not just work, but organizational design, workforce planning (such as for knowledge workers) and marketing (getting closer to the customers). The draft law invites artificial determinations that offshored work is the “same” and omits any definition of “sameness.”

Hidden Agenda: Compiling a Little List. Since public procurement procedures are accessible to the public in the United States, the draft legislation invites inquiry into its effects. If enacted, the draft law would allow the Government to compile a list of all Government contractors who had done any “outsourcing” in the prior 12 months. Such a list would then be used for political purposes to harangue any enterprise “guilty” of such lawful behavior. Instead of outlawing “outsourcing,” the draft legislation would outlaw those who wrongfully deny that they outsource (under 18 USC 1001) and create a political stigma for actions that are not illegal. This is reminiscent of the frenzy and abuses of the anti-Communist witch-hunt of Senator Joe McCarthy in the 1950’s.

A simpler legislative solution would be to ban “outsourcing.” Of course, such a ban would be so offensive (and contrary to national commitments under NAFTA, WTO and bilateral treaties) that it would never pass. But, certainly, no offense could be taken by an innocuous bill to prevent frauds and plan a smear campaign.

Strengthening American Employability. It is regrettable that such defective and ill-conceived legislation does not address the core issues of American employability, such as education, language skills, competitiveness and use of technology to improve the human touch. In fact, in the tax-haven segment of this same draft bill, the test of whether a foreign jurisdiction is a tax haven (justifying anti-deferral and other retaliatory treatment) includes some factors that the Congress should consider for promotion of American employability, such as ”Incentives which may encourage a United States corporation to invest abroad rather than domestically.” H.R. 5622, Sec. 2 (111th Cong., 1st Sess.).

There are other methods of aiding job losses from outsourcing. A legally valid solution would require re-examination of American global commitments and a balancing of benefits and burdens, including enforcement of WTO violations. Such enforcement actions are at the discretion ofthe President and not congressional legislation.

Wednesday, May 5, 2010

Managing the New "Trade Secrecy" Risks in Global Sourcing: Criminal Theft, Criminal Negligence, Espionage, Bribery, Antitrust, and Enforcement

Trade secrecy risks arise whenever an enterprise shares confidential business information with a supplier, service provider, joint venturer or customer. Trade secrecy protection measures should be planned and implemented through appropriate non-disclosure covenants by the third party and possibly even its employees and others in the value chain. Current trade secrecy are reflected in three seemingly disparate events: the Rio Tinto employee economic espionage and bribery case in China, the U.S. Department of Justice’s investigation into the anticompetitive use of non-competition covenants (“non-competes”) by high-tech companies and the Algerian-U.S. Mutual Legal Assistance Treaty (“MLAT”).


These three current events suggest that both enterprise customers and their service providers take a second look at their current practices for protecting trade secrets. At the end of this article, we offer a series of questions that need answers before any kind of outsourcing – indeed, any cross-border data flow — can take place. Such questions offer a basic refresher course, with “James Bond-compliant” updates, on challenges of trade secret protections in global operations.

I. The Current Context of Trade Secrets at Risk

Item #1: Bribery and Espionage in China (the Rio Tinto employee case). On March 28, 2010, China convicted a local sales employee of a British-Australian mining company named Stern Hu, a Chinese-born Australian citizen, and other Chinese-resident employees of Rio Tinto (but not Rio Tinto itself) of bribery and theft of trade secrets relating to price negotiations of iron ore for sale to Chinese state-owned companies. The trial was conducted largely in secret. Rio Tinto had previously rejected an investment offer from Chinalco that involved some Australian national security issues. Some analysts suggested the case was a political retaliation for that rejection and an abuse of judicial authority. Others suggested that the case leaves open the question of whether there was any rule of law or was this merely the use of judicial power to punish foreign business that used aggressive means of driving hard bargains. The case attracted global attention to the concept in Chinese law that identifies non-public commercial information of a Chinese state-owned enterprise as a “state secret.” Rio Tinto initially defended the employees but then said they had acted outside the scope of their operations and authority. The employees were convicted and sentenced to 7 to 14 years in prison plus financial penalties.

On March 25, 2010, China’s State-Owned Assets Supervision and Administration Commission issued regulations on commercial secrets, but did not disclose them until the Rio Tinto employee verdict. Those regulations remain somewhat vague, leaving foreign companies (and Chinese companies that are not state-owned enterprises, or “SOE’s”) to interpret them at their peril. See www.outsourcing-law.com/jurisdictions/countries/china.

Item #2: Anti-Terrorism and Cybercrimes under a Mutual Legal Assistance Treaty. On April 7, 2010, the U.S. and Algeria signed a mutual legal assistance treaty to combat international crime and terrorism. According to the press release:

The mutual legal assistance treaty, or MLAT, will be an effective tool in the investigation and prosecution of terrorism, cybercrime, white collar offenses and other crimes. Among other tools, the treaty will help law enforcement officials from the two countries obtain testimonies and statements; retrieve evidence, including bank and business records; provide information and records from governmental departments or agencies; and provide a means of inviting individuals to testify in a requesting country.

The U.S. has approximately 50 such MLAT’s. Such agreements could be used to enforce criminal prosecutions of misappropriation of trade secrets, assuming such misappropriation is a criminal act in the relevant jurisdictions. The press release announcing the MLAT did not link to any copy of the treaty, and the Justice Department website does not publish a copy either. Interested parties will need to do some further investigation then in how such a treaty might be used to enforce trade secret protections.

Item #3: Hiring Practices by Global Services Providers. Now, enterprise customers have to be worried about the legality of hiring practices – at least in the United States – of their outsourcing service providers. Since July 2009, the U.S. Department of Justice has been investigating the hiring practices of Google, Intel, IBM, Apple and IAC/InterActiveCorp., according to the Wall Street Journal and other news reports in April 2010. The reports claim that the U.S. Government could challenge, or chill, the use of non-competition covenants in industries, such as high-tech, where innovation drives comparative advantage and non-competes might constitute illegal collusion on cost management, thereby depriving knowledge workers of a market for their skills. The investigation appears inspired by cases where innovators are hired away and the former employer seeks to enforce a non-competition covenant, particularly where the new employer claims that the litigation lacks a valid legal basis and thus is anticompetitive. (Such a case happened in 2005 when Google hired a Microsoft engineer in China, and Google claimed that Chinese law did not permit enforcement in China of a non-competition covenant). Enterprise customers should now be concerned with compliance by their service providers with antitrust concerns.

II. The Law of Trade Secrecy

All these recent events underscore the need for prudent trade secrecy practices in the global supply chain. Trade secrets are now at risk due to potential civil and criminal espionage, bribery, cybercrime, and antitrust prohibitions on abusive and illegal anticompetitive practices. Further, the area of trade secrecy is now engulfed in national security and public policy considerations, underscoring the importance of a stable political environment for assuring the predictability of legal rights and enforcement actions in the various jurisdictions where trade secrets are shared and used in an outsourcing business relationship.

Trade Secrets. It is a best practice in outsourcing contracts, to protect the enterprise customer’s trade secrets. The customer wants to know how this is done. Such protections can be applied to individual employees under non-disclosure agreements and maybe even non-competition covenants. NDA’s are generally enforceable but are generally construed in a manner to avoid depriving an employee (or service provider) of “general skill and knowledge” in the industry.

NDA’s are essential to enable any outsourcing, resourcing (retro sourcing back in-house) and transfer sourcing (to a new service provider on expiration or termination). As a matter of public policy under national laws, NDA’s are critical. The WTO protections of trade secrets are not very strong, based instead on non-secret intellectual property rights such as patents, trademarks and copyrights.

Non-Competition Covenants. Non-compete covenants are unenforceable in California as a matter of law and possibly in the BPO provider’s service delivery jurisdiction. Non-competes deprive employees of a right to be hired by competitors. They are unenforceable in some jurisdictions, and where enforceable they must be limited to reasonable scope in time, territory and subject matter. Employers can make the arguments, in an antitrust context, that non-competition covenants:
  1. are not anti-competitive in practice;
  2. do not deny employees the right to find work in non-competitive companies;
  3. are widespread across industries and countries; and
  4. are used by companies across many industries to maintain good business relationships by promoting exchanges of information across the full spectrum of personnel (not just through a narrow channel, like a chaperone of trade secrets), and as a result collaboration between technology-based companies is promoted by such practices.


An antitrust enforcer might argue that non-compete agreements distort access by skilled workers to mobility and job choice, thus depressing competition for skilled workers and depressing wages.

Risk Management: Knowing Your Service Provider’s Hiring Practices. Based on this antitrust activity, enterprise customers should investigate the employment practices of their service providers to understand clearly the contractual framework and legal enforceability of employment practices in the relevant jurisdictions. The legal framework for protecting trade secrets, or allowing them to be disclosed to the local government without judicial review with open adversarial procedure, should also be explored and fully appreciated. Thus, trade secrecy risks should be assessed in the selection of service providers, the scoping of the functions to be outsourced and the use of encryption and decryption before data transfers.

Compliance: Knowing Yourself and the Law. These recent events raise questions that compliance officers and legal departments, as well as product managers and CEO’s, should answer before any kind of outsourcing takes place:

1. What does the enterprise customer do today to identify and protect its trade secrets internally?

a. Identify types of non-public information from all sources that needs to be maintained as non-public.

i. Securities (risk of liability for securities fraud)
ii. Financial information (risk of loss of advantage in pricing negotiations; risk of
securities liability for failure to comply with Regulation FD or other “fair disclosure”
rules)
iii. Human capital information (governed by labor laws and privacy laws)
iv. Technical data, such as designs, processes, formulae, manufacturing techniques
(risk of loss of patent rights or loss of competitive advantage)
v. Marketing information (customer names and related business information relating
to the enterprise’s customer relationship)
vi. Sales information (the existence of RFP’s and the contents of offers and other
responses to RFP’s)

2. How much data does the enterprise need to have to accomplish its mission?

a. Avoid excessive collection and preservation of unencrypted

i. personally identifiable information (“PII”) of individuals in any business relationship.
ii. healthcare information.
iii. credit card information.

b. Avoid collection of non-public information from third parties who might be under a duty
of non-disclosure, or who cannot explain how they legitimately obtained the non-public
information.

3. How does the enterprise ensure that it has the legal right to know the non-public information?

a. Obtain written confirmation from the disclosing party that it has the authority to make
the disclosure.
b. Identify non-disclosure agreements and categorize the information so that it can be
accessed, stored, retained and destroyed in accordance with the non-disclosure
agreement.
c. Limit access by persons having a legitimate “need to know.”
d. Use the non-public information only as necessary to perform a legal and permitted
business activity.
e. Avoid use of bribery, coercion, theft and other illicit means of acquiring non-confidential
information.

4. How does the enterprise identify and protect the trade secrets of third parties with whom it does business.

a. Identify source of non-public information.
b. Identify the duration of any holding period for non-public information under any
non-disclosure agreement.

5. What measures does the enterprise take to train and audit its employees for compliance with trade secrecy policies?

6. Does the enterprise identify special duties and special risks.

a. Take special measures to identify, segregate and protect “commercial secrets” or “state
secrets” when dealing with a foreign state-owned enterprise (“SOE”)?

7. How are trade secret rights recognized and enforced under local law? Are such rights clearly protected, or must a company rely upon contract or criminal prosecution?

8. What are the best ways to protect trade secrets from a practical viewpoint?

a. Divide work flows or discrete functions across suppliers, countries and sources to avoid
having one person or supplier know too much.
b. Retain competitive information in-house.
c. Segregate sales and marketing functions from non-public information in internal technical,
financial and human resources departments.

9. What is the history of trade secret enforcement in the country?

a. Risk of inadvertent criminal liability, including vicarious liability of senior executives for
misdeeds of employees (See China’s Criminal Law, article 219).
b. Risk of investing in new products or services that cannot be exploited due to
misappropriation.
c. Identify any history of data security breaches and remediation activities.

10. Does the enterprise customer’s country have a “mutual legal assistance treaty” or other agreement with the service provider’s country to prosecute “cyber-crime”, so that evidence can be exchanged and used in international abuses of trade secrets?

11. What policies, practices and contractual measures does the service provider take to protect trade secrets? Are such measures a violation of antitrust law and therefore unenforceable?

Friday, March 19, 2010

Read our newest case study on "Achieving Innovation through Outsourcing: Shifting the Paradigm"

Can an enterprise customer get real innovation through outsourcing? It depends. After looking at a case study in contract manufacturing and finance and accounting outsourcing, we can draw some lessons on the squeaky wheel that will need lubrication beyond effective governance.

New Product Development. Recently, Bierce & Kenerson, P.C. was engaged by a global enterprise to assist in a two-phase deal with a supplier. In phase one, the parties entered into an agreement for the joint development of a new type of product to retrofit an old product using new energy-efficient technology. In phase two, the enterprise customer agreed to either buy the new product from the supplier or to pay a royalty for the value of the supplier’s intellectual property and development efforts. The risk of failure was essentially nil, since the enterprise customer could have developed the product alone. Yet it chose to work in tandem with the supplier to achieve a speedier path to market for a hot product with a big potential demand in order to avoid loss of market share to well-financed agile competitors.

The contract development process took much longer than the product development process for several reasons.

o Market Positioning. First, the customer and supplier had not really reached agreement on issues of exclusivity, market positioning and branding. Having already committed resources for joint development of a new innovative product offering to the enterprise’s customers, the enterprise customer lost some of its bargaining power (and actually lost some goodwill in the marketplace) until these issues were resolved in the master supply agreement.

o Financial Viability and Contingency Planning. Second, the supplier was a new entrant into the market, with venture funding but no strong ongoing revenue stream. Financial viability issues challenged the paradigm, requiring careful scenario analysis and negotiation of step-in rights using various sources of goods, services and intellectual property rights. Both parties had different compliance issues arising from separate provisions of securities disclosure laws, including the Sarbanes-Oxley Act of 2002.

o Publicity. Third, the supplier was a publicly traded company for which the new deal would require public disclosure under investor protection laws. The enterprise customer had not focused on managing the public message that might be presented by the supplier. Initially, the supplier was considering issuing messages – through its Marketing Department – that suggested that the enterprise customer could not develop the new product through its own skill, ingenuity, foresight and initiative. The supplier wanted to build its own goodwill on the back of its customer, while the customer wanted an OEM relationship. Modifications of the supply agreement were negotiated so that it would not constitute a “material” relationship for disclosure to investors. This delayed disclosure and thus enabled the enterprise customer to pursue the OEM strategy until after its entry into the new market under its own name.

o Teamwork and Leadership. Fourth, initially, the enterprise customer’s internal teams lacked a management leader to pull together all the participants in a pre-deal analysis of the entire impact. The Sales Department wanted new product to compete with new customers. The R&D Department responded to the Sales Department’s push by offering innovation through joint development with a potential competitor. The Finance Department did not kill the deal even though it lacked a strong business continuity plan. The Legal Department was told that it did not need to bind the parties in one master relationship agreement because deal terms were still being worked out for phase two (production and delivery). As the relationship evolved, the team coalesced and aligned their common interests for achieving, selling and supporting the innovative new product.

New Service Development. Use of third parties to assist in development of new lines of service face similar issues.

o Continuous Process Improvement. It is a best practice in outsourcing deals for service providers to deliver “continuous process improvement.” In designing the outsourcing relationship, the parties need to distinguish between incremental process improvements that come from learning how to be more efficient at a given process, on one hand, and major shifts in business process design that can yield dramatic cost savings. To overcome the hurdle, some dealmakers simply accept that, if there is no measurable “process improvement,” the service provider will drop the price over time in lieu of real process improvement. This is no substitute for true innovation through joint design.

o Intellectual Property. It is a best practice in outsourcing deals to allocate rights in existing and future intellectual property. In advance of a master services agreement, the parties must therefore distinguish between ordinary intellectual property that comes from continuous process improvement and that which flows from some form of capital investment by either party or both parties. Neither party wants to be foreclosed from using improvements or new breakthroughs. The challenge is to agree in advance on scenarios for each case and to provide rewards and governance criteria to minimize disputes on governance as the “innovation” unfolds during the course of the relationship.

o Competition by Service Providers. It is also a best practice for service providers to use “state of the art” service delivery platform – people, process, technology and business processes -- to deliver competitive services. In designing their business relationship, the parties to an outsourcing need to distinguish between the service provider’s competitive service delivery platform and the enterprise customer’s unique brand and goodwill in the marketplace. Management of the business reputation and goodwill of each party to a joint innovation project thus becomes a critical contract and business element for negotiation. It requires careful scenario analysis involving business opportunities in new markets and existing markets, capital investment and ROI hurdle rates as well as contractual provisions consistent with applicable antitrust and competition laws.

o Joint Venture. It is a best practice in outsourcing for the parties to expressly disclaim they are in a joint venture. In effect, this eliminates a fiduciary duty to account for profits from the joint efforts. This clause could defeat joint efforts in innovation, since it segregates benefits and promotes potential competition.

Designing Relationships for Innovation. These examples underscore that outsourcing and OEM contract manufacturing cannot be relied upon to achieve “innovation” without a clear business plan. That plan must include the key factors that are considered in any joint venture. Each party needs to focus on its investment, the proprietary nature of its investment and the ultimate uses of those innovations. Ultimately these impact innovation’s on marketing, branding, sales, customer relationships, goodwill, competitive positioning and new product development. The parties need effective communication on evolution of the innovation and how to share future benefits and ongoing investment, if any, in maintenance.

In short, without an innovation strategy, outsourcing is unlikely to yield much other than some cost savings and some gain sharing. In any event, even such a narrow goal risks an inability to reach agreement. The parties must first reach agreement on allocating ownership of any resulting intellectual property rights and understanding the impact on each party’s competitive positioning.

Most importantly, implementing an innovation strategy will require a governance plan for managing collaboration and competition. A governance plan will identify conflicts of interest and principles for collaboratively resolving conflicts.

Monday, February 1, 2010

Humor Spotlight of the Month

Cybersecurity, n. (1) a locked door; (2) an open door with pass key; (3) trust; (4) hope.



Cyber Security Threat Management in Outsourcing: The Coming National Security Regulation of ITO, BPO and KPO

Imminent national regulation of Internet-based services will impact all companies that use the Internet for project management, collaboration, and remote transaction processing. Google and China have precipitated a showdown that may cause the extension of a web (!) of national of Internet regulations, with many consequences on the freedom and costs of running a global business or servicing customers remotely. The showdown highlights the fact that cybersecurity threats come from many sources, including foreign nation states, domestic criminals and hackers and disgruntled employees.

On January 12, 2010, Google Inc. announced by blog that it had been the target of concerted attacks from Chinese hackers, that its intellectual property had been compromised and that the attacks targeted the identities of its subscribers. See press release, http://www.sec.gov/Archives/edgar/data/1288776/000119312510005667/dex991.htm . Google’s blog revealed that “at least twenty other large companies from a wide range of businesses—including the Internet, finance, technology, media and chemical sectors” were affected. The Wall Street Journal reported that 34 U.S. companies were targets, including Adobe Systems Inc. and Juniper Networks Inc. Other companies such as Symantec acknowledged they are under constant siege of cyberattacks. Cyber warfare attacks have been reportedly used in Iran to ferret out political dissidents and in Georgia to overload telecommunications during military exercises. China filters Internet content through registration and regulation of Internet services.

Cybersecurity is a critical foundation for any country’s national security and economic security and, indirectly, global trade in IT-enabled services and in the global supply chain. Information networks support financial services, energy, telecommunications, transportation, health care, and emergency response systems, as well as ordinary commerce, employment, education, civil liberties and social and family cohesion. The security of private information networks, such as Google, Yahoo, Symantec and Juniper Networks and the underlying software such as Adobe Systems and Microsoft, are the foundation for today’s global economy.

In global sourcing, cyber security is an essential commitment by anyone business seeking to acquire and be a trusted custodian of personally identifiable information (“PII”). If enterprises (“data controllers” under the European Union Data Protection Directive) are going to gather PII and contract with service providers (“data processors”) to process it, the risk of cyber attacks frames the debate on risk allocation, roles, responsibilities, pricing and process integration.

For all participants in the outsourcing industry, it’s time to fresh look at legal structures and financial implications of cybersecurity.

Existing General U.S. Cybersecurity Laws. Current U.S. legislation and regulations already require cybersecurity compliance, audit, certification and compliance generally. Special cybersecurity mandates arise under the Health Insurance Portability and Accountability Act (“HIPAA”) of 1996, the Sarbanes-Oxley Act of 2002 (“Sox”), state security breach notification legislation and credit card rules applicable to banking transactions (the “PCI rules”). The Computer Fraud and Abuse Act, 18 USC 1030, protects against unauthorized disclosure of most computer data. In addition to securities regulations on insider trading, common law also imposes cybersecurity mandates on lawyers and others receiving confidential financial information. Other cybersecurity rules exist in other legislation:

(1) the Privacy Protection Act of 1980 (42 U.S.C. 2000aa);
(2) the Electronic Communications Privacy Act of 1986 (18 U.S.C. 2510 note);
(3) the Computer Security Act of 1987 (15 U.S.C. 271 et seq.; 40 U.S.C. 759);
(4) the Federal Information Security Management Act of 2002 (44 U.S.C. 3531 et seq.);
(5) the E-Government Act of 2002 (44 U.S.C. 9501 et seq.);
(6) the Defense Production Act of 1950 (50 U.S.C. App. 2061 et seq.);
(7) any other Federal law bearing upon cyber-related activities; and
(8) any applicable Executive Order or agency rule, regulation, guideline.

But there are no laws mandating that small business or individuals adopt cybersecurity standards (other than general rules).

Public and Private Assets: “Critical Infrastructure” and “Protected Systems.” Already, the cybersecurity jurisdiction of the Department of Homeland Security applies to both “critical infrastructure” and “protected systems.” The concept of “protected system” would extend the more restrictive concept of “critical infrastructure” to virtually any private computer network. A “protected system” would mean “any service, physical or computer-based system, process, or procedure that directly or indirectly affects the viability of a facility of critical infrastructure.” It would include “any physical or computer-based system, including a computer, computer system, computer or communications network, or any component hardware or element thereof, software program, processing instructions, or information or data in transmission or storage therein, irrespective of the medium of transmission or storage.” Homeland Security Act, Sec. 212. In short, national security and economic security mean that public and private assets will be managed as one suite of assets at risk.

Special Purpose Legislation: Electrical Grids. According to legislation proposed in April 2009, “According to current and former national security officials, cyber spies from China, Russia, and other countries have penetrated the United States electrical system in order to map the system, and have left behind software programs that could be used to disrupt and disable the system.” Proposed “Critical Electric Infrastructure Protection Act,” H.R. 2195, An Act to amend the Federal Power Act to provide additional authorities to adequately protect the critical electric infrastructure against cyber attack, and for other purposes, 111th Cong, 1st Sess. The proposed law would require the Secretary of Homeland Security, working with other national security and intelligence agencies, to “conduct research and determine if the security of federally owned programmable electronic devices and communication networks (including hardware, software, and data) essential to the reliable operation of critical electric infrastructure have been compromised,” including “the extent of compromise, identification of attackers, the method of penetration, ramifications of the compromise on future operations of critical electric infrastructure, secondary ramifications of the compromise on other critical infrastructure sectors and the functioning of civil society, ramifications of compromise on national security, including war fighting capability, and recommended mitigation activities.” Preamble. In short, the new law (if enacted) would amend the Homeland Security Act of 2002 (6 U.S.C. 133(i)) to require special studies to “ensure the security and resilience of electronic devices and communication networks essential to each of the critical infrastructure sectors.”

Pending General Cybersecurity Legislation: Cybersecurity Act of 2009. In April 2009, Sen. Jay Rockefeller (D., W. Va.) introduced a draft Cybersecurity Act of 2009, S 773, 111th Cong., 1st Sess. The bill’s long-form name is “An Act To ensure the continued free flow of commerce within the United States and with its global trading partners through secure cyber communications, to provide for the continued development and exploitation of the Internet and intranet communications for such purposes, to provide for the development of a cadre of information technology specialists to improve and maintain effective cyber security defenses against disruption, and for other purposes.” The draft focuses on the commercial impact of cyber espionage: “Since intellectual property is now often stored in digital form, industrial espionage that exploits weak cybersecurity dilutes our investment in innovation while subsidizing the research and development efforts of foreign competitors. In the new global competition, where economic strength and technological leadership are vital components of national power, failing to secure cyberspace puts us at a disadvantage.” S. 773, Sec. 2 (2). The drafters warned that the nation is unprepared for “a massive cyber disruption [that] could have a cascading, long-term impact without adequate co-ordination between government and the private sector.” S. 773, Sec. 2 (6).

Cybersecurity Advisory Panel. The draft law contemplates the appointment of a panel of advisors to include “representatives of industry, academic, non-profit organizations, interest groups and advocacy organizations, and State and local governments who are qualified to provide advice and information on cybersecurity research, development, demonstrations, education, technology transfer, commercial application, or societal and civil liberty concerns.” S. 773, Sec. 3(b)(i).

Cybersecurity Dashboard. The bill would also “implement a system to provide dynamic, comprehensive, real-time cybersecurity status and vulnerability information of all Federal Government information systems and networks managed by the Department of Commerce.” S. 773, Sec. 4.

Cybersecurity Institute. Under the bill, the Secretary of Commerce would provide assistance for the creation and support of “Regional Cybersecurity Centers” for the promotion and implementation of cybersecurity standards. Each Center would be affiliated with a United States-based nonprofit institution or organization, or consortium thereof, that applies for and is awarded financial assistance. Such centers would seek to enhance the cybersecurity of small and medium sized businesses and industrial firms in United States through the dissemination and transfer of cybersecurity standards, processes, technology, and techniques developed at the National Institute of Standards and Technology (“NIST”). www.nist.gov. S. 773, Sec. 5(a). This approach reflects other draft legislation, such as the Cybersecurity Enhancement Act of 2009, HR 4061, 111th Cong., 1st Sess., for cybersecurity research, development, education and technical standards for identity management technologies, authentication and security protocols, expanding on the existing Cyber Security Research and Development Act (15 U.S.C. 7401).

Licensing of Cybersecurity Professionals. The draft law would require a national licensing, certification, and periodic recertification program, under the aegis of the Department of Commerce, for cybersecurity professionals (defined as “providers of cybersecurity services”). Such licensing would effectively submit all outsourcing service providers to U.S. federal jurisdiction and enforcement of cybersecurity compliance standards. S. 773, Sec. 7.

Federal Standards. Within a year after enactment, the NIST would be required to “establish measurable and auditable cybersecurity standards for all Federal Government, government contractor, or grantee critical infrastructure information systems and networks.” These would include standards for

(1) security controls that are known to block or mitigate known attacks;
(2) the software security, including a separate set of such standards for measuring security
in embedded software such as that found in industrial control systems;
(3) standard computer-readable language for completely specifying the configuration of
software on computer systems widely used in the Federal Government, by government
contractors and grantees, and in private sector owned critical infrastructure information
systems and networks;
(4) standard configurations for security settings for operating system software and software
utilities widely used in the Federal Government, by government contractors and grantees,
and in private sector owned critical infrastructure information systems and networks; and
(5) sniffer standards to identify vulnerabilities in software to enable software vendors to
communicate vulnerability data to software users in real time.

The NIST would establish a standard testing and accreditation protocol for all software built by or for the Federal Government, its contractors, and grantees, and privately owned critical infrastructure information systems and networks. The testing would occur during the software development process and on acceptance prior to deployment of software.

International Standards. The draft Cybersecurity Act of 2009 would require the U.S. to participate in setting international standards for cybersecurity. But it stops short of any hope for an international law on cybersecurity. It does not call for a convention on cybersecurity. Certainly any negotiations for such a convention could lead to a “least common denominator” of weak standards and political excuses. In light of the impact on trade in services, certainly cybersecurity would be a subject that might fall under the mission of the World Trade Organization, www.wto.org, or the Organization for Economic Development, www.oecd.org. As it is, the International Standards Organization, www.iso.org, would be the probable forum for any such discussions. Also, the bill would require the President to “work with representatives of foreign governments” to develop norms, organizations, and other cooperative activities for international engagement to improve cybersecurity and to encourage international cooperation in improving cybersecurity on a global basis. S. 773, Sec. 21.

Further Legislation. The United States already has several laws governing cyber security. The draft Cybersecurity Act of 2009 would require the President to review and propose changes in existing cybersecurity laws.

“Pulling the Plug” on Impaired Cyber Infrastructure. The Cybersecurity Act would set up a framework for national regulation of the Internet, which currently is controlled by ICANN, a California-incorporated non-profit organization. www.icann.org. One of the most controversial provisions in the bill would allow the President to shut down the Internet during a time of crisis. The President would be authorized to declare a cybersecurity emergency and order the limitation or shutdown of Internet traffic to and from any compromised Federal Government or United States critical infrastructure information system or network. S. 773, Sec. 18(2). The President “may order the disconnection of any Federal Government or United States critical infrastructure information systems or networks in the interest of national security.” S. 773, Sec. 18(6). This police power would be generally without judicial review.
Insurance and Risk Disclosure and Mitigation. The bill invites Presidential reports to Congress on ways to manage commercial risks of cyber attacks. Such reports would seek to identify the feasibility of:

(1) creating a market for cybersecurity risk management, including the creation of a system
of civil liability and insurance (including government reinsurance); and

(2) requiring cybersecurity to be a factor in all bond ratings. Sec. 15.

Identity Management; Identity Theft; Civil Liberties. The bill requires the President to present a report on the “feasibility of an identity management and authentication program, with the appropriate civil liberties and privacy protections, for government and critical infrastructure information systems and networks.” This provision creates a balance between national security and civil liberties guaranteed by the Constitution.

Investment in Security. The current appropriations bill for the Department of Homeland Security, for the fiscal year ending September 30, 2010, contemplates a small budget for infrastructure security on the scale contemplated in the draft Cybersecurity Act. See, Pub. L. 111-83, H.R.2892, Department Of Homeland Security Appropriations Act, 2010, 111th Cong., 1st Sess. (Oct. 28, 2009).

Implications for Outsourcing.

New Opportunities for Outsourcing of Cybersecurity. As cybersecurity becomes more complex, new opportunities will emerge for service providers that deliver protected processes complying with new regulatory standards.

Industry Sectors; “Verticals.” Outsourcing services (including shared service centers and captive processing centers) manage many “critical infrastructures” that are essential to national security and economic security. Certain sectors are generally included in the definition of “critical infrastructures”: banking, financial services and insurance (“BFSI”), public utilities (water, telecommunications, transportation, oil and gas and electricity supply), emergency services and government. See John Motoff and Paul Parfomak, “Critical Infrastructure and Key Assets: Definition and Identification,” Cong. Research Service (Oct. 1, 2004), http://www.fas.org/sgp/crs/RL32631.pdf. The current statutory definition (established in the USA PATRIOT Act of 2001, Sec. 1016(e) and referenced in the Homeland Security Act of 2002) states:
Systems and assets, whether physical or virtual, so vital to the United States that the
incapacity or destruction of such systems and assets would have a debilitating effect on the
security, national economic security, national public health or safety, or any combination of
those matters.

Under this sweeping definition, virtually all of outsourcing and the economic supply chain of goods and services could be seen as a “critical infrastructure” for regulation, protection and ultimately potential control by the federal government for purposes of security of the government, economy, health and safety.

Covered ITO and BPO Service Providers. The Cybersecurity Act of 2009 would apply new standards to government contractors and grantees and private sector “critical infrastructure systems and networks.” However, in due course, such standards could be applied to all “protected computers” and private computers as well.

Vendor Selection. By adopting national cybersecurity standards, any new federal legislation would impact the selection of competing outsourcing vendors, based on compliance and risk assessments. Smaller vendors, that might comply today with ISO 27000 but not the PCI credit card security standards or any new federal cybersecurity standards, might not be competitive. Their market value might decline, and their selling prices in an acquisition might be lower on the basis of earnings multiples or other valuation metrics.

National Regulation of Cybersecurity. In short, all business and personal computers would be “protected systems” subject to national security protections, including registrations, licensing, compliance and verification. It is clear that the draft law would superimpose itself on all outsourcing contracts that involve the use of any computers. In short, it would apply to all sourcing contracts.

Allocation of Risk for Compliance with Applicable Law. Generally, outsourcing contracts require service providers (including software developers and IT infrastructure support providers) to comply with applicable U.S. law. The draft Cybersecurity Act of 2009 would be implicit in all applications development and maintenance contracts. It would apply to software developed outside the United States.

Extraterritorial Application of National Laws. Currently, the United States and other countries have laws intended to regulate conduct of persons outside their borders that have an impact inside their borders. Such extraterritorial laws include the Foreign Corrupt Practices Act, the Export Administration Act and the International Trade in Arms Regulations. Outsourcing service providers already are expected to comply with such legislation. Service providers should anticipate the extension of national cybersecurity regulation to their operations outside the United States (and other countries where outsourcing customers receive the services). Further, the U.S. Homeland Security department might conduct inspections on foreign territory, subject to local governmental authorization, similar to historical inspections conducted by the Federal Aviation Administration for maintenance and repairs done abroad to U.S. registered aircraft.

Reciprocity between Governments. Protecting outsourcing as an economic process will require governments to collaborate on cybersecurity management. One can easily foresee a new dialogue between the U.S. government and the Government of India, a key source of talent for software development, ITO and BPO, for the mutual adoption of cybersecurity standards, registration, licensing and compliance procedures. A similar dialogue may eventually arise with China, which hopes to promote its technology centers and “software technology parks” as centers of excellence and sources of employment for engineers servicing non-Chinese global enterprises. Similarly, cybersecurity “best practices” are likely to evolve under the aegis of the OECD for economic regulation and NATO for military use.

For related topics:

Privacy, Data Protection and Outsourcing in the United States