EXPLOIT DERIVATIVES & NATIONAL SECURITY

ABSTRACT Critical infrastructures remain vulnerable to cyber attack despite a raft of post-9/11 legislation focused on cyber security in critical infrastructures. An emerging discipline known as the "economics of information security" may provide a partial solution in the form of a hypothetical market that trades "exploit derivatives," a modified futures contract tied to cyber security events. This paper argues that such a market could serve to predict and prevent cyber attacks through the operation of the efficient capital market hypothesis, but only after changes to the present regulatory environment. Specifically, I argue that a statutory safe harbor would allow the creation of a pilot market focused on vulnerabilities in Internet protocol version six, an emerging communications standard that China hopes to deploy throughout its national network before the 2008 Olympics. Indeed, such a safe harbor would align the interests of military and civilian policymakers on the common goal of protecting critical infrastructure from a computer network attack originating in China, whether instigating by the People's Liberation Army or so-called "black-hat" hackers. TABLE OF CONTENTS INTRODUCTION I. SECURITY VULNERABILITIES ARE NEGATIVE EXTERNALITIES A. THE IDEAL MARKET B. EXISTING TRANSACTION COSTS C. THE MILITARY AS THE FIRM: THE PENTAGON'S EXTERNALITY SOLUTION D. SECRECY AS A TRANSACTION COST AND A REGULATION II. VULNERABILITY MARKETS LOWER TRANSACTION COSTS A. BUG CHALLENGES B. VULNERABILITY BROKERS C. CYBER INSURANCE D. EXPLOIT DERIVATIVES III. EXISTING LAWS INHIBIT VULNERABILITY MARKETS A. DMCA B. TRADE SECRETS C. FEDERAL CRITICAL INFRASTRUCTURE STATUTES IV. INTERNET PROTOCOL VERSION SIX AS A PILOT PROGRAM CONCLUSION INTRODUCTION September 11th inspired a host of regulations and government entities focused on what the Pentagon calls "computer network operations," or CNO. (1) The USA PATRIOT Act of 2001 created the National infrastructure Simulation and Analysis Center at Sandia National Laboratories to model large-scale cyber attacks on "critical infrastructure." (2) A year later, Congress passed the Cyber Security Research and Development Act (3) ("CSRDA") to fund "computer and network security research and development." (4) Two weeks after CSRDA went into effect, the President signed the Homeland Security Act of 2002, creating the Department of Homeland Security ("DHS") and its Directorate for information Analysis and Infrastructure Protection. (5) The Federal Information Security Management Act of 2002 ("FISMA") in turn established a statutory regime for protecting information systems in civilian federal agencies. (6) Following the release of the National Strategy to Secure Cyberspace, (7) DHS and Carnegie Mellon partnered to form the United States Computer Emergency Readiness Team ("US-CERT"), a center that "analyzes incidents reported by federal civilian agencies and coordinates with national security incident response centers in responding to incidents on both classified and unclassified systems." (8) Given such an abundance of legislation, a political novice might believe that Congress solved all of America's cyber security problems. It seems, however, that the road to lackluster critical infrastructure protection is paved with regulation. Despite FISMA, malicious software ("malware") (9) "continues to threaten the secure operation of federal information systems" due to the increasing sophistication of cyber attacks and inadequate protection of network security software. (10) A sustained computer network attack originating in China continues to target the United States government's information systems with almost seven years of unabated activity and little means of defense. (11) A 2002 war game on critical infrastructure revealed that the most vulnerable infrastructure components were the internet itself and the computer systems that underpin the financial sector. …