We all talk about the importance of data as business assets, but when it comes to buying and selling the companies that own them, we seem not to pay much attention. My anecdotal survey reveals that colleagues who focus on mergers and acquisitions confess to a lack of focus on trade secrets.
This may seem odd, even crazy, given the increasing percentage of industrial property represented by intangible assets—up from 17% in 1975 to 84% in 2015. The problem appears to start with the fact that secret information, no matter how central to the success of the business, is mysterious. Unlike the “registered rights” of patent, copyright and trademark, there are no government certificates defining secrets; and valuing them is hard. Add to that the imperative to get deals done faster and cheaper, and it’s easy to see how secrecy may have become the blind spot of transactional IP.
And there are plenty of opportunities to miss things. The statistics for 2018 reflect 49,000 M&A deals worldwide, accounting for $3.8 trillion (yes, trillion) in cumulative value. Given what we know about the extent to which industrial assets are intangible, and given the well-known preference for using secrecy to protect innovations, we would expect that the “due diligence” review for most transactions would include an intense examination of the target company’s trade secret assets and liabilities.
But that’s not what’s happening. I have spoken to quite a few lawyers who participate in this work, and have also reviewed dozens of due diligence “checklists” they typically use to guide their investigations. In many cases I was surprised to learn that trade secrets are not even on the list, crowded out by the “registered” IP rights—patents, trademarks and copyrights—that can be counted and (presumably) more easily valued. And where trade secrets are included, it tends to be a cameo appearance, usually just a note to ask the company how it protects its proprietary information from disclosure. Sometimes, I was told, the “momentum” of a deal leads to a reduction of even these minimal inquiries.
Inattention can have serious consequences. For the target of an acquisition, there is the almost existential risk of exposing core secrets to a suitor who ultimately walks away from the deal and goes into direct competition. But the potential buyer also faces a broad array of hazards, including exposure to information that could compromise its own internal development, failure to uncover liabilities from access to third party data, and ultimately a lack of preparation for the post-closing integration of different confidentiality cultures and processes.
Let’s first consider the target company. It may seem strange, but the target’s first priority should be the risk of success: if the deal goes through, it will have to provide very extensive “reps and warranties”—essentially, guarantees about the security of its information assets and freedom from third-party claims. The target needs to start preparing for this moment early in the process, by revisiting its trade secret protection program as well as its compliance with outstanding nondisclosure agreements (NDAs).
And then there is the more classical risk of the acquirer abandoning the deal after having had a close look at the target’s secret technology, strategies and other data. The best way to address this risk is through what I call progressive incremental disclosure: starting with a non-confidential exchange, and then working gradually through increasingly sensitive information as trust and confidence build. Ultimately, the target needs an NDA with maximum protections, including a broad definition of confidential information and protection for verbal disclosures. Beware of time limits and exceptions like the “residuals clause” (see below).
For the potential acquirer, the primary objectives are to keep options open and avoid unnecessary contamination by the target’s data. That risk is particularly fraught when the company already has an internal development program in place and is going to the market to consider alternatives. The biggest mistake is to include in the deal team people who are also involved in the internal project. Some situations are so sensitive that the potential acquirer may hire a third party to do the due diligence and provide only recommendations, without revealing any of the target’s technology.
The ideal NDA for the suitor is different than for the target, and that initial contract should be very carefully considered and negotiated. To limit administrative burden, obligations of confidentiality should expire after a set time. Verbal disclosures of the target’s secrets, if not forbidden, should be subject to a strict documentation requirement. And where the company has enough leverage, it should insist on a “residuals clause” that allows any use of the target’s information that is “retained in the unaided memory” of the individual participants after all the documents have been returned.
Once confidentiality obligations have been settled, due diligence can begin in earnest. And at least as to trade secrets, this needs to be more than a box-checking exercise. What are the target’s most valuable data assets, how vulnerable are they, and what has the company been doing about that vulnerability? Deploying cybersecurity controls is good but only addresses a fraction of the problem, since the vast majority of losses occur through employees or contractors, or through trusted external relationships. Systems and procedures for managing information risk need to be thoroughly examined.
All of this learning informs not just the decision whether or not to acquire the target company, but also the inevitable challenges that will confront the acquirer after closing the deal, as it attempts to integrate a new group of colleagues who may have been operating under a very different confidentiality regime, or perhaps none at all. The transition plan should account for the policy and process gaps discovered during diligence together with a robust training program to reinforce the new access and security regime.
Participants in the M&A mating dance should not let their enthusiasm for the deal get in the way of a clear understanding of the assets being acquired. There are more than enough business risks to go around, and secrecy management can always be improved. But you have to pay attention to it.
"When I use a word, it means just what I choose it to mean, neither more nor less."
— Humpty Dumpty (to Alice)
It seemed like a trade secret trifecta when Congress in 2011 passed the America Invents Act (AIA). Although the statute was aimed at patent reform, it made three helpful changes in how trade secrets are treated. First, companies could hold onto secret information about an invention without risking invalidation of their patents for failing to disclose the “best mode” of implementing it. Second, the “prior user right” that guarantees continuing use of a secret invention, even if someone else later patents it, was extended to cover all technologies. And third, the law would no longer deny a patent simply because the inventor had already commercialized the invention in a way that didn’t reveal it to the public.
Or so we thought. That last change depended on how you read the legislation. The long-standing requirement that an invention could not be “on sale” or “in public use” more than a year before filing a patent application was still there. But Congress added a qualifier to 35 U.S.C. §102: there would be no patent if the invention had been “in public use, on sale, or otherwise available to the public . . . .”
Before the AIA, the courts were strict about the consequences of choosing trade secret protection over patents. If the inventor used the invention for commercial purposes, the patent clock started ticking, even if the use was behind closed doors and did not inform the public about the invention itself. The same was true of a commercial sale of a product that used the invention, even though the contract of sale was confidential. The only real exception was for “experimental use” to refine the invention before it became ready for patenting. But even getting a prototype tested under a nondisclosure agreement could fail to qualify if there were other terms implying commercialization, like payment to the inventor.
The logic behind this interpretation of “public use” was explained eloquently by Second Circuit Judge Learned Hand in Metallizing Engineering Co. v. Kenyon Bearing & AP Co., 153 F.2d 516 (2d Cir. 1946). An inventor may indefinitely “practice his invention for his private purposes of his own enjoyment and later patent it.” However, once an invention is “ready for patenting” the inventor may not “exploit his discovery competitively” for more than the one-year grace period; otherwise “he forfeits his right regardless of how little the public may have learned about the invention.”
The insertion in the AIA of the phrase “or otherwise available to the public” indicated that Congress intended to change this rule and to provide that only uses or sales that informed the public of the invention would bar a patent. This seemed apparent just from normal standards for interpreting English, in which “otherwise” should be understood to refer to the terms coming before it. In addition, during consideration of the legislation, sponsors of the bill had taken the floor of the Senate to express their views that the new phrase would have the effect of limiting patent forfeiture to situations where the public had been informed of the invention and not just enjoyed its outputs.
Most commentators (myself included) embraced this interpretation of the AIA. And so did the U.S. Patent and Trademark Office (USPTO), which in its official regulations concluded that new section 102 “does not cover secret sales or offers for sales.” It seemed as though companies considering patenting would be able to engage in a variety of transactions to bring the benefit of their innovations to the public without risking their right to patent, so long as they didn’t publicly reveal the specifics of their invention.
Alas, assuming this is what Congress intended, they weren’t clear enough about it. In a case that tested the assumptions of the IP community, the Supreme Court recently decided that the law on public use and sale had not changed with the AIA. In Helsinn Healthcare v. Teva Pharmaceuticals, the owner of a new drug gave exclusive marketing rights to another firm, more than a year before applying for a patent. The agreement itself was publicly announced, but the dosage information claimed in the patent was kept confidential. Although something like a “sale” had taken place, the invention had not at that point been “available to the public.”
No matter, said the Supreme Court. Citing to its opinions going back as early as 1829, the court emphasized the significance of a public “sale” that effectively put the invention in commerce and beyond the ability of the patent system to pull it back. Judicial decisions about public use and sale never required that the invention itself be revealed to the public; and such a long-standing and clear interpretation could not be overturned by the “oblique” language of the AIA.
So where are we now? First, it’s still true that trade secret protection received a big boost from the AIA, through its changes to the “best mode” doctrine and the broad extension of prior user rights, which allow a company that had been practicing an invention in secret to keep using it in spite of a later patent (so long as the location and scope of use don’t change). These amendments removed a significant amount of the “trade secret anxiety” that had been created by patent law.
Basically, companies are free to classify and protect information assets through secrecy, even if the information closely relates to a patented invention, without fear that their patent will be invalidated. And by choosing to use secrecy rather than patenting to protect their innovative technology, executives can still sleep soundly knowing that a later patent can’t block them from continuing to use that technology.
But what about those “secret sales” and “public uses” that aren’t fully public? What can be done to stay out of trouble as the enterprise moves from invention to commercialization? How can you preserve your option to choose between secrecy and patenting as you get closer to market introduction?
One general piece of advice is to file for a patent at the earliest time. (Your patent lawyer can help you decide when an invention is “ready for patenting.”) The AIA was designed to encourage and reward early filing, and one of the best ways to keep your options open is to file a provisional patent application. That application, and the non-provisional application that follows it, remain unpublished for 18 months, giving the business time to consider the relative advantages and drawbacks of a patent over a trade secret, as well as the scope of what might go into a patent and what might be kept out. At any time during the 18-month period the application can be pulled and the information maintained in secret.
Key to avoiding patent forfeiture is to focus on the role of third parties in the process of commercializing your product. This is especially tricky for smaller companies, which can’t always afford to optimize the innovation in-house but have to depend on outsiders to test and improve it. Here, the good news is that you are in control of the risk, so long as you are keenly aware of it. To claim the benefit of the “experimental use exception,” make sure that your external testing programs are focused only on refining the product, not getting paid for it. And require that all participants sign strong nondisclosure agreements.
As your company builds and executes its go-to-market plan, you will often want to sign up distributors, resellers and other partners ahead of a product launch. There’s nothing wrong with that in the abstract, but you need to pay attention to how those transactions might affect your right to file a patent on an important invention. Even if no product has actually changed hands, you might have engaged in a “sale.” And even if no one else knows the still-secret invention you want to patent, your use of it may be deemed “public.”
Yes, this stretches the logic inherent in English grammar. But what can I say? It’s the law.
"I am willing to put the case into any shape you choose."
— Lord Ellenborough, 1816
It’s a challenge to resolve business disputes when emotions run high, which includes almost all trade secret cases. So, I was especially pleased when, in a hard-fought litigation where I had been appointed as a “referee” to resolve discovery disputes, both lawyers eventually reached out to tell me how much they appreciated my involvement in the case, which had settled.
What was it about this variation on typical legal combat—where a private party is selected to rule on some important aspects—that they found so satisfying? First, they had saved their clients a lot of time, and probably money, compared to the cost of dealing with unpredictable court calendars. And second, they felt that the decisions they received were thoughtful, balanced and practical, reflecting an understanding of the relevant business environment.
So-called “private judging” can be particularly useful in trade secret cases between companies. Confidential information of both sides can be more reliably protected. Important context gets the attention it deserves, which is often just not possible for a judge who handles a caseload of several hundred matters. And decisions can be informed by the special background and experience of the person selected to do the job.
The most popular way of getting more streamlined resolution is arbitration, in which the dispute is handed over to a trusted private party hired to hear the evidence and render a decision. A major advantage of arbitration is that it is completely private. When the dispute involves exchanging important confidential information of both companies, this feature can be compelling.
Arbitration also allows the parties to pick the decision-maker, rather than take their chances with the court system. This is about more than just choosing a reliable and experienced former judge or senior lawyer. You can select for specific attributes like industry or technical background, or specialty in an area of law. And whoever is chosen, the arbitrator will be able to devote substantially more time and attention to the matter than the typical judge.
So why don’t companies in trade secret disputes always choose arbitration? There are some systemic drawbacks. One of those is that the decision of the arbitrator (or panel of three arbitrators) is almost always final, without the possibility of meaningful review through the court system. While that expediency can be an advantage in many cases, it also can create risks in trade secret disputes, where the range of possible outcomes can be large and unpredictable.
In one recent case from Texas, an arbitrator awarded $6 million to the founder of a company who had invested only a small fraction of that amount. On appeal from that decision, the court explained that it was powerless to do anything about it, even if the arbitrator had been mistaken about the law.
Besides offering only limited review of decisions, arbitration also typically restricts the kind and amount of available discovery—that is, the ability to get information from the other side in advance of trial. This can be a serious problem for a trade secret owner. Misappropriation rarely happens in broad daylight, and usually the facts are known only to the defendant. Although reasonable suspicion of theft is enough to make a claim, the plaintiff usually needs discovery from the defendant in order to prove what actually happened.
Whether because of this asymmetry of available proof, or some other aspect of arbitration that both sides find wanting, seldom do both companies in a trade secret dispute agree to arbitrate if their contract doesn’t require it. It is just too difficult to identify a mutual interest once a major disagreement emerges. Instead, one side or the other (and occasionally both) sees it to their advantage to stick with litigation.
But even within the framework of existing court procedures, there may be some opportunities to enhance efficiency in the interests of both sides. For example, in the case that I referred to at the beginning, I was acting as a “discovery referee” (also known in some courts as a “special master”). Basically, the judge in the case, with the approval of the parties, had outsourced the management of all pre-trial disputes over the exchange of information: document requests, depositions and the like. As with arbitration, private referees have more time to consider those specific disputes and to propose a resolution to the judge. Although more costly than using normal court procedures, a referee can move the discovery process much more quickly and efficiently, which is usually in the interest of both companies.
Several states, most notably California, even allow an entire civil case to be handled through trial by a private person, usually called a temporary judge, whose ruling can be appealed through the court system just like any other case. Unlike arbitration, however, this form of judging is private only in the sense that you get to pick (and pay for) the decision-maker; all the filings and hearings will be subject to the same rules on public access as apply to the courts.
The vast majority of trade secret disputes are resolved by an agreement of the parties, without a trial. In an upcoming article, we’ll look at the most effective way to make that happen: mediation, in which an experienced professional helps the combatants find success, often in ways they never would have discovered on their own. Mastering mediation is an art of its own.
It’s football season, so of course we should be talking about beer. Specifically, beer secrets. For fourteen years James Clark had an enviable job at Anheuser-Busch, where he had access to the brewer’s confidential recipes. For unexplained reasons he resigned. Instead of joining a competitor, he went to see a lawyer about planning a class action against his former employer for “intentionally overstating the alcohol content” of the company’s “malt beverages.”
Building his case would be a problem, however, without a copy of something mysteriously called “Page 13.” Having neglected to take this document with him when he left, he contacted a friend still working at Anheuser-Busch, who readily passed it on, even though it was obviously top secret. Apparently alerted to the disclosure, the company demanded that Mr. Clark certify, as required by his contract, that he had not used or disclosed any confidential information. He refused, and a few days later the class action lawsuit was filed. A week after that, Anheuser-Busch sued him for misappropriation of its secrets for making beer.
There are multiple ways we could now turn with this story. There’s the history of beer, which goes back over five thousand years, beginning with a wet and presumed ruined grain cellar that fermented into a happy ending. There’s the difference between corporate and craft beers. And then there’s the high cost of lawyers relative to beer.
But instead we’ll focus on civil procedure. Mr. Clark filed a motion to dismiss the company’s lawsuit, in effect suing them for suing him. This turnabout is called an “anti-SLAPP” motion, based on a California statute enacted in 1992. The law, which stands for Strategic Litigation Against Public Participation, was intended to punish those who file frivolous, but expensive, suits for the sole purpose of intimidating and silencing critics. A legitimate goal, you might say, since it protects freedom of speech. But then the First Amendment also guarantees the right to petition the government, including by filing litigation. So the legislature crafted a long, carefully worded set of instructions to judges, expecting that this would strike the right balance between competing interests.
But as happens so often, a higher law – that of unintended consequences – intervened. It turned out that far too many legitimate lawsuits were being shut down. So the legislature added a new law to cut back on the original. And then it layered on another a few years later, so that in addition to anti-SLAPP motions, we now have “SLAPPbacks” through which the frustrated plaintiff can recover its damages and fees against an over enthusiastic SLAPP-er.
Mr. Clark’s case has wound its way twice to the Ninth Circuit Court of Appeals, which is now considering whether Anheuser-Busch opposed his motion with sufficiently strong evidence that it actually had trade secrets for making beer.
In the meantime, Texas followed the lead of California and enacted its own anti-SLAPP law, called the Texas Citizens Participation Act. It applied to any lawsuit that seemed to target not just a person’s free speech, but also their constitutional right of association. In one notable case, a high-end restoration shop called Elite Auto Body sued former employees who formed a competing company, allegedly taking with them “proprietary client forms, such as payment sheets and vehicle check lists,” and unfairly using confidential information to recruit other employees. These allegations, the defendants argued, invoked their right of association among themselves and to speak freely during their recruiting.
The trial court denied the anti-SLAPP motion, but the appellate court reversed, holding that the TCPA applies in any action that involves “communications,” and that it requires the plaintiff to prove the substance of its claims – the misuse of its proprietary information – by “clear and specific evidence.” Here, the former employer, with no opportunity to take discovery, fell short. The action was dismissed and the plaintiff ordered to pay the defendants’ attorneys fees.
Cases like these are a reflection of the struggle in trade secret law to balance legitimate competing interests. For every employer that has invested in developing proprietary techniques to improve its business, there are employees that have accumulated skills on the job and would like to use them elsewhere. When they leave, the risk of disclosure or misuse may be high, but as a society we not only want to protect investment in innovation, but we also value a freely mobile workforce.
When I arrived at law school in 1970, the Freedom of Information Act was only a few years old. It was supposed to increase public understanding of the workings of government by providing access to records. But the vast majority of requests for information come not from ordinary individuals, but from lawyers representing the competitors of companies who have been required to file confidential information with agencies. Those agencies need the information to do their job, and FOIA has arguably made some companies reluctant to share data with the government.
Tensions abound in the courtroom too. We need a place to resolve disputes over trade secrets; but how can we do that when the courts are supposed to be open to the public? In cases of broad interest, like regulated industries, what should we be doing to protect the public’s right to know through media access? And what about trade secret injunctions? It’s not just departing employees or whistleblowers that need protection from overreach; sometimes the public does too. In one case a judge had to consider whether to shut down an ambulance service that was operating unfairly but was also relied on by a hospital.
Judges frequently have to weigh in the balance diametrically opposed but valid interests. Although this is true in many other areas, it seems woven into the fabric of trade secret law. We should be thankful that our independent judiciary does such a good job dealing with these conflicts and finding thoughtful, fair resolutions.
I’m sure that many people find it exciting to read about U.S. college athletics, although it’s hard to imagine how that could result in any trade secrets. But consider this: Andy Bitter, a former sports journalist covering the travails and triumphs of the Virginia Tech football team, was recently sued by his former employer, a local newspaper, for trade secret theft. The violation? Refusing to turn over the login and password for his Twitter account when he left.
Never mind that the account had been given to him by a previous writer and that he had renamed it “@AndyBitterVT” to reflect his personal devotion to Virginia Tech. According to the plaintiff Roanoke Times he was obligated by the company’s employee handbook to turn over all company property, and this necessarily included the Twitter account he had used to stay in touch with his fans (more precisely “followers” of which he had about 17,000). The information associated with the account was alleged to be worth $150,000. (One fellow journalist, commenting on the story, wondered out loud how a sportswriter’s tweets about a single college team could be “worth as much as a small yacht.”)
As often happens in trade secret cases, it seems that the plaintiff didn’t think this one through before filing. After all, they call it “social” media because people tend to form communities of interest online, and those who had signed up to follow Mr. Bitter’s commentary on their favorite football team were pretty unhappy about how he was treated by his former bosses. One of the scores of reader comments to stories about the lawsuit read, “You guys are out of your minds. I follow Andy Bitter, not you.” Subscription cancellations followed.
In spite of the mess it created, the Roanoke Times has reminded us of some important questions for industry in the information age. Who owns social media accounts? What role do they play in building competitive advantage? And how should companies manage their use?
In ancient times (that is ten years ago, before Facebook, Twitter, LinkedIn and the like), businesses could control their own messaging to the public, through advertising and public relations firms. Social media, like other aspects of the internet, disrupted and “disintermediated” this structure, allowing not just traditional journalists but everyone else with a computer or smartphone to step out in public and (occasionally) be heard. Companies (and a few politicians) recognize the advantage of this direct marketing opportunity and have jumped on the bandwagon with their own accounts and campaigns.
But then there are the hundreds of millions of individual accounts, including in the hands of employees. What new challenges do employers face as a result?
One of the biggest threats is to corporate information security. Social media companies have succeeded, through incessant and automated behavioral conditioning, in convincing an entire generation of workers that sharing is a good thing. And sharing more is even better. That is what many employees do in the evening on their smartphones: reveal everything about what is going on in their lives.
And then we expect them to come into the office the next morning and use those same devices – which by the way are connected to the company’s networks and databases – with mature, sober discretion? If someone wants to brag, why not talk about the cool (but unannounced) product they’re working on? If they want to complain, why not troll management (anonymously of course) for its blunders? And if an engineer faces a knotty technical problem on a project, why shouldn’t she just post a description to a Facebook group where other engineers can see it and offer suggestions?
The inclination toward sharing, reinforced constantly by social media, represents a serious challenge that can only be addressed through training and consistent management, providing the antidote of a culture of confidentiality. Click here to read my October 2016 newsletter about training, “The Most Cost-Effective Way You Can Protect Your Trade Secrets?”.
But getting back to the more specific set of problems reflected in the litigation filed against Mr. Bitter, the good news is that managing these accounts, and separating the personal from the corporate, is straightforward. It begins with establishing and communicating a company policy about the use and ownership of social media. Accounts created by the company, which can be usefully deployed for sales and marketing purposes and to enhance the company’s image, should be designated and named appropriately, with control over credentials and content just as with company networks and data.
It may be best simply to prohibit employee use of personal accounts for any company business. But if you allow it, employees should be obligated by contract to provide access and to transfer ownership and control when asked, or at termination.
Employees and contractors who are employed to create content need special attention, to ensure that what they do for you is designated a “work for hire” and that they have agreed to assign to the company all rights to the content.
A word about managing the risk of new hires. In addition to getting the usual assurances that they will not bring to the job any information that doesn’t belong to them, you may want to inquire about whether they intend to use any pre-existing social media accounts to help them in their new assignment.
As for suing departing employees over their Twitter accounts, be careful what you ask for. In addition to provoking the rage of many of his followers, the Roanoke Times was just countersued by Mr. Bitter for defamation. Remember, the emotionalism that drives trade secret litigation can take it in unpredictable directions.
The Journal spoke with Jim, who shared his thoughts on the importance of trade secret protection in the global economy and how the Defend Trade Secrets Act (DTSA) has affected this practice area in the two years since it was signed into law. The following is an excerpt from the discussion.
Thank you for joining us, Jim. Can you give us a little background about where you grew up and whether there were any signs in your childhood that indicated an interest in intellectual property law?
I grew up in Wilmington, Delaware, where I think everyone in the community was affected to some degree by DuPont and the chemical industry. But I wasn’t very interested in science myself. I've frequently told people that my high school teachers would be very amused to find out what I've been doing as an adult.
I loved college geology because it got me outdoors, but the chemistry of it was a challenge. So, there wasn't anything about my upbringing that anticipated what I ended up doing. I was just very lucky to have landed in Palo Alto, CA, in the early 1970s after law school.
What would your classmates most remember about you from high school?
Well, they probably would remember me mostly as a Boy Scout. That was my main activity.
They would also remember me because my buddies and I created a feature-length movie our senior year. We went out and rented a camera and bought some 16-millimeter film and did a kind of James Bond spoof built around the school. It was a ton of fun.
Since then, you have developed world-renowned expertise in trade secret law. How did you decide to specialize in this area of law?
I certainly didn't plan that. I arrived in Palo Alto in the summer of 1972, having received a summer-job offer from an 11 lawyer firm, which is now Wilson Sonsini.
As Silicon Valley was developing, people were often leaving one company and moving to another, and very frequently, there were lawsuits against the people who left to do these startups. There weren’t so many lawyers around Palo Alto at that time, so I ended up working on these trade secret lawsuits simply because I was there, and I was a trial lawyer working with companies where these issues came up a lot.
After I had been doing this about seven years, I noticed that there was a common theme to every one of these cases, which was that someone had done something really dumb. And so it occurred to me that if people understood the basic rules of the road in leaving one company to go to another, and respecting the integrity of the trade secrets that they'd left behind, these lawsuits just wouldn't happen anymore.
Working with a publisher that I met on one of my cases, I decided to write a book on trade secrets, which was published in 1982, and six weeks later, a very big trade secret case broke, IBM-Hitachi, a criminal case where Japanese executives were being taken in handcuffs to the federal courthouse in San Jose. When the media needed someone to comment on what was going on, my book happened to be on their desk. So, it was another case of being in the right place at the right time. I started providing a lot of public commentary on trade secrets, and between that and the experience that I had developed, I just fell in love with this practice area. I eventually started teaching it, and then wrote a treatise.
It's now been a little over two years since the federal DTSA was signed into law. You recently testified before the House Judiciary Committee in D.C. as to whether the DTSA was working as intended. In your view, what were the problems that the DTSA was designed to solve?
The main issue was the patchwork nature of the laws and procedures that faced anyone who needed to enforce their trade secret rights. There was an array of state laws which varied to some extent and were administered at state- or county-level courts, making it a real challenge for companies that had actors in multiple states or internationally to address their concerns.
Many years ago, trade secret cases tended to be local, in part because information traveled only on paper, but once we moved into the computer age, and particularly the networked era, that old system of dealing at a state or local level with trade secret disputes wasn't working very well.
And so, the main reason for bringing federal civil law into the picture was to provide trade secret owners an opportunity to use the federal system, with its nationwide service and its common rules.
Now, when the act was first being considered, most of the focus was on a specific provision of the act that addressed ex parte seizures. That was something useful for a narrow set of circumstances, where you had some specific secrets that were about to be taken from the jurisdiction or destroyed unless you got very fast relief.
Do you believe the DTSA has accomplished its goals?
Yes, it has, or I should say it's well on its way to doing that. One of the expected advantages of having this federal system installed as an overlay – not as a substitute – in state-law adjudication of trade secrets was to achieve some level of harmonization. If you get harmonized rules and approaches, then enforcement of rights becomes more predictable and easier. We are starting to see federal courts look to the decisions of state courts that use the Uniform Trade Secrets Act, and state courts are now referring to federal court decisions. And federal judges in different districts throughout the country are referring to each other's decisions.
Plus, I think it's fair to say that those who thought that it might overwhelm the federal system are happy to see that there hasn't been an avalanche of cases. There's been a noticeable, but modest, increase in the workload of the federal courts over trade secret cases.
Do you foresee the need for any further tweaks or changes to make the DTSA even more effective?
There is one unsettled area that I think could benefit from greater attention, either legislatively or perhaps through the courts, and that has to do with the extra-territorial application of the DTSA. It's not entirely clear to what extent the DTSA applies to trade secret misappropriation that happens outside the U.S.
Section 1837 of the Economic Espionage Act, into which the DTSA was inserted, states the intent of Congress to apply the law extra-territorially as long as at least one act in furtherance of the offense happened in the U.S., or the offender is a U.S. citizen or permanent resident. And as you can tell from my emphasis on the words "offender" and "offense," that section is a little bit awkward to apply in a civil cause of action. In Sections 4 and 5 of the DTSA that were not codified, but were part of the bill, Congress found that any misappropriation of U.S.-based trade secrets occurring overseas must necessarily have an impact in this country, on our economy, lost jobs, etc.
If you take that expression by itself, that may be enough under existing Supreme Court jurisprudence to indicate that the law should be applied extra-territorially in a general way, but we don't know yet. We really don't have a definitive ruling from the courts, but we know that from the way trade secrets have to be distributed around the world as part of modern commerce, misappropriations happen overseas. And so, it will be very important over time to get clarity on the extent to which the DTSA can provide a robust tool for owners of secrets that happen to have been misappropriated outside of the U.S.
In your congressional testimony, you cited a National Science Foundation Census Bureau survey in which companies rated the importance of different types of IP laws in protecting their competitive advantages. According to the survey results, trade secrets were rated number one, rated at more than twice the level of patents. Did those results surprise you?
They did not surprise me. The first reason is that they were consistent with a similar survey that had been done in 2000 that indicated secrecy was at the forefront of measures taken by companies to protect competitive advantage. And it also was consistent with my own observations in working with companies regarding their intellectual-property and commercialization strategies. In many industries, like pharma and biotech, patents form an existential part of doing business, but for many other industries, they are simply one of a series of tools that are available.
And even in pharma and biotech, the secrecy of research and development is enormously important. It's important in order to preserve competitive advantage. It's important in order to be able to ever get a patent because you have to treat it as a trade secret to begin with.
As important as patents are, there is only a narrow band of information that qualifies as a patentable invention that's novel and not obvious, whereas trade secret law applies to protect any kind of information that's helpful to a business. And so the coverage is massively greater in terms of applying to information assets of modern business.
Over the past 40 years, we've shifted from a tangible asset-based economy to an intangible asset-based economy. In other words, data have become the primary asset of business these days, and data are protected mainly by secrecy. So no, the results of that survey did not surprise me, and I see it only going in a similar direction in terms of the impact of secrecy as a management tool going forward.
In light of IP-rights challenges, patentability restrictions such as Alice, and stricter damage standards in patent matters, it seems that the value of obtaining patents has taken a hit. Should companies re-evaluate the importance of trade secrets in their IP-protection strategies?
Yes. In industries where patentability issues have been hit pretty hard, looking at secrecy as an alternative way to protect information assets is extremely important.
In speaking to friends who are running intellectual property programs inside major companies, many of them have overseen a shift in the way that the company deals with their patent program. Everyone in the past had a patent committee that looked at disclosures and decided what to patent. Generally speaking, when something was determined not to justify patenting, it more or less fell to the cutting-room floor. These days, the approach is how you're going to protect these innovations if not through the patent system. How are we going to make sure that somebody in the organization is assigned to that task so that these assets get properly managed.
What are some of the decision points for a company to consider in determining whether to protect IP with patents, as opposed to trade secrets, understanding that once a trade secret is disclosed, the trade secret is gone? In addition, for some ideas and technologies, if you are going to sell it in the marketplace, that would be a big concern for using trade secrets if a competitor could take a look at it, reverse-engineer it, then figure it out on their own.
If you are putting out a product or service that reveals to the world the secrets of its composition, then you've lost it. You might have some first-mover advantage, but that's basically it.
And so, in situations where the innovation can be seen immediately or is relatively easy to reverse-engineer, you are much better off trying to find a way to use the patent system because you can get that extra period of protection.
On the other hand, we have the situation where innovations that are commercialized in secret, like process technology, are typically better protected by secrecy than by patenting because if you patent it, then you teach the world what it's all about.
In the 1940s, DuPont developed a revolutionary method for processing titanium dioxide and decided to maintain it as a trade secret rather than seek a patent. And that was, in part, because if someone else was using the process, particularly in a foreign country, there would be no way that they could find out. And so the best way to protect it was to keep it a secret, and they successfully did that for decades and decades, way longer than they would have had any patent protection. And they were able to spin off the business for a couple of billion dollars a few years ago. So, in the cases where you have technology that cannot be easily reverse-engineered, that's a very important reason to use secrecy instead of a patent.
Of course, there are some innovations that have such a short shelf life that patenting would almost be a waste of time. By the time you get the patent, it's no longer an advantage. So, one of the things that companies look at is: How long do we expect to be able to exploit this?
No matter how broadly trade secrets are used and applied, patents offer a unique kind of strength because patents allow you to exclude anyone else in the country from practicing the innovation, whereas with trade secrets, you take the risk that someone else is going to come up with the same thing and may even publish it. And so, you may lose the benefit at any time. So, patents are stronger, and particularly if you're preparing to license some of your technology or want to be able to do that, it's a good thing still to wrap it in a patent because it's generally easier to value.
For companies that decide to pursue trade secret-protection strategies for certain assets, are there any particular trapdoors or cautions that they should avoid to make their trade secret-protection strategies more effective?
The most important idea, and the most significant driver of success, is paying attention to the management of these assets. Many companies tend to think about them as kind of soaked into the woodwork, and they don't pay enough attention to the importance of active engagement.
These assets are volatile; they are vulnerable to loss. Studies have shown that 80 percent to 90 percent of information loss happens through employees or contractors who are trusted with access to these very important assets.
The biggest trapdoor for businesses is failing to focus on information security risk management. So much can be done in this area just by ensuring that you have the right policies and procedures in place, you're doing the right training, you have the right people involved running the program, you’re reviewing it for effectiveness over time, and so on. It doesn't take a whole lot of effort, and in any event the effort aligns with most companies' existing risk management and compliance programs.
At Stout, our team is involved in determining damages in disputes involving many different types of intellectual property. It appears to us that remedies for trade secret damages are still pretty wide open compared with damage remedies for other types of IP. Do you foresee that the DTSA might impose some stricter discipline in the determination of trade secret damages?
That's a very good question, and I think it's quite possible that we will see more frameworks and restrictions on trade secret damages simply because we have federal courts handling these cases under federal law. I would not be surprised if over time, we see some very illuminating commentary in the issued opinions of federal courts on what are the boundaries and touchpoints for calculating damages in trade secret cases.
Having said that, it's really important to remember the basic difference between patent damages and trade secret damages. Patent damages are based on the analysis of rights created under a federal statutory framework, and so, the issue has attracted a great deal of attention and analysis over the years, all grounded in the statute.
Trade secret damages ultimately and historically are grounded in the common law of tort, and tort law is designed mainly to provide full compensation to the victims of a wrong. Remember: Patents are a no-fault system. Trade- secret misappropriation is about fault, and so, that fundamental aspect of the law of secrecy informs how courts generally look at damages. So, you will see judges being very flexible in favor of the plaintiff because that's fundamentally how the law is supposed to work.
The DTSA provisions on damages are a direct reflection of the rules under common law, which provide the greatest recovery possible under several different theories: plaintiff’s loss, defendant’s gain, or a “royalty” measure. The plaintiff has a choice and can use one or two or three of them as long as they aren’t duplicative, and that means that, generally speaking, you can get what looks like very big verdicts that aren't constrained by some finer points of law, as you do with patents.
What should companies understand about the distinctions and differences between internal trade secret theft, such as theft by departing employees, and external trade secret theft, such as competitive espionage or hacking?
In general terms, the external, hacking-related espionage theft is more limited and harder to control than the internal issues. There's only so much you can do about hacking. It's important to address issues around information systems, your network, and to ensure that you've done as much as you can afford to do to install systems that allow rapid detection and response when you have a problem. But as we all know, there's a technological arms race where cyber hackers are concerned, and there's a limit to how much you can assure yourself that you are fully protected.
In contrast, we have frequent losses from internal operations through those whom we trust on a day-to-day basis that have access to our information. The most obvious example is the regular employee who is allowed access to the company's systems through a smartphone or a tablet or personal computer. And they take this everywhere they go, often using it to engage in robust sharing of everything that's happening in their life because they've been trained by social media to understand that sharing is good.
This is the same population that we have to deal with when they come in the next morning with those smartphones that they now use to access the company's networks as well as external ones. So, figuring out how to address the behavior of the workforce that has access to the secrets and training them to understand what the company considers to be confidential and their role in protecting it is, in my experience, far more effective in terms of mitigating the risk of loss than another program directed at cyber security.
Good advice. You are currently participating in a Sedona Conference Working Group on trade secrets, whose mission is to develop a set of guidelines to help federal and state judges do a better job in handling trade secret cases, and help companies do a better job in managing their intellectual assets. Can you give us a progress report on the activities of this working group?
The progress is very good, but we are still in the early stages. We are focusing on two topics to begin with. The first one relates to the issue of trade secret identification. The second one is about the employee life cycle. In other words, addressing the protection of secrets throughout the time that an employee comes, is recruited into the company, is trained, is supervised, and ultimately exits the company, and how companies should be looking at managing those issues.
At the end of a multiyear process, we expect to have a number of consensus-view statements on best practices for litigation and for managing information security within the company.
From 2009 to 2014, you served as deputy director general of the World Intellectual Property Organization. What were your impressions of the relative importance of intellectual property protection in the U.S. compared with other countries?
IP protection has always been very important to us as an economy, playing a critical role as a supporter and an accelerant for innovation in most industries. Over the years, the U.S. has been a leader in the international effort to promote the use of strong intellectual-property laws as a way to achieve economic development.
History teaches that countries that have thoughtful, robust intellectual property systems are much more likely to nurture domestic-innovation economies. And so, if they want to go in that direction, they need to embrace IP. You see it happening right now in China, where 15-20 years ago, there was a lot of concern that the Chinese economy was basically copying and not innovating. Now China has some leading world-class companies in many industries. And they have built a very strong patent system to support its domestic economy. This happened decades ago in Japan. It then happened in Korea.
In your recent congressional testimony, you sounded an alarm regarding 28 U.S.C. Section 1782, in which you suggested there is a danger in allowing foreign litigants to have access to testimony and other evidence from U.S. courts for use in foreign proceedings. You called this practice a one-way street for the acquisition and export of U.S. information. Please explain your concerns and what you think Congress should do to allay those concerns?
At a general level, I called this a one-way street because we offer this opportunity for foreign litigants to come here without insisting that they provide the same kind of access to evidence in their own countries. I think that the original assumption behind the statute was that if other countries saw how transparent and open we were about access to evidence, that they would institute similar procedures in their own countries, and we would achieve some level of reciprocity.
That has not happened, though, and there is no reciprocity built into this statute. The experiment has failed in terms of encouraging other countries to provide similar mechanisms so that U.S.-based organizations can get access to information in those jurisdictions. There is not a level playing field.
My more specific concern had to do with the maintenance of secrecy and confidentiality of information that's being handled in foreign jurisdictions. The assumption in most countries is that information that comes into a court is going to be publicly available.
This is certainly true throughout much of Europe, and it's one reason why the Europeans have drafted and promulgated the EU Trade Secrets Directive, one part of which requires that member states enact laws that will provide protections for confidential information that is produced in litigation.
And so we have this fundamental insecurity that exists in many other countries for information that's being handled by courts and, of course, by government agencies. Because 1782 applies very broadly to any court tribunal, and that includes, we now know, agencies of foreign governments, the information that's being sent over through Section 1782 necessarily is put at some level of risk.
What I suggested to Congress is that it require the federal judges who hear these petitions to engage in some analysis of the risk to the information and to require that protections be instituted in foreign jurisdictions for its use. This would be done as a condition of making the information available – get assurances that it will be protected when it gets to the foreign country. Some judges do that now on an ad hoc basis, but there's nothing in the statute that requires it.
Looking into your crystal ball, which industries or markets do you foresee as being most likely to face future IP challenges, and what do you see those challenges as being?
Any company that has to deal globally with secure information faces very high levels of risk in most other countries in the world. One of the reasons trade secret protection works well in the U.S. is that we have fairly easy access to proof. If you suspect that some secret has been stolen, you can start litigation and then get the information you need to prove what happened. In most of the rest of the world, you can't do that.
And so I hope over time that as a result of various actors, governments, and industry speaking about these issues and engaging in dialogue, we can find a way for companies, when they suspect they have a problem, to find and get access to the information wherever it is. This can happen in different ways.
I'm not suggesting that other countries adopt the U.S. system of litigation discovery, which has, in many ways, overburdened us, but there are ways, even in civil-law systems, to set up frameworks and protocols for the victim of a misappropriation to be able to get access to data, either through some form of seizure process or lowering the standard of proof that is required to initiate an action, and requiring the defendant to come forward and prove that it developed the information independently.
If we want to fully support companies that drive the global economy, we have to find ways to more realistically enforce trade secret rights.
Any last words of caution for our readers?
We just saw the Waymo v. Uber (“Waymo”) case, which is a reminder of the importance of managing risk around these very important assets. When Uber hired this fellow, [Anthony] Levandowski, away from Waymo, it took on a level of risk that it should have appreciated was almost existential for the company.
And yet, what it did about it actually exposed the company to more risk. Now, I'm not trying to make the point that Uber screwed up, but it's a reminder of the things that can go wrong in a rapidly evolving technological landscape, which is something that applies to an awful lot of companies these days.
When you hire away smart, experienced talent from a competitor, you face the risk that your valuable data assets may be tainted in some way, which could be a potentially massive problem. It is imperative to have careful management of these issues because they just don't come up in the same way that patent and copyright and trademark issues do – kind of clean and predictable. They tend to sneak up on you when you're not watching, or perhaps distracted by the excitement of an acquisition. Once you’ve been infected with someone else’s confidential data, extracting it can be complicated and expensive.
It was late 2010. The technician, an American in northwestern China, was performing a software check on a wind turbine when he noticed something strange. After the diagnostic program finished running, the turbine was supposed to stop. But this time the blades kept spinning. The same thing happened at the next turbine at the wind farm. And the next, and the next.
Back at the headquarters of American Superconductor Corporation near Boston, the news confirmed executives’ worst fears. Their biggest customer, Sinovel, a Chinese wind farm company financed in part by the government, had recently refused to pay an outstanding bill and had canceled all future orders, citing what it claimed as poor quality and performance of AMSC’s software. That software had supplied the brains for Sinovel’s massive turbines, enabling an efficient flow of electricity into China’s electric power grid. But Sinovel had decided to build its own controller software and had already begun to install it.
The relationship had started out so well just four years before. Following the enactment of China’s first clean energy law, Sinovel had been launched to supply wind power to vast stretches of the country, and ultimately abroad. AMSC, originally formed to apply futuristic superconductor technology to high voltage transmission networks, had pivoted to the more mundane but still complex and profitable business of wind turbine controllers. Their agreement was heralded by the companies in a joint announcement as an“example of Sino-U.S. cooperation in the new energy area,” and both companies became wildly successful in a very short time.
As happens so often, the bilateral enthusiasm was overtaken by greed as Sinovel found a way to eliminate its partner from the business. AMSC had sent a team to China to help support Sinovel. Among them was a programmer named Dejan Karabasevic, a Croatian from AMSC’s Austrian subsidiary. Recently demoted from the design group, Karabasevic was unhappy – and vulnerable.
Sinovel encouraged him to leave AMSC, promising to pay him a million dollars over five years (along with an apartment, and, reportedly, a prostitute). His advance was only 15,000 euros, but it did the trick. Karabasevic resigned, but his supervisor asked him to stay on for a while, with full access to the company’s systems. This allowed him time to create a bootleg version of the AMSC controller software, and to transfer it to his future employer in China.
This was the software that evaded the AMSC technicians’ diagnostic tools and allowed the windmills to keep turning when they should have turned off. It would be some months before the company learned about their former employee’s treachery, but in the meantime it had lost almost 90% of its revenue, shed a billion dollars in shareholder equity, and had to lay off 700 employees.
A flurry of lawsuits followed, in China, the U.S. and Austria. Karabasevic quickly confessed and spent a year in jail but cooperated in AMSC’s pursuit of Sinovel.
In 2013 the Department of Justice joined in, indicting Sinovel and two of its Chinese employees. On January 24, 2018, after an 11-day jury trial, the defendants were convicted in Wisconsin federal court of conspiracy, wire fraud and theft of trade secrets under the Economic Espionage Act. On July 3 AMSC and Sinovel announced a settlement totaling $57.5 million, including a license for Sinovel to use the AMSC technology in its current model turbines. Within a week the judge sentenced Sinovel to a year’s probation, on condition that it pay the agreed amount.
Analysts have pointed out that Sinovel’s available cash had dwindled to less than $100 million, so the outcome was probably a good deal for AMSC under the circumstances. But after six years of litigation and proven losses of over $550 million, this was a “victory” only in a very relative sense.
What lessons can be drawn from AMSC’s experience dealing with a business partner that stole its most valuable information assets? The most obvious is probably not to let enthusiasm mask obvious risks when relying on one customer, particularly in a foreign country. When you are that exposed, your trade secret protection systems need to be proportionately robust.
Of course, you can also reduce risk of theft by continuous improvement of your technology, proving to your customer the futility of trying to compete. But for your crown jewels, you must control access as if the life of your business depended on it. Because it does.
Always remember that insiders (employees, embedded contractors and temporary workers) account for 90% of information loss. Be aware of circumstances that could turn their loyalty around, and manage accordingly. Don’t keep people on after they resign without carefully assessing the risk of their maintaining access to your systems and what you can do to mitigate that risk. More broadly, use data loss prevention software that can alert you to potential problems through real-time analysis of unusual behavior by those with trusted access.
And if you suspect actual espionage, call the FBI. There’s nothing to concentrate the mind like possible jail time.
It seemed like such a good idea at the time. Quicken Loans affiliate Title Source had signed an agreement with start-up HouseCanary to build specialty software. The relationship deteriorated, and Title Source sued to avoid the $5 million fee it had agreed to pay. To underscore its determination, it served the lawsuit personally on HouseCanary executives at their trade show booth, right in front of their customers.
Commercial litigation often starts with this sort of bravado, and Title Source apparently felt it had been seriously wronged. But less than two years later, in March 2018, a jury disagreed. It decided that Title Source had used HouseCanary’s secret data to build a competing product and slapped it with a verdict for $706 million.
The back story of this turnabout case provides some important lessons, grounded in the special nature of trade secret disputes. But first let’s understand how a hopeful software development deal turned so ugly.
Real estate appraisals traditionally rely on a physical inspection by a trained professional. But much of the data they collect about a house is already available online, or can be extrapolated. So just like many other industries, this one is undergoing disruption through automation, as firms develop Automated Valuation Models, or AVMs.
Title Source, one of the country’s largest title insurance and real estate valuation companies, signed a contract with software start-up HouseCanary to develop an AVM. The product would be licensed to Title Source for an annual fee of $5 million, but HouseCanary would maintain ownership and rights in its own data. The relationship began to break down over requested changes, and Title Source decided that it wasn’t getting what it bargained for. In the meantime, HouseCanary had shared its secret information with Title Source engineers.
Those same engineers were tasked with building their own AVM. From the perspective of Title Source, this project was necessary in order to cover for HouseCanary’s failures and to mitigate the damage it was suffering. When the time came to pay the $5 million fee, Title Source decided that an aggressive litigation strategy would best serve its needs and reflect its frustration.
This is where the drama begins its teaching. Title Source believed its own narrative, in which it was a victim of HouseCanary’s breach. Its commitment to that narrative masked the possibility that hidden in the records of the two companies’ dealings lurked a massive potential liability. When emails were produced as part of the litigation, it appeared that the engineers tasked with building Title Source’s AVM had used HouseCanary’s confidential information to do it. (One email exhorted colleagues to “think big and wide about how to maximize the value of the HouseCanary data to our business.”)
Some of this evidence was ambiguous, and Title Source argued that what it did was within its rights. But it was looking through its own lens, and didn’t fully appreciate the risk that HouseCanary’s alternative narrative of deliberate misappropriation would be accepted.
Why didn’t Title Source see the potential disaster when deciding whether to sue? The answer almost certainly lies in the emotional content of disputes where information has been shared between companies. The relationship starts, as it must, with declarations of trust on both sides. So when things start to go downhill, disappointment morphs into loathing and a sense of victimhood. Each side, anxious to see its own behavior as fully justified, develops a committed perspective.
Here, the miscalculation had very serious consequences. HouseCanary, having convinced the jury that its information had been misused, was able to present a simple and compelling damage model. It argued – again, using its adversary’s own records – that Title Source planned to save a certain amount of money on each AVM that it sold. Assuming that it would have taken two years to develop that product legitimately, and using internal projections of likely use, the benefit to Title Source worked out to be over $201 million.
The jury accepted that calculation, and added HouseCanary’s lost profits of almost $34 million. Then, because it had embraced HouseCanary’s narrative of a deliberate misappropriation, the damages were tripled, for a total of $706 million.
The first lesson we can extract from this story is cautionary: assessment of risk in potential litigation requires a sober, objective analysis of the evidence, with plenty of “devil’s advocate” scenario planning. This means resisting the kind of confirmation bias that can interfere with management’s ability to appreciate how the same facts can be interpreted in different ways.
Second, and closely related to the first point, we need to be aware that trade secret cases often spring from facts learned in unrelated litigation. In one case I worked on, a patent infringement claim led to the production of records showing that a misappropriation had occurred more than fifteen years earlier. Because the statute of limitations runs from the time of discovery, the accumulated damage claim was massive, and immediately the trade secret claim eclipsed the patent dispute.
Third, the HouseCanary verdict provides a reminder of the flexible and often generous way that damages are calculated in trade secret cases. The aggrieved party can collect not only for the damage it has suffered, but also can recover the perceived benefit received by the defendant, even if it hasn’t produced any profits or even any products.
Finally, this case suggests that companies engaged in collaborative development of technology need to manage the process very carefully to reduce the risk of later disputes. Clear protocols and careful record keeping around the receipt and use of confidential information will go a long way to prevent problems.
And a bit of training in how to draft emails wouldn’t hurt.
In the wake of Uber’s blockbuster trade secrets lawsuit, prompted by its hiring of the manager of a competitor’s self-driving car program, one of the company’s lawyers published an articlecomplaining about the law that protects “negative information” stored in a person’s head. It was crazy, he argued, to force employees to feign amnesia and to deliberately repeat mistakes made in their last job, in the name of protecting confidential information.
As you may recall, a few months ago I wrote positively about negative trade secrets, invoking Edison’s string of failed experiments that led him to a working light bulb. That kind of information in the hands of a competitor would allow it to catch up without the effort, investment and risk faced by the original innovator. So it makes a lot of sense that the law protects against disclosure of the failures, mistakes and dead ends of research.
But how can we provide that protection in fast-growing industries where employees often leave to work for the competition? How can they be expected to apply their well-earned skill but to remain silent when they see their new team going down what they know is a hopeless path? And even if they are careful never to signal with an eye roll or grimace, won’t the former employer sue them anyway once it sees a competing product? Wouldn’t it be more fair – and more efficient – to just allow them to use whatever “negative” information they remember, so long as they don’t take records with them?
I don’t think so. Protecting knowledge of failed experiments encourages companies to invest in deep, long-term and risky research, since they know others can’t easily catch up. And there is other social value in the “inefficiency” of requiring competitors to do their own homework. That’s because they probably won’t follow the same path. What the first company considered a “failure,” when encountered by the second company, may provoke a new and unique insight. Indeed, this is how a lot of innovation happens, and it’s why some organizations deliberately set up competing teams to pursue identical objectives.
The same principle that recognizes value in redundancy of effort can apply to individuals as well as companies. Rather than lamenting the prospect of wasted re-work, departing employees can look forward to a new environment to apply their skills. They can challenge the assumption of past “failures” by taking a fresh look at the process of discovery, searching for new ways to tackle old problems.
But while that sounds fine in the abstract, the practical challenge remains: how does someone take his or her accumulated experience to a competitor without getting sued? And from another perspective, how do you hire someone with experience and skill, to make sure that’s all you’re getting? Here are a few suggestions.
First, recognize the risk that is wrapped inside the opportunity. Is this new position likely to put the employee in an ethical hot seat? If everyone has asked the right questions in the interviews and has been honest about what challenges the new company is facing, you can also identify the risk of having addressed the same or similar problems for the competitor. If so, are these issues critical to the expected work assignment, or merely incidental?
Second, discuss the nature of the risk at a high level, without getting into the specifics of the previous assignment, but identifying the areas where there may be some concern about applying prior knowledge of what doesn’t work. You should both agree that no one will ask for, or provide direction from, that learning. But if the discussion leads to real anxiety about whether confidentiality can be managed this way, it may make sense to temporarily steer clear of any project that looks like it will cover the same ground as the previous job. In any event, you should establish an understanding that all of the work to be done will be firmly grounded on general knowledge and skill.
Third, you should directly address what is that knowledge and skill, and how you expect it to add value in the new position. To be especially safe, the employee might also want to prepare by brushing up on the state of the art in the relevant field of work, so that they can think, speak and act comfortably from that platform.
Even in highly competitive industries we can enjoy the benefits of labor mobility while still respecting the value of “negative” trade secrets. All it takes is a healthy respect for risk and a willingness to start over in the pursuit of something better.
Here in the U.S. we have a litigation system for pre-trial “discovery” that allows access to virtually every email and every record a company owns. It costs businesses more than $40 billion every year. Foreign countries, where there is no “discovery,” sneer at this self-inflicted injury, and foreign companies do all they can to avoid getting involved in it.
Except when we give them a free pass to visit and try it out.
What would you think if I told you that anyone from France or China or Brazil that was just thinking about some legal action in their country could come here and easily force discovery from a U.S. company, even though they couldn’t dream of getting the same information through their home courts? Crazy, right? That is exactly what has resulted from a law that’s so obscure it doesn’t even have a name, so we call it by its legal citation: 28 U.S.C. Section 1782.
Congress put Section 1782 on the books decades ago, motivated by the generous impulse to help foreign courts and litigants get information they needed, and to encourage foreign countries to pass similar laws that would give our citizens the same kind of access. On the first objective, the law has been a resounding success. In recent years petitions under Section 1782 have grown to over sixty per year.
On the second one, here’s a quick quiz: how many countries do you think have enacted laws inviting our litigants to come and get discovery from their corporations? Sorry, no prize for guessing the correct answer, zero. In fact, a number of countries have responded rather rudely by passing laws that prohibit any use inside their borders of otherwise reliable information, just because it is the product of the U.S. discovery system.
But we have forged ahead anyway with our unilateral offer, nursing the hope that someone will emulate our generosity. What exactly is the offer? Under Section 1782, any “interested person” can petition a U.S. federal court to force someone “found” here to produce documents and testimony for use in a foreign “proceeding.”
It used to be that everyone assumed that getting an order like this would be at least modestly difficult. Naturally the discovery would have to be really helpful, and so you would have to show at least that the information would be admissible in the foreign court. And of course it had to be a court that wanted it, to help inform a proceeding that was, well, proceeding. And the petitioner, you would assume, would have to be a party to that foreign proceeding.
All of these were reasonable assumptions, but they all turned out to be wrong. About 15 years ago AMD tried to use Section 1782 to get discovery from Intel that it could then turn over to the European Commission, which it hoped would begin antitrust enforcement against its competitor. The federal district court denied the petition: no proceedings were underway, only “contemplated.” No foreign court was involved, only a government agency. AMD was not a party. And if the information had been located in Europe it would not have been accessible to the Commission.
The U.S. Supreme Court reversed, holding that the statute was broadly worded, and if Congress wanted to put limitations on it, it had to say so. Needless to say, this ruling caused a lot of lawyers to dust off their statute books and take another look at Section 1782, causing a dramatic uptick in filings. In fact, some law firms are now marketing this law to foreign companies as a way to collect information that they couldn’t get in their home courts.
Congress has taken notice, and the House Judiciary Committee recently held a hearing at which I was invited to testify. There I described the Section 1782 process as a “one way street for the acquisition and export of U.S. information.”
But I wasn’t there to focus on the asymmetry of this law. My concern was rooted in the fact that it includes no safeguards to ensure that the discovery material — which often can include very sensitive trade secrets — is protected against disclosure or misuse once it lands in the foreign court (or agency).
This is not an abstract problem, I explained. While U.S. courts regularly issue “protective orders” closely guarding information exchanged in litigation, foreign courts and governments often don’t have any similar tools. In fact, most countries’ laws are insufficient to protect trade secret rights in general, and even less so when information is in the hands of courts that have to guarantee public access. Even the European Commission, in proposing the EU Trade Secrets Directive to its member states, recognized that Europe had a serious problem, saying that the “main factor that hinders enforcement of trade secrets in Court derives from the lack of adequate measures to avoid trade secrets leakage in legal proceedings.”
So if we really want to help our sister courts in other countries, we should send them sensitive information only when we have first wrapped it up in limited use restrictions. That is why I suggested in my testimony to Congress that an important “fix” to Section 1782 would be to require that federal judges consider the risk to U.S. trade secrets when ruling on these petitions. And if they allow the discovery, it should come with serious, specific requirements on how it can be used in the foreign “proceeding” to avoid loss or damage.
Let’s hope that closing this loophole is something that both political parties can agree on.
You can read my formal remarks here and watch the entire hearing here.