I. CASE STUDY

Justin, age 52, and his wife, Mary, started Custom Design Industries 15 years ago. Justin and Mary had both been employees of separate firms; Justin as a computer graphics designer and programmer for a large, publicly-traded company, and Mary, a designer and salesperson for a major fashion house. They started their company, Custom Design Industries, in an attempt to build equity for their future. Justin and Mary have 3 children, 2 in college and 1 a senior in high school. They have been working 7 days a week at building their company. Custom Design has grown in the last 15 years from 2 employees to approximately 100 with offices in Kansas City, Washington, D.C. and San Francisco. Custom Design designs and manufactures custom apparel for brand name clothing manufacturers. The company employs a staff of 10 regional salespeople and 25 graphic designers. The sales force also solicits design and manufacturing work from the owners of major sport franchises, Universities and trendy Fortune 500 companies. Manufacturing is completed in China and Mexico.

In December of the past year, Custom Design s National Sales Manager, Head of Graphic Design and Vice President of Production Management unexpectedly departed the company and started their own business. The former employees  business, Copycat Enterprises, was engaged in the same business as Custom Design. After several months of operation, Justin and Mary learned that the Copycat website contained graphic and textual material substantially similar to that contained on the Custom Design website. It was discovered that the former employees had made sales calls on key customers of Custom Design and had offered competitive services at substantially lower pricing. It was also discovered that Copycat was soliciting employees from the home office, offering higher salaries and benefits, as well as a more flexible working environment. Additionally, the branch office managers of the San Francisco and Washington, D.C. offices tendered their resignations and became employees of Copycat. Copycat registered various domain names that were similar to slogans used by Custom Design. Finally, and most devastating, Custom Design s sales dropped 25% for the past quarter due to the loss of custom orders from several, long-time, loyal customers.

The stress in Justin and Mary s lives increased three-fold. What had been a company that was increasing its sales and net profits annually had become a company under siege. Sales were dropping, employees were being courted away to Copycat, customers were complaining of confusion in the marketplace, and internal moral at the company was deteriorating rapidly. The stress was becoming unbearable for both Justin and Mary as they watched Custom Design shrink almost on a weekly basis.

Angry and frustrated, Justin and Mary seek counsel from various advisors. While their advisors and consultants admonish the activities of the former employees, Justin and Mary learn that they have not adequately protected Custom Design from internal or external theft of its important business information. Company insurance did not cover the loss of business information. Custom Design had no employment agreements, confidentiality agreements, non-disclosure agreements, policies, procedures, employee handbooks or privacy protection measures in place within the company. Organizational structure was lax and a "family atmosphere" pervaded the work environment. No physical or computer security measures had been taken to protect customer lists, pricing materials, marketing plans, supplier information or other vital business information.

Custom Design filed a lawsuit against Copycat. Custom Design also filed a Motion for Preliminary Injunction in an attempt to immediately protect its business information and trade secrets. It lost the Motion for Preliminary Injunction because it had failed to take the necessary steps to protect its trade secrets. As the lawsuit dragged on with depositions, interrogatories, copies of documents provided back and forth to the parties, etc., Justin and Mary became more resigned to the prospect of losing. Litigation costs mounted and since insurance did not cover this occurrence, their financial situation worsened. They ultimately settled for no monetary damages and worked out an arrangement with Copycat for joint usage of certain business information and intellectual property.

Although the above facts are fictitious, if you think the above scenario is beyond the realm of possibility, think again. The explosion of the free transfer of information via internal computer networks, broad band communications and internet reliance has created not only greater ease of corporate communications but, unfortunately, greater opportunities for theft of business information and trade secrets. A thorough understanding of this area is relevant for every business, large or small, that seeks to protect the company from loss of its valuable business information and trade secrets.

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II. IMPORTANCE OF PROTECTION

INTELLECTUAL PROPERTY  DEFINED. Although specific "industry related" definitions of intellectual property are utilized to describe such properties in the specific industries, a broad definition is as follows:

"Non-tangible property that includes ideas, inventions, concepts, schemes, plans, processes, literary, artistic and creative works/plans/projects, names and symbols used to represent products and confidential information. Intellectual property is information that derives an intrinsic value from the unique nature of the item created. It can also be information with commercial value in addition to the underlying intrinsic value to the developer or creator."

Selective categories of intellectual property include patents, copyrights, trademarks, service marks and trade secrets. Each of these particular types of intellectual properties may possess certain federal, state and common law protections. While certain business information can be elevated to a trade secret, it may not qualify as a protectable asset under patent, copyright or trademark law. Conversely, a marketing form, customer recall methodology, inventory control system, marketing plan, etc., may qualify as a trade secret and also be eligible for patent, copyright and trademark protection.

STATISTICAL HIGHLIGHTS. In the past several years, several studies and surveys have been completed identifying the size and nature of this business risk. Several of the highlights are as follows:

• POTENTIAL LOSSES FROM THEFT OF TRADE SECRETS FROM AMERICAN COMPANIES MAY EXCEED $250 BILLION PER YEAR.*

• 40% OF THE BUSINESSES SURVEYED STILL HAVE NO FORMAL PROGRAMS FOR SAFEGUARDING PROPRIETARY INFORMATION.*

• TRUSTED INSIDERS POSE THE GREATEST RISK.*

• 70% OR MORE OF THE MARKET VALUE OF A TYPICAL U.S. COMPANY RESIDES IN INTELLECTUAL PROPERTY.**

• THE GLOBAL INTERNET AND PROLIFERATION OF INFORMATION SYSTEMS HAVE SIGNIFICANTLY INCREASED THE RISKS TO CORPORATE PROPRIETARY INFORMATION.**

• 2 MAJOR CONSEQUENCES OF LOSS OF INFORMATION ARE EMBARRASSMENT AND INCREASED LEGAL COSTS FOR PROSECUTION AND PROTECTION.**

• INCREASED INSURANCE COSTS WERE THE LEAST IMPORTANT CONSEQUENCE OF INFORMATION LOSS. INFORMATION LOSSES TEND NOT TO BE COVERED BY BUSINESS INSURANCE, AT LEAST IN PART BECAUSE THERE IS A LACK OF AFFECTIVE MECHANISMS TO CONSISTENTLY VALUE INFORMATION.**

• CUSTOMER LISTS/DATA ARE THOUGHT TO POSE THE GREATEST RISKS OF REVENUE LOSS.**

• FEW ORGANIZATIONS ENGAGE IN ANY SORT OF REGULAR REVIEW OF THEIR INTELLECTUAL PROPERTY VALUATIONS.**

• HALF OF THE INTELLECTUAL PROPERTY LAWSUITS INVOLVING THE COMPANIES WERE SETTLED BEFORE TRIAL.**

• THE THREAT FROM COMPUTER CRIME AND OTHER INFORMATION SECURITY BREACH CONTINUES UNABATED AND THE FINANCIAL TOLL IS MOUNTING.***

• AS IN PREVIOUS YEARS, THE MOST SERIOUS FINANCIAL LOSSES OCCURRED THROUGH THEFT OF PROPRIETARY INFORMATION (34 RESPONDENTS REPORTED $151,230,100.00)... .***

• 85% OF RESPONDENTS DISCOVERED COMPUTER SECURITY BREACHES WITHIN THE LAST 12 MONTHS.***

• 64% ACKNOWLEDGE FINANCIAL LOSSES DUE TO COMPUTER BREACHES.***

RELIANCE UPON INTELLECTUAL PROPERTY ASSETS. As indicated above, the PriceWaterhouseCoopers survey includes a statement that 70% or more of the market value of a typical U.S. company resides in intellectual property. Intranetworks, internet access and high-speed personal computers have accelerated the ease with which companies can share various business information with its employees, vendors and customers. The dissemination of marketing plans, advertising strategies and promotions can be completed with the click of a mouse. Sophisticated, on-line ordering systems allow customers and vendors to communicate instantaneously and share information concerning inventory levels, sales patterns, accounts receivables and accounts payable. The sophistication of today s computer systems and their networks allow faster and more extensive communications in the business realm.

LACK OF INSURANCE COVERAGE. Insurance is generally lacking in the case of a loss concerning business information or trade secrets. Unlike buildings, inventory, fixtures and supplies, intellectual property assets are difficult to value. Placing a price tag on the theft of a marketing plan can become extremely difficult. Similarly, valuing the years of work necessary to develop a highly sophisticated customer list and marketing techniques is difficult to assess in terms of the loss of value to a company. The inability to correctly value business information causes a lack of familiarity with underwriting the risk of such a loss. As such, most insurance companies are not providing such coverage. If such coverage is provided to larger organizations, deductibles are exceedingly high.

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III. DEFINITION OF TRADE SECRETS AND THE UNIFORM TRADE SECRETS ACTS

DEFINITION. A number of states have enacted versions of what is entitled "The Uniform Trade Secrets Act". Each version generally contains a definition of a trade secret as follows:

"Trade secret means information, including a formula, pattern, compilation, program, device, method, technique or process that: (1) derives independent economic value, actual or potential, from not being generally known to, and not being easily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use, and (2) is the subject of efforts that are reasonable under circumstances to maintain its secrecy."

Various types of business information can be elevated to the status of a trade secret. The essence of a trade secret as a protectable asset relates more to the importance of certain business information rather than a particular type of information. Business methodologies, marketing strategies, market testing information, customer lists and financial information would all generally constitute a protectable trade secret. The importance to the organization in terms of maintaining its competitive edge is a key factor in determining whether certain types of business information constitutes trade secrets.

USAGE OF TRADE SECRETS AND BUSINESS INFORMATION IN BUILDING A BUSINESS. Various types of information are utilized in building upon the success of one s business. Failures as well as successes can constitute a trade secret. In a number of cases, companies keep sophisticated records regarding their customers inclusive of birthdays, children s names, preferred types of food and beverages, etc. Unique marketing ideas, product designs, drawings, blueprints, testing data, surveys, and financial data all help to increase the competitive edge. While such information may occasionally be considered to be routine and mundane, all of this information can serve as a trade secret vital to a business. Competitors and start-up companies may not have the benefit of such experience and would find such information extremely valuable in eliminating waste and competing with your company.

CLASSIFYING TRADE SECRETS FOR IDENTIFICATION PURPOSES. When determining whether or not certain business information should be protected, an analysis should be completed in order to uncover the nature of such information. In determining the importance of business information, companies should ask the following questions:

1. What is the value of certain information to a competitor or, conversely, the detriment to the owner if such information is delivered into the hands of a competitor?

1. Is such information known generally to the public outside of the owner s business?

1. What is the cost or difficulty with which such information could be obtained, developed, duplicated, engineered or acquired?

1. What is the extent to which efforts have been made by the owner to protect the information?

1. What is the nature of the information itself and whether or not it has independent economic value?

1. What is the extent to which such information is generally known by employees of the company?

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IV. THE AUDIT OF BUSINESS INFORMATION AND TRADE SECRETS

An initial audit of the company should be completed to identify potential trade secrets, physical attributes of the premises and existing protective measures. If possible, this audit should be completed by counsel in order to assure that the process is privileged and protected from discovery in subsequent litigation. The audit should also be repeated at least once a year in order to assure that the company does not become "stale" in the protection of its assets.

AUDIT OF COMPANY ENTERPRISE. Counsel should meet with management of the company in order to determine product lines, pricing strategies, business and marketing plans, promotional strategies, customers, vendors, key outside contractors inclusive of advertising agencies, accounting firms and sales organizations, and any other key parties. Counsel will seek to identify the underlying enterprise of the company, its manufacturing systems, development systems, marketing and sales functions. The final results of the enterprise audit will identify vital business information that should be protected.

INTERNAL PHYSICAL AUDIT OF PREMISES. Inspection should be made of the physical premises. Depending upon the size of the organization, an objective review of a checklist of physical security precautions should be completed. Items such as fencing of the premises, access to ingress and egress, motion sensors, and other physical attributes of the organization need to be checked and reviewed. Signage, identification badges and the physical location of certain functions within the organization will all be analyzed pursuant to the physical checklist.

AUDIT OF PROCEDURES, POLICIES, GUIDELINES AND OTHER APPROPRIATE NOTICES. Once again, pursuant to a prepared checklist, the audit will examine procedures, policies, guidelines and other internal control measures. This checklist will include, but not be limited to, employee policies and procedure manuals, confidentiality and non-disclosure policies, "confidential" stamping of documents, after-hours policies, codes and passwords, shredding policies and employment practices inclusive of initial orientation, periodic review and exit interviews.

AUDIT SUMMARY AND ANALYSIS. Upon completion of the enterprise audit, physical checklist and procedural checklist, an audit summary will form the basis for establishing effective protective measures. Only after identifying the assets of the organization needing protection and the risks that may subject such assets to theft, can successful policies be implemented to protect the company s business information.

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V. ESTABLISHMENT OF INTERNAL PROTECTIVE MEASURES

Effective internal protective measures can be easily implemented using new or existing company devices.

• The employee policy and procedure manual should be updated to identify the existence of confidential information and the necessity for protection.

• Employees should be advised of the existence of confidential matter within the company and the necessity for protection.

• Similarly, internal policies and procedures governing access to information, retrieval of important documents, shredding policies, computer access policies, and other important procedures and policies should be in place to protect access to and retrieval of confidential information.

• All employees should be required to execute non-disclosure and confidentiality agreements upon hiring. In this manner, employees are made aware of the existence of confidential information and the need to protect it from disclosure.

• Exit interviews should be conducted and exit interview forms followed in order to assure that an exiting employee is reminded of their confidential and non-disclosure agreement.

• Key employees within the organization should be required to execute employment agreements incorporating and reinforcing confidentiality and non-disclosure provisions.

• Information should be disseminated to employees on a "need-to-know" basis and with the indiscriminate dissemination of company information subjecting the employee to termination.

• Since the personal computer has accelerated the sharing of information, computer policies and procedures should be put in place to protect confidential business information and assets contained within the network or on individual hard drives. Password protection is not enough. Limited access to customer lists, vendor lists and marketing plans should be protected on the hard drives of those persons having full access to that information. Employees should be made aware of areas of the computer system that are "off-limits" to those not having a "need-to-know".

• The establishment of internal controls over the ability to download files, copy files to hard drives or other medium and preventing the emailing of business information is essential. More and more, external and internal attacks will be generated via the computer systems and photocopying or actual document theft will reduce.

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VI. INTELLECTUAL PROPERTY TOOLS

• Intellectual property generally refers to patents, copyrights and trademarks/ service marks. These areas involve specific federal statutes granting rights to the holders and owners of intellectual property.

• Each company should review its business information and intellectual property to determine whether or not any of the federal statutes pertaining to patents, copyrights and trademarks/service marks is applicable. These federal statutes provide for certain rights as well as certain remedies inclusive of damages and attorney s fees for certain types of infringements.

• Counsel for the company can advise the company as to the relative merits of registration and the costs involved in registering business information.

• Counsel should also advise the company as to whether or not its business information is eligible for registration pursuant to the applicable federal statute(s).

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VII. STATUTORY PROTECTION OF BUSINESS INFORMATION AND TRADE SECRETS

As indicated above, the Uniform Trade Secrets Act has been adopted in a number of states throughout our country. In general, remedies include injunctive relief from preventing further disclosure and a recovery of damages for economic injury. As indicated in our short fictional case study, in order to fall within the protective measures of the Trade Secrets Acts, one must show a trade secret. Failure to adopt reasonable protective measures generally negates the existence of a trade secret.

The Economic Espionage Act of 1996 is a federal statute granting to the U.S. Attorney General certain powers to prosecute any person or company involved in trade secret misappropriation. The law provides for penalties and fines as well as the potential for incarceration. The EEA is a federal criminal statute and is enforced by the United States Attorney s offices located throughout the country. The EEA is also intended to prevent the theft of United States intellectual property by a foreign citizen.

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VIII. KEY CONCEPTS AND MISTAKES

• First, all of the survey data indicate that it is vitally important for key management to "buy-off on" the concept of protecting the company s business information. Failure to follow through on certain phases of the process creates employee doubts in the process. It does little good to conduct an audit if management is not willing to implement and stand behind the policies, procedures, contracts and methods to protect the company s intellectual assets.

• A second reason why protective measures may fail is the failure of management to stay current in the area of theft or appropriation. Just as a physical premise changes, technology also changes. As technology alters our computer systems, phone systems, email messaging systems and other technological tools, management must stay abreast of these changes in order to assure that protective measures remain in place.

• A third reason for a breakdown of the protection of various trade secrets is a failure to engage counsel and assure that state statutes and case law are reviewed in conjunction with the existing protective measures. Courts are often reluctant to enforce restrictive agreements that prevent any employee s basic freedom to switch employers. Likewise, the state legislatures are engaged in serious debate concerning rights of privacy, free speech, and protections against theft. A functioning trade secret program must be examined at least annually in regard to changes in statutes and case law. Failure to do so may render a confidentiality agreement unenforceable within the company s particular jurisdiction. If the company has locations in numerous states, each jurisdiction s statutes and case law should be reviewed in order to assure compliance with that particular jurisdiction.

• Failure of trade secret protective measures can result from indiscriminate disclosures by employees and the employee s failure to follow protective guidelines. The maxim of "loose lips sink ships" is very true within the area of protection of business information and trade secrets. The amount of business information revealed to reporters and quoted in newspapers and trade magazines is astounding. Likewise, invitations to speak at trade seminars and public forums are often an unfortunate opportunity to inadvertently reveal trade secrets.

• Managers sometimes feel uncomfortable implementing protection measures since they do not want to destroy the "family" atmosphere. Management should consider using counsel to assist in implementing protective measures in order to buffer employment relationships.

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IX. CONCLUSION

• The theft of business information is prevalent in the United States and damages can be astronomical.

• Insurance is non-existent or too expensive.

• An effective program of protecting trade secrets can save the company embarrassment and the legal expenses of protracted litigation and protection implementation.

• A comprehensive trade secret protection program should commence with an audit in order to identify important business information, physical faults and procedural deficiencies.

• Implementation of specific protective measures should include physical barriers, policies, procedures and a vast array of intellectual property protective devices inclusive of patents, trademarks and copyrights.

• Employment agreements, confidentiality agreements, non-disclosure agreements and other types of protective documents should be executed by the employee upon orientation and reinforced during the exit interview.

• A good, well thought out trade secret protection program can save the company thousands of dollars in lost information and legal fees.

• The program should be maintained at least on an annual basis in order to assure compliance with changing trends in technology, procedures and the law.

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* "Trends in Intellectual Property Loss, Survey Report", American Society for Industrial Security (ASIS), May, 1999.
** "Trends in Proprietary Information Loss, Survey Report", American Society for Industrial Security/ PriceWaterhouseCoopers LLP, 1999.
*** "6th Annual Computer Crime and Security Survey", Computer Security Institute conducted by CSI and the FBI, 2001.

Nothing in this article should be construed as legal advice between an attorney and client. The materials are for personal information and education. You should always consult with legal counsel on occasions where you are involved in legal matters.

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