Growing importance of trade secrets

What are the reasons for an increased importance of trade secrets? Law, tax, changes in patent law, trade war, litigation, all that. Read more how these factors interact

The neglected stepchild of IP

Trade secrets have up until recently been the neglected stepchild of IP. After all, trade secrets were not included in many IP educational sessions. The subject rarely came up at IP conferences and seminars. This form of IP was not addressed by most IP law firms, even so-called full-service IP law firms. It clearly was not in the ‘job spec’ of many in-house IP managers or Chief IP Officers.

The growing importance of trade secrets

In hindsight, I am really pleased that I did spend considerable time and energy over the past few years exploring the world of trade secrets and trade secret asset management as this form of IP has been transformed during that time period. What happened to raise the profile of trade secrets? I suggest that it was not one thing but rather a combination of a few factors that have enhanced the importance of trade secrets.

Law changes

Trade secret laws have changed dramatically in key jurisdictions in recent years. Japan’s Unfair Competition Prevention Act had a major update on 1 Jan 2016 following 5 incremental changes since 2003. The USA’s Defend Trade Secrets Act was signed into law on 11 May 2016. The EU Directive on Trade Secrets was passed on 8 June 2016 and enacted by member states on 9 June 2018 (although a few countries were late doing so). China’s Anti Unfair Competition Law was updated on 1 Jan 2018 and then again on 23 April 2019.

Increased litigation

The number of trade secret disputes are increasing. Trade secret misappropriation litigation is mostly a US issue but not exclusively so.  The 2017 Trends in Trade Secret Litigation Report by Stout on US trade secret litigation at both state and federal level reveals some insightful data.

  • 25% of all cases originated in the industrials sector.
  • 46% of trade secret cases involved multiple forms of trade secrets.
  • IT, Consumer Discretionary; and Healthcare saw major increases in cases.
  • Trade secrets related to computer software; computer technology; customer info; pricing info; supplier relationships; and designs/blueprints made up a significant percentage of cases.
  • Plaintiffs received favorable decisions 69% of the time. Defendants / counter-claimants 24%, with 7% of cases split.
  • Damages awarded in 52% of Federal cases. Top 5 cases were each over $100M.
The taxman

There is a growing interest in intangible assets including trade secrets by the tax authorities. The OECD BEPS Guidelines include trade secrets as an intangible asset requiring proper management. Much of the EU’s Anti Tax Avoidance Directive (ATAD) enacted on 1 January 2019 relates to intangibles including trade secrets. Patent Box Tax Regimes in a number of jurisdictions now allow trade secrets as qualifying IP. The US Government is encouraging US companies to repatriate their IP back to the US by lowering tax rates for royalties received from all forms of IP to be materially less than the rate on ordinary corporate income. The International Accounting Standards Board standard 38 (IAS 38) defines an intangible asset as: “an identifiable non-monetary asset without physical substance.” IAS 38 specifies the three critical attributes of an intangible asset to be

  • identifiability
  • control (power to obtain benefits from the asset)
  • future economic benefits (such as revenues or reduced future costs)

IAS 38 contains examples of intangible assets such as customer lists, copyright, patents and franchise agreements. Trade secrets qualify as far as IAS 38 is concerned, provided that three attributes above are satisfied.

IP reform

In recent times, we have witnessed minor and major changes to patent law, especially in the USA. In the USA, we have seen many changes in recent times – First to file, validity challenges of issued patents, changes to the submission of prior art by 3rd parties, markings, restrictions on where companies may file patent cases, more cases reaching the Supreme Court disputes about eligibility; etc.

The implications of this IP reform are as follows. It is harder to get patents. More inventions are considered patent-ineligible. More inventions are considered obvious in view of the prior art. It is easier to challenge patent validity. Many patents are eliminated at the USPTO via IPR. Many patents are eliminated through litigation in federal court. It is harder to prove infringement. Many patent infringement suits are thrown out of court early: With a motion to dismiss under 12(b)(6), the case does not even get into the courthouse. As a result, some companies that previously may have gone down the patent route are opting to go down the trade secret route instead.

Open innovation

Traditionally, internal innovation was the paradigm under which most firms operated, with most innovative companies keeping their discoveries highly secret and no attempt made to assimilate information from outside their own R&D labs. This was driven by the belief that: “the smart people in our fieldwork for us”. However, in recent years the world has seen major advances in technology and society which have facilitated the diffusion of information. Companies have also begun to realise that “not all the smart people work for us and that we need to work with smart people inside and outside our company”.

Open innovation can take many forms. It can include working with universities, cooperating closely with key suppliers and vendors, collaborating with application developers, content providers, technology house, and design houses, working with various communities including ‘open’ communities, innovation networks, standardization bodies as well as customers and end-users. It can of course involve collaboration with start-ups, SMEs and MNEs.

At first glance, it may sound strange to have open innovation and trade secrets mentioned in the same sentence. However, companies and organizations that embrace collaborative or open forms of innovation face a significant risk of having their trade secrets misappropriated. Collaborative or open forms of innovation by their very nature involve the sharing of IP, and in many instances, this IP is in the form of valuable business confidential information (i.e. trade secrets). For reference, just look at the number of trade secret misappropriation court cases involving former collaboration partners.

The nature of employment

Organizational loyalty is a general term and denotes a person’s commitment and attachment to the place they work. Long gone are the days when an employee joined a company after leaving school and stayed with that company until retiring. These days, people expect to move around across numerous companies over their working careers. The generation of young millennials now in the workplace clearly has a different set of expectations compared to older generations about their careers.

In a nomadic world, one of the casualties is a decreasing sense of loyalty to a particular organization. If loyalty is defined as being faithful to a company, then there seems to be a certain amount of disloyalty in the workplace these days. The recent global recession has also had an adverse impact on such loyalty as loyalty is a two way street.

Have you ever done this on your last day of employment? Taken a USB memory stick, plugged it into your computer, and accessed various documents (e.g. process diagrams, supplier info, client data, source code, market data, etc.) on the shared drive on the network of the company?

Cyber crime

The cyber criminals are really only interested in one particular form of IP, namely trade secrets. The cyber criminals are after any trade secrets that can be harvested and monetized. They are not seeking to steal what is on the menu in the company canteen. They do not want to know what colour paint is on the wall of the offices of the CEO. They are not after information which has already been put into the public domain by the company.

Rather, these cybercriminals are after the trade secrets of the company, the confidential business information which provides an enterprise with a competitive edge. The cybercriminals leverage a variety of different approaches and techniques to identify the vulnerabilities in the IT network of the company and then attack.

The cybercriminals may leverage back-doors into the IT network. They may try a denial-of-service attack or even a direct-access attack. They may try eavesdropping, spoofing, and even tampering directly with the IT network of the company. The cybercriminals may use privilege escalation, phishing, click-jacking, or social engineering techniques. In some cases, they create a false environment of stealing non-pertinent data, diverting the attention of incident responders only to exfiltrate trade secret data residing elsewhere on the network. Regardless of what, where, and how they attack, they are after the trade secrets of the company.

Technology changes

Technology is changing. Futurists of the 1950s and ’60s predicted that by the 2000s, flying cars, meal pills, time travel, and robots would be a part of our everyday lives. We live in a world dominated by live streaming, smartphones and social networks. Technologies like self-driving vehicles and robot assistants are under development or already out in the market-place.

One clear trend in technology is towards software, algorithms, and cloud based solutions. The importance of data (both raw and processed) is increased dramatically. In the pharma and biotech world, we have seen the emergence of bio-similiars.

I suggest that much of the innovations in many of these new technology areas lend themselves more to being protected as a trade secret rather than registered forms of IP such as patents.

Trade wars

A trade war is an economic conflict resulting from extreme protectionism in which states raise or create tariffs or other trade barriers against each other in response to trade barriers created by the other party.

The US and China are locked in a bitter trade battle. US President Donald Trump has complained about China’s trading practices since before he took office in 2016. The US launches an investigation into Chinese trade policies in 2017. It imposed tariffs on billions of dollars worth of Chinese products in 2018, and Beijing retaliated in kind. Both countries agreed to halt new trade tariffs in December 2018 to allow for talks. But hope for a deal faded, and further tit-for-tat tariffs were imposed.

One key aspect of this trade war is IP and allegations of IP theft.

“China national charged with stealing trade secrets” – U.S. Justice Department

“Chinese battery expert is charged with stealing trade secrets from US employer, as he prepared to join mainland firm” – South China Morning Post

“US charges Chinese companies with stealing trade secrets” – The Guardian

“Supreme Court Declines to Hear Chinese Trade Secret Theft Case” – Law360

“Why Trump tariffs on China not stopping theft of trade secrets” – USA Today

“China accused by US and allies of ‘massive hacking campaign to steal trade secrets and technologies’” – South China Morning Post

These are just some of the headlines pulled from various publications during December 2018, all linking China and trade secret theft together.

Getting the basics rights

For all of these reasons outlined above, companies need to take trade secret asset management seriously. Unfortunately, many companies are poor when it comes to trade secret asset management.

Executives from companies of all types acknowledge the importance of trade secrets to their businesses while privately admitting that their company has no idea how many trade secrets they have, which ones are important, or how any of them are protected. The same executives will also sheepishly admit that they have no idea how many trade secrets their company has received from third parties in various business ventures, how adequately their company protects them, or if they even bother to return or destroy them once the collaboration ends.

  • Trade secrets are poorly managed
  • Education is not happening
  • There is a lack of ownership
  • Documentation is poor.
  • Protection mechanisms are poor or non-existent.
  • There is a lack of any classification of such assets.
  • Details on whether trade secrets have been shared is often missing
  • Trade secrets not properly addressed in agreements & contracts
  • There is no information sharing between the legal / IP function and the Accounts / Tax function
  • There is no audit trail.

Nearly everyone acknowledges the importance of trade secrets while doing very little to protect them or even making a simple list. It’s like knowing you have a Rembrandt in your attic and not bothering to have it appraised, insured, or even protected from rodents and birds.

Good practice

Those exceptional companies who have this mastered tend to have the following things in place

  • Education of employees about trade secrets
  • A robust trade secret policy
  • Fit for purpose trade secret process & procedures
  • A system to underpin that process
  • Good quality trade secret metadata
  • Trade secret governance

The importance of education of employees about trade secrets cannot be stated enough. It is a self-enlightening process. It is crucial to the overall development of the individual participant and the company or organization at large. Trade secret education provides the participant with knowledge about the world of trade secrets and enables informed decisions to be made.

A corporate trade secret policy is a formal declaration of the guiding principles and procedures by which the organization will operate, typically established by its board of directors, a senior management policy committee or by the Legal / IP function within the organization

A trade secret process can be seen as an agreement to do certain things in a certain way and the larger the organization, the greater the need for agreements on ways of working. The trade secret process is like the memory of the organization, and without such a process, a lot of effort can be wasted, and the same mistakes can be repeated.

If a company only has one or two trade secrets, then they probably do not require any trade secret asset management system. However, if the number of trade secrets in a company is more than a handful; if they are sharing their trade secrets with others; if other entities are entrusting their trade secrets to the company; if the company has any direct or indirect links with entities in the US (given the growing issue with trade secret litigation there); if the company has trade secrets located across diverse EU member states (given the EU Directive on Trade Secrets being enacted in June 2018), if the company is doing any business in China (for the reasons outlined above); and/or if the company is conducting any IP due diligence exercises due to some corporate event (e.g. M&A, JV, Investment Round, etc.), then a trade secret asset management system is absolutely required.

Metadata is a set of data that describes and gives information about other data. Metadata is simply data that describes other data. Meta is a prefix that in most information technology usages means ‘an underlying definition or description’. Some mistakenly believe that because trade secrets are not registered, then the concept of trade secret metadata may not apply. Others mistakenly believe that because trade secrets are meant to be kept secret, then no metadata should exist.

Governance is the act of governing. It relates to decisions that define expectations, grant power, or verify performance. In the case of a business, governance relates to consistent management, cohesive policies, proper guidance, well defined processes, KPIs and metrics, and decision-rights for a given area of responsibility. Trade secret governance is simply about defining the ‘rules’ for those involved in trade secret asset management within the organization.

The first and last items listed, namely education and governance, are like book-ends keeping everything else in order.

We would argue that trade secret metadata is key. Without trade secret data, you have no trade secret information. Without trade secret information, you have no trade secret knowledge.

Donal O’Connell, IPEG consultant

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