Trade secrets of the firm

Most companies, including start-ups, have a wealth of information that is critical to their success but does not qualify for patent, trademark, or copyright protection. Some of this information is confidential and needs to be kept secret to help a firm maintain its competitive advantage. An example is a company’s customer list. A company may have been extremely diligent over time track- ing the preferences and buying habits of its customers, helping it fine-tune its marketing message and target past customers for future business. If this list fell into the hands of one or more of the company’s competitors, its value would be largely lost, and it would no longer provide the firm a competitive advantage over its competitors.

A trade secret is any formula, pattern, physical device, idea, process, or other information that provides the owner of the information with a competitive advantage in the marketplace. Trade secrets include marketing plans, product formulas, financial forecasts, employee rosters, logs of sales calls, and laboratory notebooks. The medium in which information is stored typically has no impact on whether it can be protected as a trade secret. As a result, written documents, computer files, audiotapes, videotapes, financial statements, and even an em- ployee’s memory of various items can be protected from unauthorized disclosure.

Unlike patents, trademarks, and copyrights, there is no single government agency that regulates trade secret laws. Instead, trade secrets are governed by a patchwork of various state laws. The federal Economic Espionage Act, passed in 1996, does criminalize the theft of trade secrets. The Uniform Trade Secrets Act, which a special commission drafted in 1979, attempted to set na- tionwide standards for trade secret legislation. Although the majority of states have adopted the act, most revised it, resulting in a wide disparity among states in regard to trade secret legislation and enforcement.

1. What Qualifies for trade Secret protection?

Not all information qualifies for trade secret protection. In general, informa- tion that is known to the public or that competitors can discover through legal means doesn’t qualify for trade secret protection. If a company passes out brochures at a trade show that are available to anyone in attendance, nothing that is in the brochure can typically qualify as a trade secret. Similarly, if a secret is disclosed by mistake, it typically loses its trade secret status. For ex- ample, if an employee of a company is talking on a cell phone in a public place and is overheard by a competitor, anything the employee says is generally exempt from trade secret protection. Simply stated, the general philosophy of trade secret legislation is that the law will not protect a trade secret unless its owner protects it first.

Companies can maintain protection for their trade secrets if they take reasonable steps to keep the information confidential. In assessing whether reasonable steps have been taken, courts typically examine how broadly the information is known inside and outside the firm, the value of the information, the extent of measures taken to protect the secrecy of the information, the ef- fort expended in developing the information, and the ease with which other companies could develop the information. On the basis of these criteria, the strongest case for trade secret protection is information that is characterized by the following:

■ Is not known outside the company

■ Is known only inside the company on a “need-to-know” basis

■ Is safeguarded by stringent efforts to keep the information confidential

■ Is valuable and provides the company a compelling competitive advantage

■ Was developed at great cost, time, and effort

■ Cannot be easily duplicated, reverse engineered, or discovered

2. Trade Secret disputes

Trade secret disputes arise most frequently when an employee leaves a firm to join a competitor and is accused of taking confidential information along. For example, a marketing executive for one firm may take a job with a competitor and create a marketing plan for the new employer that is nearly identical to the plan being worked on at the previous job. The original employer could argue that the marketing plan on which the departed employee was working was a company trade secret and that the employee essentially stole the plan and took it to the new job. The key factor in winning a trade secret dispute is that some type of theft or misappropriation must have taken place. Trade secrets can be lawfully discovered. For example, it’s not illegal for one company to buy an- other company’s products and take them apart to see how they are assembled. In fact, this is a relatively common practice, which is another reason compa- nies continuously attempt to innovate as a means of trying to stay at least one step ahead of competitors.

A company damaged by trade secret theft can initiate a civil action for damages in court. The action should be taken as soon after the discovery of the theft as possible. In denying the allegation, the defendant will typically ar- gue that the information in question was independently developed (meaning no theft took place), was obtained by proper means (such as with the permission of the owner), is common knowledge (meaning it is not subject to trade secret protection), or was innocently received (such as through a casual conversa- tion at a business meeting). Memorization is not a defense. As a result, an employee of one firm can’t say that “all I took from my old job to my new one was what’s in my head” and claim that just because the information conveyed wasn’t in written form, it’s not subject to trade secret protection. If the courts rule in favor of the firm that feels its trade secret has been stolen, the firm can stop the offender from using the trade secret and obtain financial damages.

3. Trade Secret protection methods

Aggressive protection of trade secrets is necessary to prevent intentional or unintentional disclosure. In addition, one of the key factors in determining whether something constitutes a trade secret is the extent of the efforts to keep it secret. Companies protect trade secrets through physical measures and written agreements.

Physical Measures There are a number of physical measures firms use to protect trade secrets, from security fences around buildings, to providing employees access to file cabinets that lock, to much more elaborate measures. The level of protection depends on the nature of the trade secret. For example, although a retail store may consider its inventory control procedures to be a trade secret, it may not consider this information vital and may take appropri- ate yet not extreme measures to protect the information. In contrast, a biotech firm may be on the cusp of discovering a cure for a disease and may take ex- treme measures to protect the confidentiality of the work being conducted in its laboratories.

The following are examples of commonly used physical measures for protect- ing trade secrets:

■ Restricting access: Many companies restrict physical access to confiden- tial material to only the employees who have a “need to know.” For example, access to a company’s customer list may be restricted to key personnel in the marketing department.

■ Labeling documents: Sensitive documents should be stamped or labeled “confidential,” “proprietary,” “restricted,” or “secret.” If possible, these documents should be secured when not in use. Such labeling should

be restricted to particularly sensitive documents. If everything is labeled “confidential,” there is a risk that employees will soon lose their ability to distinguish between slightly and highly confidential material.

■ Password protecting confidential computer files: Providing employees with clearance to view confidential information by using secure passwords can restrict information on a company’s computer network, website, or intranet. Companies can also write-protect documents to ensure that employees can read but not modify certain documents.

■ Maintaining logbooks for visitors: Visitors can be denied access to confidential information by asking them to sign in when they arrive at a company facility, having them wear name badges that identify them as visitors, and always making sure they are accompanied by a company employee.

■ Maintain logbooks for access to sensitive material: Many companies maintain logbooks for sensitive material and make their employees “check out” and “check in” the material.

■ Maintaining adequate overall security measures: Commonsense measures are also helpful. Shredders should be provided to destroy docu- ments as appropriate. Employees who have access to confidential material should have desks and cabinets that can be locked and secured. Alarms, security systems, and security personnel should be used to protect a firm’s premises.

Some of these measures may seem extreme. On the other hand, we live in an imperfect world and, because of this, companies need to safeguard their information against both inadvertent disclosure and outright theft. Steps such as shredding documents may seem like overkill at first glance but may be very important in ultimately protecting trade secrets. Believe it or not, there have been a number of cases in which companies have caught competitors literally going through the trash bins behind their buildings looking for confidential information.

Written agreements It is important for a company’s employees to know that it is their duty to keep trade secrets and other forms of confidential infor- mation secret. For the best protection, a firm should ask its employees to sign nondisclosure and noncompete agreements, as discussed in Chapter 7.

Intellectual property, and the problems that underlie the need for intellec- tual property to be created, are important enough that firms have been started strictly for the purpose of helping companies solve problems and obtain the intellectual property that they need.

Source: Barringer Bruce R, Ireland R Duane (2015), Entrepreneurship: successfully launching new ventures, Pearson; 5th edition.