Trade Secret Audits – Why Bother?
What is a trade secret audit and why get one? At first blush an audit sounds expensive, distracting and unnecessary. Let’s face it, we live in the age of the long tail. Over the past few years, things people would have given a remote chance of coming to pass seem to be happening on a regular basis. What’s more, the pace of change and disruption in business and in the personal world is so great, it is almost impossible to keep up. It seems that whatever you are doing today will have to be radically altered very soon. With all this change most of us are running just to stay in place – so any distraction from the daily chores of simply keeping up needs a powerful justification. I would argue however, that the frenetic pace of business life is precisely why audits are so important. Just as mindfulness is rightly understood as being key to a centered life, trade secret audits are essential to continued success as a business.
A trade secret is anything that has economic value (e.g., gives you a competitive advantage in the marketplace) because it is kept secret. Understood that way, it should be evident that regular stock-taking of a company’s competitive advantages comprises a necessary component of good business practices. Thoughtful companies will utilize these corporate self-assessments – of which trade secret (and more broadly IP) audits are a necessary component – to understand their true growth drivers, both current and anticipated. With the assessments in hand companies can take any actions necessary to better protect and cultivate those growth drivers. The assessments allow companies to proactively course-correct their trajectory in a way that maximize how they utilize their identified competitive advantages.
When it comes to trade secrets, there is often resistance to audits because executives mistakenly think they are just for engineered technology. This is incorrect. Trade secrets can include: customer preferences; marketing and branding plans; sales techniques; negotiated pricing and contracts; training programs; financial data; algorithms; negative knowledge (what a company knows does not work – e.g., failed lab experiments, failed marketing plans); employee reviews and labor market assessments; profit margins and projections; internal development strategies; metrics and analytics; vendor or supplier lists; bills of material, recipes; product roadmaps; competitor analyses; manufacturing processes; and many, many others.
What is involved in ensuring a successful audit? The first and most crucial step is to establish the audit’s goals. What does management think or hope the audit will accomplish? To even answer that question, an audit must have management buy-in and a key person within the company who is properly authorized to conduct the audit. Not defining realistic expectations and/or providing proper staffing and authorization is a recipe for failure.
There are, roughly speaking, five categories of goals for trade secret audits. They are: (1) developing a basic awareness of what trade secrets exist within the company and ascertaining all associated meta-data[1] about those secrets; (2) review and/or development of agreements appropriate for the company in light of its trade secrets; (3) an assessment of how a company’s current, former and potential employees interact with those trade secrets and the relevant policies that govern those interactions; (4) developing technical tools and processes to maximize trade secret asset protection and policy compliance; and (5) devising a monetization strategy that leverages safeguarded trade secrets in way that bring additional, concrete value to the company. Each goal identified builds on the previous one, and a trade secret audit can have some or all of them as a goal. Below I discuss what these goals entail in some more detail.
The first goal, awareness, has as a first step reviewing all the trade secrets that management believes comprise its trade secrets. The next step requires collaboration with management to identify employees and other key business partners who have access to the management-identified trade secrets; who have developed relationships with key customers; and/or who are otherwise considered key employees. After these people have been identified their cooperation must be secured (no easy feat!). Then they must be interviewed with an eye to understanding how they bring value to the company – which may not always be how management thinks they bring value. Those sources of value are then scrutinized to see if they are protectable as a trade secrets – even if not previously identified by management as one.
Once the company has a working list of all its trade secrets, the metadata for each of those trade secrets must be identified including: the creation date; the creators; the physical location of the trade secret; the legal owner of the trade secret; the person(s) responsible for managing the trade secret; the persons with authorized access; the protection mechanisms in place to protect the trade secrets – both contractual (nondisclosure and employment agreements, etc.) and physical; whether any third parties have accessed the secret and under what conditions; and many others.
The second goal requires a thoughtful review of all agreements relevant to the company’s trade secrets. The agreements and provisions within broader agreements to be reviewed will include: nondisclosure agreements; noncompete and intellectual property (patent, trademark, copyright and knowhow) assignment provisions in employment or contractor agreements; remedies provisions in the identified agreements as well as remedy provisions in any agreement for breach of confidentiality; and agreements governing the treatment of a third party’s confidential information by the company as well as the company’s treatment of a third party’s confidential agreement (e.g., in the case of an OEM arrangement). These agreements must be reviewed and modified to ensure they comply with best practices as developed through relevant case law and statutory changes (e.g., with all Defense of Trade Secrets Act notice requirements). One challenging aspect of this goal is being able to identify situations where there should be an agreement to cover a particular trade secret “situation” but none exists, and then drafting the “missing” agreement(s) and getting the necessary parties to enter into it.
The third goal concerns the company’s policies and procedures regarding employees. It entails drafting, review and updating a company’s trade secret document preservation policy and procedures (including any relevant forms). It also requires a review of all relevant human resources policies and procedures and employee manuals and training that may impact trade secret policies. Finally, it requires human resources training on trade secret protection to ensure compliance with relevant policies and practices during recruitment and hiring; during employment departure processes and exit interviews; and the treatment of former employees’ workspaces, laptops, mobile devices, and the like.
The fourth goal relates to the use and implementation of objective tools to promote trade secret protection. This can include a forensic audit of all electronic security policies and protocols. It may include the design and implementation of appropriate physical and electronic security measures to protect trade secrets and ensure compliance with all the processes discussed above. Finally, it may include the use of a trade secret tracking tool like Hazel[2] to ensure uniform, trade secret meta-data collection and reporting.
The fifth goal relates to monetization. When a trade secret portfolio is organized and well understood the first step towards monetization is valuation. Evaluating trade secrets in a vacuum is always challenging, but the answers to the following questions will go a long way to assigning a non-speculative value to the trade secret: (a) how much will it cost to replace the trade secret if it were lost and had to be recovered? (b) what was the cost to creating the trade secret? (c) what is the future anticipated income and present value of any cash flows associated to the trade secret? (d) what is the cost of maintaining the trade secret? (e) what is the marketplace value of similar trade secrets in transactions? (f) what is the market value of the company without the trade secret? and (g) what are the economic benefits of the asset?
Once a (tentative) value to the trade secret has been ascertained, a company can explore monetization. In addition to standard licensing of the trade secret to third parties, a company may be able to place the trade secret in a patent box regime thereby reaping large tax gains.[3] Moreover, as a result of changes in the guidelines on international tax co-operation put out by the Organization for Economic Co-Operation and Development (OECD) companies may now or in the near future need to recognize in their books the value of trade secrets for their businesses.[4] Finally, there are a number of interesting financial products being developed where properly secured trade secrets can be used as collateral for loans.[5]
In sum, a trade secret audit will help a company identify and focus on its key value drivers. It will also help set up policies, procedures and agreement that will go a long way to ensure that those drivers a protected using best practices. Finally, it may be possible to leverage the results of an audit toward previously unconsidered sources of revenue or savings for the company.
David L. Cohen, president and founder of David L. Cohen, P.C. was former in-house counsel at Nokia and former Chief Legal IP Officer at Vringo. His law firm focuses on outsourced IP counsel services including: SEP licensing; F/RAND and anti-trust compliance; offensive and defensive patent licensing and litigation management; IP and public markets concerns; outside counsel management; agreements; and trade secret auditing and protection. Through Kidon IP corp., David also offers: IP and standards white-spacing to guide R&D, patent brokering, patent review and valuation services, IP services for M&A, and global IP portfolio building.
[1] As my former colleague, Donal O’Connell rightly notes, understanding a trade secret’s meta-data is a critical, if not the critical component, of strong protection http://www.hazeltradesecrets.com/trade-secret-metadata/.
[2] http://www.hazeltradesecrets.com/
[3] At least 5 European countries include some or all trade secrets within their patent box regimes. https://www.linkedin.com/feed/update/urn:li:activity:6328586705930588161
[4] https://www.linkedin.com/pulse/viewing-trade-secrets-assets-donal-o-connell/
[5] http://www.patentinsuranceonline.com/collateral-protection-insurance/index.html
