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Monday, May 16, 2022

ENTREPRENEUR’SNOTEBOOK

First in a series.

Monday morning. You review your company’s quarterly sales report.

Orders from your best customers have plummeted. Even worse, your eye catches a headline in your industry’s trade journal in which the CEO of your primary competitor boasts of record-high sales in a market your company was about to launch into.

You spent hundreds of thousands of dollars and years to identify and collect information about the narrow band of customers who use your products and services and you thought your marketing plans were unknown in the industry.

You conclude that your competitor must have your confidential customer list and marketing plans and that the vice president of marketing you fired months ago for insubordination is likely involved.

You are not alone. A survey by the American Society for Industrial Security revealed that known information piracy has skyrocketed. This vulnerability only increases when companies fail to implement an effective trade-secret protection program.

Management often mistakenly assumes that the company’s personnel already understand that the information is confidential and cannot be disclosed outside of the company.

In an increasingly competitive economy with highly mobile employees, companies are often lax in preventing their executives, engineers and other employees from stealing their trade secrets and then using them to compete in the market. According to the ASIS survey, three-fourths of the incidents involved company insiders.

California law defines a “trade secret” as information that has actual or potential economic value from not being generally known to others and is the subject of reasonable efforts to maintain its secrecy. Courts, however, are typically unpersuaded by a suit for damages or an injunction over trade-secret misappropriation where it is clear that the company never gave much advance thought to identifying trade secrets and taking steps to protect the information at the outset.

The first step to developing a trade-secret protection program is to determine what information needs to be protected.

You should inventory your proprietary information with the help of counsel or other professionals experienced in information protection. Examine your research and development of new products and negative know-how (i.e., what does not work), designs and prototypes, manufacturing processes, marketing and business plans and forecasts, pricing research and schedules, internal financial data, special vendor relationships and pricing, and proprietary customer lists and purchasing requirements, all of which may be trade secrets.

Identify what information must be protected by answering these questions:

1) What information, if taken by a former employee or unearthed by a competitor, could damage your business or eviscerate the competitive edge you enjoy?

2) How much time and money have your company spent to develop this information? Exclude things that are uniformly known in your industry or obtained from public sources.

Generally, the greater competitive value the information has and the harder or more expensive it is to duplicate, the greater the likelihood that a court will find the information to be a protectable trade secret.

This will help you identify your “real” trade secrets that need special protection and will also help prove their value if you need to go to court to seek an injunction or damages. Two California customer-list cases are helpful examples. In one case, a packaging supply company alleged that former sales employees violated the trade-secret statute when they sold the company’s customer list to a competitor. The list contained each customer’s purchasing requirements and sales history data. The court denied relief because everybody in the packaging business knew who the key accounts were and could easily create a similar list of their own.

Conversely, in another case involving former employees accused of stealing a trade-secret customer list, the court found that the plaintiff company had spent years and substantial money to meticulously whittle down lists of potential clients to find a relatively small percentage who actually purchased a unique type of service.

The court found that the specialized information in the company’s customer lists were trade secrets, and issued an injunction restraining the former employees from using the information.

Paramount to a trade-secret protection program is deterrence of unauthorized disclosure and use of trade secrets. At the outset, this will minimize the need for litigation, which can mean heavy attorney’s fees and costs, diversion of management’s time, embarrassment of adverse publicity, and loss of confidence of shareholders, potential investors, and public markets.

In my next column I will discuss some techniques for protecting trade secrets such as instituting “need to know” policies, confidentiality agreements and controlled access to computer data.

Mark E. Terman, Esq. is an employment and business litigation partner with the Los Angeles office of Reish & Luftman where he heads the firm’s Employment Law practice.

Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact Dan Rabinovitch at (213) 743-2344 with feedback and topic suggestions.

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