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Protection of Trade Secrets in the Computer Industry

By
Lee T. Gesmer

Industrial espionage and theft of trade secrets go back far in the history of civilization. In ancient China, death by torture was the penalty for revealing the secret of silk making to outsiders.

Today, the penalty for theft of trade secrets, if the perpetrator gets caught, is usually just financial. Although trade-secret thefts exists in almost all areas of American business, the computer industry is particularly susceptible to this problem, due to the following mix of ingredients:

  • enormous investments in technology development
  • an always increasing tempo of technological change
  • rapid product cycles
  • an emphasis on imitative or compatible products
  • a high degree of employee mobility
  • an international marketplace

Thus, in the computer industry, with research so expensive and the need to know so great, many companies have shown themselves willing to take the risks involved in technology theft. This willingness is fueled and exacerbated by widespread recognition that trade secret litigation is costly and slow, and that misappropriation often is difficult to prove. It is generally believed that most trade-secret theft goes undiscovered, and if discovered goes unprosecuted.

This article will focus on three areas of trade-secret law. First, practically speaking, what is a trade secret and how should its owner protect it? Second, what are the differences between trade-secret protection and the other two over-lapping forms of intellectual property protection provided by U.S. law, copyright and patent protection? Third, what are an employer’s rights against a former employee and that employee’s new employer, where trade-secret theft is suspected?

I. What is a Trade Secret?

There have been many attempts by courts and commentators to create a generic definition has proven very difficult. Many courts have taken the approach that, as with pornography, “I can’t define it, but I know it when I see it.”

However, for purposes of most applications, the law can be distilled to the following definition:

A trade secret is

(1) a secret which gives its owner an actual or potential advantage in business,

(2) which the owner exercises reasonable measures to maintain as a secret.

As with many broad definitions, this one needs further explanation.

First, what limitations, if any, are there on the subject matter of a trade secret? As a practical matter, there appear to be almost none.

Some of the more commonly recognized subjects of trade-secret protection are scientific processes of all kinds, product blueprints, algorithms, the contents of pending patent applications, database compilation, manufacturing processes, technical data (such as the results of tests), the knowledge that a certain approach to a problem does not work (“negative know-how”), customer lists, financial information, the results of market research studies, and internal costing and pricing information.

In Massachusetts, the state courts have protected the formula for chocolate chip cookies and the proportions of the ingredients in herbal dog food. The Massachusetts federal district court has expressly held that computer source code may qualify as a trade secret.

It is critical to an understanding of trade-secret law to appreciate that a protectable trade secret need not be a single idea or invention but can be a combination of processes or inventions that, individually, are already in the public domain. As one court has stated, “a trade secret can exist in a combination of characteristics and components, each which, by itself, is in the public domain, but the unified process, design and operation of which, in unique combination, affords a competitive advantage and is a protectable secret.”

II. What is a Secret?

A secret is not necessarily something that is possessed by one person, but it is something that is not “generally known”.

By way of example, take the following hypothetical. Company A has developed a data compression algorithm that gives it a competitive advantage. Several other computer companies, not necessarily competitors, have also independently developed a similar algorithm. One of Company A’s employees goes to work for one of its competitors, who does not have the algorithm, and reveals the secret to it. Company A brings suit against the former employee and the competitor, and one of their defenses is that several members of the industry possess the so-called secret, and therefore it is no secret at all. Will this defense succeed? Almost certainly not. A trade secret can be independently discovered and owned by more than one company and still remain a trade secret.

On the other hand, assume that an employee of one of the companies that has independently discovered the algorithm has written a technical paper describing it, and this paper is published in an academic journal. At this point, the trade secret is available in many libraries, it can no longer be considered to be a trade secret, and Company A’s suit is likely to fail.

As a practical matter, in many trade secret cases, whether a secret has become general knowledge is not black or white, but is a question of fact which the judge or jury must decide.

Third, how much effort does a trade secret owner have to expend to preserve the trade secret? The answer is that the law demands secrecy; however, it does not demand absolute secrecy, only that the owner take “reasonable measures” to protect the secret.

In part, what constitutes reasonable measures depends on the nature of what is sought to be protected. Many courts have recognized a spectrum of trade secrets; a secret is entitled to different degrees of treatment depending on where it falls on the spectrum. At the one end are “hard” secrets, e.g., chemical formulae, source code, product blue prints; things of the sort that employees either know, or should know, are of a confidential nature. At the opposite end of the spectrum, at the periphery of trade-secret protection, are “soft” secrets, such as customer lists, business plans, and general financial or marketing information.

In the case of “hard” trade secrets, the courts are more willing to overlook the absence of confidentiality agreements and even relatively weak precautions to protect the secret, and to find that there has been a confidential relationship that provides protection. Even in the absence of a contract containing a confidentiality provision, the courts are willing to find that there is an “implied contract” of confidentiality.

In the case of “soft” secrets, such as customer lists, marketing plans, and the like, the owner of the alleged secret will have to show that it took considerable precautions to protect the information, if it expects a court to provide protection.

Because of the uncertainty that these distinctions will lend to any lawsuit involving the litigation of a trade secret, any company believing that it owns a trade secret would be reckless to rely on an implied contract. Express contracts so-called “nondisclosure” or “confidentiality” agreements – are unequivocally the best way to achieve protection.

To ensure that a trade secret will not be lost for lack of secrecy precautions, the following measures should be taken:

  1. All employees and independent contractors, potential and actual customers, licensees, joint venturers, subcontractors, and manufacturers exposed to trade secrets should be required to sign nondisclosure agreements.
  2. Employees should be periodically reminded what items the company considers trade secrets.
  3. If the company has a policy manual, it should warn employees that they will be exposed to trade secrets during the course of their employment, identify in general terms the types of information that fall within this category, emphasize that these materials must be treated as confidential, and remind employees that the duty to preserve confidentiality extends beyond the termination of employment.
  4. Documents containing trade secrets should be stamped confidential, and forms that are likely to have confidential information printed on them should have pre-printed restrictive legends.
  5. The company should have a formal policy of conducting exit interviews with departing employees, at which time the employee should be reminded that his or her trade-secret obligations continue after resignation or termination, and asked to return all materials belonging to the company.
  6. In a large company with many technical employees, there should be a formal policy for previewing materials intended to be presented at speeches, trade shows, and in publications.
  7. To the extent that it is reasonably possible to do so, physical access to trade secrets should be restricted. For example, if a company hopes to persuade a judge to provide trade-secret protection to its customer list, it will have a far better case if a limited number of copies of that list are kept in a locked location, or an encrypted or restricted-access computer file, than if the list is disseminated throughout the company, even to employees who have no need to possess it. of course, computer source code that embodies trade secrets should be treated the same way.

Efforts of these kinds to protect secrecy are enormously persuasive in a trade-secret suite; they show that the company took its trade secrets seriously, and went to significant efforts to protect them. In a preliminary injunction proceeding, where the plaintiff is asking a court to take the extraordinary step of enjoining the defendant’s use of certain technology pending a full trial, these precautions can prove critical. Often, it is extremely difficult for a judge to make a determination of whether there is in fact a “secret” involved at this stage of the litigation, and he or she will be heavily influenced by the extent that the plaintiff can show that it treated the information in question as a trade secret.

Similarly, at the trial of the case, a jury that my have difficulty understanding subtle distinctions in technology, and concluding whether the technology at issue is indeed a “secret” in the plaintiff’s industry, may be heavily influenced by the fact that the plaintiff took careful precautions to treat it as a secret.

III. Suing Your Former Employee and His/Her New Employer

The most common form of trade-secret dispute is where an employee leaves a company that possesses trade secrets, and either starts his own competitive business, or goes to work for a competitor.

Often, in this situation, the former employer has no immediate evidence that the employee is revealing secrets to the new employer, or that the new employer is making use of them. All the former employer has are strong suspicions.

A. The Former Employee

Suing a former employee for trade-secret misappropriation brings into play directly competing policies. On the one hand, the law recognizes that an employer is entitled to enforce its trade-secret rights, even against former employees. On the other hand, there is a strong public policy to encourage employees to use the general skills and knowledge they acquired during employment. The policy favoring employee mobility puts a burden on the employer.

As one Massachusetts court stated:

an employer asserting trade-secret misappropriation against a skilled employee bears a heavy burden of isolating the secret for which he claims protection and of demonstrating that the employee is left free to use the knowledge and skill he brought to the employment.

Thus, in any case against a former employee, the battle lines are clearly drawn: the employer will portray the employee as seeking to profit from trade secrets taken from the employer; the employee will argue that the employer is seeking to restrain competition, and try to force the employer to identify as specifically as possible the trade secrets it seeks to protect. In one respect, the success of a trade-secret owner in a suit against a former employee will depend on the trade-secret owner’s ability to narrowly define and describe its trade secrets, and to show the court that the trade-secret owner followed strict secrecy precautions.

B. The New Employer

What are the rights and liabilities of the new employer (or the purchaser or license of misappropriated technology)?

It is clear that trade-secret law imposes liability not only on those who breach a confidential relationship but also on third parties who, with notice that there has been a breach, benefit from it. Usually, the third party is a new employer or one who purchases or licenses technology embodying the “secret” from one who has misappropriated it.

The key element here, so far as the new employer or the purchaser/licensee is concerned, is notice. The new employer must know, or have reason to know, that its new employee had access to trade secrets and may be about to breach a confidential relationship.

Notice may be constructive or actual. Constructive notice arises where the new employer should reasonably know that its new employee may be acting improperly. Of course, a case where the plaintiff must prove constructive notice may involve difficult issues of proof over whether the new employer should have known or inferred that it was receiving trade secrets.

By far the better situation for the former employer, the trade-secret owner, is if the new employer has actual notice of a potential breach of a confidential relationship. This can be accomplished by sending a letter to the new employer, return receipt requested, indicating that the new employee has knowledge of trade secrets, the general subject matter of the trade secrets, an explanation of the legal basis for the employee’s obligation to maintain secrecy (for example, a nondisclosure agreement), and that by virtue of the foregoing, the trade-secret owner may have a cause of action against the new employer.

If the new employer does not have either actual or constructive notice that its employee is acting improperly, the new employer can argue that it should be permitted to avoid liability because it acted in good faith.

Some practical pointers:

1. What should a trade-secret owner do when it only suspects that its former employee may be inclined to reveal trade secrets to his or her new employer? If the owner gives immediate notice, it has the benefit of taking away the new employer’s good faith defense. On the other hand, the owner may be accusing a former employee who had no intention of disclosing your trade secrets. Worse, the owner may be alerting the new employer that its new employee has this knowledge, with the potential that a misappropriation will result where none previously had been contemplated.

There is no general answer to this problem. The trade-secret owner must act on a case-by-case basis, after considering all of the factors that might be relevant.

2. How should a company act if it is the one hiring the former employee of a competitor? First, as part of every employer’s standard employment agreement, each new employee should be required to certify that he or she is not illegally providing the employer with trade secrets. Second, the new employer should consider sending a letter to the employee’s former employer, informing it that the new employer is aware the employee had access to trade secrets, and that it has no intention of inducing or permitting the use or disclosure of these secrets. This letter might forestall litigation, and in the case litigation ensues, be helpful in showing that the new employer acted in good faith.

FOOTNOTES

1. Although there are criminal penalties for misappropriation of trade secrets, prosecutions are rare. See , e.g. , M.G.L. c. 266, sec. 30 (4), which provides a definition of trade secret for both civil and criminal purposes. It is interesting to note, however, that the first reported case of a criminal prosecution for trade-secret theft arose in Massachusetts. Commonwealth v. Engleman , 336 Mass. 66 (1957). See also Commonwealth v. Robinson , 7 Mass. App. Ct. 470 (1979) (conviction for trade-secret theft overturned based on state’s failure to prove that the secret’s owner had taken any security precautions).

2 See Jet Spray Cooler, Inc. v. Crampton , 361 Mass. 835, 840 (1972); See also M.G.L. c. 266, sec. 30 (4), which defines the term “trade secret” for both civil and criminal purposes under Massachusetts law.

3. SI Handling Systems, Inc. v. Heisley , 581 F. Supp. 1553 (E.D.Pa. 1984), illustrates the flexibility of the subject matter that can be protected by trade-secret law. There, the court found that the identities of key executives within General Motors Corporation, a customer of the plaintiff, constituted a protectable trade secret that had been misappropriated.

4. Peggy Lawton Kitchens, Inc. v. Hogan , 18 Mass. App. 937, 466 N.E. 2d 138 (Mass. App. 1984).

5. Sissy Harrington-McGill v. Old Mother Hubbard Dog Food, Inc. , Middlesex Superior Court C.A. 81-4385, Joint Memorandum of Decision, January 3, 1985.

6. See Dickerman Associates, Inc. v. Tiverton Bottled Glass Company , 594 F. Supp. 30 (D. Mass. 1984). Computer software has been recognized as protectable under the trade-secret law of many other states. See, e.g., Structural Dynamics Research Corp. v. Engineering Mechanics Research Corp. , 401 F. Supp. 1102 (E.D. Mich. 1975).

7. Syntex Opthalmics, Inc. v. Novicky Tsuetaki , 223 U.S.P.Q. 695, 703 (Fed. Cir. 1984).

8. Compare J.P. Healy & Son, Inc. v. James A. Murphy & Son, Inc. 357 Mass. 728. 737-38 (1970) (“The essential characteristic of a trade secret [is] secrecy…[I]ndividuals must be constantly admonished that a process is secret and must be kept so.”) and USM Corp. v. Marson Fastener Corp. , 379 Mass. 90 (1970) (“The question whether a plaintiff has taken “all proper and reasonable steps” depends on the circumstances of each case, considering the nature of the information sought to be protected as well as the conduct of the parties”).

9. See, e.g., USM , supra at note 10.

10. See, e.g., Pressure Science, Inc. v. Kramer , 413 F. Supp. 618 (D. Conn. 1976) (Plaintiff’s failure to require all employees working in a supposedly confidential area to sign a nondisclosure agreement evidenced a lack of concern for confidentiality fatal to trade-secret status).

11. See, e.g., Pressure Science, Inc. v. Kramer , 413 F. Supp. 618 (D. Conn. 1976) (Plaintiff’s failure to require all employees working in a supposedly confidential area to sign a nondisclosure agreement evidenced a lack of concern for confidentiality fatal to trade-secret status).

12. See, e.g., Jostens, Inc. v. National Computer Systems, Inc. , 318 N.W.2d 691, 214 U.S.P.Q. 918 (Minn. 1982) (Article by employee explaining “theoretical concepts” of computer-aided design/computer-aided manufacture system resulted in loss of trade-secret rights in system).

13. Dynamics Research Corp. v. Analytic Sciences Corp. , 9 Mass. App. Ct. 254, 268 (1980).

14. See Restatement of Torts, Section 757 (1939).

15. See, e.g., Metallurgical Foundations, Inc. v. Fourtek , 790 F.2d 1195, 229 U.S.P.Q. 945 (5th Cir. 1986). In the Fourtek case, the purchaser of the product utilizing the trade secret in question had notice of trade-secret litigation that was pending against its vendor regarding that product. See also FMC Corp. v. Spurlin , 224 U.S.P.Q. 720 (W.D. Pa. 1984) (denying motion for summary judgment by alleged bona fide purchaser).

16. See, e.g., Vantage Point, Inc. v. Parker Brothers, Inc. 529 F. Supp. 1024 (E.D.N.Y. 1981), where the court found that the defendant had invested monies in anticipation of use of the trade secret before receiving notice of the existence of a trade secret. The court concluded that the defendant should not be subjected to the loss of this investment for actions taken when it was under no duty to the plaintiff. See also Restatement of Torts, Section 758(1939); Milgrim, “Rights and Liabilities of Third Parties Who May Receive Another’s Proprietary Rights,” 2 THE COMPUTER LAWYER, Vol. 2, No. 11 (1985).