Trade Secret Basics
Trade secret law gives the owner of important commercial information the right to keep others from usingit. Here's what business owners need to know to protect trade secrets and maintain a competitiveedge.
What is a trade secret?
In most states, a trade secret may consist of any formula, pattern, physical device, idea, process,compilation of information, or other information that is both of the following:
- Provides the owner of the information with a competitive advantage in the marketplace
- Is treated in a way that can reasonably be expected to prevent the public or competitors from learning about it, barring improper acquisition or theft
Some examples of potential trade secrets are a formula for a sports drink, survey methods used byprofessional pollsters, recipes, a new invention for which a patent application has not yet been filed,marketing strategies, manufacturing techniques, and computer algorithms. Unlike other forms of intellectualproperty such as patents, copyrights, or trademarks, trade secrecy is basically a do-it-yourself form ofprotection. You don't register with the government to secure your trade secret; you simply keep theinformation confidential. Trade secret protection lasts for as long as the secret is kept confidential. Once atrade secret is made available to the public, trade secret protection ends.
How do businesses put trade secrets to use?
Trade secrets often protect valuable technical information that cannot be sheltered under other forms ofintellectual property law, such as the formula for Coca-Cola. Trade secrets may also do the following:
- Protect ideas that offer a business a competitive advantage, thereby enabling a company or individual to get a head start on the competition -- for example, an idea for a new type of product or a new Web site
- Keep competitors from learning that a product or service is under development and from discovering its functional or technical attributes -- for example, how a new software program works
- Protect valuable business information such as marketing plans, cost and price information, and customer lists -- for example, a company's plans to launch a new product line
- Protect "negative know-how" -- that is, information you've learned during the course of research and development on what not to do or what does not work optimally -- for example, research revealing that a new type of drug is ineffective
- Protect any other information that has some value and is not generally known by your competitors -- for example, a list of customers ranked by how profitable their business is
What rights does the owner of a trade secret have?
A trade secret owner can prevent the following groups of people from copying, using, and benefiting fromits trade secrets or disclosing them to others without permission:
- People who are automatically bound by a duty of confidentiality not to disclose or use trade secret information, including any employee who routinely comes into contact with the employer's trade secrets as part of the employee's job
- People who acquire a trade secret through improper means such as theft, industrial espionage, or bribery
- People who knowingly obtain trade secrets from people who have no right to disclose them
- People who learn about a trade secret by accident or mistake but had reason to know that the information was a protected trade secret
- People who sign nondisclosure agreements (also known as confidentiality agreements) promising not to disclose trade secrets without authorization from the owner
This may be the best way for a trade secret owner to establish a duty of confidentiality. Even though bound under an implied duty not to disclose sensitive information, all employees who come into contact with a company's trade secrets -- including high-level employees and company presidents -- should sign nondisclosure agreements because such agreements make it clear to the employee that the company's trade secrets must be kept confidential. In addition, a company's lenders, investors, and potential investors may require employees to sign nondisclosure agreements.
There is one group of people that cannot be stopped from using information protected under trade secretlaw. These are people who discover the secret independently -- that is, without using illegal means orviolating agreements or state laws. For example, it is not a violation of trade secret law to analyze (or"reverse engineer") any lawfully obtained product and determine its trade secret.
XCEL glue is made of a formula protected by trade secret. Phil, a chemist, analyzes the contents of XCEL glue, determines its composition, and re-creates the formula. Phil can legally use this information to make and sell his own glue.
How can a business protect its trade secrets?
By now it should be clear that simply calling information a trade secret will not make it so. A businessmust behave in a way that proves its desire to keep the information secret. Some companiesgo to extreme lengths -- for example, the formula for Coca-Cola (perhaps the world's most famous tradesecret) is kept locked in a bank vault in Atlanta, which can be opened only by a resolution of theCoca-Cola Co.'s board of directors. Only two Coca-Cola employees ever know the formula at thesame time; their identities are never disclosed to the public, and they are not allowed to fly on the sameairplane.
Fortunately, such extraordinary trade secrecy protection measures are seldom necessary. Although youshould take reasonable precautions to protect any information you regard as a trade secret, you don't haveto turn your office into an armed camp to do so. Sensible precautions include, for example, markingdocuments containing trade secrets "confidential," locking away trade secret materials after businesshours, maintaining computer security, and limiting access to secrets to people with a reasonable need toknow.
But again, the best way to establish and protect trade secrets is through the use of nondisclosureagreements. This is because courts have repeatedly reiterated that the use of nondisclosure agreements isthe most important way to maintain the secrecy of confidential information. Or put another way, withoutnondisclosure agreements, the odds go up that information you consider to be extremely valuable to yourbusiness will be deemed to have no legal protection.
How can a business enforce its rights if someone steals or improperly disclosesconfidential information?
Every state has enacted a law prohibiting theft or disclosure of trade secrets. Most of these laws arederived from the Uniform Trade Secrets Act (UTSA), a model law drafted by legal scholars. A listing ofstates that have adopted some version of the UTSA is provided at the end of this article.
A trade secret owner can enforce rights against someone who steals confidential information by asking acourt to issue an order (an injunction) preventing further disclosure. For example, if Company A learnsthat an employee has e-mailed trade secrets to Company B, Company A can obtain a court order preventinguse of the secrets by Company B. A trade secret owner can also collect damages for any economic injurysuffered as a result of the trade secret's improper acquisition and use. Here are some common examples ofincidents that lead to trade secret lawsuits:
- Sarah, a former employee of C-com, discloses C-com trade secrets to her new employer.
- Mary hacks her way into the network for a computer company and downloads the specs for a new silicon chip. She sells the information to a third party -- a rival computer company.
- Sheldon is a software programmer who works as an independent contractor for Diskco. Sheldon signed a nondisclosure agreement with Diskco, but later discloses Diskco secrets to a rival.
To prevail in a trade secret infringement suit, a trade secret owner must show that the information allegedto be confidential really is a trade secret -- and again, a confidentiality agreement is usually the best wayto do this. In addition, the trademark owner must show that the information was either improperly acquiredby the defendant (if the defendant is accused of making commercial use of the secret) or improperlydisclosed -- or likely to be so -- by the defendant (if the defendant is accused of leaking the information).
The "Inevitable Disclosure" Doctrine
A company may prevent a former employee from working for a competitor if the company can demonstrate that employment with the competitor will inevitably lead to disclosure of trade secrets. In a 1995 case, PepsiCo successfully argued that a former executive could not work as CEO of Gatorade/Snapple because the executive could not help but rely on PepsiCo's trade secrets as he plotted Gatorade and Snapple's new course, giving the competitor an unfair advantage over PepsiCo. Some states have rejected the inevitable disclosure doctrine because it challenges an employee's basic freedom to switch employers. In one case, for example, a court refused to apply the doctrine unless there was additional showing of bad faith, underhanded dealing, or employment by a competitor lacking comparable technology.
Is stealing trade secrets a crime?
Intentional theft of trade secrets can constitute a crime under both federal and state law. The mostsignificant federal law dealing with trade secret theft is the Economic Espionage Act of 1996 (EEA) (18U.S.C., Sections 1831 to 1839). The act gives the U.S. Attorney General sweeping powers to prosecuteany person or company involved in trade secret misappropriation.
The EEA punishes intentional stealing, copying, or receiving of trade secrets "related to or included in aproduct that is produced for or placed in interstate commerce." (18 U.S.C. 1832.) Penalties for violationsare severe: Individuals may be fined up to $500,000 and corporations up to $5 million. A violator mayalso be sent to prison for up to 10 years. If the theft is performed on behalf of a foreign government oragent, the corporate fines can double and jail time may increase to 15 years. (18 U.S.C. 1831.) In addition,the property used and proceeds derived from the theft can be seized and sold by the government. (18U.S.C. 1831, 1834.)
The EEA applies not only to thefts that occur within the United States but also to conduct outside the U.S.if the thief is a U.S. citizen or corporation, or if any act in furtherance of the offense occurred in the U.S.(18 U.S.C. 1838.) The EEA is a federal criminal statute and is enforced by the United States Attorneys'offices located throughout the country.
Several states have also enacted laws making trade secret infringement a crime. For example, inCalifornia it is a crime to acquire, disclose, or use trade secrets without authorization. Violators may befined up to $5,000, sentenced to up to one year in jail, or both. (Cal. Penal Code Section 499c.)
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