Protecting Trade Secrets

By Michael Barrier Jul 1, 2004
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HR Magazine, May 2004​ ​R professionals are key lines of defense when it comes to protecting information that provides your business with a competitive advantage.

In September 1997, Victor Lee, a research scientist for Avery Dennison Inc., a Pasadena, Calif.-based manufacturer of office supplies and adhesives, went to a hotel in Westlake, Ohio, to meet P.Y. Yang, the owner of a Taiwanese company called Four Pillars. Lee handed Yang confidential documents, including an Avery patent application related to a new adhesive product.

Lee emphasized that the information was the confidential property of Avery Dennison. Yang responded by tearing the “confidential” stamps off the papers.

Lee had been conducting meetings like this for eight years, providing Yang with a stream of proprietary information from Avery Dennison. But the 1997 meeting was their last. Lee’s industrial espionage had been detected, and his meeting with Yang was a sting operation, videotaped by the FBI. Yang was subsequently convicted in federal court of violating the Economic Espionage Act of 1996.

While Lee did not profit greatly from selling this highly valuable information—his annual “consulting” fee amounted to $25,000—the cost to Avery Dennison was far greater. The company lost trade secrets worth $200 million, estimates Steven B. Fink, a security consultant who worked with the business during the crisis provoked by Lee’s espionage.

Because it involved one of the first prosecutions under the Economic Espionage Act, this case received more attention than many cases involving the theft of trade secrets. Such thefts are, however, a chronic, everyday worry for businesses of all kinds.

For example, Kforce, a specialty staffing company based in Tampa, Fla., has been going to court three to six times a year to ask for injunctions against competitors and former employees. “In the specialty staffing business, customer information can be very valuable,” says William S. Josey, the company’s general counsel. “Customer contact information, customer history and job order information, the makeup of a customer’s business—this is information that may not be generally available.”

Protecting such information is “especially tricky” in a business like Kforce’s, Josey continues, “where your employees must have access to this information to do their jobs. But when they’re no longer your employees, the information could be valuable to a competitor. Companies spend enormous sums of money to develop these databases, and it’s very tempting for a competitor without those resources—for example, a startup—to get this data the easy way, by misappropriating it.”

The damage from such thefts can be difficult to measure, but its dimensions appear to be enormous. In the most recent data available, the American Society for Industrial Security (ASIS) estimates that, during the 12-month period from July 2000 through June 2001, 138 companies that responded to the organization’s survey lost a total of $59 billion, most of it in lost revenues and legal fees. Of these companies, 40 percent had lost proprietary information, about half in research and development. Customer lists and financial data also were targets.

The ASIS survey focused on the Fortune 1,000, but Fink, who is president of Los Angeles-based Lexicon Communications Corp., says these “are not the companies that are targeted most by economic espionage. It’s the mid-level companies. Most of the thefts of trade secrets are done by competitors, or people working for competitors, and there are more competitors of medium-size companies than there are of Fortune 1,000 companies.”

Regardless of the dollars involved, Fink says, “if you steal the right trade secret from the right company, you’re going to put that company out of business. The only relevant question is, how much loss can a company sustain?”

Statutory Help

Protection of trade secrets from misappropriation by employees or competitors has long been established under common law. The Uniform Trade Secrets Act, now adopted (sometimes with modifications) by 45 states, embodies and strengthens those common-law protections.

The Economic Espionage Act goes even further by providing for criminal sanctions, but prosecutions under that statute have been rare, and some of the sentences imposed under the act have been remarkably light.

Corporate secrets can take many forms, but to qualify as legally protected trade secrets, they generally must have the following essential characteristics:

First, a trade secret must truly be secret—that is, not something generally known or ascertainable through legal means. If a company claims that a former employee has stolen a trade secret by taking its customer list, but its marketing department has posted a list of those customers on the Internet, no court is likely to be sympathetic. Likewise, anything that has been copyrighted or patented does not qualify as a trade secret, even when it qualifies for legal protection on other grounds, because it has already been made public.

Second, a trade secret must have real economic value or bestow a competitive advantage. The “shelf life” of a trade secret can be critically important in such determinations. Some trade secrets hold their value for many years—the secret formula for Coca-Cola is perhaps the most famous example—but others lose their value very quickly. A high-tech firm’s current strategic plan may very well qualify as a trade secret, but its plan from 1996, even if it is kept secret, may have no value at all.

Finally, the owner of a trade secret must take reasonable steps to protect it. This may be the area where employers, and the courts, will face their greatest challenges in the years ahead.

So far, says Richard Stim, a Berkeley, Calif., attorney and co-author of Nondisclosure Agreements: Protect Your Trade Secrets & More (Nolo Press, 2001), the only test the courts have applied is “basic reasonableness. Did you lock your cabinets? Are your computers secured inside and outside? Can the janitor turn them on at night? Do you have password protection of your really valuable information?”

But technological change has made it much easier to steal trade secrets, thanks to the ways that data can be compressed. “Basically, someone can put an entire file cabinet onto something they can slip into their pocket and walk out with,” says Mark F. Radcliffe, an attorney with the technology-focused East Palo Alto, Calif., law firm Gray Cary—and that’s not to mention the ease of transmitting secrets via e-mail. (For more information on preventing secrets from escaping via e-mail, see “Control E-mail the Right Way.”)

Radcliffe believes that “as technology evolves, the standard of reasonableness is going to change,” so that locking the cabinets will no longer be enough.

Moreover, although documents can be stamped “confidential” and locked in a safe, employees’ knowledge cannot. In an increasingly information-based economy, many of a company’s trade secrets are likely to be walking out the door at night, inside employees’ heads.

“Companies spend about 80 percent of their security dollars trying to keep outsiders out,” says Fink. “They build walls and fences and have security guards walking around the perimeter of the building. They build firewalls so people can’t access their computers. But in terms of trade secret theft, the people who are doing most of the stealing are already on the inside.”

Thus, the job of protecting trade secrets is likely to devolve more and more from traditional security departments onto human resources.

But a significant proportion of HR professionals may not be ready for that shift, suggests a March survey from the Society for Human Resource Management. Of the 247 HR professionals who responded to the poll, 47 percent said their HR department did not play a key role in protecting trade secrets, and 30 percent said their organization had not taken any measures to protect its trade secrets.

When organizations did take steps to keep secrets safe, two of the techniques they used most often were non-disclosure and non-compete agreements. (See the chart “Steps Businesses Take To Protect Trade Secrets.”)

Nondisclosure And Noncompete Agreements

A critical element in protecting a company from miscreant employees is usually a nondisclosure agreement between employer and employee, through which the employee agrees not to reveal trade secrets in a new job. Such contractual obligations are “really the cornerstone of any effective trade secret program,” says Paul J. Kennedy, an attorney with the Washington, D.C., office of the national employment law firm Littler Mendelson.

State law uniformly prohibits employees from disclosing an employer’s trade secrets, but, Stim says, a nondisclosure agreement “adds extras that go beyond the state law, that make it easier, perhaps, to get an injunction to stop the dissemination of the secret, to get attorney’s fees if you have to pursue that person, to guarantee that your lawsuit will be heard in a certain state.”

Despite the importance of such agreements, “a lot of companies, at the front end, don’t pay a whole lot of attention to them,” Kennedy says. “You pull out a one-size-fits-all form, slap it up and throw it in somebody’s file. That only takes you so far.”

The critical first step is determining what information needs to be protected—that is, what’s really a trade secret. “Each industry is unique,” says Robert M. Tils, an attorney with the Garden City, N.Y., law firm Moritt Hock Hamroff & Horowitz, and businesses in each industry “have to examine what gives them a competitive advantage.”

In New York, for example, the law does not protect the names of an insurance company’s customers—but it protects renewal information, which is far more valuable. “If I know when a company’s insurance policy is up for renewal,” Tils says, “and I target my solicitations to them 60 to 90 days before they re-up their insurance, I have a competitive advantage over someone who cold-calls them six months after they renew.”

Tils suggests that identifying the most important trade secrets needn’t be an exhausting exercise. “It doesn’t cost a lot of money for a couple of key executives to sit down over lunch and talk about how the business really works,” he says. “What’s important to us? Why are we better than our competitors? The more specific you can be, the stronger your argument that it’s really a trade secret.”

Says Stim: “I’m sure if you narrow it down, there are only a few things, for a lot of businesses, that they really don’t want anyone else to know. If you isolate those, and keep them secret among key employees only, and tie those key employees with a stricter nondisclosure agreement, I think you’re in a fairly good position.”

There is, however, an inherent problem with nondisclosure agreements. It’s summed up by Wilbur A. Glahn III, an attorney with the Manchester, N.H., law firm McLane, Graf, Raulerson & Middleton: “You can have all the nondisclosure provisions in the world, but if your key person goes to work for one of your competitors and has access to information and knowledge that would be very damaging to the company and is going to be working in a field that is directly competitive with the company, I don’t think you can trust the other side or the employee when they say, ‘We have a nondisclosure agreement and we’ll abide by it.’ ”

Glahn thinks that agreements that bar an employee from working for a competitor are more effective, as long as they’re reasonable in scope and time—and they’re legally permissible.

But so-called “noncompetes” also have limitations. These agreements have been outlawed by statute in several states, most notably California, and the courts generally frown on them.

“A noncompete says you can’t go to work for a competitor,” Tils explains, “which basically says that you can’t work in this industry anymore, which means in a lot of situations that you can’t work anymore. Courts are loath to enforce those.”

Taking Legal Actions

When businesses find evidence that a former employee is violating a nondisclosure agreement, they usually seek an injunction. As Radcliffe says, an injunction barring the former employee and new employer from using a trade secret acts as “kind of a catch-up,” restoring to its rightful owner the head start that came from possessing the trade secret.

Injunctions are a rapid-response option. “In the vast majority of these cases, there’s a burning building,” Kennedy says. “They have a meeting tomorrow with your best customer, or somehow they’ve gotten hold of your source code and they’re going to be using it,” or something of that sort.

Sometimes, though, it makes sense to seek judicial relief of another kind, as when the employee’s loyal customers follow that employee away from the company. “If the employer gets an injunction,” Tils says, “the customers aren’t coming back. In fact, if they get an injunction against the employee, it will harm the employee, it will prevent him from earning any money. But the customers will just scatter and go to 90 other suppliers.”

That outcome might serve as a deterrent to other employees, but it might be more effective for the employer to file a suit for recovery of the profits the former employee makes from sales to the former customers.

In interpreting nondisclosure agreements, some courts, struggling to balance the rights of employers and employees, have fallen back on a doctrine called “inevitable disclosure.” Under that rubric, a nondisclosure agreement is interpreted as barring a former employee from working for a competitor for a time because disclosure of the former employer’s trade secrets would be unavoidable in the new job. So far, that doctrine has not made much headway.

Balancing Control and Trust

Efforts to protect trade secrets may be vital. But, if handled clumsily, they can potentially create mistrust and suspicion that is destructive to the employer’s business.

“You want to keep people loyal to you, and you want to keep morale high and maintain a level of trust that induces a productive working relationship,” Kennedy says. “When you inject something like a noncompete agreement into the process, people start to feel defensive, and concerned about their future livelihood if they leave.”

Despite their potential downsides, nondislosure and noncompetition agreements are business necessities, Kennedy says. “I think it’s something that employers really have to do. If you’re going to protect your trade secrets, you’d better do it while your employees are still employed and you can communicate with them.”

Although a great deal of attention is focused on employees who deliberately take trade secrets, either for their own use or to sell to competitors, Fink points to what he calls a “large, large segment: employees who are uninformed, who don’t know what a trade secret is, because they’ve never been told, and who don’t know how to handle a trade secret, because they’ve never been told. Because a lot of trade-secret theft is done through ignorance, just by educating employees you can reduce the risk of trade-secret theft by a significant factor.”

Educating employees as to the worth of proprietary assets is not without its hazards, says Chicago attorney R. Mark Halligan, who specializes in trade-secret cases with the firm Welsh & Katz. The problem, he says, is that if a company makes its employees more sensitive to the value of proprietary assets, “you proselytize them to how valuable they’d be if they went to work for a competitor or started their own company.”

Michael Schonberg, who as an attorney at the Dallas law firm Thompson & Knight has litigated numerous trade-secret cases, says such an outcome can be forestalled if the company not only educates employees as to the value of its trade secrets, but also impresses upon them what their responsibilities are throughout the “life cycle of employment.”

“Upon the departure of the employee,” he suggests, “visit with them and remind them of all they learned through their years with the company about the significance of confidential materials. Remind the employee that those materials need to be returned and not used or disclosed in any future employment. Provide them with a copy of the confidentiality agreement on their way out the door and suggest they show it to any prospective employer. That way, the prospective employers are made aware immediately of the confidentiality agreement and are, in my experience, much more hesitant to let the employee tread on thin ice.”

(For more information on how to respond when a new employee appears to be passing trade secrets to your company, see “What If You’re on the Receiving End?”)

Unfortunately, Schonberg says, the typical exit interview is still not geared to protecting trade secrets but is instead “conducted along the lines of making sure the company gets the employee’s parking pass back.”

Halligan believes that relaxed attitude is widespread: “Most companies pay lip service to trade secrets. When most trade-secret cases are filed, the plaintiff really doesn’t know what the trade secrets are. When the plaintiff takes a deposition from the former employee, and the former employee says he kept something, that’ll become the trade secret.”

If people who deal frequently with trade secrets are in accord on any one thing, it is that such a lackadaisical stance will become increasingly dangerous in a future driven by rapid changes in technology and intensified global competition.

Michael Barrier is a former senior editor of Nation’s Business and former senior editor of American Lawyer Media. He holds a J.D. from the University of Chicago. He served as assistant attorney general in Arkansas.

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