Trade Secrets are highly valuable assets. How can digital technologies help to protect them?

Modern technologies demonstrate a rapid and furious innovation pace, creating an incredible amount of intellectual property (IP) every second. The speed and amount of information exchange are growing, and the problem of IP protection is becoming increasingly important. This is especially true for a Trade Secret, one of the most valuable and the most vulnerable categories of IP as it’s an unregistered form of IP. While legislators introduce stronger legal instruments for IP protection, they are clearly behind the digital era’s challenges. Computer technologies like blockchain can make a revolution in intellectual property management and bring safety to this sector.

We discussed these issues and opportunities with Donal O’Connell, managing director of Chawton Innovation Services Ltd., engaged in consultancy, education, and software solutions in the areas of innovation and intellectual property management, and the leaders of CADChain B.V. CEO Violetta Shishkina and COO Timo Wolthof who are involved in blockchain system architecture, IP protection, and data security.

So what is a Trade Secret?

In international law, article 39 of the Agreement on Trade-Related Aspects of Intellectual property Rights (TRIPS Agreement) states that general standards of a trade secret are: the information must be secret, i.e., is not generally known or readily accessible to those who usually deal with such information; the information must have actual o potential commercial value because it is a secret; the information must have been subject to reasonable measures by the rightful holder of the data to keep it secret, e.g., through confidentiality agreements.

A Trade Secret is confidential information with an inherent commercial value known only to a definite number of persons (reasonably a minute number of people, the smaller, the better for tracking purposes). This information is required to be kept by persons in possession of the data to remain a secret. Generally, it is information that you do not want the competition to know.

The reasonable protection measures may include: storing confidential information safely; concluding non-disclosure agreements where trade secrets must be discussed with business partners; including non-disclosure clauses within agreements such as license agreements, employment agreements, and consortium.

A Trade Secret does not require to be technical, unlike a patent. Some trade secrets can be technical, like software or design information, or non-technical, like financial information, process description, client data. Technical secrets may include drawings and designs, prototypes, not patentable or not patented inventions, manufacturing processes, formulae or recipes, know-how, genetic materials, and fragrances, whereas commercial secrets may consist of customer and supplier lists, business methods, and strategies, and cost and price information.

Why Trade Secrets?

Generally, a Trade Secret is the least expensive form of protection. The process of getting a patent can last up to several years and cost a company tens of thousands of euros. Moreover, patenting is, generally speaking, not fit for new technology like 3d printing. Software is hard to patent in Europe as well. Digital twins are also highly incompatible with patents. Copyright is hard to enforce, seeing as the burden of proof lies with the infringed party, and going to court is expensive and, in many cases, pointless.

Moreover, a Trade Secret does not require public disclosure of technical components as required in a Patent Application. Once a combination of facts, figures, formulae, procedures, steps, and constituents of a solution or product is kept secret, the competitive advantage can be maintained till an equally efficient competitor arrives.

Based on a survey among 198 small US firms operating in high technology sectors, Cordes, et al. (1999) find support for the view that SMEs prefer trade secrets over patents to protect innovations. The authors determined that small high-technology firms often prefer informal intellectual property protection mechanisms, such as trade secrets and gaining lead time, over formal intellectual property rights protection, such as patents, copyrights, and trademarks. Cordes, et al. (1999) conclude that the main reasons are:

Trade secrets can be licensed; they may be a tool to generate revenue or royalties like Patents and Trademarks. They are protected by the TRIPS agreement and, in the EU, the Trade Secrets Directive. The downside to this is once a trade secret is exposed or becomes known to a rival company, the competitive advantage triggers a countdown timer till a similar product or service is developed and offered to the public or relevant buyers.

Why do trade secrets need to be protected?

Trade secrets and other forms of Intellectual Property are valuable assets of a company. Today the value of a company is based on its intangible assets: brand, patents, know-how, relationships, software, trade secrets. Intangible assets may have a significant portion of a company’s market value, and often it is trade secret information. For some companies, trade secrets take even the largest part of their value. Therefore, the loss or theft of this information can be disastrous and entail significant losses: loss of competitive advantage; loss of key core technologies; loss of company reputation; loss of business opportunities; loss of key customers; loss of profitability, return on investment, loss of shareholder value; loss of valuable personnel. Thus companies must be prepared.

It is also essential that there is a link between the valuation of trade secrets and their protection. While reasonable steps for protection would reduce the risks and support the higher valuation, the poorly protected trade secret would significantly discount in value.

The peculiarity of trade secrets is that they are the most intangible among intangible assets. A trade secret is like a Genie that cannot be put back into the bottle once it has gone out. Once it has been made public, it is gone. So, it is a very fragile form of IP.

Generally, there is popular fear of hackers and cybercrime. However, the statistics show that the parties identified as being primarily responsible for the attempts or acts of trade secret misappropriation are competitors (53%), former employees (45%), and customers (31%).

And human error is a very common cause. A Study on Global Data Leaks in 2018 by Infowatch shows that in 2018, current (50.5%) or former (2%) employees were the perpetrators in 53% of all data leak cases. In more than 4% of the cases, executives (top managers, heads of departments, and divisions) and system administrators (the so-called ‘privileged’ users) were behind data leaks.

There’s plenty of examples concerning trade secrets theft that seem to be following a similar scenario. In 2018, for example, there was a trade secret case between Sinovel Wind Group, a manufacturer and exporter of wind turbines based in the People’s Republic of China, and AMSC, a U.S.-based company formerly known as American Superconductor Inc. A former employee of AMSC Windtec Gmbh, who was head of AMSC Windtec’s automation engineering department in Klagenfurt, Austria, left AMSC Windtec, joined Sinovel, and stole intellectual property from the AMSC computer system by secretly downloading source code from an AMSC computer in 2011, that Sinovel used for the production of their own wind turbines. In this case, the claimant revealed trade secret theft only after several years when another company produced similar goods.

What are the challenges?

Recent research shows that over 80% of senior executives recognize that trade secrets are crucial for their businesses. 50% of the senior executives say that trade secrets are more important than patents and trademarks. And 69% believe that trade secret protection is more critical than safeguarding other types of IP because of the fast pace of innovation.

So why is there a gap between recognizing the importance of trade secrets and the failure of companies to manage these assets? There are several reasons for that.

The IP law has changed not so long ago

First of all, not long ago, trade secret laws had some weaknesses. And it’s only recent developments in various jurisdictions in the EU within the European Directive of Trade secrets enacted by states by June 2018, brought some improvement. So the Law has changed and strengthened quite considerably in a short period. These changes have taken some by surprise.

The Criminal Code also protects trade secrets by Article 248(1) 103, which states that whoever breaches legal regulations on unfair competition by infringing business secrets and thus causing in larger extent detriment to other competitors or consumers, or gains for himself or herself or another in larger extent unjustified gains, may be punished with up to three years of imprisonment, an activity ban or the sequestration of a thing or other valuable asset. And this is in the post-computer age when high communication and collaboration levels result in a situation when companies and persons share their trade secrets and at some moments possess the trade secrets of others. And another counterparty may file a claim anytime because your company employee has intentionally or unintentionally misappropriated someone’s trade secret.

Companies have to protect trade secrets by themselves

The second issue is that a Trade Secret is an unregistered form of IP, unlike patents and trademarks. Trade secrets have to be therefore managed internally. That might sound easy to do, but it is a challenge for some companies as they have to do it themselves, unlike patent management, when external firms can handle the process.

The Law requires that the trade secret owner take reasonable measures to protect trade secret assets’ secrecy. This is a challenging task nowadays because trade secret assets are no longer locked in a file cabinet in an engineer’s office. Today, trade secrets are in motion and in use via computer systems and networks with access points all over the world. The boom of transnational data disputes serves as a notable marker of the latest trend.

This presents a huge challenge. Companies must actively monitor the access and movement of sensitive information or risk the serious consequences of forfeiting trade secret assets by failing to take the reasonable efforts necessary to protect these assets. The recent notorious case of Tesla suing a former employee for allegedly stealing 26,000 confidential files, which represented “200 man-years of work” by downloading them to his personal Dropbox, shows that even large companies still have no secure solution for trade secrets protection.

Litigation requires companies to collect specific data

The litigation process also requires a trade secret owner to prove specific facts. First of all, he/she will have to show that misappropriated information is a trade secret, i.e., it is a secret, it has commercial value, and reasonable measures were taken to keep it secret.

Court practice shows that cases on trade secret misappropriation fall apart when it comes to claimants needing to prove they have taken reasonable steps to secure their confidential information. For example, a case of United Financial Services (USA) against their former employee Michael Calisi in 2009, who they accused of customer list theft, is an excellent example. UFS failed to demonstrate that it had treated its customer lists as a secret. Hence, the Court noted, “although secrecy does not need to be absolute, the claimant must nevertheless show “it made reasonable efforts to maintain the secrecy of the information such as to ensure that it would be difficult for others to discover the information without using improper means.”

Courts also require proof of existence and possession of a trade secret at a certain period. Another point is that the plaintiff has to prove that he or an entity is the lawful owner of the trade secret, not an employee or another party. Although a person who independently invented or developed the same idea may also be a lawful owner of the trade secret, but this he will have to prove too. The fact of misappropriation has to be established, which means that the plaintiff must prove who, when, and how received unauthorized access, acquisition, or used an alleged trade secret.

The above-mentioned circumstances depict a complex challenge that may be solved only with a reasonable combination of the legal system, corporate safety norms, and IT technologies.

Read the second part of this article to learn about the possible solutions that blockchain technology may bring to provide an unprecedented level of trade secret protection that even freelancers and small businesses can implement with ease.

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CADChain is a software development company creating a solution for trade secrets protection

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