Professional Strength Trade Secret Audits – Part I

By Steve McDaniel, JD, PhD; Jon Hurt, PhD; & Beth McDaniel, JD, Technology Litigators | July 24, 2012

Regardless of whether you have conducted a DIY trade secret audit (good idea) or not (not good - asking for trouble), you should consider finalizing your trade secret protection with a professional third party audit. Why? Because having your security and legal procedures in place is not the same as putting them through the gauntlet of full-on attacks to see if they hold together and keep your valuables safe. That’s where outside third party experts come in—to give your systems a swift, hard kick, or three—and tell you what weaknesses still need improvements. 

There are two main goals of a professional audit. The first is to insure your procedures are strong enough to discourage and/or prevent a trade secret theft under “real world” attacks, though foolproof or absolute security is not legally required; and the second is to use the documentation of these procedures to provide ammunition in court to quickly and decisively stop any breach, i.e., get an injunction, and recover damages.

During a professional audit, your physical and electronic security will be put under the gun. From the outside looking in, for instance, hackers will test whether your systems firewalls and password protections can be breached and confidential information such as customer lists and technology data obtained. Often commercial stores hire “mystery shoppers” to evaluate the performance of sale personnel and the quality of products. A trade secret audit may also use a “mystery shopper” in the form of a faux potential client, customer, vendor, or employee to evaluate security at places where trade secret information may be utilized outside of a secured fixed location, such as a trade show. The mystery shopper would then try to obtain trade secret information from an employee while “on the road,” and again report back on the strength of security. 

But more importantly, the ability to stop and/or catch thefts will be tested from the inside of your business. 

Part of this evaluation will check the effectiveness of the coverage and monitoring of security cameras, entry and exit checkpoints verification and documentation of security clearance, limitations placed on access to documents and notebooks, including those in your trash disposal systems, or other secured items, marking of documents as “confidential” or “proprietary,” security patrols, etc. Unauthorized access to electronic information will also be tested, including electronic notices of authorized use. Further, the legal restrictions placed on the employee or other person who may have access to trade secret information, as well as training that such individuals undergo regarding these agreements, will be accessed. Your protocols for pre-screening public disclosures of your technology through publications, lectures, etc. will be reviewed to insure that trade secrets are not inadvertently revealed.

One challenging aspect of a professional audit would be a careful comparison of your trade secret portfolio to your patent portfolio. For a trade secret to maintain its value, it must be secret. For a patent to be valid, it must disclose publically after publication the “best mode” of making and using an invention. A “best mode” would be potentially prime trade secret knowledge. So the conflict between the requirements of these two types of intellectual properties would require someone both knowledgeable in coatings chemistry technology and the law. This combined skill set will be used to determine if there has been an undesired revelation of trade secrets in your patent portfolio, particularly in filed but unpublished patent applications that would disclose trade secrets upon their publication, and suggest options as how to proceed for optimal intellectual property protection. Such an evaluation would likely include in depth interviews with your inventors, trade secret creators, corporate counsel, managers, and IT, security and human resources personnel to help delineate the separation of your IP into the two categories, and honing your procedures for keeping the two separate and secure. Clearly auditing both types of assets will also allow their application in determining your business’s value and enhancing your balance sheet.

Though an open review of security procedures will often identify weak areas for improvement, a more stringent test can be applied. A professional trade secret audit may include a “mystery employee” hired to work at a company to see if trade secrets, whether access was given to the employ or not, can be downloaded, copied, emailed, obtained in conversation, or otherwise removed from secure locations, and the effectiveness of the procedures in place to prevent or determine if a security breach occurs. If someone suspects that a colleague has misappropriated materials, who do they report their concerns to that person who would be in charge of the investigation? Given the technical nature of such trade secrets, the “mystery employee” will be selected by the audit firm to possess the needed education and work experience to be placed in a position where access to trade secrets would be granted. 

Once the audit is complete and improvements made, the security procedures in place and documentation of the audit itself are evidence for use in court of the “reasonable efforts” you use to protect your trades secrets. Why is this of value to you? When the dark day occurs that you run to court to prevent use of a misappropriated trade secret, you will need as much evidence as possible pre-prepared for immediate use in arguing that preliminary injunction to stop the thief’s use of it that day is appropriate to protect your interests. The case you make for this type of suit is usually built on circumstantial rather than direct proof of misappropriation. And, obtaining a preliminary injunction is generally considered by courts as “extraordinary relief” which means the burden is on you, the applicant/plaintiff, to convince the judge in short order of: 1. the likelihood that the applicant will prevail on the merits at the final hearing; and 2. the extent to which the plaintiffs are being irreparably harmed by the conduct complained of. From some past court cases, you must first meet the burden of these two points before the court considers other factors used in issuing an injunction. Regarding point one, remember, a trade secret must be a secret, and all that evidence of secrecy protection will help in establishing the quality of the case you will make at the final hearing. And, when asking for preliminary injunctive relief, an “unexplained delay” can fatally damage your assertion of “irreparable harm” (criteria 2 above, and generally the most important), so spending a week to document your secrecy procedures after the fact is not a good plan.
The other criteria considered by the court includes: 3. the extent to which the defendants will suffer irreparable or greater harm if the preliminary injunction is issued; and 4. whether the injunction serves the public interest. Given that injunctive relief may impose some pretty stiff economic disruptions on the defendant, such as in the case of preventing a former employee from working for a competitor or impoundment of materials that may demonstrate the trade secret, you need to be loaded for bear when arguing on points 1 and 2 to outweigh the concerns of point 3. Keep in mind that all these considerations are useful in court when acting to prevent just the threat of misappropriation, such an accidental or mistaken disclosure (e.g., disclosure that is not loudly public and widely available, yet) that could lead to use by a competitor, and you want to stop the movement of trade secret information now before events go any further. If a trade secret is inadvertently or intentionally disclosed, then it loses its protection as a trade secret, forever. All these efforts to protect and document your trade secrets provide evidence to defend against counter-claims that you were making an unjustified misappropriation claim. 

Secrecy and the difficulty of discovery may add to the trade secrets value though the law in this area is shifting somewhat. Compensatory monetary damages generally are based on your losses and/or gains by the thief during the time the information was a protectable trade secret and the time the thief used it to his competitive advantage. Alternatively, a court may assign a reasonable royalty for use of your trade secrets. Punitive damages may be issued up to twice the compensatory damages and reimbursement for attorney’s fees may occur depending upon a successful showing of misappropriation that was “willful and malicious.” Examples of “willful and malicious” actions include the defendant using what they are aware might be or know to be a trade secret, or obtaining and then transferring trade secret information in violation of a confidentiality agreement after deciding not to pursue a business opportunity with you and not telling you (i.e., they string you along and keep you talking about your technology to rip you off). Again, making sure that the protective steps described above to keep your trade secrets under tight physical and contractual control will provide evidence in court of where a breach occurred, and whether that misappropriation qualifies as “willful and malicious.”

But at the end of the day, you don’t want to go to court. It’s too expensive! The desirable outcome from a professional trade secret audit is to put the FOG (the fear of going to federal court) into the hearts and minds of those who have access to your proprietary information. And that is where the “protective wall of paper” comes in—a series of contracts, non-disclosure agreements, exit interview documents, etc. to discourage any potential bad actors from walking away with that which is not theirs. Next month in Part II of this series, we will discuss how to review and build this “protective wall of paper.”