License to Steal
Print Issue: June 2014
You’ve probably heard of Fellowes, Inc. The company makes paper shredders that are used in businesses worldwide, from mom-and-pop shops to multinational corporations. But its equipment may bear a different name in China, if it can be found at all. And the technology that went into those machines is now being conscripted for use in other technology that will compete with Fellowes’ own products, with none of the proceeds going to Fellowes. That’s due to a joint venture with a Chinese firm gone bad, a deal that led to the theft of trade secrets that staggered Fellowes and continues to bedevil the company today.
In the mid-2000s, Jiangsu Shinri Machinery Co. established a joint venture with Illinois-based Fellowes to open a product facility in Changzhou, China. Besides shredders, Fellowes, Inc., uses patented processes to manufacture various other types of office equipment, such as air purifiers and laminating machines. After the two entities entered into their agreement, Shinri changed ownership and the company insisted that Fellowes assign proprietorship of the production tools in the joint venture to Shinri. The company also made various other requests, including that Fellowes sign over its engineering capability to the Chinese firm.
When Fellowes refused to meet Shinri’s demands, the Chinese company locked all of the 1,600 joint-venture employees out of the production facility in China, placed security guards at the gates to prevent the removal of the production tools and the 70,000 finished shredders, and transferred joint-venture funds to a Shinri-controlled bank account. To try to stop the takeover, Fellowes pursued legal action, and a court preservation order was filed to stop Shinri from accessing the facility in China. However, Shinri violated the order by driving a truck into the facility and stealing several Fellowes-owned injection molding machines used in the manufacturing process.
Shinri then sought legal action on its own and initiated judicial proceedings to liquidate the joint venture and auction all of its remaining assets, which would allow Shinri to purchase the remaining equipment, real estate, molding tools, and unshipped shredders. This would also give the company access to Fellowes’ engineering expertise and intellectual property, giving it a leg-up in its competition with the American company in the shredding business. Shinri has begun marketing shredders to potential buyers in Europe, and Fellowes estimates that its cumulative losses from the trade secret theft exceed $100 million.
This series of events was documented in a recent report by the Center for Responsible Enterprise and Trade (CREATe.org), a nonprofit advocacy group that helps companies, suppliers, and business partners reduce corruption and intellectual property theft. Its latest report details the continued challenges that businesses are facing in managing the growing threat of trade secret theft.
“What used to be the stuff of James Bond movies and spy thrillers that were often times government-on-government espionage has really now gone into the industrial espionage realm with the number of newly emerged and emerging economies around the world,” says Rick Martinez, a partner practicing intellectual property law at Robins, Kaplan, Miller, & Cirisi. “And due to the advent of reliance on computerized systems that are all networked, you have greater and greater risk of trade secrets actually being not just accidentally lost, but stolen from you through acts of industrial espionage.”
As thefts continue to occur, businesses are developing a new understanding of just how important trade secrets are to their brand and future success as a business in the era of globalization.
When most people think of a trade secret, they think of the secret sauce, or the special recipe that gives Coca-Cola its distinctive flavor. But a trade secret can be much more than that one special ingredient. According to the U.S. Economic Espionage Act (EEA), trade secrets are information that the owner has taken “reasonable measures” to keep secret and that “derives independent economic value, actual or potential, from not being generally known.”
For businesses, trade secrets can be specialized software, strategic data that they’ve collected, or analytics that businesses use to extract meaning and value out of strategic data, Martinez says. “In the business realm…your secret sauce really is your business processes, your practices,” he explains.
In the digital age, trade secret theft has become easier, and businesses are more vulnerable as trade secrets are stored on networks that can be breached. “You’re seeing more and more businesses dependent on computer systems, more and more business being done in computer systems, and more and more risks occurring because of accessibility,” Martinez explains.
This problem has grown as American companies send trade secrets offshore to their manufacturing plants overseas. Because of this, “your valuable trade secrets are sort of exposed to the potential risk of being compromised by a security breach,” Martinez says.
A recent report by CREATe.org cites International Trade Commission (ITC) estimates that the misappropriation of trade secrets in China costs the U.S. economy $1.1 billion in 2009. That amount is expected to have grown since then.
Previously, in the business world there was a lack of understanding of what trade secrets are and just how valuable they are to a business, says R. Mark Halligan, a partner at Nixon Peabody and a trial lawyer focused on intellectual property litigation. Over the past 25 years, companies have excelled at creating accounting systems for their tangible assets. However, Halligan says that the market value of S&P 500 companies has “deviated greatly” from their book value. This indicates that the physical and financial assets reflected on the company’s balance sheet are less than 20 percent of the true value of the company, leaving intangible assets unmeasured.
“We have absolutely no accounting system for intangible assets,” explains Halligan. “We have an accounting system for physical assets and every company can tell you every table they bought, every chair they bought, every pencil they bought, but they can’t tell you or provide any valuation on their intangible assets—when that’s 80 percent of the company.”
This perception can’t continue to exist and companies are beginning to realize it, Halligan says. “I’m starting to see in the reported press, people refer to trade secrets as trade secret assets, so this transformation of a litigation cause of action into a valuable corporate and tangible asset is occurring.”
The most traditional method for addressing trade secret violations is through the court system, but sometimes that’s taking the approach of trying to force the cat back into the bag. In addition, cross-border judgments can be hard to enforce, and courts might be more sympathetic to companies in their jurisdiction. Companies should start with a proactive approach by securing their assets up front before a trade secret can be stolen, says Tom Stutler, CPP, corporate security manager for Raymond James.
The first step in taking a proactive approach to protecting trade secret assets is identifying what those trade secrets are, explains Stutler, who is also a member of the ASIS International Investigations Council. Stutler suggests identifying these assets annually because business practices and processes may change over time. Then companies need to identify countermeasures and devise a way to ensure that these steps are being taken.
Some of these countermeasures are simple. For example, Stutler recommends adopting a “clean desk” policy in the office, which requires employees to secure documents in a locked drawer at the end of the day so people walking through the office after hours won’t have access to them.
Along with new policies, Stutler suggests that companies engage in a robust awareness program to make employees aware of what a trade secret is and policies in place to protect those, along with other business assets. This program should “impact everyone who is on board for however long they stay at the company” and be supported by the C-suite to be effective, he says.
Part of this awareness program is helping employees understand their vulnerabilities while traveling overseas. For example, the U.S. State Department has issued warnings for various countries, including Russia and China, for business travelers, saying they should not expect the same level of privacy for their online actions and for equipment they might be traveling with that they would in the United States. “It’s a known fact that in many of these countries now, if you’re an American business traveler and connecting to their networks, they are going to take steps—firm steps—to seek out information on your computer,” Martinez says. “I would counsel travelers overseas to certain identified risky countries to take loaner laptops…and don’t bring anything with them that could be stolen off that laptop.”
Many large companies prohibit employees from taking any device with company data into China or other high-risk countries. They will instead provide the traveling employee with a “dumb” phone or a smartphone from which all data has been wiped. Shrewd security executives advise employees to assume that their laptops, tablets, and smartphones will be compromised whenever they are out of sight in places like China. Some companies even discard the devices upon return, assuming that they have been planted with spyware or other types of malware.
Martinez recommends that companies have their security teams make sure that any computer equipment travelers do take with them is protected and discuss how to connect to networks back home, safely, if they need to while they’re abroad. “All of your most valuable trade secrets may not be at Fort Knox, or back in your well-guarded corporate headquarters in the United States,” he explains. “They could be with your employee on that laptop. So security managers really have to take extraordinary care in the systems they put in place to protect those trade secrets."
The United States has a strong set of legal protections in place to enforce trade secret laws, but many other countries lack the same legal protections, according to Halligan. The United States, like Australia, Canada, and the United Kingdom, operates under a common law jurisdiction. This means that they have the right to discovery.
“So I can file a lawsuit in the United States, even before the misappropriation [of a trade secret] occurs,” Halligan says. In the United States, a business or individual can file a lawsuit if there has been a threat of a misappropriation of a trade secret. “And then I can serve documents…I can take depositions, I can build a record, and I can present to the court evidence that there has either been an actual misappropriation of trade secrets, or there’s a threat of misappropriation of trade secrets.”
This differs from other countries that operate under civil law, such as China, Germany, and Italy, where there is no right of discovery. “Unless you’ve got an open and shut case, almost approaching a criminal violation, you can file an action for trade secret misappropriation or file an action to protect trade secrets, but because you have no right of discovery, it’s very difficult to prove your case,” according to Halligan. “There’s no way to actually enforce your rights and get effective relief because time is of the essence in a trade secrets case. A trade secret once lost is lost forever.”
The difference in these two processes can be frustrating for American companies, so Halligan suggests that when a business engages in a partnership with an overseas firm, it puts all common law protections into their contracts. “In other words, you create, in essence, an American style within your contract in China, or elsewhere, where you define in the contract what a trade secret is, you define what constitutes a misappropriation, you define the penalties for each offense,” along with interim relief that can be awarded by the arbitration body of your choice, according to Halligan. “That way you don’t have to go into the Chinese courts; you can actually protect the trade secrets based on contractual rights you have.”
Even with the best prevention measures, sometimes trade secret theft occurs, forcing companies to seek legal action to protect their assets. The Uniform Trade Secrets Act has allowed “trade secret law to flourish in the United States” over the past few decades, according to Halligan. However, one of the most significant measures occurred recently when the ITC took steps to block the importation of a company’s products into the United States because it misappropriated a trade secret.
The business in question was TianRui Group, Co., which stole trade secrets from an American company, Amstead, for the manufacturing of railway wheels. TianRui was planning to use that trade secret information to create its own railway wheels and sell them to the United States. In an effort to protect its domestic business, Amstead filed a lawsuit that eventually reached the ITC. The commission decided that TianRui had misappropriated trade secrets from Amstead and issued an exclusion order barring the importation of TianRui’s railway products into the United States.
The ITC’s actions in the TianRui case have opened the door for additional American companies to bring their cases to the commission, giving businesses another alternative to prevent stolen trade secrets from affecting their competitive advantage in the United States, Halligan explains.
Additionally, the Obama admin-istration has made prosecuting trade secret theft a top priority, issuing a white paper last year on the topic. The paper, released in February 2013, outlines a plan of diplomatic efforts to protect trade secrets overseas through the Departments of Commerce, Defense, Justice, Homeland Security, State, and Treasury, as well as the U.S. Trade Representative.
“As an administration, we are committed to continuing to be vigilant in addressing threats—including corporate and state sponsored trade secret misappropriation—that jeopardize our status as the world’s leader for innovation and creativity,” the paper says. “We will continue to act vigorously to combat the theft of U.S. trade secrets that could be used by foreign companies or foreign governments to gain unfair economic edge.”
Along with efforts through the executive branch, the white paper also suggests improving domestic legislation. The paper proposes increasing penalties for economic espionage from 15 years in prison to 20 years and raising penalties for transferring, or attempting to transfer, trade secrets outside the United States.
While companies are adopting the mindset that trade secrets are businesses assets, Congress is also coming around to the idea. Two measures have been introduced, one in the House of Representatives and one in the Senate, that would allow businesses to bring a civil action to protect their trade secrets.
Currently, theft of trade secrets is a federal crime, but the Department of Justice has limited resources and lacks the authority to prosecute foreign actors working abroad, says Bronwyn Lance Chester, communications director for Sen. Jeff Flake (R-AZ). “Due to a gap in current law, these foreign entities are not subject to the same laws protecting trade secrets as U.S. entities. A business has little recourse when a foreign entity steals its trade secret,” according to Chester.
To help give companies and Americans an alternative course of action, Flake and Rep. Zoe Lofgren (D-CA) have both introduced measures in their respective chambers calling for a civil course of action for individuals and companies who have had trade secrets stolen from them.
Lofgren has introduced a new bill, the Private Right of Action Against Theft of Trade Secrets Act (H.R. 2466). The measure would amend the Economic Espionage Act of 1996 to authorize anyone who has suffered a violation of their trade secret to file suit in civil court against the violator. Those who prevail could collect damages for compensation or relief.
Chester says that Lofgren’s bill is a “valuable improvement” to current law, but that Flake’s measure would have more impact. “Sen. Flake’s bill does more to remedy the problem because it would also apply to thefts from cyberspace, which the Office of National Counterintelligence Executive called ‘a significant and growing threat to the nation’s prosperity and security,’” Chester explains. “Sen. Flake’s bill also would apply to thefts by foreign nationals from a foreign office of a U.S. company, which is a major source of trade secret theft.”
Flake’s measure, the Future of American Innovation and Research Act (FAIR Act), is similar to Lofgren’s in that it allows the owner of a trade secret to file a suit in U.S. District Court against someone who misappropriates, threatens to misappropriate, or conspires to misappropriate that trade secret. Where it differs, is that it would also apply to anyone—not just those in the United States—and it allows the court to order the seizure of any property used to or facilitate the theft of the trade secret.
This provision is vital, says Halligan, as it allows the court to take immediate action to prevent a trade secret from being transferred electronically anywhere else via e-mail or other means. “Unless you have the ability to immediately seize and secure the defendant’s computers, by the time you get there, they’ve transferred the trade secrets to another part of the country, another part of the world, or they’ve destroyed the evidence,” Halligan explains.
Both measures are pending in congressional committees, but Chester is optimistic that legislative action will be taken in some form. “Whether the bill moves in committee or on the floor is the prerogative of the majority party, but there is a great deal of bipartisan interest in this issue and recognition that there is a problem,” she says.
With the new mindset and the developments in the American legal system, Halligan says he feels like the “stars are aligning” to protect trade secrets more effectively. In his opinion, the United States has “the most robust and the best system in the world for the protection of trade secret assets, and if U.S. companies would take advantage of that, it would give them a huge competitive advantage.”