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Trial of the trade secret.

WHAT CONSTITUTES A TRADE secret? This article presents a case study concerning company secrets and how the court ruled in a case dealing with "stolen" secrets, Electro-Craft Corporation v. Controlled Motion, Inc. (1) The facts and rationale are without significant paraphrasing so as not to diminish the import of the decision.

The Electro-Craft Corporation (ECC), a Minnesota-based company, employed about 500 people in four plants, three of which manufactured moving-coil and brushless servo motors and motor parts, among other products. These motors were used in high-technology applications, such as computer disk drives and printers and industrial robots.

ECC was one of only three major producers of moving coil motors, and although seven companies produced brushless servo motors, ECC had more than half of the private sector domestic market. ECC's share of military, foreign, and overall servo motor markets was substantial. Projected market growth for a five-year period from 1980 to 1985 was 25 to 30 times the 1980 market share figure.

ECC spent considerable time and money increasing the performance of its motors through design and by building prototypes and workable models. ECC worked with IBM to develop a motor for an IBM printer, and the motor was very successful. ECC became the only known source of motors for the IBM project.

Also, for about five years ECC had worked with Ford Motor Company on a new application for brushless motors. ECC had produced several prototypes for Ford and hoped to begin production in 1983.

In 1980, five ECC employees left ECC to work for a new company, Controlled Motion Inc. (CMI), which was formed by an ECC employee while still working for ECC. The prospectus for CMI proposed competition with ECC in its applications to IBM and Ford and indicated that prototypes for IBM would be completed within 12 weeks.

The former ECC employees had the following experience while employed at ECC:

* Ex-employee number one guided the development of the IBM and Ford projects.

* Ex-employee number two was a mechanical engineer who had worked on the design of the moving coil and brushless motors.

* Ex-employee number three was a quality assurance manager and acting plant manager.

* Ex-employee number four was a technician.

* Ex-employee number five was a buyer's assistant with knowledge of ECC's vendors and motor parts

All five employees had signed confidentiality agreements. However, none of the agreements contained a noncompetition clause. Four of the employees were given exit interviews, and only one signed a form acknowledging confidentiality.

In September 1980, ECC sued CMI, claiming CMI had misappropriated ECC's trade secrets. ECC sought temporary and permanent injunctions as well as compensatory and punitive damages.

On October 1, 1980, the district court granted a temporary restraining order enjoining CMI from accepting orders from ECC's principal customer for brushless motors. On April 16, 1981, the court issued a temporary injunction in favor of ECC, enjoining CMI from directly or indirectly selling or soliciting sales of any low-inertia electric servo motors.

On July 9, 1981, CMI was held in contempt for continuing to produce and sell motors after April 16, 1981, and was ordered to pay ECC $50 for each motor sold after that date as damages.

On October 19, 1981, the court found that CMI had misappropriated ECC's trade secrets and judgment was entered enjoining CMI for 12 months from producing or selling any brushless or low-inertia electric motor or tachometer with dimensions within 10 percent of ECC's brushless motors produced for IBM.

The decision was appealed to the Supreme Court of Minnesota, which adopted the four-point test of the Restatement of Torts No. 757. To be a trade secret the information claimed to be secret must: not be generally known or readily ascertainable; provide a competitive edge; have been developed at the plaintiff's expense; and be the subject of the plaintiff's intent to keep it confidential.

The court also said that "trade secret" means information - including a formula, pattern, program, compilation, device, method, technique, or process - that derives independent economic value - actual or potential - from not being generally known to and not being readily ascertainable by proper means by other persons who can obtain economic value from its disclosure or use. The information must also be the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

The supreme court reversed the district court's findings that trade secrets existed and commented on the security-related matters pertaining to ECC's failed or nonexistent efforts to maintain secrecy.

One subject commented on was that of maintaining trade secrecy. The supreme court noted that maintaining absolute secrecy is not required. However, more than just a showing of an intention to keep company data and processes secret is required, and a plaintiff must show that it manifests that intention by making some effort to keep the information secret. ECC could not complain about an ex-employee using information if ECC had never treated the information as secret.

Protecting a trade secret depends on a continuing course of conduct that creates a confidential relationship. This relationship in turn creates a reciprocal duty for the ex-employee to treat the information as confidential insofar as ECC had so treated it.

While acknowledging that ECC took minimal precautions in screening its handbook and publications for confidential information and requiring some of its employees to sign confidentiality agreements, the court felt these precautions were not enough.

According to the court, "security" meant the protection of information from discovery by outsiders. ECC's overall security was lax, and its physical security measures did not demonstrate any effort to maintain secrecy.

For example, the main plant had a few guarded entrances and seven unlocked entrances without limited access warning signs. The requirement that employees wear badges had been abandoned, and although some design notebooks were kept locked, discarded drawings and plans for motors were not destroyed but simply thrown away. Other motor drawings were not kept in a central or locked location.

The court found that ECC's confidentiality procedures were fatally lax. To the court, "confidentiality" meant procedures by which ECC signaled to its employees and others that certain information was secret and not to be disclosed. The court also noted that physical security measures are one way of signaling to employees that certain types of information are secret.

In addition, just before one employee left ECC to join another company, the president of ECC found him copying documents after hours. The employee was never questioned or warned that certain information was confidential, nor was his new employer.

The court noted that although ECC should have let its employees know that certain features were secret, it treated its information as though it was not secret. None of ECC's technical documents was marked "confidential," and drawings, dimensions, and parts were sent to customers and vendors without special markings.

Employee access to documents was not restricted, and ECC never issued a policy statement outlining what it considered secret. Informal tours were given to vendors and customers without warnings concerning confidential information, and two of the plants had an open house at which the public was invited to observe the manufacturing process. ECC's confidentiality agreements were too vague to apprise the employees of specific secrets.

Another factor considered by the court was that the exit interviews, initiated only after it became clear that the employees were about to work for CMI and which occurred only 10 days before litigation, did not constitute reasonable efforts to maintain secrecy.

The court felt these interviews were attempts to threaten employees or intimidate them from leaving ECC and engaging in legitimate competition. The court noted that such thinly veiled threats did not qualify as ongoing efforts to maintain the secrecy of specific information.

The court pointed out that the law to protect trade secrets does not condone conduct of this nature and held that ECC had not established the existence of any trade secrets, nor had it shown consistency in treating information as secret.

ECC was required to show some duty on the part of the employee not to disclose the information. ECC claimed this duty arose from employee agreements and a confidential employer-employee relationship.

However, a common law duty of confidentiality arises out of such a relationship only as to information treated as secret by the employer. Since ECC failed to make reasonable efforts to maintain secrecy, its confidential relationship claim was fatal.

This claim was fatal because ECC never notified its employees of any duty of confidentiality because its employee agreements never pinpointed specific information and the language in them was vague. Thus, since no trade secrets existed, there was no misappropriation.

The trial court's award of punitive damages against CMI for violating the temporary restraining order was rescinded as was the contempt damage award of $50 per offending CMI motor.

The purpose of a case study is to learn what went wrong and what went right. Since this is an information age, where the strategic resource is information (2) and a valuable company asset, the security manager must make every effort to protect that information.

If an individual or company is protecting trade secrets, knowledge of legal countermeasures coupled with positive action is essential. General security measures include.

* providing adequate physical security,

* limiting employee knowledge,

* marking and controlling documents,

* having knowledge of the requisite level of security,

* providing clear and unambiguous confidentiality obligations,

* creating a climate of corporate confidentiality,

* maintaining careful debriefing and exit procedures, and

* controlling disclosure to outsiders. (3)

Having an effective information security program is a critical security management task in the information age. (4) For any business that derives significant gain from the use of secret information, the loss of that secrecy can cause severe and irreparable harm. (5)

(1) Electro-Craft Corporation v. Controlled Motion, Inc., Minn., 332 N.W. 2d 890 (1983).

(2) John Naisbitt, Megatrends, (New York, NY: Warner Books, 1984), p. 6.

(3) J. Kirk Barefoot and David A. Maxwell, Corporate Security Administration and Management, (Stoneham, MA: Butterworth Publishers, 1987), p. 150.

(4) "Safeguarding Proprietary Information - 2000," Brian R. Hollstein and James A. Schweitzer, Security in the Year 2000 and Beyond, Louis A. Tyska and Lawrence J. Fennelly, (Palm Springs, CA: ETC Publications, 1987), p. 100.

(5) Laurence H. Pretty, "A Comprehensive Program of Precautions to Forestall Loss of Trade Secrets," Protecting Trade Secrets, 1983, (New York, NY: Practising Law Institute, 1983), p. 169.

About the Authors . . . Candy M. Cain, CPP, is chief investigator at YaleNew Haven Hospital in New Haven, CT. Edward J. Drew, Jr., is director of security at United Illuminating Co. in New Haven and a member of the ASIS Standing Committee on Crime/Loss Prevention. David A. Maxwell, CPP, is a professor and coordinator of security management programs at the University of New Haven in West Haven, CT, and a member of the ASIS Standing Committee on Safeguarding Proprietary Information.
COPYRIGHT 1991 American Society for Industrial Security
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Special Seminar Issue; cases involving corporate espionage
Author:Cain, Candy M.; Drew, Edward J., Jr.; Maxwell, David A.
Publication:Security Management
Date:Sep 1, 1991
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