Legal Issues: Choose Your Poison

FRAMINGHAM (04/18/2000) - How can you tell the difference between a lawyer and a skunk lying dead on the road? There are skid marks before the skunk. How can you tell the difference between a company that shelled out hundreds of dollars per hour in legal fees to protect its intellectual assets and one that didn't?

The first marked a record-breaking quarter; the other is no longer in business.

You probably don't want to hear this, but your professional destiny may well lie in the hands of twenty-something attorneys in intellectual property law firms, learning on the job while charging $150 an hour. Or, if you prefer, in the hands of the partners who oversee the young-uns--for a mere $500 an hour.

Think of your company's most important business process or innovation. Then imagine not being able to use it because your competitor's lawyer figured out a way to patent it. Or imagine watching your competitors gleefully adapt your secret technology application because you trusted your lawyer to write an employment contract that would keep employees from blabbing the secret to the world.

"But why should I care?" a CIO is bound to ask. "Isn't that stuff the job of corporate counsel?" Right, like profits are strictly the concern of the CFO.

CIOs should care about patents and trade secret protection for three reasons.

First, failure to do so can deep-six the bottom line. In the worst case scenario, a company could be forced to stop using mission-critical processes or applications. Then it could be hauled into court and forced to pay millions of dollars in damages for infringing another company's patent or stealing its trade secrets. CIOs have a duty to educate themselves about something so vital to their company's operating success. Second, they have a personal stake in the matter because when violations of intellectual property laws are especially egregious, executives can be held personally and criminally liable. Granted, this outcome is unlikely, but a little knowledge still goes a long way toward prevention. Finally, CIOs should know about the latest developments in patent and trade secret law because they represent a huge opportunity to make money for the company, and to come out looking like an ace. Many business executives have no idea that the patent system now permits companies to get patents on technology and business processes--patents that mean big money for the patent holders. Who better than the CIO to suggest possible technology systems for patenting? Similarly, CIOs can help their companies gain competitive advantage by guiding the executive team to institute a smart trade secret program. Need to know more? Read on.

BUSINESS PROCESS PATENTS DIBS ON THAT IDEA Just how many ways are there to do business on the internet? You might think there could be as many new e-business models as there are creative ideas and innovative technologies. But when the definition of "way to do business" can be as basic as using an electronic shopping cart or enabling customers to make secure online credit card payments, the possibilities narrow. There simply aren't too many other options for electronic commerce transactions.

Recent developments in the United States Patent and Trademark Office (PTO) and in the courts suggest that some of the most common of these e-commerce processes, as well as many other key business and technology processes, are now owned by individual companies holding patents. Think about it. Microsoft's market hegemony is nothing compared with a company that holds a 17-year monopoly on the process or mathematical formula necessary to do such functions as electronic commerce or online content delivery. And this isn't fiction--it's really happening. If the trend continues, the marketplace will be divided into the haves and have-nots like never before. The haves--companies that came along at the right time and had the sagacity to apply for business model and software algorithm patents--will own the key processes for doing business on the web.

The rest of the great unwashed business masses that did not contemplate using the patented process until after the patent holder submitted its patent application will either be blocked from doing electronic commerce (unless they can devise totally new methods) or be forced to pay royalties to license the process from the patent owner.

For an idea of how far reaching the implications of these business patents are, consider some that have been granted thus far. The electronic shopping cart concept and the system for secure credit card payments over the web is owned by Open Market in Cambridge, Massachusetts. Push technology's most common manifestations are patented by a few fortunate companies, including NetDelivery and VCast.

If you can't quite get your head around the idea of somebody being able to own a concept as common as push technology, you're not alone. But believe it. In truth, the concept is not altogether shocking from a legal standpoint--if a party can get a patent on a new light bulb, why not an innovative business process? But from a business perspective, business process patents are a cataclysmic phenomenon that will forever alter the landscape.

ANCIENT HISTORY Two years ago, such patents would have been unthinkable because courts would not enforce patents on abstract ideas. That changed with the Federal Court of Appeals' 1998 decision in State Street Bank & Trust Co. v.

Signature Financial Group Inc. Signature had a patent on a data processing software system that performed a set of elaborate calculations required to maintain a complex investment portfolio. State Street Bank wanted to license the technology from Signature. When negotiations broke down, however, State Street challenged the patent as invalid because the system was based on a previously unpatentable mathematical algorithm. The Federal Appeals Court surprised the world by finding the patent valid, thus opening the door for new patents of abstract business models.

This decision caused turmoil in the business world. "Nobody thought business process patents were available before," says Anthony J. Carbone, partner at the New York City law firm Richards & O'Neil. "It seemed unfair that [a company] could suddenly patent processes that other companies had been using for a long time."

One reaction to these developments has been to engage in "defensive patenting," which means paying $7,000 to $20,000 in attorney's fees to submit a patent application in the hopes of being first. The PTO is granting new business process patents every week.

THE GAME'S NOT OVER YET The situation may not be quite as dire as these facts would suggest. In 1999 Congress passed the American Inventors Protection Act, which provides that any company that had been using a business process or algorithm for at least a year prior to its being patented could continue to use it, patent notwithstanding. Patent holders have the right to use the business process to the exclusion of all others, including companies that may have independently conceived of the idea less than a year before the patent was granted. These latecomers will either be prevented from using the process or will be charged fees and royalties. In extreme cases, they may also be sued for all the profits they earned from their illegal use of the patented process or technology.

Not all patents granted by the PTO will be enforced by the courts. When the PTO considers a patent application, it decides whether the innovation is novel, useful and nonobvious in the legal sense. But it lacks the resources to perform an exhaustive search to see whether that is truly the case. Companies can challenge a patent if they think the PTO made a mistake. The majority of patents, however, will be enforced. The Federal Appeals Court that hears all patent challenges tends to be sympathetic to the patent holders.

And Amazon.com Inc.'s recent success in court does not bode well for the patent have-nots. In December 1999, the United States District Court for the Western District of Washington State upheld and enforced Amazon.com's one-click patent in Amazon.com Inc. v. Barnesandnoble.com Inc. Like many companies in the internet space, Barnesandnoble.com believed Amazon.com's patent was invalid because it was too obvious and similar to what everyone was doing.

Barnesandnoble.com offered its own one-click option for online purchases.

Amazon.com brought Barnesandnoble.com to court, and eventually prevailed. The court ordered Barnesandnoble.com to stop offering one-click transactions, although it could continue to employ a virtual checkout line system.

Barnesandnoble.com will undoubtedly appeal this decision, but the troubling precedent still stands. Amazon.com's patent is extremely broad and could potentially block many others from enjoying the staggering competitive advantage of an easy, idiot-proof version of electronic commerce.

LOSERS WEEPERS Ironically, what may be unfolding is a scenario in which a few fortunate patent holders can accomplish the seemingly impossible task of making a profit on the internet. Few could have predicted that profits would come from such an indirect, unlikely source as business process patents. As an illustration, the website for internet software developer Intermind unequivocally states that its main purpose in securing its patent on the push model of content delivery is to collect revenue through a licensing program.

The company considers any business that keeps a computerized file of information (meta data) about subscriber preferences in order to enable automatic delivery of information over a computer network to be infringing on its patent. That's pretty broad. According to Intermind, possible infringers include the deep pocketed Microsoft and Netscape. As outrageous as this may seem, it's simply good business sense. The way the law works, somebody will own the patent on that particular business process.

Whether Intermind would prevail in the face of a legal challenge remains to be seen. And that's the problem. The legal lay of the land is bumpy and certainly bound for upheaval in the years to come. For the time being, the patent holders seem to be laying low. For example, Open Market claims not to have plans to license its patents. It could be that it fears public outrage and legal challenges that could cost millions to defend. Simply owning the patents without collecting royalties is still valuable because of the bargaining power the patents offer for "cross licensing" arrangements with other patent holders.

There is little a company can do right now to protect itself besides getting its own patent as quickly as possible, says Carbone. Companies can also run a search for existing and pending patents in the PTO to see what patents they might be ignorantly infringing. But there is no way to know what patents are pending. "It's thought that there are a lot of patents in process in the Patent Office that have not yet been issued," says Edmund W. Kitch, Joseph M.

Hartfield Professor of Law at the University of Virginia School of Law. "Nobody knows what will pop out, and nobody knows what the courts will deem valid." Of course, applying for a patent carries its own set of pitfalls, the biggest of which is public disclosure of a potentially valuable trade secret.

TRADE SECRETS SECRET SHARERS Two seemingly unrelated business trends combine to bring a second intellectual property peril to executives. One is the increased mobility of the workforce. Nobody knows better than an IT manager how fast employees come and go in today's economy. At the same time, more and more companies are choosing to bypass the patent system and protect their intellectual assets by simply keeping them secret, says R. Mark Halligan, partner in the Chicago law firm Welsh & Katz. Each of those phenomena makes the other more troubling.

Horror stories of trade secret losses abound. Most common is when an employer thinks it's made itself safe from an employee telling secrets to its competitors, only to discover that the contract the employee signed to that effect is legally unenforceable. Or that the employee never signed a contract at all. Clearly, a volatile workforce makes secret-keeping a relentless challenge. If a departing employee knows even a piece of the employer's secret strategies, technologies, processes, suppliers or customers, he or she can suddenly become the company's biggest threat. Who knew that Joan in sales could bring the company to its knees with her specialized knowledge and memory of customer lists? All she has to do is tell her new employer about the company's distribution plan or secret technology that cuts valuable hours out of the production process. Or, worse yet, post that information on the web out of spite and revenge. Then the secret is spoiled forever, and with it the employer's competitive advantage or even survival.

Trade secret law attempts to strike a balance between protecting a company's intellectual assets and an employee's right to change jobs and benefit from knowledge amassed by working in a particular industry. Many state courts refuse to enforce contracts between the employer and employee that say the employee cannot work for a competitor for a certain time period after leaving the company. Many companies rely on "noncompete" agreements without realizing that they are often unenforceable. Consider the example of Baxter International v.

Morris. In that case, a research scientist for Microscan Systems signed an employee agreement prohibiting him from working for a competitor for one year after terminating employment with Microscan. He quit, and immediately began working for Microscan's only competitor, Vitek Research. While the lower court enjoined Morris from disclosing any trade secrets for a year, it refused to block him from joining Vitek. In other words, Vitek got its key employee and had to wait only a year until Morris could spill the beans with complete immunity. When courts do enforce noncompetes, they generally only permit them to last for one year for the sake of the employee's livelihood. The duration is much shorter in the internet industry because the technology changes so fast, says Carbone--possibly as short as a week or two.

Another problem with noncompetes is that they are very expensive. "Employees rightfully resent being told who they can and cannot work for," says Julia Mahoney, associate professor at the University of Virginia School of Law.

"You'll have trouble recruiting if you ask people for something that's not commonly done in the industry, unless you're willing to pay them 20 percent above the market rate."

By comparison, confidentiality or nondisclosure agreements between employers and employees usually are enforceable, and are an effective way to protect trade secrets. They force employers to identify their trade secrets, and put employees on notice. "Otherwise, the employee may make an unauthorized disclosure to a competitor without even being aware that it's a trade secret," says Halligan. Identifying a trade secret is as simple as a manger or executive declaring it is secret. There is no legal aspect in the identification process; lawyers come in to draft contracts that will prevent employees from stealing those secrets.

Companies should organize their processes so that secrets are disclosed to employees on a need-to-know basis. For example, if a company's competitive advantage comes from a relationship with an inexpensive supplier, the company should code all communications with the supplier so that few employees know its identity.

YOU CAN KNOW TOO MUCH Keeping defectors from stealing trade secrets is only one aspect of trade secret law that executives must be aware of. Knowing how the law affects hiring decisions is equally important. Companies hiring competitors' employees will find themselves paying a lot for a temporarily worthless employee because he is blocked from sharing the specialized knowledge for which he was hired. More distressing than that, the company could lose a ton of money. It might be ordered to hand over all profits made from its use of a misappropriated trade secret. If the company knowingly stole trade secrets, it and the loose-lipped employee can be held criminally liable under the 1996 Economic Espionage Act. The Act makes it a felony to steal or communicate a trade secret without authorization, with penalties of up to $500,000 and/or 15 years in jail for individuals, or $10 million for organizations. The offenders will probably have to be aware of the fact that they're stealing trade secrets to be held liable. And the offense will most likely have to be very obvious.

But as with all law in this rapidly changing area, it is impossible to say with certainty that an executive who is merely stupid or ignorant, as opposed to a vicious lawbreaker, will be completely safe from the punishments described in the statute.

For companies, however, stupidity and ignorance is never an excuse. Companies can run afoul of the law even if they have no intention of using or stealing trade secrets. If an employee is hired because of her specialized knowledge, the courts assume she will not start at page one. Rather, she will probably use the knowledge gained in her former job. "Intent is not the issue," explains Halligan. "The court will find it inevitable that [she] will disclose the trade secret."

That's exactly what happened in the first case to recognize this "inevitable disclosure" doctrine, PepsiCo. v. Redmond. In 1995 William Redmond was an employee of Pepsi who helped prepare the company's secret marketing plan for its All Sport beverage. Redmond then took a position with Quaker Oats that entailed developing the marketing program for its competing Snapple and Gatorade brands. The Court said that Redmond could not help but rely on Pepsi's marketing plan when formulating that of Quaker Oats. "Unless Redmond possessed an uncanny ability to compartmentalize information, he would necessarily be making decisions about Gatorade and Snapple by relying on his knowledge of [Pepsi's] trade secrets," said the court. Thus, it enjoined Redmond from assuming any duties with Quaker relating to beverage pricing, marketing and distribution for the duration of Pepsi's marketing plan--approximately one year, during which time Redmond was an extremely expensive ornament.

CIOs and all other executives need to be extra sensitive to trade secret law because they could be held personally liable for failing to take reasonable measures to protect a company's secrets, says Halligan. This theory has yet to be tested in court, but the signs indicate that courts are moving in this direction. "Executives are responsible for protecting the physical assets of a company, so why not also the intangible intellectual assets?" says Halligan.

"The law is just starting to develop. I think you'll start to see shareholder suits and liability where the court finds no trade secret protection of a company's key assets, [causing] the company to lose significant value."

The moral of the story? Call a lawyer. There are some things only attorneys can do. For example, only attorneys specially admitted to practice before the PTO can submit companies' patent applications. Should a company be challenged and found guilty of trade secret or patent infringement, it will be inoculated against extra punitive damages if it can show that it acted on the advice of an attorney. More generally, the intellectual property landscape is so uncertain that it seems that only the people who helped make it so are suited to navigate it. But it may just be the smartest $500 an hour that your company could ever spend.

Former CIO Senior Writer Jennifer Bresnahan is now a student of law and contributing writer. Send your feedback to letters@cio.com.

PATENT OR TRADE SECRET? Patents and trade secrets are the ways companies can protect their intellectual assets. There are benefits and downsides to both.

PATENTS Definition: The United States Patent and Trademark Office (PTO) will grant a patent to an inventor if the invention is new and useful, and nonobvious compared with prior inventions.

Benefits: Provide a 17-year monopoly on an idea, during which the owner has exclusive rights to profit from the invention and build name brand recognition in preparation for the end of the monopoly. Patents are appropriate for innovations that cannot be kept secret, such as a new business strategy that must be explained to customers.

Cons: The invention must meet the requirements of novelty, usefulness and nonobviousness. After the 17 years are over, ownership of the invention passes to the public and can be used by anyone.

TRADE SECRETS Definition: Any information that gives a company competitive advantage by its not being generally known.

Benefits: Have the potential to endure forever. They are preferable when the invention would be obsolete by the time the PTO assigns the patent, or when the company plans to keep the invention a secret forever, as with the Coca-Cola recipe. A trade secret is useful for ideas that do not meet the requirements of a patent.

Cons: Competitors are free to study and take apart another company's invention to figure out how a trade secret works, and then use that knowledge. Another company could come up with the same idea on its own, get a patent on the invention, and block the original company from using it. -J. Bresnahan WHO'S GOT WHAT Many business methods are already patented; here are some patent holders and their protected process. For more information, see the Patent and Trademark Office's website at www.uspto.gov/.

Amazon.com (www.amazon.com) Method of online ordering using credit card Citibank (www.citibank.com) Method of issuing and tracking electronic money ShopWisely.com (www.shopwisely.com) Online coupon delivery Cybergold (www.cybergold.com) Giving customers incentives to respond to online ads MessageMedia (www.messagemedia.com) Method of online payment using offline agents Flycast Communications (www.flycast.com) Software that matches buyers and sellers of online advertising Intermind (www.intermind.com) Push technology based on automated delivery of content to subscribers Pitney Bowes (www.pitneybowes.com) Fifteen patents on several PC metering technologies, from printing postage on a standard computer to coding and decoding addresses NetDelivery Corp. (www.netdelivery.com) Technology that delivers personalized content over the internet through automatic retrieval of URLs Open Market (www.openmarket.com) Three patents including electronic shopping carts; secure credit- and debit-card payments over the web; analysis of how users browse website content Priceline.com (www.priceline.com) "Conditional purchase" technology, whereby buyers state how much they're willing to pay and Priceline finds a seller V-Cast (www.vcast.com) Push technology, recoverable downloada, background delivery, scheduling and confirmation Walker Digital Corp. (www.walkerdigital.com) Four patents for online gaming and travel, including a system that adds low-cost web purchases to a user's phone bill.

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