Banning noncompete agreements will radically reshape trade secret risks
In addition to directly impacting trade secrets protections, the changes could trigger D&O policies.
The New York legislature sent a bill to the governor’s desk that would make it the fifth state to effectively ban noncompete agreements, while the Federal Trade Commission has also proposed a rule that bans noncompetes, which the commission contends “suppresses wages, hampers innovation and block entrepreneurs from starting new businesses.”
“We’re seeing this at the state level all over the place and I think the FTC ban is going to go through,” says Mary Guzman, founder and CEO of Crown Jewel Insurance. “I think this is going to be an absolute game changer for trade secrets and the risk around them.”
Specifically, the FTC’s new rule, which isn’t expected to be finalized until 2024, would make it illegal for an employer to:
- Enter into or attempt to enter into a noncompete with a worker.
- Maintain a noncompete with a worker.
- Represent to a worker, under certain circumstances, that the worker is subject to a noncompete.
Guzman explains that many companies leaned, typically after the fact, on noncompetes to protect anything deemed confidential and hold former employees liable if something was misappropriated.
However, if the FTC proposal goes into effect, organizations would be forced to rely solely on traditional trade secret law, which requires that assets be identified upfront.
Additionally, companies would be required to demonstrate that reasonable measures were taken to protect those assets. This includes making sure the people working on those projects are specifically told they are working on a project that involves trade secrets and that they aren’t allowed to take the information with them should they leave the company, Guzman explains.
“Companies are going to be forced to start at the beginning if they haven’t done so already, and formally identify, index and register their trade secret assets and the metadata around the trade secrets, and put together a summary and justification around why they think these are trade secrets,” she says.
Determining if something is a trade secret is a pretty straight-forward process, as the case law sets out a strict litmus test. According to Reuters, the six-factor test includes:
- The extent to which the information is known outside the claimant’s business.
- The extent to which the information is known by employees and others involved in the claimant’s business.
- The extent of the measures taken by the claimant to guard the secrecy of the information.
- The value of the information to the claimant and to its competitors.
- The amount of effort or money expended by the claimant in developing the information.
- The ease or difficulty with which the information could be properly acquired or duplicated by others.
Identifying, protecting trade secrets
In the past, trade secrets might have been neatly contained in the engineering department. However, they are now dispersed far and wide in digital environments. This makes finding them a challenge.
Once the trade secrets are identified, Guzman says the next step is to align the confidential information with the employees that were working on those projects.
From there, narrower nondisclosure agreements could potentially be written to protect the assets. Guzman cautions that this process should be carried out with corporate counsel’s guidance.
While some cyber policies cover digital assets, the coverage only handles costs to recreate data, but not the actual value of trade secrets themselves, Guzman explains. During client conversations concerning digital risks, she says trade secrets became a recurring topic.
“Clients would say, ‘It is great that you can cover all of these other things like cyber and data that runs the business, but what happens if someone steals our crown jewels, those things that make us different and better?’” Guzman says, noting the “crown jewels” could range from proprietary logistic and supply chain functions to an algorithm or software code.
Coupling these conversations with the fact that intangible assets underpin as much as 90% of the S&P 500’s value, of which only 15% is protected by patents and trademarks, Guzman saw an opportunity to develop specialized coverage to handle these unique risks. Crown Jewel’s trade secret asset risk management solutions help companies identify, value and protect these intangible assets.
A D&O nightmare in the making?
While changes to the rules around noncompetes will reshape trade secret risks, they could also upend the D&O market. Guzman likens the potential trade secret situation to recent litigation in cyber around failures to close security vulnerabilities appropriately.
Many of those cases are built around failures to identify risks, improperly acting to mitigate them and coming up short when responding to a breach. She says a very similar pattern is likely to play out around trade secrets, as they are truly the most valuable assets for most companies and need to be protected as such.
“If you are sitting on the board of a public company and you don’t know what trade secrets the company has, where they are and how well they are protected, then how in the world can you possibly know that the proper measures are being taken to protect those secrets?” Guzman says. “I think that is leaving directors and officers wide open. It is just a matter of time before the SEC catches on, or the plaintiff’s bar.”
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