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Corporate Securities Info

Proprietary information

/ 09:00 PM September 15, 2011

In what may be considered a sign of the times, it is standard practice today for officers and employees of companies engaged in highly competitive businesses to be required to sign confidentiality agreements before they start working.

Under pain of damages or prosecution, they are forbidden from disclosing the company’s trade secrets or proprietary information to unauthorized parties unless with management’s prior clearance or required by law.

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Proprietary information is “information a company wishes to keep confidential, such as secret formulas, processes, production methods, business strategies, marketing plans, customer lists and significant contracts.”

The fear of such information falling into the wrong hands (read: the competition and government regulators) has led companies into limiting access to their internal database on a need-to-know basis.

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Sometimes, firewalls are put up or passwords are required to prevent the unauthorized reading or downloading of information.

But, like all human inventions, a way will always be found to go around security measures installed to protect the confidentiality of proprietary information.

Trade secrets

For manufacturers of material goods or products, proprietary information usually consists of component materials, industrial formula, technical specifications, production methods and pricing mechanism.

Except for pricing mechanism, all the other data mentioned are capable of intellectual property protection through the patent system. The unauthorized use of patented products or processes could give rise to civil and criminal liabilities to the unauthorized user and all those who may have participated in the commission of the unlawful act.

The problem arises if the information, although critical or sensitive from the owner’s point of view, does not meet the criteria for patent protection.

Can the information gathered and processes developed by law offices, auditing firms, financial advisers and other professional experts in the course of their work be considered proprietary information as to justify prohibiting their staff from disclosing them to third parties or using for personal advantage?

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That, in a nutshell, is the issue involved in a case being heard in a US court between a financing services company, Trust Company of the West (TCW), and its former investment manager, Jeffrey Gundlach.

In 2009, Gundlach was, after 24 years of service, dismissed because he threatened to resign and bring his entire staff with him.

He was later sued by TCW for breach of fiduciary duty, unfair competition and misappropriation of confidential information.

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The company claims that Gundlach downloaded confidential data consisting of clients’ lists, research data and other trade secrets from TCW’s computer network.

The information allegedly stolen from TCW’s databases could fill up nine million sheets of paper!

The trade secrets include financial models, algorithms, valuations and other processes that the company uses to advise its clients on their investment plans and programs.

These secrets were supposedly misappropriated and used by Gundlach in crafting the investment strategies of the financial services company he later organized.

TCW compared those secrets to the tightly guarded fried chicken recipe of Colonel Sanders of Kentucky Fried Chicken fame, which is key to the food chain’s success.

Understandably, the reference to the chicken recipe did not sit well with snooty financial advisers who felt the processes of their multibillion-dollar business activity were trivialized by the chicken reference.

The jury hearing the case, which consists of people with limited financial background, is hard put making odds and ends of the legalese and financial babble that dominate the proceedings.

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Defining the parameters of proprietary information in entities engaged in advisory or consultancy services, e.g., law offices, accounting firms and investment houses, is not easy.

When a lawyer or accountant comes up with a practical (read: legally defensible, but not necessarily sound) solution to a ticklish legal or accounting issue, word about it quickly spreads in the business community.

And why not? The idea has to be put in writing and then sent to the client or government agency involved for consideration or review. As soon as the letter leaves the office or is sent by e-mail, any claim of confidentiality over it simultaneously vanishes.

Thus, no matter how novel or innovative the professional advice may be, or is the product of expensive research and brainstorming, it cannot be the subject of patent protection or be treated as proprietary information.

Any lawyer or accountant, or for that matter anybody, who learns about it can use or apply it, free of charge. He will, in effect, get a free ride from the client for whom it was initially prepared and who paid the professional fees.

The same principle applies to investment advisers or financial consultants who design investment or financing programs for their client companies.

Since financing programs usually involve listed or public companies and therefore tightly regulated, those schemes become public knowledge upon their filing with the regulatory agencies concerned.

All told, the biggest threat to the confidentiality of trade secrets is the Internet. With its service engines, and don’t forget WikiLeaks, proprietary information is a threatened species.

For feedback, write to [email protected]

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