The Inadequacy of Trade Secret Law and Why Congress Should Pass the DTSA

By James Pooley
December 22, 2015

capitol-flag-close-335U.S. trade secret law emerged in the nineteenth century to accommodate the shift from agrarian and cottage production to larger-scale industry, in which the secrets of production had to be shared with workers or business partners. Court decisions sought to enforce the confidence placed in those who were given access to valuable information about machines, recipes and processes. At the core of every case was a confidential relationship. Protecting this trust, the courts explained, was a simple matter of enforcing morality in the marketplace.

The common law origins of trade secrets – in contrast to the federal patent statute – meant that the majority of cases were heard in state court. Even when there was a special basis for jurisdiction, such as diversity of citizenship or a separate federal question, federal courts applied state common law. And at first there was little variation, with most states looking to the Restatement of Torts § 757 as a guide. But as industrial development continued through the middle of the twentieth century, legal foundations shifted, and the reporters of the Second Restatement dropped the subject completely.

Meanwhile, a school of thought had developed among commentators that trade secret law should be abolished altogether because it was inconsistent with, and therefore preempted by, federal patent law. This argument was famously rejected by the U.S. Supreme Court in Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470 (1974). Two important public interests, the Court explained, were served by trade secret law: the “maintenance of standards of commercial ethics and the encouragement of invention.” Without guaranteed secrecy, businesses would be left to expensive self-help security measures that would disadvantage smaller competitors and discourage dissemination of information through sharing. And as a practical matter, there was no conflict between the two systems because they operate so differently: patent law is strong, providing an exclusive right “against the world;” while trade secret rights are “weaker,” because they do not protect against reverse engineering or independent development.

The Uniform Trade Secrets Act Has Failed to Produce Needed Uniformity

By the time of the Kewanee decision, U.S. commerce was increasingly interstate and global. Some leaders in the IP community voiced concern that trade secret law would become too fractured and inconsistent for modern business. Therefore, in 1979 the National Conference of Commissioners on Uniform State Laws issued the first of two versions of the Uniform Trade Secrets Act (“UTSA”), proposing harmonized rules on establishing and enforcing trade secret rights.[1] Measured by adoption rates, the UTSA has been a great success, with 47 of the 50 states so far embracing it. However, measured by its objective of uniformity, the law has been a disappointment, because so many states have decided to deviate from the uniform text and customize their own version.

A few examples will help illustrate the scope of the problem. California dropped the language requiring that a trade secret be not “readily ascertainable,” with the result that the defendant is required to specially plead that circumstance as an affirmative defense. Illinois also eliminated the “readily ascertainable” language, and it prohibits royalty injunction orders, sets a different limitations period and allows permanent injunctions. Idaho requires that computer programs carry a “copyright or other proprietary or confidential marking” to qualify for protection. Georgia limits protection of customer lists to physical embodiments, in effect allowing employees to appropriate such information in (human) memory. South Carolina’s version of the UTSA requires a court hearing an injunction request to consider “average rate of business growth” in determining the length of an injunction, and prescribes very particular rules for discovery of trade secret information.[2]

The problem is not just variations in trade secret law from state to state. Dealing with information theft in the modern world runs up against procedures that were not designed for efficiency in resolving cross-border litigation. If a case in Illinois requires testimony of a witness in California, the plaintiff has to petition its home court to authorize a deposition, and then file an action in California based on the Illinois order, to secure the required subpoena. During the weeks or months of this process, the witness could easily have left the country, with the secrets in her pocket.[3] Clearly, U.S. businesses cannot adequately address the full scope of modern threats to their trade secrets by filing litigation in state court.

Existing Federal Laws Cannot Solve the Problem

Civil claims for trade secret misappropriation can sometimes be brought in federal court, but only in two limited situations. First, if another claim exists under federal law, such as patent infringement, then a related trade secret claim can be asserted in the same case, but only if it is based on the same central set of facts as the federal claim.[4] This is no help to the business owner facing the classical problem of an employee leaving with the company’s secrets, because usually there is no other federal law that can be applied to the case. Second, if the theft is in service of an out-of-state competitor, it may be possible to get into federal court with a state law claim by asserting diversity of citizenship. But in the typical case where the departing employee is a local resident, this can’t work because diversity has to be “complete,” and the presence of any local defendant will defeat the claim.[5]

Another option may be to ask the U.S. Attorney to bring criminal charges under the Economic Espionage Act (“EEA”).[6] But because of limited prosecutorial resources and a higher burden of proof, only a fraction of deserving cases can be accepted. And many companies decline to pursue criminal remedies because of the required surrender of control or the effects on a concurrent civil claim of the defendant’s assertion of a Fifth Amendment privilege.[7] Although the EEA provides potentially powerful remedies, it is unrealistic to expect the underlying problem to be solved comprehensively by a criminal statute.

In other words, the time-critical nature of interstate and international misappropriation of valuable digitized data requires an immediate and sophisticated response mechanism, and neither state law nor the EEA criminal framework provides a satisfactory solution. Federal courts, however, can provide the necessary resource. First, under the DTSA federal courts would operate under a single, national standard for trade secret misappropriation and a transparent set of procedural rules, offering predictability and ease of use. Second, federal courts provide nationwide service of process and a unified approach to discovery, enabling quick action by trade secret owners even when confronted with actors in multiple jurisdictions. Third, as a result of their extensive experience with complex cross-border litigation involving intellectual property, federal courts would be able to resolve jurisdictional issues quickly and applications for injunctions or seizures fairly. Fourth, their generally more predictable discovery procedures will serve the legitimate needs of trade secret plaintiffs, who typically must develop most of the facts to prove their case through defendants and third parties.

The Defend Trade Secrets Act and the Law Professors’ Opposition

The Defend Trade Secrets Act (“DTSA”) will improve trade secret protection, which will incentivize innovation and benefit companies–large and small–in all industry sectors. I have seen the letter in support of this legislation signed by the Chamber of Commerce, the National Association of Manufacturers, tech associations, and an array of well-known companies in a variety of industries. But I can also tell you from my experience representing small businesses that they rely on trade secret law far more than patenting to protect their intellectual property, and this legislation will improve their ability to compete.

I applaud the work that Senators Hatch, Coons, Flake, Durbin, Tillis, Blumenthal, Klobuchar, Sessions, and Purdue have done on this legislation. The DTSA will create a unified, federal civil remedy, similar to what exists for other forms of intellectual property. It maintains the important balance between trade secret owner and alleged misappropriator that exists under state law. And it adds an important, but limited, ability to seize a trade secret that has been stolen before the thief can take it out of the jurisdiction.

The approach of the DTSA is straightforward. It uses existing language of the EEA where appropriate, such as the definition of a trade secret, and where other language is required to define the civil aspects, such as misappropriation and damages, it uses language taken from the UTSA. Indeed, the only meaningful departure from the UTSA is to add a section allowing ex parte seizures of the misappropriated property. But even that portion draws from established provisions of the Lanham Act, tightened up considerably in order to discourage abuse.

The DTSA has received strong support from industry, but has been opposed by a group of law professors who published an “open letter” in 2014 criticizing the previous draft legislation,[8] and who have recently released another letter describing their concerns.[9] Mainly, they argue that we don’t need federal legislation because state laws are uniform enough; that the DTSA’s seizure provisions are too broad; and that the legislation would burden small companies with higher costs and interfere with the right of individuals to change jobs.

I strongly disagree with these arguments, which either ignore important facts or make implausible assumptions. As we have seen, the need for this legislation is clear; today’s technologies and international markets pose threats that cannot adequately be addressed with inefficient state laws designed for a simpler and less risky time. And based on my experience in litigating similar cases, the ex parte seizure process is so narrow as to effectively eliminate the risk of abuse; the cost of trade secret litigation is not substantially different in federal court than it is in state court; and the DTSA will not be used to stop employees from changing jobs.

I will briefly explain each of these points here; a more detailed response to the arguments of the law professors’ letters and published articles can be found in my article The Myth of the Trade Secret Troll: Why We Need a Federal Civil Claim for Trade Secret Misappropriation.

The DTSA Will Create More Uniformity, Not “Undermine” It

The law professors argue not only that the DTSA is not necessary because the UTSA provides a harmonized legal environment, but also that the DTSA will “undermine” the uniformity that has already been achieved. The most obvious flaw in this argument is that the UTSA has not delivered the uniformity that its drafters had planned, and the state-by-state variations today are in some cases worse than had existed before the UTSA was proposed. This inconsistency creates a substantial burden for companies – including small businesses – that operate across state lines and who increasingly rely on trade secrets to protect their competitive advantage.

The professors point to the five-year statute of limitations in the DTSA as an example of undermining uniformity. But existing state versions of the UTSA already vary in their limitations periods from three to six years. They also claim that the EEA’s definition of a “trade secret” is “broader” than the UTSA’s, but this doesn’t hold up to analysis. Both the EEA and the UTSA define a trade secret very broadly, but use different examples for illustration.[10] That one definition has more or different examples than the other doesn’t matter, since the examples provided by each statute fit equally well under the definition of the other one. Finally, while the DTSA is not preemptive and would allow litigants a choice to sue in state or federal court, the professors fail to explain why having that choice should be deemed undesirable “forum-shopping,” any more so than in other areas, such as trademark and securities law, where concurrent state and federal jurisdiction has long existed.

The Ex Parte Seizure Provisions Are Narrowly Tailored and Difficult To Abuse

In their most recent letter the law professors admit that the current language on ex parte seizure is “more limited in scope” than in the 2014 legislation. For example, only property “necessary to prevent the propagation or dissemination of the trade secret” can be seized, and the court must take possession of the property. These changes were made to a process that was already narrowly drawn to meet the need but go no farther. For an application to succeed, it must “clearly appear” to the court from “specific facts” sworn under oath that a restraining order under Federal Rule 65(b) would be insufficient, and the court must make specific findings supporting a balance of harm in favor of the applicant due to an imminent danger of irreparable harm. The order must be written in a way that minimizes interruption to the defendant’s related business and avoids any disruption to unrelated business. A hearing must be held within seven days, and during that time the defendant may apply to dissolve or modify the order.

As any lawyer who has practiced in this area can confirm, getting an ex parte order under these restrictions will be extremely difficult. And the consequences of getting it wrong will be severe: in addition to the usual sanctions that federal judges readily impose on parties and on lawyers when they feel they’ve been misled, the exposure to damages for wrongful seizure are not limited by the amount of the required bond. As a result, only the most seriously aggrieved plaintiff whose trade secrets are in imminent danger will take the risk of applying for an ex parte seizure.

The law professors argue that even this extraordinarily narrow remedy will still cause harm because all the defendant’s computers and storage media might be seized, and because the defendant will be unable to immediately challenge the plaintiff’s claim. But the first argument ignores the language of the DTSA that limits seizure to that property “necessary to prevent the propagation or dissemination” of the trade secret. The second argument also ignores the bill’s clear statement that anyone “may move the court at any time to dissolve or modify the order.” In my experience with ex parte restraining orders in trade secret cases, any defendant that can show there’s been some terrible mistake will bring this to the court’s attention promptly, sometimes the same day, and judges who realize that the plaintiff has misinformed them will have no hesitation in dissolving the order immediately.

In cases where a trade secret has been misappropriated and is in clear danger of being destroyed or transferred out of the jurisdiction, companies – including small businesses that rely heavily or exclusively on this kind of intellectual property – need the ability to get protection from a court without giving advance notice to the person who stole it. Of course, such an extraordinary proceeding should be strictly limited to minimize the risks of abuse. Under the DTSA, it is. The legislation achieves this balance by making a seizure very difficult and risky to get, while preventing collateral damage to the maximum extent possible.

Litigation Costs Will Not Be Higher, and May Be Lower, In Federal Court

The recent professors’ letter asserts that the DTSA will “increase the length and cost of trade secret litigation.” They base this argument only on the threshold requirement that the trade secret be “related to a product or service used in, or intended for use in, interstate or foreign commerce.” But experience with other similar jurisdictional standards in federal statutes does not support the fear that discovery or motion practice will be required on this issue. In almost all cases, the fact that the plaintiff’s business meets the interstate commerce test will be obvious, the allegation will not be challenged at all, and there will be no impact on the cost or length of the litigation.

The second reason the professors give for their prediction of increased costs is that trade secret litigation is expensive, and the “liberal discovery standards” in federal court are likely to make litigation there more expensive. But federal courts have been handling trade secret cases for decades, under diversity or supplemental jurisdiction, and there is no evidence that costs there are any higher than they are to litigate in state courts. Most states’ discovery standards are not materially different in any way that would affect trade secret litigation; and for the ones that do not employ standards as broad as federal courts, in my experience this can actually increase the cost of litigating in those states, as plaintiffs have to return repeatedly to court to get the evidence that they need to prove their case. Finally, beginning next month the revised Federal Rules of Civil Procedure will place a new emphasis on “proportionality” in discovery disputes,[11] and we have no reason to think that federal judges will apply that principle with any reduced rigor in trade secret cases.

The DTSA Ensures Free Mobility Of Labor

Finally, the professors speculate that certain language in the DTSA might be read to embrace the so-called “inevitable disclosure doctrine,” which it claims “typically” leads a court to stop a departing employee from taking a new job. In fact, the “doctrine” is simply a label affixed by some commentators to a selection of court decisions applying the common-sense UTSA provision that “actual or threatened misappropriation may be enjoined.” The vast majority of courts do not dwell on the “inevitable disclosure” label, but directly apply the statutory language about “threatened” misappropriation by thoughtfully considering the circumstantial evidence in individual cases. And where a court grants relief against threatened misappropriation, the result is only rarely to entirely block taking a new job.[12]

In any event, the DTSA does not imply either acceptance or rejection of the “doctrine.” Significantly, it uses precisely the same “actual or threatened misappropriation” language as the UTSA. But – and this should have satisfied the professors’ concerns – it adds a proviso that limits judicial discretion by prohibiting any injunction that would “prevent a person from accepting an offer of employment under conditions that avoid actual or threatened misappropriation.” This provides additional assurance that a court will not interfere with any job offer unless it finds evidence that demonstrates actual or threatened misappropriation. And it is fully consistent with the law in every state that has enacted the UTSA, including California.

Conclusion

The DTSA is sorely needed to fill a gap in remedies available to U.S. businesses that now operate in an information-based, globalized economy. This is one of those special circumstances where parallel federal structures are required to address a critical set of interstate and international problems. The DTSA has been carefully fashioned to deter and punish abuse. Using well-established definitions and norms, it provides businesses a choice to file a familiar claim in an effective forum. And it accomplishes this without creating any new risks for small companies or individuals.

_______________

[1] Unif. Trade Secrets Act, available at http://www.uniformlaws.org/shared/docs/trade%20secrets/utsa_final_85.pdf.

[2] For a comprehensive collection of state variations, see Sid Leach, Anything but Uniform: A State-By-State Comparison of the Key Differences in the Uniform Trade Secrets Act (2015) available at http://www.swlaw.com/assets/pdf/news/2015/10/23/How%20Uniform%20Is%20the%20Uniform%20Trade%20Secrets%20Act%20-%20by%20Sid%20Leach%20-%20AIPLA%20paper.pdf

[3] See R. Mark Halligan, Revisited 2015: Protection of U.S. Trade Secret Assets: Critical Amendments to the Economic Espionage Act of 1996, 14 J MARSHALL REV. INTELL.. PROP. L. 476, 494 (2015).

[4] See 28 U.S. C. §1367; United Mine Workers of America v. Gibbs, 383 U.S. 715, 725 (1966); Tech Enterprises, Inc. v. Wiest, 428 F.Supp.2d 896, 902 (W.D. Wis. 2006) (dismissing trade secret claim because it did not share a “common nucleus of operative facts” with a trademark claim).

[5] Lincoln Property Co. v. Roche, 546 U.S. 81, 82 (2005).

[6] 18 U.S. C. §§ 1831-1839.

[7] See Pooley, Lemley and Toren, Understanding the Economic Espionage Act of 1966, 5 TEX. INT. PROP. L.J. 177, 205, 219 (1997)

 

[8] http://cyberlaw.stanford.edu/files/blogs/FINAL%20Professors’%20Letter%20Opposing%20Trade%20Secret%20Legislation.pdf.

[9] https://cyberlaw.stanford.edu/blog/2015/11/newprofessors-

letter-opposing-defend-trade-secrets-act-2015.

[10] The EEA, at 18 U.S.C. § 1839(3), describes the scope of “trade secret” as “all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing.” The shorter definition of UTSA § 1(4) is “information, including a formula, pattern, compilation, program device, method, technique, or process . . . .”

[11] Fed.R.Civ.Pro. 26.

[12] See Pooley, Trade Secrets §7.02[2] (Law Journal Press, updated 2014).

The Author

James Pooley

James Pooley is a Silicon Valley-based expert in trade secret law and litigation. Jim is currently Senior Counsel with Orrick. For more than 35 years, Jim has represented clients as lead trial counsel and strategic advisor in high-stakes patent and trade secret disputes. His broad litigation experience, combined with his service as an international diplomat and business executive, make him uniquely qualified to handle today’s global IP challenges. Jim testified before the Senate Judiciary Committee on the Defend Trade Secrets Act, and has worked with congressional staff on the legislation. His most recent book is Secrets: Managing Information Assets in the Age of Cyberespionage, available here. For more information or to contact Mr. Pooley please visit his firm profile page.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 2 Comments comments.

  1. Anon December 22, 2015 10:39 am

    There can be NO creation of uniformity unless the Federal legislation preempts the state by state variations.

    As I understand all current versions of proposals, there is no such preemption under consideration, and thus, AT BEST, all that we will have is (yet another) layer of variation on top of existing state laws.

    As my friends from the Boston area would say, “You can’t get there from here.

  2. Night Writer December 22, 2015 12:00 pm

    This is the second wave of destruction of the patent system–trade secrets. No analysis of trade secrets is complete without an analysis of how it will be used in employment agreements and how it will affect the movement of employees between companies.