In the highly competitive global economy, trade secrets often differentiate manufacturers from their competitors as advantages in other areas erode.
But executives need to handle such secrets according to new rules or be subject to punishment under Sarbanes-Oxley (SOX), warns attorney R. Mark Halligan, a partner and specialist in trade secret law at the Chicago law firm Welsh & Katz. Halligan says because of SOX, companies no longer can treat trade secrets as an amorphous intellectual property right. SOX sets new duties of disclosure and governance that require publicly traded companies to identify, protect, set a value on and report trade secrets as assets.
The trade secrets must be reflected in quarterly and annual reports; the CEO and CFO must personally certify the reports; and the company must document and certify both the internal control structure and procedures for financial reporting and controls. SOX imposes civil and criminal penalties for violations of its requirements.
So far, no companies or executives have been sanctioned by the Securities and Exchange Commission or sued by shareholders for mismanagement in this area under SOX, but Halligan expects it.
Some companies, such as IBM, DuPont and Microsoft, have developed systems for tracking trade secret assets, but most companies neglect these assets until a key employee leaves, and then they turn the matter over to outside attorneys to investigate and pursue legal actions if necessary, Halligan says. This approach completely neglects the type of internal controls required by SOX. Halligan suggest these practices for compliance:
- Identify trade secrets by using both a systematic procedure and a classification scheme.
- Implement security measures and internal controls to protect trade secrets by limiting access; defining different levels of access through password protection; using tracking systems to control and monitor the distribution of trade secrets after initial access and to certify non-disclosure agreements from third parties before revealing trade secrets.
- Set the value of trade secrets based on the net present value of expected future cash flows to be derived from them.
- Implement internal controls to assure notice to management and timely reporting of material changes or losses related to trade secrets.
