Trade Secrets & Noncompete Blog

Trade Secrets & Noncompete Blog

News & Updates On Developments in the Law of Restrictive Covenants, Unfair Competition & Trade Secrets

Leave The Source Code Behind

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U.S. Attorneys in many jurisdictions are more willingly stepping into the fray between financial services firms and their former employees who have misappropriated trade secret information. In a recently reported case out of the Northern District of Illinois, two former employees of Citadel LLC, a Chicago based premier hedge fund in the high frequency trading space, pled guilty and received three-year sentences for their participation in a scheme to steal source code from Citadel and a prior employer in order to create their own trading strategy for their personal future use. This continues a trend begun in earnest in 2013 after the Department of Justice issued the Administration’s Strategy On Mitigating The Theft Of U.S. Trade Secrets. Since that time, federal criminal enforcement efforts in trade secret matters have been on the upswing in the financial services industry as well as other areas.

In this matter in Illinois, the former employees eventually admitted their guilt and were sentenced. While Yihao Pu admitted stealing the code from Citadel and his prior employer and received a sentence of three years in prison, Sahil Uppal admitted he provided some of the code to Pu in violation of his confidentiality agreement with Citadel and then assisted Pu in hiding his computer and stolen data, thus obstructing justice for which he received a three-year sentence and probation. The two were also ordered to make restitution of $759,000 to Citadel.

The moral of this story is that proprietary software code related to particular strategies used by you and your employer should never be taken or shared without the employer’s express consent. If already taken, it must be returned rather than removed and hidden from the employer or authorities. Employers in financial services and other industries appear more inclined to report such conduct to governmental enforcement agencies than in the past. While there is always a balance of judgment employers must make when involving Federal or State law enforcement authorities in their employment-related matters, there certainly appears to be an emerging trend for such authorities to actively investigate and thoroughly prosecute cases against employees who steal trade secrets.

The cases referred to above are U.S. v. Pu, 1:11cr-00699 and U.S. v. Uppal, 1:11cr-00699-2 in the United States District Court for the Northern District of Illinois.

One Step Closer To Making A Federal Case Out Of It

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In the year-end holiday rush, employers and other trade secret owners may not have noticed that the Judiciary Committee of the United States House of Representatives in mid-December reported favorably on HR 5233, a proposal to create a federal civil cause of action concerning trade secrets. (Click here for copy of Committee Report and here for text of bill). The Senate has its own version. (Click here). While Congress did not vote on it before year end, the bill is said to have bi-partisan support in the House and there are intimations of White House approval.

The House Report provides the rationale for federal legislation at this time:

The trade secrets of American companies are increasingly at risk for misappropriation by thieves looking for a quick payday or to replicate the market-leading innovations developed by trade secret owners. Using ever-more sophisticated means of attack, these thieves aim to steal the know-how that has made American industry the envy of the world. The Commission on the Theft of American Intellectual Property found that the illegal theft of intellectual property is undermining the means and incentive for entrepreneurs to innovate, slowing the development of new inventions and industries that could raise the prosperity and quality of life for everyone.

Recognizing that up until now trade secret owners had only criminal remedies under federal law and civil remedies under state law, the Judiciary Committee concluded that more was needed:

While 48 states have adopted variations of the UTSA, the state laws vary in a number of ways and contain built-in limitations that make them not wholly effective in a national and global economy. First, they require companies to tailor costly compliance plans to meet each individual state’s law. Second, trade secret theft today is often not confined to a single state. The theft increasingly involves the movement of secrets across state lines, making it difficult for state courts to efficiently order discovery and service of process. Finally, trade secret cases often require swift action by courts across state lines to preserve evidence and keep a trade secret thief from boarding a plane and taking the secret beyond the reach of American law. In a globalized and national economy, Federal courts are better situated to address these concerns.

America’s strength has always been found in the innovation and ingenuity of its people–its inventors, creators, engineers, designers, developers, and doers. American businesses that compete globally will lose their competitive edge if they cannot quickly pursue and stop thieves looking to shortcut the innovative products, designs, and processes that have fueled our economy. This bill will equip companies with the additional tools they need to protect their proprietary information, to preserve and increase jobs and promote growth in the United States, and to continue to lead the world in creating new and innovative products, technologies, and services.

Expect some continued attention to these issues, and possible passage, early in the just convened Congress, perhaps shortly after the State of Union address if there is any search for legislation with support on both sides of the aisle.

For trade secret owners, at least as of now, passage of the House version of the bill would be an added tool. That is a purposely loaded statement because, despite references in the report to federal courts being better equipped to handle such claims, the proposed legislation requires neither pre-emption of state claims nor exclusive federal court jurisdiction. Hence, employers and trade secret owners will still be able to proceed in state court or append state law claims to claims brought in federal court under such new federal question jurisdiction. This can be an important added weapon since some states, such as New Jersey, recognize an employer’s right to enjoin disclosure of confidential business information that does not itself meet the definition of a trade secret. See, e.g., LaMorte Burns & Co. v. Walters, 167 N.J. 285 (2001) (“Importantly, however, information need not rise to the level of a trade secret to be protected… Other jurisdictions also have held that information not technically meeting the strict requirements of trade secrets may be protected as ‘confidential information’ and may serve as the basis for a tort action”). While this could mean that passage of the proposed bill alone would not promote uniformity implied by the Committee, it may move things in that direction as a practical matter.

Importantly, the Act also contains mechanisms for relief not found in the Uniform Trade Secrets Act or its various state-by-state progeny. The House bill provides for ex parte seizure when “necessary to preserve evidence” or to “prevent dissemination of the trade secret.” While neither the bill nor the Committee report expressly says so, this ex parte seizure order mechanism seems to lessen the burden, somewhat, on those seeking injunctive relief because it creates an entitlement when available remedies under Rule 65(b) “would be inadequate” to preserve evidence or to prevent dissemination of the trade secret. Of course, there is a bit of a problem for trade secret owners (and their counsel) lucky enough to obtain such orders because the proposed act also states that “The court shall take appropriate action to protect the person against whom an order under this paragraph is directed from publicity, by or at the behest of the person obtaining the order, about such order and any seizure under such order.” Read literally, that seems to say that a movant can obtain the order but not make the third parties or the public aware that movant has done so. Because the value of such relief is often the deterrent effect that such an order can have in depressing the market, or market value, for the pilfered secrets, further tweaking (either textually or through interpretation and pragmatic application) will probably be necessary for that aspect of the Act to reach its intended potential.

So, it appears that we are one step closer to a federal civil remedy for protecting trade secrets. Even if it passes, however, employers and other trade secret owners will have to figure how, and if, to incorporate this added weapon into their arsenal. While it may complement state law claims in some circumstances, it may complicate them in others, and it remains necessary to have counsel who is prepared to sort out such options to put forward the best, most effective arguments promptly in the right court at the right time to stop the trade secret from escaping. In the end, added weapons are nice, but only when placed at the disposal of those who can pick the right ones for the job and get it done.

The First Illinois Appellate Court Decision To Address Fifield’s “Two Years Of Employment/Consideration Rule” Strictly Adheres To It

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Readers of this blog know that in the summer of 2013, long held beliefs about the required consideration for a restrictive covenant under Illinois law were thrown a curve when the Illinois Appellate Court for the First District (i.e., Cook County) held in Fifield v. Premier Dealer Services, Inc., 2013 IL App (1st) 120327, that, absent other consideration, two years of employment is required for a restrictive covenant to be deemed supported by adequate consideration—even where the employee signed the restrictive covenant as a condition to his employment offer and even where the employee voluntarily resigned.

Since then, two Federal district judges in Chicago split over whether to follow Fifield and the Illinois Supreme Court chose not to weigh in. Now, the first Illinois appellate court to address Fifield has done so – and it strictly adhered to it.

In Prairie Rheumatology Associates, S.C. v. Maria Francis, D.O., 2014 IL App (3d) 140338, Dr. Francis entered into an employment agreement with a two year post-employment non-compete. She tendered her resignation after 15 months of employment and resigned after 19 months of employment. When her former employer Prairie Rheumatology Associates (“PRA”) sought to enjoin her from competing in violation of her non-compete, Dr. Francis challenged the enforceability of her non-compete, arguing that it was not supported by adequate consideration because she was not employed for 24 months after entering in to it.

The Illinois Appellate Court for the Third District agreed, holding that because Dr. Francis was not employed for 24 months after entering into the non-compete, and because Dr. Francis “received little or no additional benefit from PRA in exchange for her agreement not to compete,” it was not supported by adequate consideration.

In an effort to show that Dr. Francis had received consideration in addition to the 19 months of employment, PRA argued that Dr. Francis had “received PRA’s assistance in obtaining hospital membership and staff privileges, access to previously unknown referral sources and opportunities for expedited advancement.” However, the Appellate Court found “that PRA failed to assist Dr. Francis in obtaining her hospital credentials and neglected to introduce Dr. Francis to referral sources.” Additionally, the Appellate Court found that PRA did not provide access to previously unknown referral sources, and that purported “expedited advancement and partnership opportunities” were “illusory” because “[e]ven though the employment agreement provided that PRA would consider Dr. Francis for partnership after 18 months, there was no guarantee she would become a partner and make shareholder.”

Accordingly, the Appellate Court held that PRA failed to provide adequate consideration and the non-compete was unenforceable.

We will continue to monitor developments regarding Fifield. In the meantime, Illinois employers hoping to enforce restrictive covenants within two years after the signing date should be prepared to distinguish Fifield factually or legally.

 

Scope of Uniform Trade Secrets Act Trimmed By Arizona Supreme Court

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A recent Opinion issued by the Arizona Supreme Court highlights a noteworthy dichotomy in the way various states interpret the pre-emptive effect of their respective Uniform Trade Secrets Acts (“UTSA”). Forty-eight states have enacted some form of the UTSA, which aims to codify and harmonize standards and remedies regarding misappropriation of trade secrets that had emerged in common law and which differed from state to state. Only New York and Massachusetts have not enacted some form of the UTSA.

One important feature of the UTSA is its pre-emptive effect upon state common law causes of action involving trade secrets, including misappropriation and unfair competition. Whether this “displacement” provision of the UTSA applies to claims that involve “confidential information” that does not rise to the level of being a trade secret is the point of departure for the split of authority among the states.

The recent Arizona Opinion in Orca Communications Unlimited, LLC v. Noder, No. CV-13-0351-PR (November 19, 2014), involved Ann Noder, who served as president of Orca Communications Unlimited, LLC between 2002 and 2009. The complaint alleges that in 2009 Noder set up a competing company, Pitch Public Relations, LLC and urged Orca’s customers to do business with her new company. The claim at issue before the Arizona Supreme Court alleged that Noder engaged in unfair competition by intending to steal and exploit “confidential and trade secret information about Orca.” Ruling on a motion to dismiss, the Court held that, to the extent the unfair competition claim pertained to confidential information that falls outside of the Arizona UTSA’s definition of trade secret, it was not pre-empted by that statute.

The Court went on to recognize the split of authority among states on whether the UTSA displaces all common law tort claims based on misappropriation of confidential information, noting by example that such claims are pre-empted in Hawaii and New Hampshire, but are not pre-empted in Virginia and Wisconsin.

For employers in UTSA states, it pays to be aware of how the UTSA’s displacement provision is interpreted. Depending on the state’s law, if pursuing litigation against an employee who has resigned and taken merely confidential information which does not amount to a trade secret, the employer may not be limited to the remedies set forth in the UTSA.

Complimentary Webinar – A Year in Review: What’s New in the World of Trade Secrets and Non-Competes

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To register for this webinar, please click here.

Join Epstein Becker Green Attorneys David J. Clark, Robert D. Goldstein, and Peter A. Steinmeyer on Tuesday, December 16, 2014 at 1:00 p.m. EST for a 60-minute webinar.

This webinar will discuss recent developments and what to expect in the evolving legal landscape of trade secrets and non-competition agreements. With some businesses progressively feeling that their trade secrets are at risk for attack by competitors – and perhaps, by their own employees – this session will focus on how to navigate this developing area and effectively protect client relationships and proprietary information.

Topics will include:

  • Recent decisions regarding what constitutes adequate consideration for a non-compete
  • The trend toward criminal prosecution of trade secret theft, especially in the international context
  • Interesting decisions determining choice-of-law issues
  • New and pending state and federal legislation

Registration is complimentary. To register for this webinar, please click here.

A New Bill is Proposed in Massachusetts Legislature to Adopt the Uniform Trade Secrets Act

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A new Uniform Trade Secrets Act bill has been proposed by the Massachusetts Board of Commissioners on Uniform State Laws for the Massachusetts Legislature to consider in its 2015 legislative session. The proposed bill represents another effort to bring Massachusetts law protecting trade secrets in line with that of the vast majority of other states. As discussed here last August, previous efforts to reform Massachusetts law on trade secrets and non-compete agreements have failed, including Governor Patrick’s efforts in the last legislative session to make non-compete agreements unenforceable in Massachusetts.

The current proposal tracks quite closely the 1985 Uniform Trade Secrets Act (“UTSA”), key provisions of which have been enacted by 48 states (other than Massachusetts and New York). The definitions of “misappropriation” and “person” are essentially the same, while the Massachusetts proposal expands the definitions of “improper means” and “trade secret,” which are expanded only slightly to reflect some additional explanation and newer technology. Like the UTSA, the Massachusetts proposal provides for injunctive relief, treble damages if willful and malicious misappropriation can be proved, and attorneys’ fees to either plaintiff or defendant if the opposing party acts in bad faith in seeking or defending a misappropriation claim. The statute of limitations in both the UTSA and the proposed bill is 3 years from the date the misappropriation is discovered, or by exercise of reasonable diligence should have been discovered. If this bill passes, the Massachusetts Uniform Trade Secrets Act would be scheduled to take effect July 1, 2016. We will watch to see whether this attempt at reform passes.

Connecticut State Court Rejects Trade Secrets Theft Complaint

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After a bench trial, a Connecticut state court rejected a violation of trade secret complaint by an employer against a former employee in BTS USA v. Executive Perspectives, Superior Court, Waterbury, Docket No. X10-CV-116010685 (Oct. 16, 2014). The plaintiff, BTU USA, provides training and consulting services to corporate clients using learning maps, computer simulations and board games. The defendant, Executive Perspectives (“EP”), offers essentially the same services and products.

Marshall Bergmann, a former BTS Senior Director who had access to much of BTS’ proprietary information, had signed a non-compete clause stating, among other things, that when he left, he would not solicit current BTS customers, or any client BTS had, during the last two years of his employment. BTS claimed that after Bergmann left his employment, he violated the non-compete provision by contacting and soliciting BTS clients through LinkedIn, and he stole some of the technology and products, such as packaging, the name of the packaging vendor and client lists, in violation of the Connecticut Uniform Trade Secrets Act. Other claims included Connecticut Unfair Trade Practices Act Violation, tortious interference with business relationships and breach of contract.

The Court found that there was little evidence that BTS made an effort to conceal the claimed product trade secrets, because the products were widely distributed to clients and prospective clients. Also, a third party – a former BTS Australia employee who was not bound by any restrictive covenant agreement that banned sharing of information – had already shown EP photographs of the products at issue. EP had the products in place before Bergmann was hired by EP. Therefore, the product and vendor names were not misappropriated through improper means. Moreover, BTS failed to prove that it lost business to EP, and actual loss or harm is a prerequisite to monetary recovery. Therefore, BTS failed to carry its burden of proof.

In addition, BTS claimed Bergmann breached his employment contract by the way he used the LinkedIn page he had while he was employed at BTS. He did not change his BTS-related LinkedIn connections when he joined EP, and he announced his new job on LinkedIn. In response, Bergmann claimed that BTS had no policy barring what he did.

The Court ruled that absent an explicit provision in an employment contract, which governs, restricts or addresses an employee’s use of social media, the Court would not read such restrictions into an employment agreement since social media “has become embedded in our social fabric.”

BTS USA v. Executive Perspectives is another example that an employer must actively maintain the confidentiality of trade secrets in order to seek trade secret protection. In addition, the case demonstrates that employment contracts, company policies and procedures should include explicit provisions regarding an employee’s use of social media during and after employment with the employer, and the employer should require ex-employees to delete clients or customers from LinkedIn accounts on termination of employment, if that is what the employer expects.

Criminal Conviction Affirmed By Ninth Circuit For Trade Secret Theft

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Co-authored by Ted A. Gehring.

On November 5, 2014, the United States Court of Appeals for the Ninth Circuit, in an unpublished disposition, issued its opinion in U.S. v. Suibin Zhang. There, the Ninth Circuit upheld the criminal conviction of Suibin Zhang under 18 U.S.C. Section 1832 for the theft of Marvell Semiconductor Inc.’s trade secrets. According to an FBI release, Zhang was an employee of Netgear, Inc., and through that employment had access to Marvell’s secure extranet. According to the release:

Evidence at trial showed that Zhang, 44, of Belmont, California, was employed as a Project Engineer at Netgear Inc., of San Jose, which gave him access to Marvell’s secure database (“Extranet”). On March 8, 2005, Zhang accepted a position at Broadcom Corporation (Broadcom), which is also Marvell’s chief competitor. Beginning the very next day, March 9, 2005, and continuing on two other days before he left Netgear, Zhang used his Netgear account to download and steal trade secret information found in dozens of documents, datasheets, hardware specifications, design guides, functional specifications, application notes, board designs, and other confidential and proprietary items from Marvell. On April 27, 2005, Zhang loaded the Marvell trade secrets onto a laptop issued by Broadcom, where they continued to reside on June 24, 2005, when the FBI served search warrants at Zhang’s home and at Broadcom and took possession of his laptop.

After a bench trial, Zhang was found guilty and sentenced to three months in prison followed by three months of supervised release, 200 hours of community service, and $75,000 in restitution.

Zhang appealed the verdict, challenging the sufficiency of the evidence, challenging an evidentiary ruling of the district court and contending that his Sixth Amendment right to a public trial was violated.

On appeal, the Ninth Circuit held that there was sufficient evidence, beyond a reasonable doubt, that Marvell took “reasonable measures” to protect its trade secrets. It advised users of the existence of trade secrets and limited access on a need to know basis and controlled access through passwords. The Ninth Circuit found these measures “reasonable” though some were delegated to Marvell’s partner. The Court also held that, although Zhang did not personally sign the Marvell non-disclosure agreement, he accepted a limited license agreement that incorporated its terms. And he had signed a non-disclosure agreement with Netgear. Zhang was advised in the terms of use of Marvell’s extranet of the confidentiality of information on the extranet and the terms of use. The Court also held that sufficient evidence established that Zhang stole the information. Zhang had claimed that information downloaded by him was relevant to a new project. But the Court found the timing of the downloads suspicious. And there was no evidence that Zhang had ever worked on the new project. Zhang had also transferred files to a Broadcom laptop. The Court further held that even though Zhang never sold the documents or sent around economically valuable secrets, sufficient evidence established that he intended to reap an economic reward. The Court held this same evidence established an intent to injure Marvell.

Finally, the Ninth Circuit held that the lower court had adequately supported its decision to close the courtroom for the testimony of one witness whose testimony went to the contents of documents that the government alleged contained trade secrets. The Court held that the lower court had properly heard the concerns of all parties, including the objections of Zhang to closure and the arguments of Marvell that testimony could not be parsed question by question and held that Zhang’s Sixth Amendment rights were not violated.

Zhang is a reminder that not only can the misappropriation of trade secrets constitute a crime, but also that the intent to reap an economic benefit is sufficient to sustain a conviction under 18 USC Section 1832.

Indiana Appellate Court Reverses Non-Compete Injunction Bond Of Only $100

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The size of an injunction bond is not a common topic in appellate cases. Accordingly, a recent decision by the Indiana Appellate Court reversing the trial court’s setting of an injunction bond at only $100 in a non-compete case is noteworthy.

In Donald Moss v. Progressive Design Apparel, Inc., the Indiana Appellate Court affirmed a preliminary injunction which restricted a salesman’s ability to call upon customers of his former employer or disclose confidential information. As part of the trial court’s order granting injunctive relief, the trial court found that the enjoined salesman’s foreseeable loss in commissions due to the injunction “might be $60,000, less what he would have in the way of earnings from the extra ten to fifteen hours a week he would have by not selling” to one of his former employer’s customers. Nevertheless, the trial court only required the former employer to post a $100 injunction bond, which the Appellate Court held was insufficient.

In reaching this conclusion, the Appellate Court pointed to the applicable Indiana rule of civil procedure, which provides that “[n]o restraining order or preliminary injunction shall issue except upon the giving of security by the applicant, in such sum as the court deems proper, for the payment of such costs and damages as may be incurred or suffered by any party who is found to have been wrongfully enjoined or restrained.” (emphasis added). (Note: Federal Rule of Civil Procedure 65(c) similarly provides that “[t]he court may issue a preliminary injunction or a temporary restraining order only if the movant gives security in an amount that the court considers proper to pay the costs and damages sustained by any party found to have been wrongfully enjoined or restrained.” In contrast, in some states, such as Illinois, bond is not mandatory.)

The Appellate Court explained that while the setting of an injunction bond “is a discretionary function of the trial court and is reversible only for an abuse of that discretion,” setting bond at only $100 when the estimated damages (should the injunction later be found to have been wrongfully issued) were so much higher, was an abuse of discretion. Accordingly, the Appellate Court reversed the trial court on that issue and remanded the case to the trial court for “determination of a proper bond.”

Amidst the furious activity that generally accompanies non-compete litigation, the size of an injunction bond is frequently given little or no thought until the issue arises at the end of an injunction hearing. Nevertheless, as the Appellate Court noted in the Progressive Design Apparel case, in many litigation forums, the setting of an appropriate bond is a procedural requirement that cannot be ignored. Both sides should therefore be prepared to address the issue and any strategic significance it may have.

 

Illinois Appellate Court Draws Distinction Between Officers And Non-Officers When Determining What Is An Impermissible Solicitation

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In determining what is an impermissible “solicitation” by a current employee, the Illinois Appellate Court recently drew a distinction between officers and non-officers. See Xylem Dewatering Solutions, Inc., d/b/a Godwin Pumps of America et al. v. Szablewski et al., Case No. 5-14-0080 (Ill. App. 5th  Dist. 2014).

In Xylem Dewatering Solutions, the defendants were accused by their former employer of wrongfully soliciting customers and suppliers on behalf of a competitive business that they were planning to launch. According to the Appellate Court’s decision, while still employed by their former employer, the defendants “asked customers and suppliers what they ‘thought’ about” the defendants’ formation of a new, competitive business. However, the defendants never “actually solicited any business or sold goods and services” to their then-employer’s customers on behalf of their new business until they had resigned and started the new business.

Although the defendants “agreed that those conversations were intended to persuade” customers and suppliers “to eventually do business with” their new business, the Appellate Court held that it was not an abuse of discretion for the trial court to conclude that these conversations were merely “preliminary actions” that did “not rise to the level of a breach of an ordinary employee’s duty of loyalty.” (emphasis added).

In reaching this conclusion, the Appellate Court drew a distinction between the duty of loyalty owed by ordinary employees (who are permitted “to plan and outfit a competing corporation so long as they do not commence competition”) and the “heightened duty of loyalty owed by corporate officers” (who are prohibited from “actively exploit[ing] their positions within a corporation for their own personal benefit” or “hinder[ing] the ability of a corporation to continue the business for which it was developed”).

Given the nature of these communications and their admitted purpose, their legality was not a foregone conclusion. Indeed, the Appellate Court may have reached a different conclusion if it was reviewing the trial court’s determination de novo, rather than merely reviewing it to determine if it was an abuse of discretion.

That being said, the Appellate Court’s decision makes clear that while all Illinois employees owe a duty of loyalty to their employer, corporate officers owe a heightened duty. Both they, and their employers and prospective employers, should be very aware of this distinction.

It should be noted that an employee’s duty of loyalty is governed by state common law. Accordingly, what passes muster in one state may not in another, and employers and employees should be aware of what is and is not permissible conduct in their own state.

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