What Independent Directors Need To Know About Intellectual Property - Part II

Saturday, May 1, 2004 - 00:00

Part I of this article appears in the April 2004 issue of The Metropolitan Corporate Counsel.

Copyright Law

Copyright is the right given to authors to prevent unauthorized copying, reproduction, distribution and display of their work. Copyright covers "works of authorship," including not only books and songs but also computer software.

The sidebar description of Xerox's creation of the now ubiquitous windowing user interface and its failure to protect its proprietary rights to that work of authorship, shows a real-life example of opportunities associated with copyrighted intellectual property. If the Xerox board had been up to date in relevant intellectual property law, it could have prodded an evidently unaware management into protecting by copyright, and possibly patent, aspects of the interface now known as Windows. Instead, Apple and then Microsoft benefited richly from the technology that Xerox developed but failed to protect.

A more recent example of how copyright-based actions can affect a company's future involves SCO Group, a small company that has asserted that its copyright rights to the UNIX operating system have been infringed by IBM and others through their activities with respect to the LINUX operating system. While the merits of SCO's action have not yet been ruled, SCO's stock price has increased from 2 to 15 between March and mid-December 2003, a 750% increase.

Board Inquiries About Copyright

Copyright, though it lacks the scope of patent law and the power of patent law to prevent use of even independently created technology, nevertheless can be a powerful form of intellectual property, particularly where computer software is involved. Board oversight of how a company deals with copyright issues should cover these areas:

•Does the company keep track of developed software?

•Are copyright registrations obtained where appropriate?

•Are employees involved with software development instructed as to the legal, as well as moral, imperative not to copy or use competitors' software in their current employment?

•Are they instructed not to bring code from a former employer to use "as a guide" in current matters?

•Has the company properly documented its relationships with consultants who write software for company products to insure company ownership of their work product?

Trade Secret Law

Trade secret law, an under-appreciated form of intellectual property, is extremely broad in its coverage. A trade secret is any form of information having two qualities: first, it has economic value derived from not being generally known, and second, it is kept as a secret by its owner. Trade secret law covers everything from the formula for Coca-Cola to manufacturing tolerances for aircraft engine turbine blades, to supplier and customer lists and algorithms buried in computer programs.

GM's legal action against Volkswagen for trade secret misappropriation exemplifies how trade secret law can impact corporate activity, and how trade secret issues should be considered in hiring decisions. Volkswagen paid a billion dollar settlement and received significant attendant bad publicity related to the hiring of a GM executive and several colleagues. Major financial and other relief was awarded to GM without even the need to go to trial.

Protecting and enhancing a corporation's intellectual property position requires board awareness and oversight of the company's competitively valuable knowledge and of the company's policies and practices regarding protecting that knowledge against disclosure. As valuable as a trade secret may be, it is also extremely fragile. Once it becomes publicly known, its legally protectible status evaporates, permanently and irrevocably.

Board Inquiries About Trade Secrets

Since a basic requirement of trade secret law is that care reasonable under the circumstances be taken to preserve the secrecy of the subject matter, companies must take affirmative steps if they are to have an effective trade secret program. Boards should measure the performance of management against the parameters of reasonable care by asking, among other things:

•Are the company's procedures for protecting confidential information appropriate in substance?

•Are those procedures effectively disseminated throughout the company?

•Has management restricted physical access to areas containing valuable trade secrets?

•Are computer systems protected against intrusion?

•Do arriving and departing employees receive appropriate instruction in the do's and don't's associated with their respective positions?

•Are confidentiality notices properly used on documents? Or, are they either missing when they should be present or routinely applied to non-confidential documents so that their message has been "cheapened" to the point of becoming worthless?

•Does the company monitor competitors for evidence that its trade secrets have found their way into unauthorized hands?

•Who is responsible for initiating and enforcing those policies and procedures? Who monitors competitors' activities for suspicious events suggesting possible misappropriation?

Active Investment In Intellectual Property And Its Exploitation Brings Corporate Benefits

By paying attention to perfecting and exploiting the value of their intellectual property assets, corporations can reap significant revenue. It has been estimated by the Harvard Business Review that from 1980 to 2000 annual royalties received by U.S. companies from patent licensing grew from $3 billion to nearly $110 billion.

IBM's aggressive pursuit of a patent licensing strategy has generated about $10 billion over the last 10 years. In 2000 alone, IBM earned $1.7 billion, or 15 percent of its total corporate profit, from patent licensing. Similarly, Texas Instrument's efforts to invest in and exploit its patents and other intellectual property assets have caused related revenues to account for 42% of the corporation's total operating profit. The company has made an estimated $3 billion through patent licensing since 1990, including $500 million in 2000 alone.


In today's highly competitive business world, every source of competitive advantage or potential risk becomes critical. Corporate boards need to understand the potential advantages and risks relating to the company's intangible intellectual property assets. As Alan Greenspan noted, intellectual property assets are increasingly the core of corporate asset valuation already, and their relative importance is increasing at an accelerating rate. Misjudging the value of these assets has proven dangerous for some companies; it may even be fatal to a company's future. Active, informed oversight by the board of the company's practices in this area can reap enormous benefits; therefore, board-level attention to a company's strategy as it relates to intellectual property assets is consistent with fiduciary obligations.


Strategic Positioning: To Protect Or Not? Xerox vs. Adobe
Xerox Corporation's Abandonment of Windows
For the first 15 years of the personal computer era (from 1975 to 1990), mice and graphical user interfaces were not commercially available. Instead, users memorized keyboard commands or studied cardboard templates to figure out how to bold a word, create a footnote, or print a document.

Back in the 1970s, a group of computer engineers at Xerox Corporation's Palo Alto Research Center developed a windowing environment that could be controlled by moving and clicking a mouse. This groundbreaking technology was likely subject to protection under the intellectual property laws. But Xerox did nothing to protect its technology. Indeed, just the opposite - PARC invited others in to see its technology. On a day in 1979 now legendary in the personal computer field, Steven Jobs of Apple, then marketing the Apple II, visited PARC and was shown the revolutionary user interface. Jobs appreciated the importance to Apple of what he saw and, a few years later, Apple released the Macintosh computer, complete with graphical user interface and a mouse. The Macintosh changed the rules of the game, and shortly after its release Microsoft began its development of Windows.

How informed was the Xerox board about the open door policy at PARC which resulted in sharing, rather than protecting, intellectual property developed there? If Xerox had patented its technology relating to the windowing environment, would it be in a different market position today?

The Perils Of Trade Secret Misappropriation:
General Motors vs. Volkswagen and Purchasing Officer
The 1996 suit brought by General Motors against Volkswagen and its top purchasing officer, Jose Ignacio Lopez, illustrates the potential for large scale trade secret theft in the age of electronic information transmission and related publicity, monetary and legal repercussions.

In 1993, Lopez, former head of GM's worldwide purchasing, joined Volkswagen AG with seven other employees. GM sued Volkswagen ("VW") and Lopez in Detroit, claiming that they had been secretly planning Lopez' departure from GM for some time, while he amassed volumes of highly confidential GM data for transmission to VW. The information allegedly included plans for a super-efficient car factory, future product designs and strategies, a cost-cutting system for supplier inventory, as well as GM's supplier lists and data on worldwide costs of vehicle parts and components. (All of these types of information can qualify as trade secrets.) GM also brought a criminal suit in Germany. In connection with that suit, German police found four boxes of GM documents in the home of two of Lopez's defecting colleagues. The U.S. suit was settled in 1997, with VW paying GM $100 million and promising to buy $1 billion worth of GM parts. The following year the German court fined Lopez some $230,000 while dropping the criminal charges of corporate espionage.

The monetary repercussions were severe; the effect on VW's public image compounded the damage. As the Los Angeles Times put it, referring in part to this case: "VW Falls Into a Big Publicity Pothole."

Did the VW board know the circumstances about the hiring of Mr. Lopez? Was it properly briefed on the boundaries between legally permissible hiring of talented employees away from a competitor and impermissible trade secret misappropriation?

Weil Gotshal Plans IP Seminar
Weil, Gotshal & Manges LLP will present an intellectual property seminar entitled IP Pitfalls in Corporate Transactions on Tuesday, May 11 from 12:30 to 2 p.m. at the Weil Gotshal Conference Center, 767 Fifth Avenue, New York City.

Speakers will be Weil Gotshal attorneys Michael A. Epstein, Stephen D. Kahn and Jeffrey D. Osterman. For additional information call Melissa Phillips at (212) 310-6848. To register online visit www.weil.com/wil/ipmedia.html.

Stephen D. Kahn and Holly J. Gregory are Partners in the international law firm, Weil, Gotshal & Manges LLP. Mr. Kahn specializes in patent litigation and other areas of intellectual property law with a focus on the legal protection of computer software. Ms. Gregory specializes in advising boards and managers on corporate governance responsibilities, compliance with governance related laws, regulations and listing rules, and "best practices."

Please email the authors at stephen.kahn@weil.com or holly.gregory@weil.com with questions about this article.