The marginal utility of trade secrets.

• Author: Risch, Michael
• Position: Why Do We Have Trade Secrets?

Trade secret law provides (a) protection in addition to contract or tort theories, and (b) remedies not offered by the common law. Thus, economic analysis of trade secret law must be confined to trade secret law in order to be useful. In other words, the analysis must be with respect to the marginal costs and benefits afforded by trade secret law versus the existing common law. Performing an analysis of trade secrets without this distinction can lead to two problems. First, the task of justifying all of tort and contract law, which may underlie trade secrets, would take a book, (182) not an article. Second, failing to consider marginal costs and benefits may lead to overstatements about the costs and benefits of trade secret law, especially in cases where tort and contract law are sufficient and confer the same benefits of trade secret law.

This Part considers the various rights and obligations afforded to trade secret owners and asserts that the marginal benefits of trade secrets outweigh the marginal costs. The Appendix provides a detailed example of the points discussed.

1. Only Some Information May Be Protected

   The determination of what information may be protected is a key to understanding how trade secrets differ from underlying law.

   1. Economic Value Due to Secrecy

      The requirement that the information have value derived from its "secrecy" (183) distinguishes trade secrets from the common law. Neither breach of contract nor tort law requires that the subject matter have value or that the subject matter not be generally known. (184) The economic benefits of this are twofold. First, unlike contract and tort law, the plaintiff must be protecting something of value before administrative costs are incurred. Second, and more importantly, economic value is a signal to the court that the special rules associated with trade secrets are warranted. Conversely, if the subject matter does not have value from secrecy, then remedies such as injunctions would impose an unjustified social cost by limiting potentially valuable information (though not valuable due to secrecy) from those who could use it.

      Critics might argue that trade secret law imposes a cost by keeping valuable information from the public, (185) which is directly contrary to the conventionally understood policies of copyright (186) and patent law. However, this particular social cost is minimal because the information would already be kept secret by the owner in the absence of trade secret law while others would attempt to discover the same information independently. (187) The marginal cost of protecting secret information is that those who would use "improper means" (188) cannot obtain that information and must duplicate innovation. (189) This is especially pronounced where former employees must "recreate the wheel" or, even worse, where employees with experience are not assigned to key projects because of the risk of use of confidential information. As discussed below, this marginal cost is likely outweighed by the benefits of protection, especially considering the fact that "duplicate innovation" or reverse engineering may lead to improvements better than the first secret. (190)

      The discussion thus far has assumed that because the information has value to the owner, there should be some protection. This might not necessarily be true; perhaps it would be more efficient if competitors could simply take what information they want without repercussion, or even if every company were forced to disclose its information. There are bound to be times when the cost of such activity is well justified by the value of such secrets, and the competitor might even be able to make better use of the information so that society will be better off. The subsections below test the alternatives, namely "forced disclosure" and "no liability."

      1. Forced Disclosure

         It may be that the most efficient rule requires that owners disclose all information learned during business operations. Such disclosure would fall into two categories: low cost and high cost.

         Low cost forced disclosure might include rules that software be distributed with its source code (191) or rules that competitors be allowed to tour factories. Contrary to the discussion in Part III.A, a low cost forced disclosure rule would likely have an impact on incentives to innovate. Because others could utilize information cheaply without expending the costs of development, owners might receive a much smaller rate of return on investment in developing valuable information and thus might be less likely to develop such information. However, with copyright and patent protection, the most valuable improvements and writings might be protected even if disclosure were forced. Thus, one would expect that the incentive to create otherwise unprotectable information would decrease more than the incentive to create information that is otherwise protectable. The requirement that information have value is a "bootstrap" incentive to create secret information. This is not quite the quid pro quo associated with patent filings, but it is nonetheless an important societal tradeoff--if you create valuable secret information, society will protect it.

         High cost forced disclosure would relate to disclosure of information that is not easily shared in a timely manner, such as detailed customer information, pricing, product roadmaps, and other ephemeral or unwritten information. (192) In practice, high cost forced disclosure would fail because enforcement and administration costs would be sufficiently high that information producers would risk nondisclosure. (193) Additionally, owners would be more likely to keep information in memory rather than in writing, which would likely make the information less valuable to its owner with no offsetting benefit.

         Further, at the present time, there is no mechanism that would allow third parties to determine whether or not a business has developed high disclosure cost information and what that information is. Even factory tours might fail to disclose useful information, as secrets might be effectively "hidden in plain sight." (194) As a result, lawsuits might be filed just to learn whether or not a claim is present. The outcome would likely be either (a) a court system overburdened with so many frivolous lawsuits that the meritorious claims might be lost, (b) a world in which owners keep information secret anyway, with the hope of not being sued, or (c) a series of agreements between competitors in which each company agrees not to sue the other. None of these outcomes are particularly palatable from an efficiency point of view, in light of the alternatives for developing and learning information.

         Even if all companies followed the rules, the signal to noise ratio would probably eliminate all value--indeed, just reaching agreement on what is a sufficient disclosure and what system would track disclosures is difficult to fathom. It is possible, of course, that there are a few secrets that are difficult or impossible to reverse engineer and that would be more valuable if shared. The cost of "setting free" the vast amount of information held by companies but not shared--whether or not they are trade secrets--would cause so much turmoil that the information might still be lost. (195)

      2. No Liability

         Even if disclosure were not forced, one could envision a rule where companies can maintain secrecy, but also where competitors have no liability for using improper means to obtain secrets other than the existing common law. The problem with this rule is twofold. First, as discussed throughout this Part, the common law is insufficient to create liability in all cases. I discuss the failings of tort and common law in each subsection, but, in general, liability would be insufficient for those not in privity of contract, for certain costly behavior that is not a tort, and with respect to remedies. Furthermore, without clear definitions of trade secrets, employee agreements might be interpreted too narrowly, allowing employees to escape liability by claiming that information was not really "confidential."

         Second, such a rule might increase the number of transactions as well as transaction costs. Ostensibly, if there were only one competitor and one owner, then the owner would either spend more to protect information or pay the competitor not to take the secret. In reality, there is usually one secret holder and many competitors who would like the information. The amount of protection would be determined by the value of the information to the owner and potential acquirers, the cost of protection, and other factors. For example, the ability to protect against employees absconding with information is difficult and costly, and the owner would have to choose between inefficient ways to keep information from being taken by employees, suing for the limited remedies available for breach of contract, or paying the employees more than they could gain by absconding.

         Without some added protection, as the number of potential competitors increases, the transaction costs of the owner negotiating with (or possibly suing for breach of contract) each potential misappropriator would be prohibitively high. (196) As a result, the owner is entitled to keep the value from the trade secret by default rather than having to distribute its value by paying others not to take the secret.

   2. Requiring No More than Reasonable Efforts to Maintain Secrecy

      The fact that trade secrets may be protected without requiring more than reasonable efforts is a primary economic justification for having trade secret law. (197) Perhaps a better way to state this proposition is that the ability to recover damages changes the definition of what is reasonable and efficient.

      In the absence of trade secret law, one would expect the efficient amount spent on protection of the secret to be the point where the marginal cost of protection equals the marginal...