Limits on Exclusive Use of “Trade Secrets” in Deal Structuring: Investment Banker Cannot Claim Misappropriation of Trade Secret for Bowie Bonds

Posted October 9, 2009 by   · Print This Post Print This Post

What right does an external advisor have to own the exclusive right to structure a business transaction?   This question may become more interesting to consultants and outsourcing service providers who might wish to rely upon trade secrecy to develop a “new market” in a “new type of service” or “best practices.”

The bottom line appears to be that outsourcing consultants and outsourcing service providers must show a very high standard of secrecy in order to be allowed to exclude others from using an unpatented business process.  The business process cannot merely be the simple application of business expertise to analysis of numbers by previously known techniques.

Music Royalty Securitization as Deal Structure.

David Pullman, an employee of an investment bank Gruntal & Co., introduced a concept for securitization of intellectual property royalties.   He developed a plan to securitize the projected royalty stream from the music of an internationally renowned musical performer, David Bowie.   Gruntal & Co. entered into a written engagement letter with Prudential Securities Corp. and affiliates in which Prudential agreed not to disclose Gruntal’s confidential information about the structure of the deal.   (Mr. Pullman moved to Fahnestock & Co., another investment bank, which purchased Gruntal’s rights.)  Prudential purchased $55 million allotment of bonds issued in a private placement in which David Bowie was paid a lump sum in cash for the right to receive royalty income from his music catalog for a 15-year period.  The bonds were self-liquidating, meaning that the royalty stream was applied directly and paid to the bond holders to reduce principal and interest.  Mr. Pullman claimed that he and his team “created formulae that were used in the financial analysis methodology model for the Bowie Transaction, and that using the formulae and applying it to a model, the user could predict cash flow, volatility, timing, currency risks and other factors required to analyze a proposed bond transaction.”

The Failed Joint Venture.
In June 1997, Mr. Pullman proposed that Prudential enter into a joint venture with his employer, Fahnestock, to form “Royalty Finance Co. of America.”    Prudential would be the exclusive revolving warehouse lender and provider of subordinated debt on future bond issues secured by intellectual property royalties.  Fahnestock was to act as exclusive agent for the placement of the loans and securitizations completed through the joint venture.  Instead of completing this joint venture, Prudential allegedly used confidential information on the deal structure from Fahnestock and formed a joint venture with RZO, an entity that had had a joint venture with Fahnestock on music royalty securitization.  The prestigious law firm of Willkie Farr & Gallagher represented both Fahnestock in the Bowie Bond transaction and later represented RZO in a transaction with Prudential that excluded Fahnestock and Mr. Pullman, and the absence to trade secret protection apparently justified the law firm’s representation of RZO in the Prudential relationship.

The Law firm’s Right to Represent Others.

The prestigious law firm of Willkie Farr & Gallagher represented both Fahnestock in the Bowie Bond transaction and later represented RZO in a transaction with Prudential that excluded Fahnestock and Mr. Pullman (and the absence to trade secret protection apparently justified the law firm’s representation of RZO in the Prudential relationship). The court noted: “The legal document prepared by WFG does not appear to differ materially from those of any other band transaction.” The court did not find any fault with the law firm’s actions.

Trade Secrets in Deal Structures.

The proponent of a trade secret must identify in detail the trade secrets and confidential information allegedly misappropriated by the defendant.   Xerox Corp. v. Int’l Bus. Machines Corp. 64 F.R.D. 367 (S.D.N.Y. 1974).  “If [the party claiming ownership of the trade secret] intends to rely upon a unique combination of previously known elements as the basis for its trade secret production [that discloses this to the court], it must specify what particular combination of components it has in mind and how these components operate in a unique combination.”   Pullman Group LLC v. Prudential Ins. Co. of America, ___ NYS2d __, NYLJ (July 3, 2003), p. 24, cols. 1-6, p. 25, col. 1 (Supreme Ct. N.Y. Co. 2003), Judge Gammerman, at p. 24, col. 5.    “The secret must be one which can be described with sufficient particularity to separate it from matters of general knowledge in the trade or the special knowledge of those persons skilled in the trade.”  Imax Corp. v. Cinema Technologies, Inc., 152 F.3d 1161 (9th Cir. 1998).

Lessons for Outsourcing Customers.

Outsourcing contracts frequently contain provisions that allow the parties to continue to use information that is not trade secret.  The wording of such provisions needs to be carefully reviewed.   In the Pullman decision, the court identified several circumstances to support its conclusion that there is no claim against a service provider (or by a consultant against a customer) where the “trade secret” was “created” solely by applying “business expertise to the analysis of numbers by means of previously known techniques.”   Pullman, supra, at p. 24, col. 6.

  • The disclosure of the “trade secret” to others as part of a marketing concept or new product idea, which makes the concept inherently incapable of trade secret protection,  Boyle v. Stephens, 1997 WL 529006 (S.D.N.Y. 1997).
  • The fact that the concept was a “mere distillation of general knowledge which is common to a particular trade,”  Laff v. John O. Butler Co., 64 Ill.
  • Once a trade secret has been made public, it loses its status as a protected trade secret.
  • The plaintiff failed to reveal the alleged formula.

As a result, a customer wishing to preserve its rights in trade secrets disclosed to its outsourcing service provider must treat those trade secrets with all the usual protections that are necessary to protect them from any other third party.   In the context of joint development of business processes with an outsourcing service provider, the customer must carefully delineate the nature and scope of intellectual property protections.

Lessons for Outsourcing Vendors.

The mere claim that a customer’s operations are “trade secrets” might not mean that they are protected as such by applicable law.  However, as a matter of marketing and credibility, the outsourcing service provider must show as much confidentiality concerning the processes as practicable.   Maintaining confidentiality preserves both the customer’s goodwill, the service provider’s potential right to own internally developed ancillary or corollary processes, and avoids the unfavorable publicity of a dissatisfied customer’s claims of misappropriation.

Lessons for Outsourcing Consultants.

This decision raises a number of questions about an outsourcing consultant’s right of ownership of “trade secrets” that it uses in its consulting business. If the consultant did nothing but apply “business expertise” to the analysis of a business problem by the use of “previously known techniques,” the consultant might not have any ownership in the alleged trade secrets. If a consultant has been using essentially the same methodology for over a year then patent protection may be unavailing. Outsourcing customers selecting outsourcing consultants therefore may ask about the consultant’s claims to intellectual property as part of the process of selecting a consultant.

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