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Outsourcing Law & Business Journal™: June 2010

June 30, 2010 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services.  www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.

Insights by Bierce & Kenerson, P.C., Editors.  www.biercekenerson.com

Vol. 10, No. 6 (June 2010)
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1.  U.S. Discrimination against Foreign Call Centers: Sen. Schumer’s Personal Trade War.

2.  Business Method Patents for Business Process Sourcing : Strategies for Hedging Your Bets when Strategies for Hedging Weather Futures are Unpatentable under U.S. Supreme Court’s Bilski Decision.

3.  Humor.

4.  Conferences.

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1.  U.S. Discrimination against Foreign Call Centers: Sen. Schumer’s Personal Trade War. Call center operations can be conducted anywhere in the world without U.S. regulation, unless the activities involve regulated business services such as mortgage banking, consumer credit and lending, broker-dealer securities brokerage, life insurance sales and the regulated professions such as public accounting, the practice of law, engineering and architecture.  The Democrats and the Obama Administration appear to want to control call center operations more than the mere directive in the TARP program, which forbids the use of any federal funds by TARP stimulus recipients for foreign call centers.  Now comes Sen. Charles Schumer (D., N.Y.) with a proposal to tax all foreign call center calls at $0.25 per call, but exempt all U.S. call center calls from this tax.  For the complete article, click here:  http://www.outsourcing-law.com/2010/06/u-s-discrimination-against-foreign-call-centers/

2.  Business Method Patents for Business Process Sourcing : Strategies for Hedging Your Bets when Strategies for Hedging Weather Futures are Unpatentable under U.S. Supreme Court’s Bilski Decision. Business process outsourcing (BPO) has led many entrepreneurs and their investor cousins (sometimes called “patent trolls”) to seek patent protection for their business methods.   The long-awaited decision of the U.S. Supreme Court in Bilski v. Kappas, 561 U.S. ___ (June 28, 2010) was anticipated to lay down the groundwork for defining the parameters of patentable business methods.  Its decision disappoints the more than 60 parties that filed briefs on both sides of the debate over what is patentable.  Read more by clicking here:  http://www.outsourcing-law.com/2010/06/business-method-patents-for-business-process-sourcing/

3.  Humor.

Patent, n. (1) a legal monopoly until it is declared illegal, invalid, obvious or not useful; (2) bargaining chip for a standard agreement; (3) public declaration of what you do in private.

Patent troll, n. (1) non-operating owner of a business method that everyone uses; (2) sheriff deputized for highway robber.

4.  Conferences.

July 14-16, 2010.  IQPC Presents Shared Services for Finance and Accounting, Chicago, Illinois. The SSFA 2010 Summit brings together leading financial shared services experts to network, benchmark and learn through keynote presentations, interactive roundtables, case studies and discussion panels. This program will help you improve internal accounting processes, maximize your efficiency with less resources, make smarter sourcing decisions, and drive continuous value through your financial services.  For more information, visit http://www.sharedservicesfa.com/Event.aspx?id=314126

September 13-15, 2010.  5th eDiscovery for Pharma, Biotech and Medical Device Industries, Philadelphia, Pennsylvania.  Presented by IQPC, this event will bring together industry leaders from in-house eDiscovery teams, expert judges and outside counsel as they discuss:

• How the new Pension Committee decision will effect eDiscovery professionals in the life science industries
• The unique challenges biopharmaceutical and medical device companies face with respect to social media content
• Preparing and responding to FDA inquiries, patent issues, and other types of pharmaceutical litigation
• A progress report on the 7th circuit eDiscovery pilot program and its implications for Pharma and Biotech
• Reducing patient privacy risks and unnecessary disclosures due to indiscriminate document retention
• Discovering new technologies to reach your goal of gaining proactive control over all your data

To register and view the whole program, click here.

September 26-28, 2010.  IQPC Shared Services Exchange™ Event, 2nd Annual, to be held in The Hague, Netherlands. Shared Service Centres have long been seen as the cost saving centre of HR, Finance & Accounting and IT processes, but with changing employment trends and global challenges facing organisations, how can SSC’s continually offer service value?

Unlike typical conferences, the Shared Services Exchange™, which will be co-located with the Corporate Finance Exchange™, focuses on networking, strategic conference sessions and one-on-one meetings with solution providers. The Exchange invites strategic decision makers to take a step back from their current operations, see what strategies and solutions others are adopting, develop new partnerships and make investment choices that deliver innovative solutions and benefits to their businesses.

To request your complimentary delegate invitation or for information on solution provider packages, please contact: exchangeinfo@iqpc.com, call +44 (0) 207 368 9709, or visit their website at http://www.sharedservicesexchange.co.uk/Event.aspx?id=263014

October 21-22, 2010, American Conference Institute’s 5th National Forum on Reducing Legal Costs, Philadelphia, Pennsylvania.

The essential cross-industry forum for corporate and outside counsel who are truly motivated to create value and reduce legal costs through innovative fee arrangements, enhanced relationships, and streamlined operations

Come join senior corporate counsel responsible for cost-reduction success stories, as well as leaders from law firms that have pioneered the use of alternative fee arrangements and other innovative cost-reduction initiatives, as they provide a roadmap for navigating the complexities of keeping legal department costs in check. Now in its fifth installment, this event offers unique networking opportunities with senior practitioners from around the nation, including in-house counsel from a wide range of companies and industries.

Reference discount code “outlaw” for the discounted rate of $1695!  To get more information, visit www.americanconference.com/legalcosts

October 25-27, 2010, The 8th Annual HR Shared Services and Outsourcing Summit, Orlando, Florida. This will be a gathering for corporate HR & shared services executives from companies across North America to exchange ideas, develop new partnerships and discuss the latest tools, technologies and strategies being employed in the profession to enhance departmental efficiencies and propel corporate growth. The event will focus on the most current topics in the HR shared services industry including metrics, automation, outsourcing, globalization, compensation & rewards, benefits and an overall focus on the new strategic role of HR shared services.  We will review how to tackle change management, analyze current and future projects and further develop the instrumental key areas within HR shared services. Outsourcing Law contacts can receive 20% off the standard all access price when they register with the code HRSS5. Register by calling 212-885-2738. View the program brochure for more details by clicking here.

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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com . Edited by Bierce & Kenerson, P.C. Copyright (c) 2010, Outsourcing Law Global LLC. All rights reserved.  Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

Insider Theft of Trade Secrets in India: Employee of Captive R&D Subsidiary Accused of Source Code Theft (and What You Need to Know About Protecting Your Trade Secrets Abroad)

October 9, 2009 by Bierce & Kenerson, P.C.

In a global economy, which risks are greater: theft of trade secrets by a service provider or theft of trade secrets by an employee of a foreign subsidiary?  How can a global enterprise contain such risks in either case?  The story of theft of source code by an employee of an Indian research and development center highlights the need for proper strategies for risk mitigation in the face of the inherent risks of human nature.

Indian R&D Center, Site of Source Code Theft.

On August 4, 2004, Jolly Technologies, a division of U.S. business Jolly Inc., publicly reported that one of its employees at its Mumbai, India R&D center had misappropriated key ports of source code being developed along with confidential documents.   The trade secrets relate to one of its key products for the labeling and card software for the print publishing industry.

Profile of a Thief and a Theft.

Jolly Technologies was new to India.  Its center was established only three months prior to the trade secret theft.   The employee alleged to have stolen the trade secrets was a new hire.  The theft was done by simply uploading the source code to her Yahoo account.

Consequences to the R&D Center.

Jolly reportedly shut down its R&D center immediately to assess and contain the damage.  It also sought assistance from Indian police to deal with the matter as a criminal act.  The company’s investment may be a loss, and it may need to expend further resources to prevent the use by its competitors and other third parties of any stolen source code.

Security Precautions.

The theft shows how simple it is for any person with Internet access to misappropriate trade secrets.

• Data Export Controls on Internet Access.
  Internet access may be essential to virtually all knowledge-economy employees, so management may consider that shutting off Internet access may be impossible.  The Affaire Jolly suggests that software development might need to occur in an environment that allows employees access to information but does not allow them to transfer certain types of information from a company computer to anyone via the Internet.   The advent of network administration software, XML metatags, html, virus sniffers and spam blockers may introduce technology that allows a company to prevent the transfer of source code to unauthorized Internet addresses.
• Segregation of Function.
  Most software development projects start with modules and build into integrated suites of modules.  In the manufacturing sector, complex trade secrets may be protected by separating multiple manufacturing processes into separate functions and separating the component processes.  This can be done by either putting the component processes into different operations or by separating subassemblies from final assembly.  Software development could be structured similarly, though segregation of function reduces efficiency.
• Background Checks.
  The new hire at Jolly Technologies might have been investigated for a possibly criminal background.  But background checks probably do not help with curious employees interested in studying stolen code or restructuring it for possible other purposes.

Legal Precautions.

The trade secret theft also highlights the weakness of national legal systems where, in the case of India, courts have historically taken a decade to decide civil disputes.  Whether establishing a foreign captive service subsidiary or hiring a foreign service provider, the legal environment and legal precautions are critical to risk management.

• Statutory Protection for Trade Secrets.
  Most countries hosting R&D centers or outsourcing service centers are members of the basic international conventions on the protection of intellectual property.  Even China, by adhering to the World Trade Organization, now officially grants intellectual property rights under the WTO Agreement on Trade-Related Intellectual Property right (“TRIP’s”).  India has long been a member of the Paris Convention on Industrial Property and protects copyrights, patents and trade secrets.  As the Affaire Jolly demonstrates, it is not sufficient to have a legal right.  You need to have a credible forum for enforcing those rights.
• Contractual Commitments.
  Well-advised enterprises require their employees by contract to abide by various policies and procedures, including respect for intellectual property rights and trade secrets of the employer and third parties doing business with the employer.  Contractual commitments are a basic requirement of any IPR protection.
• Security Surveillance.
  Jolly’s security surveillance, by an internal audit, discovered the theft.  Pre-emptive security precautions cannot prevent fraud or theft, but surveillance can discover it.
• Risk Mitigation after the Theft.
  After the horse has left the barn, how do you get it back into the barn?  In a global digital economy, the only solution might be to find some way to tag the digital works, just as ranchers did for their cows in the 1880’s.
  • Court Systems.
    Indian courts now have a commercial part that is intended to accelerate adjudication. It is not clear whether the Mumbai courts offer any real adequate forum, and even adjudication of civil liability does not automatically result in enforcement of a money judgment.  Access to court systems are so fundamental to investors and employers that the issue should become one of diplomatic entreaty (as the U.S. has done with China), investor due diligence, and recommendations by intermediaries such as trade associations (such as Nasscom and ITAA), venture capitalists, private equity funds and investors and multinational enterprises and their advisors such as international business lawyers and business process and sourcing consultants..  Ratings on access to judicial systems should be part of the due diligence in all international operations.

Other Measures.

Insurance may be available, but the consequential loss may be too high for a fair premium.

Conclusion.

In captives and outsourcing, IPR protection needs practical and legal protections.  Blatant misappropriation will continue as a matter of human nature, so risks can only be mitigated.   Effective methods of mitigation will continue to evolve.  Technology and IP lawyers should be consulted before international operations are launched.

Trade Secrets in Outsourcing

October 9, 2009 by Bierce & Kenerson, P.C.

Summary.

The ability to develop and protect trade secrets is an essential requirement for the development and maintenance of an enterprise’s competitive advantage.  This commentary discusses some of the business, contractual and criminal issues involved in trade secrets in outsourcing.  At a minimum, both users and providers of outsourced services should understand the nature and scope of trade secrets being used in the delivery of the services.

Business Issues.

Benefits to Service Provider.

Trade secrets give economic benefits to businesses by creating barriers to entry by competitors, facilitating and accelerating business processes that can be delivered to customers, and allowing the business’ employees, contractors and customers to collaborate efficiently.  However, a trade secret loses its power if it becomes public.  As a result, any business that has or uses trade secrets should take steps to protect and preserve them.  Outsourcing service providers normally are keen to adopt and maintain appropriate measures to protect their trade secrets.

Risks to the Service Customer.

Trade secrets create risks for the customer.  The service provider might not be willing to allow the customer to use the provider’s trade secrets after the service agreement expires.  Well-advised customers adopt appropriate protections to ensure their ability to continue operations whether or not the same service provider continues to render the required services.

Contractual Issues.

Protection of trade secrets can be achieved by several methods:

• non-disclosure agreements;
• restrictions on access to persons within the business itself, such as preventing persons in one group from accessing confidential business processes in another group;
• retention of the key information in a small group of senior managers.

Intellectual Property.

Most laymen believe that trade secrets are a form of intellectual property.    Actually, they are not owned, but only kept confidential.  Indeed, many businesses in the same industry might know and use the same trade secrets in delivering goods or services to customers.  However, none of them owns the trade secret, since the others that know it have the lawful right to use it.  This assumes each acquired the knowledge without wrongful access to another’s secrets.

Trade Secret is Not a Patent.
Parties to an outsourcing contract should understand the differences between patents and trademarks.  In general, a patent is a governmentally-granted monopoly, for a statutorily defined limited period,  to make, use or sell products or services using an idea or process.  In general, a trade secret is not exclusive, is not made public and may be continued in use for an indefinite period.  An example of a trade secret is the secret formula for making Coca-Cola®, but not the formula for making soap.

Misappropriation of Trade Secret under Common Law.
Misappropriation of a trade secret is a well-recognized tort under common law in England and other countries that adopt the common law system.  Anyone who acquires knowledge of the trade secret by a disclosure that is not authorized can be held liable for “misappropriation” of the trade secret.  Such misappropriation is a tort, or violation of a common law duty that causes damage that can be foreseen when the misappropriation occurs.

Statutory Protection of Trade Secrets.
Trade secrecy rights arise out of both common law and state and federal statutes, as well as foreign laws.   In the United States, trade secrets are also protected by laws adopted by states.

WTO.
Article 39 of the Agreement on Trade-Related Intellectual Property under the GATT Uruguay Round likewise protects trade secrets in member countries of the World Trade Organization.

Trade Secret.
Fundamentally, a trade secret has three components.

• The secret is some form of knowledge that is used in a business.
• The owner derives economic or business benefit from the fact that such information is secret.
• The owner has taken reasonable measures to keep such information secret.

Criminal Issues.

Criminal Abuse of Trade Secrets under the U.S. Economic Espionage Act of 1996.

The U.S. Economic Espionage Act of 1996 amended the federal criminal statutes to impose criminal penalties on persons who engage in misappropriation of trade secrets, whether for private gain or for a foreign government.  Protection of private trade secrets is therefore a matter of public policy.

Definition of Trade Secret.
The Economic Espionage Act of 1996 defines trade secret consistently with the common law.  The owner must derive economic or business benefit from the secrecy.  The owner must take reasonable protective measures.  And the information that is the trade secret can be very broadly defined as:

all forms and types of financial, business, scientific, technical, economic or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled or memorialized physically, electronically, graphically, photographically, or in writing.”   18 U.S.C. 1839(3).

Economic Espionage.
In the case of espionage, the offense occurs when the misappropriation of trade secret is done “knowingly and without authorization,” while “intending or knowing that the offense will benefit any foreign government, foreign instrumentality or foreign agent.”   18 U.S.C. 1831(a).

“Economic espionage” occurs when such a person “steals, or without authorization, takes, carries away, or conceals, or by fraud, artifice, or deception, obtains a trade secret.”  18 U.S.C. 1831(a)(1).  Receipt of a stolen trade secret, attempted theft or attempted receipt, and conspiracy to do so, are also “economic espionage.”  18 U.S.C. 1831(a)(2), (a)(3), (a)(4) and (a)(5).

Theft of Trade Secrets.
Under the same law, the offense of “theft of trade secrets” occurs, when the same acts are undertaken “with intent to convert a trade secret…to the economic benefit of anyone other than the owner thereof” and “intending or knowing that the offense will injure any owner of that trade secret.”  18 U.S.C. 1832(a).  Similarly, receipt, attempted theft, attempted receipt and conspiracy are all predicate offenses for “theft of trade secrets.”

Penalties.
The penalties for espionage are more severe than for simple theft of trade secrets.  For economic espionage, individuals are subject to penalties of $500,000 and 15 years’ imprisonment per offense, while any “organization” that commits an offense is subject to a fine up to $10 million.    For theft of trade secrets, individuals are subject to fines and imprisonment of up to 10 years, while organizations are subject to fines up to $5 million.  18 U.S.C. 1831(b) and 1832(b).

Inapplicability to Trade in Services.
The Economic Espionage Act of 1996 does not necessarily protect trade secrets when there is a delivery or performance of services that use trade secrets in only one state in the Untied States, or where there is no resulting sale of a product.

Thus, in the case of “theft of trade secrets,” the offense exists only where the conversion (theft) of the trade secret “is related to or included in a product that is produced for or placed in interstate commerce or foreign commerce” of the United States.  18 U.S.C. 1832(a).  If the thief is in the business of providing services, then this statutory requirement would appear to fail.  Thus, customers that are consultants, advisors, or providers of intangibles (such as license rights, banking services, financial advice, etc.) would appear not to fall under this statute.

Place where Offense is Committed.
The Economic Espionage Act of 1996 covers conduct occurring anywhere in the world.  However, acts done outside the United States are only covered where either (1) the offender (a “natural person”) is a U.S. citizen or permanent resident alien or an “organization” organized under American law, or (2) an act in furtherance of the offense was committed in the United States.”  18 U.S.C. 1837.

Thus, economic espionage or theft of trade secrets could not occur if the act were done between non-resident aliens and there was no furthering act in the United States.

Criminal Abuse of Trade Secrets under the U.S. National Information Infrastructure Protection Act of 1996.

Similarly, the Economic Espionage Act of 1996 adopted a subtitle, the “National Information Infrastructure Protection Act of 1996,” that expands the scope of “protected” computers.  18 USC 1030.  Under prior law, private industry computers used in government and financial institutions enjoyed protection from unauthorized access.  The National Infrastructure Protection Act of 1996 expanded the scope of protection to include computers used in business.  The new law criminalized the act of making any unauthorized communication to third parties, or the unauthorized retention, of “information from any protected computer if the conduct involved an interstate or foreign communication.”  18 U.S.C. (a)(2)(C).   It is now illegal to attempt to extort “any money or thing of value” from any person, firm, governmental entity or other legal entity, by transmitting any communication (in interstate or foreign commerce of the United States) that contains a “threat to cause damage to a protected computer.”   18 U.S.C. 1830(a)(7).

Impact of Espionage Law on Outsourcing.
Outsourcing companies that manage “protected” computer networks for their clients must interpret this law.  Does it prevent an outsourcer from threatening to “damage” a computer in order to get paid the amount lawfully due under the contract?   The statute does not define “damage” to include consequential damage (where the client’s business is damaged but the client’s computers are not.  Rather, “damage” is defined as “any impairment to the integrity or availability of data, a program, a system or information” that where the impairment causes any one of three types of loss: (1) any loss of $5,000 or more in value during any one-year period “to one or more individuals,” (2) any actual or potential modification or impairment to “the medical examination, diagnosis, treatment, or case of one or more individuals, (3) any physical injury to any person, or (4) any threat to public health or safety.  18 U.S.C. (e)(8).

As a result, the National Information Infrastructure Protection Act of 1996 does prevent outsourcers from shutting down, or threatening to shut down, facilities or services that are used in providing medical, emergency or public safety services.

Criminal Prosecutions under the Espionage Act.
As of January 2003, only about 35 prosecutions had been filed against people accused of abusing trade secrets or threatening protected computers.   According to a January 2003 article by The Associated Press, prosecutors charged a college student with theft of hundreds of secret documents from a large national law firm where the student had worked as a summer clerk.  The student allegedly stole documents from files that his job required him to examine for purposes of litigation for the law firm’s client.  The student reportedly sent copies of such documents to three websites for posting, though he was not claimed to have done so in return for any money.  The trade secrets were owned by DirecTV, owned by Hughes Electronics Corp., which said that it had invested over $25 million in the development of its most recent “Period 4” anti-piracy access cards for viewer satellite TV signal descrambler boxes.   The recipient websites, none of which apparently solicited this particular set of secrets, reportedly were offering their readership information on how to obtain access to satellite television signals.

Lessons Learned from the Crimes of Others.
While this case focused on the prosecution of the allegedly rogue student, The Associated Press article did not discuss the vicarious liability of the national law firm that hired the student, or the liability of the national law firm for any negligence in the hiring or supervision of the student and the documents to which the student had access.

Service providers should adopt measures in the fields of document access, physical security of documentation and hiring and supervision of employees.  Ultimately, however, even a well-designed system to prevent “insider” abuses will not stop someone from abusing a trust.  However, even the independent abuse of trust by a rogue employee might not shield the employer.

International Outsourcing.
This U.S. legislation governs activity conducted in the United States.  It may cover foreign activity having an impact in the United States.  But extension of criminal jurisdiction one country’s laws into another country generally is treated as an infringement on sovereignty, and lacking in “comity” between nations, if there is no treaty or convention authorizing such extension.  Accordingly, contracting with foreign service providers  does not involve the same legal enforcement rights as a purely domestic American contract.

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

October 9, 2009 by Bierce & Kenerson, P.C.

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.

Business Intelligence and Industrial Espionage in Outsourcing

October 9, 2009 by Bierce & Kenerson, P.C.

Boeing Loses $1 Billion in Transactions as Punishment, Escapes Debarment

Summary.

“Business intelligence” refers to the practice of collecting and analyzing competitive information in the marketplace to assist an enterprise in self analysis and redirection of its resources to maintain and improve competitiveness.  “Industrial espionage” refers to the clandestine methods of obtaining competitive information that is not publicly available.  As a legal matter, this distinction can have serious consequences. This case study offers some suggestions for staying on the right side of the law not only in business intelligence but also for internal audit controls and business ethics.

Boeing Punished.

In July 2003, the U.S. Air Force hit Boeing Company with the harshest punishment on any major U.S. military contractor in decades.  Boeing was found to have stolen thousands of pages of confidential technical documents of its archrival, Lockheed Martin Corp.  Boeing reportedly used such industrial secrets in submitting proposals to the Air Force in 1998 to provide satellite launching services.  As a result, the Air Force transferred to Lockheed the services of providing seven launches previously awarded to Boeing, and in addition awarded three more launches to Lockheed.

Boeing Escaped Debarment: “Too Big to Punish”?

Many commentators on the Boeing punishment have asserted that Boeing escaped debarment under the Federal Acquisition Regulations simply because it was too big to punish. The losses by other agencies would have been considerable.  Instead, the punishment related to the Boeing business segment that had allegedly violated the law, rather than to all other Boeing divisions.  This punishment reflects the difficulty of the Government’s use of the debarment process to protect Government interests when the supplier community is highly concentrated and consolidated.

The Economics of Business Intelligence.

Business intelligence serves a valid competitive purpose in the marketplace.  Gathering publicly available information:

• sharpens the competition and increases opportunities for consumer and customer choice;
• enables competitors to restructure their offerings of services and goods, often by restructuring key business processes for improved efficiency, reduced cost, better quality, a more attractive suite of services and goods and a broader appeal to a wider range of customers;
• and improves the efficiency of markets, accelerating improvements in customer service and thereby improving the customer’s quality of life, integration of external services with in house services and other external services.

The Law of Business Intelligence.

The law of business intelligence is limited by common law and statutes that protect proprietary rights, privacy rights and intellectual property.

Debarment under the Federal Acquisition Regulations.

Causes of Debarment.
Debarment can occur based on conviction, violation of law or a serious or compelling cause. Debarment is a remedy available to the U.S. Federal Government under the Federal Acquisition Regulations.  The purpose is to exclude “ineligible” contracts from new bidding.

Violations. The debarring official may debar a contractor for a conviction of or civil judgment for:

(1) Commission of fraud or a criminal offense in connection with-

(i) Obtaining;

(ii) Attempting to obtain; or

(iii) Performing a public contract or subcontract.

(2) Violation of Federal or State antitrust statutes relating to the submission of offers;

(3) Commission of embezzlement, theft, forgery, bribery, falsification or destruction of records, making false statements, tax evasion, or receiving stolen property;

(4) Intentionally affixing a label bearing a “Made in America” inscription (or any inscription having the same meaning) to a product sold in or shipped to the United States or its outlying areas, when the product was not made in the United States or its outlying areas (see Section 202 of the Defense Production Act (Public Law 102-558)); or

(5) Commission of any other offense indicating a lack of business integrity or business honesty that seriously and directly affects the present responsibility of a Government contractor or subcontractor.

Nonperformance; Violations of Public Policy.
In addition, a debarring officer my debar a contractor, based upon a preponderance of the evidence, for:

(i) Violation of the terms of a Government contract or subcontract so serious as to justify debarment, such as-

(A) Willful failure to perform in accordance with the terms of one or more contracts; or

(B) A history of failure to perform, or of unsatisfactory performance of, one or more contracts.

(ii) Violations of the Drug-Free Workplace Act of 1988 (Pub. L. 100-690

(iii) Intentionally affixing a label bearing a “Made in America” inscription (or any inscription having the same meaning) to a product sold in or shipped to the United States or its outlying areas, when the product was not made in the United States or its outlying areas (see Section 202 of the Defense Production Act (Public Law 102-558)).

(iv) Commission of an unfair trade practice as defined in 9.403 (see Section 201 of the Defense Production Act (Pub. L. 102-558))

Violation of Immigration Laws.
Additionally, debarment is available as a remedy against a contractor, based on a determination by the Attorney General of the United States, or designee, that the contractor is not in compliance with Immigration and Nationality Act employment provisions (see Executive Order 12989). The Attorney General’s determination is not reviewable in the debarment proceedings.

Lack of Present Responsibility.
Finally, debarment may be imposed against a contractor or subcontractor based on any other cause of so serious or compelling a nature that it affects the present responsibility of the contractor or subcontractor.  Such a determination is more subjective than other reasons, and may include abuse of confidential information through industrial espionage or as suggested below, failure to maintain internal accounting records and a history of unethical business conduct.

Consequences of Debarment.

Debarment prevents an entity from being an eligible bidder on new contracts but does not terminate existing contracts.   Contractors debarred, suspended or proposed for debarment are also excluded from conducting business with the Government as agents or representatives of other contractors, from acting as subcontractors and from acting as individual sureties.   Exceptionally, an agency head or a designee determines that there is a compelling reason for contracting with the debarred supplier.    This exception leaves open the choice of sanctions for misconduct, and leaves the affected agencies free to decide to ignore the debarment for their own internal purposes. FAR 9.404.

Non-Procurement Common Rule.

Also, under the “non-procurement common rule,” debarred contractors may be ineligible for nonprocurement transactions such as grants, cooperation agreements, scholarships, fellowships, contracts of assistance, subsidies, insurance and other government benefits.

Existing Contracts Not Abrogated.

Notwithstanding the debarment, suspension, or proposed debarment of a contractor, federal agencies may continue contracts or subcontracts in existence at the time the contractor was debarred, suspended, or proposed for debarment unless the agency head or a designee directs otherwise.   In addition, the Governmental agencies may continue to order goods or services under purchase orders against existing contracts, including indefinite delivery contracts, in the absence of a termination.    However, agencies may not renew or otherwise extend the duration of current contracts, or consent to subcontracts, with contractors debarred, suspended, or proposed for debarment, unless the agency head or a designee authorized representative states, in writing, the compelling reasons for renewal or extension.

Business Judgment and Evaluation of Factors in the Decision to Debar.

Under the Federal Acquisitions Regulations (Section 9-406(a)), before arriving at any debarment decision, the debarring official should consider a range of business judgment considerations and an assessment of the impact on the government factors.  The list includes:

(1)     Whether the contractor had effective standards of conduct and internal control systems in place at the time of the activity which constitutes cause for debarment or had adopted such procedures prior to any Government investigation of the activity cited as a cause for debarment.

(2)       Whether the contractor brought the activity cited as a cause for debarment to the attention of the appropriate Government agency in a timely manner.

(3)       Whether the contractor has fully investigated the circumstances surrounding the cause for debarment and, if so, made the result of the investigation available to the debarring official.

(4)       Whether the contractor cooperated fully with Government agencies during the investigation and any court or administrative action.

(5)       Whether the contractor has paid or has agreed to pay all criminal, civil, and administrative liability for the improper activity, including any investigative or administrative costs incurred by the Government, and has made or agreed to make full restitution.

(6)        Whether the contractor has taken appropriate disciplinary action against the individuals responsible for the activity which constitutes cause for debarment.

(7)       Whether the contractor has implemented or agreed to implement remedial measures, including any identified by the Government.

(8)       Whether the contractor has instituted or agreed to institute new or revised review and control procedures and ethics training programs.

(9)       Whether the contractor has had adequate time to eliminate the circumstances within the contractor’s organization that led to the cause for debarment.

(10)     Whether the contractor’s management recognizes and understands the seriousness of the misconduct giving rise to the cause for debarment and has implemented programs to prevent recurrence

Proposed Debarment of MCI WorldCom.

Debarment may also be asserted for lack of adherence to internal controls over accounting and reporting systems and business ethics.  This argument was asserted against MCI (formerly WorldCom) on July 31, 2003, subject to administrative determination.

The argument is based on the contractor not being “presently responsible” because in this case, the contractor was alleged to have been previously involved in one of the biggest shareholder frauds in U.S. history and still suffered ten “material weaknesses” in the company’s internal controls.  In the case of the General Services Administration’s notification letter to MCI WorldCom assorting the proposed debarment, “A material weakness is a weakness found to be pervasive throughout an encore organization.  Each individual weakness is considered to be a significant control deficiency.  The acceptable standard is for a company to have no material weaknesses or of one is found for it to be promptly corrected.”

In MCI’s case, the GSA alleged that the company needed to implement “procedures and controls to review, monitor and maintain general ledger accounts. Implementing adequate controls on the general ledger is significant because that is where all of the company’s financial transactions are summarized for all of its accounts.”  MCI has promised to comply with Sarbanes-Oxley Act of 2003 by June 30, 2004 one year earlier than the statute requires.  MCI noted it is aware of the deficiencies and is cooperating with the GSA and investigating agencies.

What a Customer Should Know about an Outsourcer’s Key Personnel.

Concentration of Sellers in an Industry.
Ordinarily an enterprise customer should not have many concerns about the prior employment history of a major outsourcing services provider.   After all, the services provider’s business is to maintain the confidentiality of its customers’ confidential data.  Without the customer’s trust that its data will be protected, the customer will not engage in outsourcing.   If the outsourcing service provider is engaged in a tightly competitive environment with only a few competitors, the customer could become concerned that its confidential information might float around the industry and become known to multiple outsourcing service providers, particularly those who service the customer’s competitors.  Thus, the customer should be concerned about the normal employment and privacy protection polices practices and enforcement methods that the external services provider has adopted.

Employment Practices.
Employment practices are probably the most frequently abused methods of collecting competitive information in an illegal or wrongful manner.   Hiring an experienced person from a key competitor has long been a method of gathering competitive information.   If the person was in a position of trust and confidence, having had access to key competitive policy, strategy and tactical information,  the newly hired employee is in a position to damage his or her former employer’s business.  Outsourcing customers may properly inquire about a proposed contractor’s hiring process.

Hewlett Packard and NEC, 2002 Joint Ventures in Outsourcing

October 9, 2009 by Bierce & Kenerson, P.C.

Overview.

On December 12, 2002, Hewlett Packard and NEC announced a joint venture (“JV” or “alliance” for our discussion) with NEC to deliver managed information technology outsourcing services in Asia, the United States and Europe.   The legal structure of the joint venture was not fully disclosed, but some guesses may be made.   This case study explores business and legal issues frequently arising in joint ventures.   We trace some of the prior relationship and the resulting economic, cultural and operational fit of the venturers.

Joint Venture as a Business Model in a Depressed Global Economy.

The joint venture starts with the realization that the resources of each joint venturer are insufficient to meet a particular market need. ( In a sense, a shared services center is a joint venture of the department or lines of business of a large enterprise.) This particular JV targets a need to serve global companies engaging in mergers and acquisitions. This view of the world suggests that increasingly, for the foreseeable future, consolidation and concentration of multinational enterprises will continue.  In essence, the HP-NEC joint venture targets this wave of global consolidations across industries.

Prediction for Future Restructuring of the Joint Venture.

Business analysis suggests that, after NEC completes a spin-off of its semiconductor business, the new joint venture will be a candidate for merger into HP, provided that the joint venture achieves satisfactory performance goals.  NEC’s Chairman and CEO, Koji Nishigaki, observed at the December 2002 news conference that “we have laid the foundations [for a merger], so the potential is there.   Part of the companies could be merged.   We will see many dynamic changes.”

Ultimately, like any joint venture, the potential for any merger and the success of the joint venture will depend on the joint performance of the JV partners, raising the issue of what commitments each is making to compete successfully in an increasingly competitive, increasingly concentrated market for outsourced international services in information technology management.

The joint venture presents a number of legal issues that are common to any international joint venture in information technology, hardware, software and managed services.

Geographical Scope.

The alliance will market to multinational companies that have offices in one or more territories.  Initially, these territories are limited to China, Japan and the United States.  As of 2004, the joint venture will expand the territory to South East Asia and Europe.   The phased introduction of jointly-provided services into targeted territories should enable the parties to manage the inevitable transitional kinks in their relationship before taking the relationship to distant markets.

Service Scope.

The JV includes marketing, systems integration and customer support services.

Target Customers.

The JV partners intend to create a new market for IT outsourcing for customers that are not dependent on mainframes.   They admit that IBM dominates the mainframe computer market.  Rather, the JV will be targeting large global customers in the “post-mainframe-era market,” particularly the integration of computer systems after mergers of large global corporations that have disparate IT infrastructures.   In Japan, the two have already worked on an integrated system for Sumitomo Mitsui Banking, which is the product of a recent merger of two banks.   That deal not only inspired the joint venture, but probably will also serve as the “sweet spot,” template and benchmark for future joint venture service offerings.

Legal Structure.

The two alliance partners indicated that they will establish one or more joint ventures to provide a range of information technology services.   The HP-NEC announcement did not elaborate on the terms or structure of the JV, so we will speculate.

Under a joint venture, there are basically two methods of developing a “joint venture”

• Contractual Joint Venture:
  In a “contractual” joint venture, the two partners establish a business operation that is based solely on a contract.  No new legal entity is formed.  Such joint ventures were popular in East-West trade during the Soviet era.  At that time, contractual joint ventures had several ideological and legal advantages for the Soviets.   No one had to establish a legal entity that would have an existence independent of the joint venturers.  The Soviets did not have to implement a capitalist tool of an entity owned by someone other than the State (the Fatherland).   Accounting could be defined in the contract, leaving everything to negotiation and nothing to the application of capitalist legal systems.  (Did you hear of Hollywood Accounting?  It spawned many lawsuits.  The Soviets had their own style of contractual accounting, too!).   And termination could be achieved by contract termination, without transfer of any assets from an entity.   We doubt that the HP-NEC deal was inspired by a contractual JV structure.
• Entity Joint Venture:
  In an “entity” joint venture, the joint venturers agree to form a new entity (the “JVCo”), which then serves as the focal point for the business operations.  In an outsourcing JV, the joint venturers typically contribute cash to the JV Co. to conduct certain defined operations (such as its officers and key employees in administration and marketing).   But, the JV partners rarely transfer ownership of intellectual property, operating employees, real estate or technology systems to JVCo.   Instead, the JVCo takes licenses and leases from its JV partners, who also agree to provide defined services to the JVCo so that JVCo can, in turn, deliver the outsourcing package to the JVCo customers.   A JVCo need not have much capital: any transitioning of customer employees and other resources under management could be made to either, or both, of the JV partners instead of to the JVCo.   In fact, JVCo might have no assets at all, assuming that the JV partners each make available, on a “secondment” basis, its own employees performing functions in the name of the JVCo.   Maybe the Soviets had a smarter idea, since at least the third parties dealing with the JV under a contractual JV could make a claim against some deep pockets!

Scope of the JVCo’s Operations.

Under corporate law, the JV partners must carefully define the scope of the JV’s operations.  Like lines in the sand, the scope defines the realm of business opportunities that each JV partner must bring to the JV, rather than perform on its own.  Anything outside the defined scope does not involve any fiduciary duty of a JV partner to bring the corporate opportunity to the JV and to avoid competing with the JVCo for the opportunity.

Scope of Contributions in Kind.

In the HP-NEC deal, the announcement failed to mention anticipated financial contributions.  This suggests that the two parties will minimize invested capital by allocating functions in a complementary, non-competitive, fashion.    Such an allocation justifies a joint venture since the two companies might not have been able to offer or compete in the marketplace alone.   See Antitrust in Joint Ventures in Outsourcing.

In the press conference, HP’s President, Carly Fiorina, said that HP “focuses on capability, invention and innovation,” while NEC “brings important capabilities in open mission-critical systems.”   This suggests that NEC would be providing managed services for data centers operating legacy systems under Unix (or variants), and HP would be providing customer solutions design, project management and custom services in software development, product design, technology improvement plans and strategic consulting.

HP’s Contribution.
HP is already a leading outsourcing company in North America and Europe.  In September 2002, Canadian Imperial Bank of Commerce awarded HP with a seven-year, $1.5 billion contract for the provision of IT services.

NEC’s Contribution.

Technology Solutions.
NEC’s Solutions group offers custom consulting and systems integration services that could be used to provide back-office support in Japan.   NEC Solutions offers highly reliable computing solutions to enterprise, government, and individual customers by providing software, hardware, and services necessary to design, integrate, and operate these elements.  NEC Solutions focuses on customized solutions packages for new technology deployments for customers.

In addition, NEC’s Systems Integration services group, which has approximately 13,000 systems engineers, provides end-to-end systems design, development, deployment, and systems operation solutions.  System integration is provided directly and through NEC Soft, Ltd. and other subsidiaries. SI services consist of (a) systems design, development, and deployment services, (b) operational support services, including system problem diagnosis and correction, and (c) consulting services on systems architecture design and technology planning, including the evaluation and selection of technologies and platforms.

In software, NEC develops and provides software products primarily for use in its computers. Software products include operating systems, middleware for managing large-scale distributed data processing systems, and application software. NEC continues to further develop its capabilities in middleware to enable the more rapid, cost-effective integration of different systems, protocols, and software.

Rationale for a Joint Venture in Outsourcing.

Several key factors brought this joint venture into being:

Prior Collaborative Relationship over Many Years.
Since at least 1995, HP and NEC have been collaborating on technology other than services.   They share mutual competitors, including Microsoft and IBM.    Prior to the merger of Compaq into HP, HP had already established a series of joint activities in research and development, design, manufacture and distribution of computers and their components.  The past relationship focused on combining mainframe technology expertise of NEC and, in at least one case, Hitachi, Ltd., with HP’s operating systems and computers.

In 1995, the two companies partnered in the Unix server arena, allowing NEC to purchase large-scale servers and related technology from HP on an OEM basis for resale in Japan.   As a result, the NEC NX7000 product line is based on HP technology.

In 1997, HP became an OEM supplier to NEC and Hitachi, Ltd. of entry-level models in the HP 9000 D-class Enterprise Server family.    Also, HP signed a multi-year software development agreement with NEC and Hitachi to integrate Japanese mainframe expertise into HP-UX operating system for grater modularity, scalability, performance, reliability and management by self-healing enhancements to detect and repair unexpected software problems in the HP-UX kernel.  Incidentally, in 1989, HP and Hitachi signed a broad alliance including the joint development of HP’s Precision Architecture RISK CPU chips and the design and construction of HP’s PA-RISC systems.   The two companies established a technical support center in Japan (the “HP-NEC Enterprise Solution Integration Center,” or “HP-NEC ESIC”).

In 1998, HP and NEC signed a development agreement to optimize HP’s HP-UX operating system to run on systems using the upcoming Merced 64-bit processor.    As of 2002, the Merced processor has not generated widespread market demand.

In 1999, HP and NEC agreed to collaborate on what they called was the next generation of Japan’s Internet Protocol (IP) network.   Under the 1999 agreement, NEC distributed IP servers using HP-UX (HP’s Unix-like operating system) and HP OpenCall (HP’s middleware) together with NEC’s application software and IP network equipment.   On the R&D level, the two companies agreed to combine their computer and telecom technologies to provide real-time high performance for telecom carriers.

In May 2002, HP and NEC announced a strategic collaboration to deliver large-scale, open mission-critical solutions for targeted industries.    They noted that, together, they had already jointly delivered several complex mission-critical solutions in the financial and telecommunications industries.   This collaboration expressed an intention to target a number of U.S. financial services companies and a range of global Japanese companies.   They intended to explore broader market opportunities worldwide, common systems integration and solutions, to leverage each other’s enabling technologies such as NEC’s OpenDiosa middleware for high-availability applications on non-mainframe servers and HP’s Utility Data Center and Integrated Service Management.  The allocated roles for HP to provide IT infrastructure services and outsourcing capabilities and NEC’s systems integration and support technologies.

Common Technology Architectural Orientation.
While each of the JV partners has developed thousands of patents, every patent is subject to challenge and invalidation.

Concentration and Vertical Integration in the International Markets for Information Technology Outsourcing.
In 1997, Computer Associates reportedly offered to acquire Computer Sciences Corporation so to support distribution of CA’s software products.   CSC successfully rebuffed the offer.  But the dialogue raised the question of the viability of a future IT outsourcing business where the Service Delivery group was merely the distribution channel for proprietary software of Computer Associates and its favored channel partners.

Restructuring of NEC.
NEC has been hard hit by a combination of a decline in global demand for computers (and the computer components that NEC manufactures), falling prices for IT hardware, excess capacity in broadband telecommunications (and consequential decline in optical networking), and a general economic decline in Japan during the 1990’s and early 2000’s.  As a result, NEC has restructured for cost-cutting, redirection of capital investment and supply-chain management to improve manufacturing efficiency.   The restructuring includes closing of aging factories, layoffs, transfer of semiconductor business (including system LSIs, integrated circuits and discrete devices and compound semiconductor devices but not DRAM’s) to a new subsidiary that NEC intends to spin off in a public offering.  Since 2000, NEC has also separated its plasma display panel division and merged several similar units at group companies.

In short, NEC has decided to slim down from its “giant” size into a series of separate companies, each with its own business plan.   Development of an outsourcing business suggests a new business plan.  In announcing the JV, NEC’s President and CEO Koji Nishigaki admitted that NEC had no experience in the full-scope type of outsourcing business, and hoped to learn from HP’s business model.

Restructuring of HP.
HP is the fish that swallowed the second fish that swallowed the third fish.  HP merged with Compaq Corporation, a computer manufacturer and outsourcing services provider, after Compaq had acquired Digital Equipment Corporation, a computer manufacturer and outsourcing services provider especially for distributed networks of computers.   As part of the post-merger integration, HP has shed thousands of workers and sought economies of scale and new channels for leveraging core competencies — including outsourcing — into new geographical markets.

Coopetition: Competition and Collaboration amongst Outsourcers.

“Coopetition” refers to the anomaly of companies that compete in one sector cooperating closely in another sector.

IBM.
In this case, HP, NEC and Hitachi, who have all worked closely to compete with IBM and other computer manufacturers, have joined IBM in the promotion of “open source” computing, to be supported by a non-profit Open Source Development Lab in Portland, Oregon, to test enterprise-class Linux.

Microsoft.
Microsoft licenses eHome technology to NEC and HP.

HP and NEC.
Each of HP and NEC sell computers, personal digital assistants / Windows CE devices and other technologies that perform similar functions.

Securities Law Disclosures for Joint Ventures.

Joint ventures involve significant risk to the business and reputation of each party.   Formation and operation of a joint venture could require disclosure under securities laws, since a significant venture could have a material impact on the financial performance of either party.   Each of HP and NEC has annual revenue in the neighborhood of about $35 billion to $40 billion.   A venture that does put at risk 1% or 2% of that revenue stream (consisting of $350 million to $700 million) probably is not “material.”

On the other hand, such information might be disclosed generally in the issuer’s “management discussion and analysis.”   This disclosure is much more general in nature.

As NEC said in such discussion in its Form 20-K filed in August 2002:

As part of our strategy, we have entered into a number of long-term strategic alliances with leading industry participants, both to develop new  technologies and products and to manufacture existing and new products. If our strategic partners encounter financial or other business difficulties, if their strategic objectives change or if they perceive us no longer to be an attractive alliance partner, they may no longer desire or be able to participate in our alliances. Our business could be hurt if we were unable to continue one or more of our alliances.

Under the Sarbanes-Oxley Act of 2002, joint venturers such as NEC and HP will probably need to disclose more information relating to joint venture operations.  While that law generally does not change the definition of materiality, it does require disclosure of information the previously was ignored under former financial accounting principles.   The act does require closer attention to disclosure of “off-balance-sheet” transactions.   The SEC has issued a proposed rule on such disclosures.

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