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.
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.
- Court Systems.
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.
Outsourcing as a Tool in Exiting a Failing Business: National Australia Bank’s Acquisition of Shares in Rival AMP Ltd.
October 9, 2009 by Bierce & Kenerson, P.C.
Outsourcing can provide a unique benefit in preserving the value of a declining line of business. Consider an industry where many major players are suffering operating losses, where “ill-timed” acquisitions have resulted in write-offs and loss of shareholder value, and where there are no buyers or where the assets impaired by recent losses cannot be sold for what has been the historical valuation. In such cases, outsourcing offers to management the “breathing room” to maintain a customer base while waiting for either a recapture of the same outsourced business in a future up-market. This principle applies to international as well as domestic markets.
We take a case study in the financial services industry in Australia and the United Kingdom as the backdrop for some “lessons learned” in the use of outsourcing as a tool for exiting, or preserving value, in a failing line of business. The case involves National Australia Bank and AMP Ltd. (formerly named Australia Mutual Provident). The lessons apply to any business that has been challenged by recession or by failed over expansion through failed acquisitions.
Background.
AMP Ltd. and National Australia Bank are both Australian financial services companies that entered into the UK life insurance market as part of a diversification strategy. They compete in Australasian banking and insurance markets as their principal markets. Both concentrate on insurance and funds management services. AMP has about A$235 billion in funds under management, compared to NAB’s A$65 billion, as of August 2003. AMP’s crown jewel is its network of about 1,900 financial planners in Australia.
AMP and Its Demerger Strategy for Unlocking Shareholder Value in a Declining Market.
AMP, whose shares are owned by about 1 million Australians, experienced financial troubles and a steep decline in the price of its stock from 1999 to 2003. In response, in late 2002, the company adopted retrenchment measures, including closures of certain lines of business, a new board of directors, reductions in costs and in risks and a demerger, announced on May 1, 2003, that it would “demerge” its UK and Australasian businesses. The demerger announcement asserted that each new entity would benefit by having distinctive strategies, customer bases and growth prospects, and would operate in simpler, more transparent structures. As restructured, AMP Banking will focus on Australian markets for mortgages, retail deposits and retail financial planning services.
NAB and its Rolling Acquisition Strategy.
National Australia Bank operates in 15 countries and is one of the 50 largest banks in the world by revenue. NAB made an informal offer in 1999 to purchase AMP for A$21 a share, less than one third the A$6 per share that it offered in August 2003. On August 28, 2003, NAB announced that it was offering to acquired a small 5.4% stake in AMP for A$6.00 per share. When NAB “waded in” to make an initial purchase, AMP was trading at A$5.40 per share. While NAB’s 2003 share purchase did not involve a tender offer for control, it clearly put AMP’s shares “in play” for a potential tender offer, which would give NAB a dominant position in the Australian funds management industry.
Role of Outsourcing for Both Financial Institutions.
Outsourcing played a role in the business strategy of one of the two financial services institutions. Both experienced hard times from one of the worst bear markets in UK history. Their strategies differed. AMP sought a split-off, or demerger, of the UK and Australasian lines of business. NAB decided to continue in both markets as a distributor of third-party services, rather than as an integrated seller of life insurance.
Outsourcing by NAB.
NAB used outsourcing to drop losing lines of business without losing customer goodwill and without losing the opportunity to cross-sell customers using service products that it did not “own” or produce directly. By outsourcing, NAB positioned itself to retain customers and, one may presume, the legal right, on expiration of the outsourcing agreement, to recapture the outsourced services or find another service provider. After the outsourcings, NAB can now focus on distribution and customer relationship management.
Outsourcing of Life Insurance Underwriting.
Facing tough competition and an economic downturn in England, in early August 2003, NAB closed down its life insurance underwriting business in the United Kingdom and appointed Legal & General Group as its “alliance partner” to underwrite life insurance for retail customers of NAB’s three UK bank subsidiaries. NAB’s announcements in the press did not specify any material details. In a bid to persuade its retail customers that a brand name was better than an affiliated “house” name, NAB praised Legal & General’s status as a leading life insurance underwriter. The Australian Financial Review called this an “outsourcing deal.”Outsourcing of Insurance Administration Services.
NAB also formed an “alliance” with Junction, a part of the UK’s Budget Group of Companies, to provide product and administration services for its home and motor vehicle insurance operations.
Outsourcing by AMP.
AMP used outsourcing to drop its own losing lines of business, but only as a means of termination and liquidation of a dying business.
Insurance Business.
As part of its cost cutting, AMP discontinued its reinsurance and direct insurance businesses. AMP hired another insurance services company, Cobalt, to “manage the runoff,” or claims processing for the eventual expiration of all pending policies written by such AMP lines of business.Investment Operations Outsourcing Services.
AMP was apparently in such dire straits in 2002 that it had to sell off a crown jewel, its Cogent subsidiary in the UK, to BNP Paribas Securities Services. For BNP Paribas, which had extensive operations in serving mutual funds and providing custodian banking, AMP’s sale was an opportunity to relaunch its position in the United Kingdom by expanding further into outsourced support for mutual funds and private equity funds.
Legal Issues in the Acquisition Strategy.
Use of an outsourcing strategy to reduce corporate capital investment in operations and accelerate an acquisition campaign poses legal hurdles. The “big payoff” will not be available if the acquisition violates antitrust or competition rules. But the outsourcing strategy pays off anyway because it deals with an inherent problem instead of closing out a business.
Lessons for Corporate Strategists, Investment Bankers and Shareholders.
When a company hires an outsourcing services company, the engagement can signal an exit in the line of business. In the case of AMP, it signaled a total exit for the closed lines of business. For NAB, it signaled a chance to retain customer loyalty while shifting to Legal & General Group the business of managing a life insurance underwriting operation.
From a corporate strategist’s viewpoint, we think outsourcing (or some variation such as “strategic alliances” or subcontracting) can provide significant advantages in different types of markets. In this case, the markets had suffered significant declines in customer purchases. The loss of gross revenues in 2001 opened opportunities for creative strategic responses using outsourcing techniques
- Outsourcing as a “Least-Worst” Alternative to Closing a Line of Business.
Outsourcing can be a viable exit strategy for a line of business. When a business is closed, its assets are lost. By preserving the semblance of continued operations, the goodwill associated with the line of business can be preserved. The goodwill can continue to generate shareholder value without permanent impairment. Even where the business is actually closed, hiring someone else to manage the “runoff” of expiring business obligations (in this case, life insurance policies) allows an immediate closeout of the business operations, thereby allowing management to focus on other business needs.
- Outsourcing as a Tool for Cost Containment.
Outsourcing can contain costs. The extent and predictability of such cost containment depends on how the outsourcing is structured and managed by the enterprise customer. In the case of NAB, the “strategic alliance” dramatically reduced the costs of the UK bank subsidiaries for valuable products.
- Outsourcing as a Tool for Customer Retention Strategy.
Outsourcing can increase customer retention for services and products that the enterprise cannot viably deliver at competitive prices or terms. By shifting from a proprietary service suite to an outsourced service suite, NAB’s UK bank subsidiaries can argue that they have improved the quality of service by a “strategic alliance” with a “best of breed” life insurer. In the process, NAB retained the full line of service, so that customers will continue to view it as a “full-line” service provider in its field, financial services. And NAB can be seen as a distribution company, retaining goodwill.
- Outsourcing as a Tool for Risk Mitigation.
Outsourcing can mitigate the risks of continuing a business in a highly challenged marketplace.
- Outsourcing as a Tool for Nimbleness in Mergers and Acquisitions.
Outsourcing can allow management the time to focus on strategic mergers and acquisitions. In Australia, NAB had already offloaded the underwriting function to Legal & General Group and could easily integrate and expand that outsourcing to accommodate the AMP UK life insurance business as well, if NAB were to acquire or merge with AMP. In doing so, NAB position its self to either swallow AMP as a “full fledged fish” with a poorly performing life insurance underwriting business, or it could elect to offer only to acquire the crown jewels of AMP, its financial management services business.
- Outsourcing for Renewed Focus in a Down Market.
As management guru Peter Drucker once said, companies have two purposes: to innovate and to market. By outsourcing effectively to avoid loss of market share, NAB is able to focus on its core business and contemplate the possibility of acquiring its chief rival in Australia. If it acquires AMP, NAB will reportedly have a 52% market share above that of its nearest rival, Commonwealth Bank, in the institutional investment funds management industry.
- Failure to Outsource.
In selling its Cogent subsidiary in 2002, AMP chose to sell a line of business rather than outsource it and keep the customer relationships. One may second-guess this decision as a precursor to a financial and strategic restructuring of AMP. In making “sell vs. outsource” decisions, management should consider both. If management has to raise cash to pay off debt, the “sell vs. outsource” decision becomes skewed towards a simple sale.