TexasBarToday_TopTen_Badge_VectorGraphicThis is part two of my four-part series commemorating the one-year anniversary of the Defend Trade Secrets Act. The series will culminate with a live webcast from the Texas State Bar on May 16: “One Year of Defend Trade Secrets Act Litigation.”

Has the Defend Trade Secrets Act put a stop to corporate espionage by foreign governments and companies?

The NFL draft was last week, so it was a time for predictions. My Dallas Cowboys used their first two picks on guys named Taco and Cheeto. I predict TV commentators will have fun with that.

Speaking of predictions, back in May 2016 when the federal Defend Trade Secrets Act became law, I wrote this:

People think of a shadowy foreign company smuggling sophisticated plans for the next iPhone out of the country.  But the typical trade secrets lawsuit is more mundane.  Given the fact that a “customer list” can be a trade secret, an employer can sue for misappropriation of trade secrets just about every time a low-level sales employee leaves the company with the names and numbers of her customers on her smartphone.  Are routine customer list cases now headed for federal court?  We will see.

A customer list case is a “soft trade secrets” case. Soft trade secrets are the kind almost every company has or claims to have: customer lists, customer information, pricing, business strategies, etc.

“Hard” trade secrets are what people commonly think of as trade secrets: secret technology, secret sauce. This is the kind of thing most members of Congress probably had in mind when the Defend Trade Secrets Act passed with bipartisan support. It is probably also what the press had in mind when they hailed the DTSA as the dawn of a new era of protection of U.S. companies.

Indications from the first opinion applying the DTSA

Henry Schein, Inc. v. Cook was the first opinion I saw applying the Defend Trade Secrets Act. It augured that the typical DTSA case would be a soft trade secrets case. As I reported here, Henry Schein involved customer information in the sale of medical, dental and veterinary supplies and equipment.

Of course, that was just one case. But at that time I made this prediction:

A year from now when we look back at the cases filed in federal court under the Defend Trade Secrets, many more of them will be ordinary “customer list” cases like Henry Schein than complex schemes involving sophisticated secret technology. It will turn out that the first case applying the Defend Trade Secrets Act was the typical case.

So has the first year of litigation under the Defend Trade Secrets Act proven me right? Largely, yes. Judging by the opinions available on Westlaw (an admittedly unscientific sample), most Defend Trade Secrets Act lawsuits have been soft trade secrets cases like Henry Schein. I haven’t seen a single DTSA case that involved a foreign government or company stealing secret technology from a U.S. company.*

Another customer list case: First Western

Another good example is First Western Capital Management v. Malamed.[1] It was a classic customer list case.

The customer lists in trade secrets lawsuits usually fall into two categories: (1) a “big” list covering the company’s entire clientele; (2) a shorter list of the employee’s own customers.

The customer list in First Western was a big list: 130 pages, printed from the company’s “CRM” system, containing roughly 5,000 names, including 331 current company clients. The employee also printed out 22 pages of spreadsheets listing names of clients, the total market value of their holdings under management, the management fees being charged by the company, and “similarly sensitive information.”

In short, the customer list in First Western provided the identity of the customers, their specific preferences, and the prices charged to them. These are commonly the alleged trade secrets in a customer list case.

The issue in First Western was whether the company was entitled to a preliminary injunction barring the employee from using the alleged trade secrets to compete for the company’s clients. It’s a good DTSA case to study because it addresses so many interesting issues.

1. Witness credibility

First Western illustrates the paramount importance of witness credibility. The employee, Malamed, instructed his assistant by email to print three copies of the company’s “Client book” that was “on the disc.” Malamed admitted keeping a copy of the printout but said he never looked at it.

The district judge was not impressed with Malamed’s testimony at the temporary injunction hearing. Malamed said he had no idea how the last 22 pages of the printout were included, denied those pages contained highly sensitive client information, and claimed he was not sufficiently computer literate to use a disk or to “really know what a disk is.”

The judge wryly observed: “All of these examples, and others, lead this Court to conclude that Malamed has become willing to make statements or take positions with reference to what he believes will prevent liability in this case.”

Ouch. You could tell it was going to go downhill from there.

Lawyers, push hard on your clients when they plan to offer testimony that is going to raise judicial eyebrows. For example, if your client is going to deny that a customer list contains sensitive confidential information, test that assertion. If it holds up, and that’s really what the client thinks, then prepare the client to stick to his guns. But if not, persuade your client not to deny the obvious.

2. Employee intent

Malamed denied the client list contained trade secrets, claimed he could use public sources or his own memory to recreate a similar list, and did not deny his intent to go to work for a competing firm and service clients on the list. This was enough to convince the judge that Malamed would use the client information to compete with the company if not enjoined.

Again, as First Western illustrates, the lawyer representing the employee who took a customer list has a difficult choice. If you admit the customer list is a trade secret, you’ve helped the plaintiff prove half of its trade secret claim. But if your client denies the list is a trade secret, the judge may see that as evidence your client intends to use it.

3. Price undercutting

The judge in First Western saw a real threat of the employee using his knowledge of the company’s pricing to take its clients:

[W]ithout making any explicit comparison to FWCM, [Malamed] can offer management fees that are, say, a quarter of a percent lower than what he knows the individual was paying at FWCM, and thereby entice the client—who almost certainly would recognize that he or she was being offered a discount as compared to FWCM.

This is the usual “price undercutting” theory. I’ve made the same kind of argument for my clients. But this theory has some problems that the First Western opinion doesn’t address. I’ll have to save that for another blog post.

4. Is a customer list a “trade secret” in the first place?

A trade secret must have “independent economic value” to a competitor in the industry. The judge found that the company’s big customer list had value in two ways. First, the identity of the clients had value. The judge said a compilation of wealthy individuals willing to consider the financial management services the company provided was a valuable asset because it would at least save a competitor the time of identifying prospects by, for example, cold-calling individuals employed in high-paying professions.

Second, the judge found that information about the clients had value: their management fee percentages, preferences regarding risk, time horizon, communication style, etc. These were “informational assets” that a competitor would find “especially valuable.”

Ok, that sounds plausible. But riddle me this, Batman. Couldn’t Malamed just call up a client and say, “Hey, Jim Bob, it’s your buddy Kenny. Can I ask you something? What is your investment manager charging you for management fees? What’s your risk preference? What’s your time horizon?”

That’s the other side of the coin in customer list cases.

5. Does a trade secret have to be on paper, or can it be in your head?

What if the employee credibly testifies that he doesn’t have the customer list anymore and isn’t going to use it? Does that get the employee off the hook?

The judge in First Western didn’t think so. He found it sufficient that Malamed would remember the names of clients and the information about them. “Thus, the Court finds that Malamed, at a minimum, remembers trade secret information, even if he does not possess any trade secrets in physical or digital form.”

What does First Western tell us about the effect of the DTSA?

These were just some of the issues in First Western. None of these issues are unique to the Defend Trade Secrets Act. They are the same issues that would have come up under Colorado’s version of the Uniform Trade Secrets Act.

There was one issue in First Western that was particular to the DTSA, but you’ll have to tune in to our May 16 webcast to hear about that.

While the issues in First Western are interesting, the case is further confirmation that the main effect of the DTSA has been to shift some typical customer list cases from state court to federal court.

That is a significant change for lawyers who handle trade secret litigation, but it doesn’t show there was any compelling need to place a federal trade secrets statute on top of the trade secrets laws already found in 50 states.

The defensive line of the Dallas Cowboys generating a more disruptive pass rush next season? Now that’s a compelling need.

______________________________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands. His client list is not 130 pages long.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] First Western Capital Mgmt. Co. v. Malamed, No. 16-cv-1961-WJM-MJW, 2016 WL 8358549 (D. Colo. Sept. 30, 2106).

*After publishing this post, I saw a case where a Chinese company allegedly received a secret recipe for caramel popcorn coating. I’m not kidding.

6 thoughts on “It’s All In Your Head: Customer List Cases Under the Defend Trade Secrets Act

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