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Sarbanes Oxley : Law
Protecting IP Assets
By
Kenneth Hautman
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Kenneth Hautman
Partner Intellectual Property Group
Hogan and Hartson
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U.S. public companies have been developing and implementing procedures to comply with the Sarbanes-Oxley Act (the ?Act?) since the Act?s passage in July, 2002. Among other requirements, the Act requires a public company to provide enhanced disclosure in its filings with the U.S.
Securities and Exchange Commission (?SEC?) of matters that materially affect, or are likely to have a material impact on, its business and financial performance.
In light of the Act?s stringent requirements, it is prudent for every public company to implement some form of ?best practices? and disclosure processes and controls with regard to intellectual property (?IP?) assets. Many if not all of these best practices are also beneficial to non-public companies seeking maximum protection of and value from their IP.
At the core of the Act is the requirement that public companies establish and maintain ?disclosure controls and procedures? to ensure that information required to be disclosed by a public company in its SEC reports is communicated to the company?s management in a manner which allows timely decisions regarding required disclosure.
The effectiveness of disclosure controls and procedures must be reviewed and evaluated on a quarterly basis. The Act does not prescribe the steps a public company must take regarding timely and accurate disclosure of matters related to its intellectual property assets, and neither the courts nor the SEC have provided any guidance on this issue.
While it is not possible to predict what a court or the SEC could determine at a later date as to appropriate disclosure controls and procedures regarding intellectual property assets, listed below are five steps that we recommend public companies take to implement IP best practices in light of the uncertain requirements of the Act regarding intellectual property.
Implementing IP Best Practices
Step 1 ? Inventory Intellectual Property Assets
Every public company has IP assets. For some public companies, these are the most important or key assets. However, it is not possible to make any meaningful assessment of how these assets contribute to the financial performance of a company without doing an inventory to determine the types of intellectual property the company owns or on which it relies in order to conduct its business.
The areas to examine include at a minimum (i) patents and inventions, (ii) works of authorship such as videos, books, manuals, plans, specifications and software, (iii) business processes, know-how, trade secrets and other proprietary information, and (iv) brands, trademarks and service marks (collectively, ?IP Assets?).
There is no easy way to gather the necessary information to create the inventory of IP Assets. However, we recommend that an audit team of internal legal and business personnel, coupled with outside financial and/or legal advisers, be assembled. This team can decide on the best information gathering process based on the organization and culture of the company.
One vehicle that companies often use is to solicit this information through an electronic questionnaire sent to the heads of business units, as well as to the legal department. The questionnaire will ask the business unit heads through appropriate questions to list the IP Assets on which they rely for the functioning of their business unit.
The legal department is asked to supply, among other things, (i) a list of all patents and pending patent applications, (ii) a list of all trademark registrations and pending applications, and (iii) a copy of all form consulting and nondisclosure agreements. With some companies, personal interviews need to be conducted in order to obtain the information. Whatever approach is taken, the creation of an inventory of IP Assets is an essential first step.
Step 2 ? Determine the Value of Each IP Asset
Once the information is collected from the business units and legal department, an initial assessment must be made as to the relationship of each of the identified IP Assets to the company?s financial performance to determine whether the asset is essential, critical, useful, or minimally important to the company.
One way to do this assessment is to make a judgment as to the economic result (i) if the company were unable to use the asset in its business, (ii) if use of the asset were restricted or (iii) if others could use the asset without restriction. At this stage, the company can also consider retaining an IP valuation expert to assist the company in determining the value of the IP Assets.
After each identified IP Asset has been assessed, it is advisable to determine for all identified IP Assets, other than those characterized as minimally important, how well the IP Assets have been protected from an intellectual property perspective.
Protection can be afforded through different mechanisms. For example, for a proprietary technology that is critical to the company?s business, it is recommended that patent protection be sought ? perhaps in the U.S. and abroad ? and maintenance fees continue to be paid following issuance of the patent.
If there is a brand or trademark associated with a key product or service that contributes significant revenues to the company?s bottom line, it is important to know whether the mark or brand has been federally registered and, if relevant, perhaps registered abroad.
If the company?s products include works of authorship such as software or books, it is important to know whether the copyright for such works has been registered, and to ensure that agreements are in place with the authors of those works so that ownership rests with the company.
If the company has proprietary information or other trade secrets, it is important to know whether the company has had employees and consultants sign non-disclosure agreements. If the company has utilized consultants, freelancers or independent contractors, it is important to know if IP assignment agreements have been executed.
Upon completion of Step 2, the company is in a position to determine (i) the current value of its IP Assets and how well they have been protected legally and (ii) whether the company can enforce its intellectual property rights in those IP Assets in the event of infringement.
For example, if the company failed to obtain foreign registration for a key brand or service mark, its ability to use that brand or service mark outside the United States would not be a certainty. This would, in turn, reduce the value of that brand or service mark.
Similarly, if the company had paid a consulting firm to produce a piece of software which provided the company with a key competitive edge in its business, but failed to obtain an assignment of intellectual property rights, the consulting firm would be free to make that software available to the company?s competitors.
In that case, the software would have less value. Because value is lost or created based on the intellectual property protections obtained, it is critical for every public company to create a plan for protecting its intellectual property, which is Step 3 of the recommended IP ?best practices.?
Step 3 - Establish an IP Protection Plan
An Intellectual Property Protection Plan (?Plan?) establishes (i) the varying levels of intellectual property protection to be obtained for any class of IP Asset and (ii) the process for determining the appropriate level of protection for each IP Asset.
For IP Assets which are essential or critical to the business of the company, it is essential that a maximum level of protection be sought. For example, for a key brand or trademark, the company will, at a minimum, want to (i) make sure adequate clearance checks had been performed prior to use, (ii) obtain federal and, if relevant, comprehensive global registrations, (iii) obtain a copyright registration for any associated logo or design element, and obtain ownership thereof from any vendor or third party who created it, (iv) adopt strict usage guidelines, (v) obtain maximum domain name protection and (vi) monitor use through subscription to a trademark watch or monitoring service. For less important trademarks, a lower level of protection might be obtained. The determination as to what level of protection to seek for a particular IP Asset is a determination to be made by a combination of legal and business personnel.
To assist the business personnel in making that determination, a checklist or criteria document can be prepared and distributed. For example, every work of authorship a company employee creates is eligible for copyright protection and can be registered.
While copyright registration is relatively inexpensive, the universe of documents, papers, reports and other works created by company employees is so vast, seeking copyright registration for every work is neither practical or advisable. On the other hand, there are powerful benefits to obtaining copyright registration.
Thus, every public company needs to evaluate whether it owns or distributes works where it is advisable to obtain copyright registration. For example, if the company sells a product which is itself eligible for copyright protection, such as software or a book, it is clear that copyright registration is appropriate.
Dealing with whether to file a patent application requires a similar though different approach. Filing to obtain a patent for an invention is more costly than copyright registration and thus the decision on whether to file for any particular invention requires legal, technical and business input.
Certainly, if there is a substantial likelihood the invention when productized will have significant commercial value, filing a patent application is most likely the way to go. Indeed, in certain industries (e.g., pharmaceutical), obtaining patents on products is the primary form of intellectual property protection which is implemented.
For some IP Assets, certain measures can be implemented without specific reference to assets, so that appropriate steps can be taken before the asset is developed or reduced to practice. To protect the trade secret status of a company?s proprietary process or know-how, a series of non-disclosure agreements need to be in place for a variety of different circumstances.
Similarly, appropriate agreements need to be in place to ensure that the company owns the IP Assets it develops or commissions and pays third parties to develop. For example, a consultant or vendor owns the copyright and patents in the work product it produces for the company, unless the parties have entered into an agreement assigning those intellectual property rights to the company
Step 4 ? Implement the Plan and Audit/Monitor Compliance
Once a Plan has been completed, it needs to be implemented. First, employees need to be educated about intellectual property rights, the Plan and how the company?s financial well being depends on the IP Assets. These educational efforts include in-house seminars and the dissemination of complementary written materials. Most importantly, however, is a message from the CEO of the company, reinforced by the division heads, setting as a company objective the identification and protection of IP Assets and emphasizing the importance of these assets to the company?s bottom line.
Unless a corporate culture is attuned to intellectual property rights, any seminar and written materials on intellectual property will likely have only a minimal impact.
In tandem with the educational efforts, the company needs to implement the Plan with regard to the IP Assets identified in the initial inventory. To the extent the company is not in compliance with the Plan, remedial steps need be taken as soon as possible.
In certain cases, it may be impossible to remedy certain deficiencies resulting in a loss of intellectual property protection. If the loss involves a critical IP Asset, then a determination needs to be made as to whether this loss is a reportable event under the Act.
For example, such a determination would need to be made if the U.S. trademark registration for a key brand or trademark were lost due to failure by the company to file a required affidavit of continued use with the United States Patent and Trademark Office, resulting in a diminution of the company?s rights.
Once the initial implementation and analysis has been completed, the company needs to monitor compliance and do periodic ?maintenance? audits. Processes and policies need to be put into place to capture and assess any change in the value of any IP Asset and whether such change materially affects the financial status of the company.
Strategic transactions involving the acquisition of IP Assets need to be included as part of the Plan and included in maintenance audits.
It is recommended that a public company identify an individual or team within the company to receive information regarding new IP Assets developed, acquired, and transferred through sale or otherwise, and/or circumstances or events which could result in a change in the value of IP Assets.
Larger public companies can consider the appointment of an IP Compliance Officer knowledgeable about intellectual property law and skilled and experienced at valuing and evaluating IP Assets.
Step 5 ? Establish Internal Procedures to Ensure Material Changes to IP Assets Materially Affecting Financial Performance are Reported
Obtaining information regarding IP Assets and more particularly any material changes in value to particular IP Assets is not very useful unless there is a procedure and process in place to ensure that this information is communicated to the company?s management, including its CEO and CFO, charged with overseeing compliance with the Act and SEC reporting requirements.
Clear lines of communication must be established with sufficient redundancy so that valuable information regarding IP Assets does not fall through the cracks. The Act also requires that the company evaluate on a quarterly basis the effectiveness of the controls and procedures implemented regarding intellectual property. The quarterly meeting needs to be a part of a regular schedule of meetings of the group of individuals charged with IP-SOX compliance.
Conclusion
Compliance with the Act is an important matter. Protecting IP Assets that are important to a company?s financial performance is equally and independently important.
Thus, in the absence of any clear direction from the Act, the courts or the SEC, the prudent course for a public company to follow is to adopt IP ?best practices,? including implementation of adequate disclosure controls and procedures, and assume reporting responsibility to the company?s management regarding material changes in the value or other features of IP Assets that could materially affect the company?s business and financial performance.
Kenneth Hautman
Partner Intellectual Property Group
Hogan and Hartson
Mr. Hautman is a senior partner in the intellectual property group at the global law firm of Hogan & Hartson L.L.P.
He has over twenty-five years experience counseling clients on intellectual property matters.
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