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PERSPECTIVES: Protecting trade secrets helps protect the bottom line

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PERSPECTIVES: Protecting trade secrets helps protect the bottom line

INTRO: What is intellectual property worth to a company's bottom line? This is one of the most difficult assets to quantify, so using risk management to prevent intellectual property theft in the first place is crucial. Ben Beeson, a London-based partner who leads the global technology and privacy practice at Lockton Cos. L.L.C., provides guidelines.

As with other emerging risks, the insurance industry is developing ways to protect businesses from the loss of intellectual property, which often is the foundation of a company's commercial advantage, such as the code that drives a financial transaction, an electronic game animation or the secret recipe for Coca-Cola.

As always, it starts with placing a value on the asset, which is easier said than done in this case. It is much more straightforward to compensate a policyholder for damage to a structure or calculate the replacement value of an automobile.

It's a daunting task, however, to determine how much losing control of a trade secret means to the bottom line.

While a fully developed market for intellectual property theft is going to take time, limited coverage is available to help organizations face some of the financial consequences arising from competition. While this coverage doesn't indemnify against deliberate theft, it responds when a company faces legal action that could separate it from its intellectual property.

There's an instructive lesson in today's technology. Apple Inc. took Samsung Electronics Co. to court — several courts in several countries, in fact — claiming Samsung had copied its patented designs for smartphones and tablets. A U.S. jury awarded Apple more than $1 billion in damages, the judge later reduced it to $640 million; and a new jury will revisit the award in November. Here we have a pitched battle for pre-eminence in the global mobile communications war, and in cases such as this an insurance market exists to compensate the insured for its defense costs and damages.

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Let's consider another competitive situation, in which two companies produce similar products. Company A accuses Company B of infringement and secures an injunction against Company B to stop producing and selling a product based on its intellectual property. An intellectual property value policy can help Company B recover at least some of revenue lost during this period. The most protection available is around $50 million, which would be more than adequate for most startups.

However, the deliberate pirating or stealing of intellectual property poses a challenge for risk managers, insurers and brokers. First-party intellectual property is largely uncharted territory, and begs some critical questions, such as:

• How does one place a value on intellectual property? Whether based on share price or loss of revenue or both, sophisticated algorithms must be developed to accommodate a host of key financial variables.

• How can a pharmaceutical formula or a piece of computer code be insured against loss or theft?

• For which losses would a policyholder be compensated? Traditional liability recognizes things such as defense costs, cost of medical care and noneconomic damages. On the other hand, the theft of intellectual property could saddle a company with a much different set of expenses and losses.

We can thank the U.S. Securities and Exchange Commission for helping in our pursuit of some of the answers through more stringent disclosure requirements. To satisfy the investment community, public companies must define the nature and scope of their intellectual property and how it could be stolen or compromised. The more that is known about the nature, scale and vulnerability of intellectual property, the more rigor can be applied to underwriting and reserving.

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Similarly, there's much to be gained from President Barack Obama's executive order calling for tougher measures against intellectual property theft. The United States is mobilizing its trading partners in a campaign of increased vigilance and action, enacting trade protections, enforcing existing agreements and publishing watch lists. The data that emerges over time will aid underwriters, risk managers and brokers in developing coverage sophisticated enough to meet the challenge.

It is our opinion that underwriting companies and brokers will need to partner with high-end security consultancy firms which have significant expertise and possess substantive threat information. Those firms can help insurers get their arms around the issue. Time and again we are seeing that putting up a firewall isn't good enough; static defenses fail to keep the enemy out. Consultants advise clients to act is if the bad guys are already residing in your network. Rather than an exaggeration or hype, it's a valid concern. It's important to motivate organizations to conduct more real-time monitoring and implement layered defenses. And again, as more data emerges from these exercises, the insurance industry will be better positioned to design insurance products.

Given the magnitude and commercial effect of intellectual property, we at Lockton Cos. L.L.C. envision the emergence of a substantive insurance market and ancillary risk management services to combat intellectual property theft. In the meantime, prevention is the best way forward. It is wise to set up a data classification system, identify sensitive information, and establish the data trail within the organization and also outside to third parties. This helps prioritize the data and segregates the most sensitive data, while assigning more stringent security controls to it. Ensure vendors do the same and match your levels of security. They also should be willing to assume contractual risk in the event that the data is compromised.

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Theft of intellectual property is bad for business. It can harm a company's good reputation, alarm investors and threaten revenue projections. Regardless of the insurance coverage available, it's imperative to foster an ongoing culture of trust and help employees understand that protecting intellectual property is good for the company and ultimately good for them.

Ben Beeson, is a London-based partner who leads the Global Technology and Privacy Practice at Lockton Cos. L.L.C. He can be contacted at Ben.Beeson@uk.lockton.com.