This document summarizes a presentation given by Jay Hoenig of Hill & Associates on protecting trade secrets in China. It discusses that trade secrets are more than just intellectual property and includes things like manufacturing processes, financial data, and business plans. It outlines China's transition from communes to a market economy and some of the challenges of operating in China's business environment today, including fraud, corruption, and lack of transparency. The presentation emphasizes that prevention is key, and recommends measures around human resources, information technology, physical security, controls and monitoring, and enforcement to protect trade secrets in China.

1. You’re not in
Kansas anymore!
Protecting
Trade Secrets
In China
Jay Hoenig
MGM Studios
Hill & Associates, China
February 2009

2. About Hill & Associates
Hill & Associates – Global
Established in 1992 (HQ in Hong Kong)
Asia’s largest risk management firm with 16 offices and 400 staff
Hill & Associates - China (Shanghai, Beijing, HK)
Established in the PRC in 1994
Wholly Foreign-Owned Enterprise (WFOE)
Four Primary Service Lines
Fraud Prevention & Integrity Risk Management
Corporate Intelligence
Asset Protection & Enterprise Risk Management
Risk Intelligence
Compliant with international and local regulations and professional
business ethics

3. Hill & Associates -- Clientele

4. Discussion Topics
I. Trade secrets – More than just IP
II. The Long March – Communes to market economy
III. Prevention is key!
IV. Fraud, theft, and corruption in China
V. Proactive protection measures
VI. Conclusion

5. Trade Secrets & IP
“American Nobel Laureate Robert Solow discovered back
in 1956 that about 88 % of economic growth is attributable
to innovation.
…………………In today’s globalized economy that is truer
than ever. Innovation is a fundamental means of
differentiation.”
Mr. Werner Wenning
Chairman of the Board of Management, Bayer
June, 30th, 2004

6. Trade Secrets – More than just IP
• Intellectual property (R&D activities)
• Brands, trademarks, copyright, patents
• Chemical processes, formulations and recipes
• Manufacturing know-how
• Machine design and performance data
• Plant design and operations
• Internal work processes
• Training manuals
• Financial data, client data, employee list
• Vendor and supplier data
• Strategic and tactical business plans

7. “…………Tell Me About China…….”
Land of Complexities/Extremes/Contradictions
• Old/new cultures and environment
• Very rich/very poor
• “Relationship based”/rule of law
• Ethical/unethical behavior
• The “Party” direction/market economy
• Open/protected markets
• SOE’s - employment driven/profit driven
• Centralized/decentralized government
• Regulated/under regulated businesses
• Fast/slow – “rate of change”/bureaucracy
• Plaza 66/Wuling – the real China
All of these impact the IP/TS operating environment

8. Not in Kansas anymore…
• China is a high risk environment for IP
and trade secret protection “Toto, I have a feeling
• PRC investment incentives for we’re not in Kansas
bringing advanced
technologies….why? anymore!”
• Threats from rogue employees,
domestic and foreign competitors,
vendors, suppliers and the State
• Competition for technology and a
“competitive” edge is increasing
• Relying on the “legal” system for
appropriate recourse is not realistic
• The question is not “if” you will loose
your trade secrets, but “when”
• Companies should have a structured,
disciplined and integrated approach MGM Studios
to IP and TS protection

9. Business Environment – “Free for All”

10. The Long March -- Communes to market
economy
1989…a swamp!
…and now a global
business centre!

11. Before 1979 – Absolute economic disasters
Eating from the Big Guo The Great Leap Forward
The Great Steel Production The Cultural Revolution

12. Phase 1: 1979 to 1992
Starting from zero
• People’s communes ceased to
exist
• Production units responsible for
own profits and losses
• “Special Economic Zones”
established
• From SRE to SOE
• 1989 Tiananmen Square incident
– major set back to reform

13. Phase 2: 1992 to 2003
Deng’s economic reforms
State-owned enterprise reform
• Protect larger ones, let go of small ones
• SOEs step back, private enterprises move
forward
• Privatization of SOEs
M&A
Convert to share holding company
Sell to private sector
Famous Deng quotes:
• “Black cat and white cat”
• “Feeling the stones to cross the river”
• “Let a small group of people get rich first”

14. Phase 3: 2004 to Present
Scientific Development/Harmonious Society
• Less need for foreign capital; just technology & innovation
• Migration to high value/high tech products (R&D)
• Greater protectionism & worker rights (ACFTU)
• Greater investment scrutiny
• Increasing awareness of social and environmental issues
• Global resource “mining”
• Rising nationalism, more emboldened China
• Continuing reluctance to participate in global affairs
A riskier operating environment for foreign MNC

15. Continued Industrial Policy in China
China market economy is structured and regulated to meet a
clear and deliberate “industrial” policy established every 5
years. Example:
• Foreign AP Headquarters – 223 (Shanghai alone)
• Foreign R&D Centers – over 700 FIE
• FDI “Go West” (high-tech outpost)
11th – 5 year plan (2006-2010) includes:
• Two themes:
“Scientific approach to development”
“Constructing a harmonious Socialist society”
• Industry structure – quality, not scale
• Strengthen services (FSI, legal, banking, etc)
• Energy-saving and environmental protection

16. Operating challenges
AmCham's Top 10 challenges to conducting business in China:
#1 HR constraints 33%
#2 Bureaucracy, lack of transparency 18%
#3 IPR infringements 13%
#4 Protectionism/corruption/fraud 11%
#5 Visa difficulties for Chinese traveling to the US 7%
#6 Collecting payments, assessing credit 6%
#7 Contract enforcement 5%
#8 Difficulty obtaining RMB/USD, remitting capital 3%
#9 Non-tariff market access barriers 3%
#10 Obtaining materials for production 2%
Source: AmCham Shanghai: 2007 China Business Report

17. Legal and Administrative Steps
• Non-compete clauses with employees
• Non-disclosure agreements with employees, vendors and
suppliers
• Confidentiality Agreements
• Register Trade marks, patents and copyrights
“Provides foundation & framework
for litigation”

18. Legal Protection and Recourse in China
Although the legal system
is improving, foreign companies
cannot rely on the system for fair
and impartial recourse and
enforcement of an IP/TS judgment.
Investigations and litigation are time
consuming, operationally disruptive,
and costly with unpredictable
results….enforcement is difficult.
Prevention is the key!

19. High Cost of Fraud in US
• Corruption impact is estimated at 4% of GDP
• The median loss caused by fraud is $175,000
• 7% of annual corporate revenue lost to fraud
• Costs $994 billion annually
• More than one quarter of the frauds cost in excess
of $1 million Source: 2008 ACFE Report to the Nation

20. IP Theft & Fraud Statistics – US (combine
with previous slide)
• 69.6% of business professionals have stolen some form of
corporate IP from their employer when leaving a job.
• 32.6% of employees leaving a job took sales proposals
and/or presentations with them.
• 30.4% admitted to taking information such as customer
databases and contact information.
• The most commonly used method for stealing IP is to send
electronic copies of documents and files to a personal email
account.
• Only 28.2% think that IP theft is completely unacceptable.

21. Fraud & Corruption: China Statistics
• Corruption accounts for an estimated 13% to 16.9% of GDP
• Counterfeiting accounts for 8% of GDP
• “95% of those with jurisdiction over monopoly industries
would be considered corrupt…….”
• “80% of government officials and 70% of CEO’s of SOE would
be considered corrupt by other countries’ standards…..”
• 82% of major fraud cases involved company’s own employees
• 23% of applicants have used false names
• Secret commissions or kickbacks (43%)
• False invoicing (27%)
Source: Association of Search & Selection Consultants, Maxima plc, Economist

22. Why All the Fraud/Corruption in China?
• Relationship-based society – “guanxi”
• Lack of transparency/checks-balances – opportunities
• Concentration of Power – The Party, PLA, PSB, etc
• Extremely low compensation for professionals – social
pressure
• Poorly developed corporate governance – owner driven
• Under-development regulatory bodies
• Hesitant enforcement services – “source of tax revenue/jobs”
• Shifting/conflicting social values
• Vague moral/ethical business “grounding”

23. Motives for Fraud in China

24. Motivation for Committing Fraud/Theft
• Greed; money, power, prestige
• Lifestyle (gambling, sex, partying, etc)
• Financial pressures (business or personal)
• Family pressures
• Revenge
• Industrial espionage

25. Rationalization Reward / Risk
• Immature legal system
• Two-tier management -transparency
• Immature/incomplete company controls
• Reluctance to prosecute by MNC
• Greater labor law protection
• Increased sophisticated domestic competition
• Growing nationalism
• Growing protectionism

26. Opportunity to Commit Fraud / Theft
• JV vs. WFOE
• Lack of clear ethics policies and procedures
• Poor internal controls
• Immature company operating procedures
• Two-tier management structure
• Insufficient prevention strategies
• Insufficient detection strategies
• Failure to deal with fraud (e.g. allowing fraudsters to resign
without criminal and / or civil action)

27. Prevention -- Protecting IP/Trade Secrets
• Human Resources
• Education and Training
• Information Technology (IT)
• Physical Security
• Controls and Monitoring
• Enforcement Measures

28. Prevention – HR: Education & Training
• Integrity training and awareness training-all levels
Set company expectations
Appeal to sense of national pride
Deputize your staff
Explain PRC criminal law (not FCPA)
In Mandarin
Install “hotline”
• Instill company loyalty through effective
HR practices
• Brief company travelers/visitors on
security procedures
• Develop a “need to know” IP culture
• Develop an TS/IP working group
• Rigidly enforce and prosecute
violators

29. Prevention – Human Resources
• Pre-employment screening
• Reputation Due Diligence on senior employees
• Due Diligence on CDI, vendors and suppliers
• Non-disclosure and non-compete
provisions
• Clear policies & procedures
(what are trade secrets)
• Effective HR retention programs
(reduce turnover)
• Rotation of key employees
• Termination procedures (laptops)

30. Prevention – IT Security
• Encrypt laptops, no USB ports
• No personal computers allowed
• Create an IT security training team
• Identify business critical systems (process
flow maps)
• Establish an intrusion reporting system
• Continual vulnerability and penetration testing (server
hardening)
• Develop standardize hardware and software enterprise wide
• Implement secure data transmission systems using
encryption or other devices (LAN segmentation, WAN link
routing, secure movement of high-risk data)

31. Prevention – Physical Security
• Perimeter fence / barrier/ CCTV systems
• Access control and ID’s
• Guarded lobbies/dual entry
• “Trained” guard force
• Compartmentalize functions
• Secure areas/controlled assess
• Surveillance/CCTV/motion detectors
• Occasional sweeps
• Unannounced audits, security searches
• Clean desk policies/shredders
• Visitor/Escort policies – laptops, camera’s

32. Controls and Monitoring
• Know what is your IP.TS; what must/want to bring to China
• Inventory and classify IP/TS according to the sensitivity
level/segregate and control access
• Document Protection:
• Secure Storage (how, controlled by whom)
• Copying procedures
• Disposal procedures - internal or contracted
• How are proprietary documents circulated
• How are proprietary documents moved in or out of the country
• Track data flows for unauthorized access
• Manage suppliers w/multiple people (transparency)
• Develop unique product or information identification
• Team approach to key functions; i.e. procurement

33. Enforcement Measures
• Spot checks and audits
• Collaborate with other Companies in the industry
• Develop relationships with other industry groups
• Know your legal rights – register & apply
• Have good local counsel and risk consultant
• Vigorously prosecute violators
• Develop relationships with local government & law
enforcement
• Know your competitors and the market

34. FDI Operating Lessons Learned
• People steal IP/TS …..failure to develop, present and train,
and implement clear ethics policies in a timely manner
• Do not begin operating with immature operating and security
procedures
• Avoid a two-tier management structure and localizing 100%
too quickly
• Failure to aggressively deal with ethics violations

35. Conclusion
• Risks are manageable only
when identified
• Know what you want to protect
• Develop a structured,
disciplined approach to IP/TS
protection “early”
• Know who you are dealing
with!
• When investing, a
reputational/operational due
diligence is a must in China
• Remember the 6 D’s and 3 V’s

36. Thank you!
Jay Josef Hoenig
President
6A, Huamin Empire Plaza
728 Yan’an West Road
Shanghai, PR China
Tel: (86 21) 5238 5599
Fax: (86 21) 5237 1693
Jay.hoenig@hill-assoc.com
info@hill-assoc.com
www.hill-assoc.com