Protecting Trade Secrets in China

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Protecting Trade Secrets in China

  1. 1. You’re not in Kansas anymore! Protecting Trade Secrets In China Jay Hoenig MGM Studios Hill & Associates, China February 2009
  2. 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. 3. Hill & Associates -- Clientele
  4. 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. 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. 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. 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. 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. 9. Business Environment – “Free for All”
  10. 10. The Long March -- Communes to market economy 1989…a swamp! …and now a global business centre!
  11. 11. Before 1979 – Absolute economic disasters Eating from the Big Guo The Great Leap Forward The Great Steel Production The Cultural Revolution
  12. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 23. Motives for Fraud in China
  24. 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. 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. 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. 27. Prevention -- Protecting IP/Trade Secrets • Human Resources • Education and Training • Information Technology (IT) • Physical Security • Controls and Monitoring • Enforcement Measures
  28. 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. 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. 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. 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. 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. 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. 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. 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. 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

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