Intellectual Property - A Key Asset Not To Be Overlooked
Editor: How does Sarbanes-Oxley ("SOX") affect the practice of intellectual property law?
Friedman : Sarbanes-Oxley was adopted in July 2002. bringing much heightened scrutiny to corporate governance. Under SOX. particularly Sections 302. 404. and 409. companies must be very diligent in disclosing and certifying their "tangible" and "intangible" assets in all financial reports. They must identify and then list their important intellectual property ("IP") assets. value the IP assets and disclose any "impairment" to those asset values. IP assets must be identified and reviewed at least on an annual basis to determine whether there has been any impairment or loss that needs to be accounted for under FASB rules.
The Act places a requirement on all publicly held companies to conduct regular audits - at least once per year - of their IP assets. and to report on any material changes to those assets likely to impact the company's financial operations and well-being. This must be done under the close scrutiny of IP counsel. If you follow the Act through to a logical conclusion in the light of its statutory purpose. companies must at least annually (if not more often) follow a process for determining what intellectual property exists. what the strengths and weaknesses of its pool of IP property are. and what changes have transpired since the last reporting period. The IP property pool includes not only patents. filed trademarks. copyrights. trade secrets. and also. arguably. IP or know-how not yet subject to governmental certification. i.e.. still in the lab or test tube.
As you can see. SOX has significantly changed the IP landscape for publicly held companies. In order to make the certification required by SOX. CEOs and CFOs have to become as familiar with their IP assets as with their accounts receivable.
Editor: What mechanisms should be put in place to assure compliance with SOX?
Friedman: All companies. not just those publicly held. should set up a multi-disciplinary IP audit team. The IP audit team would include IP counsel. accountants. engineers and perhaps some of the sales personnel. Their function is to determine what constitutes IP. the importance of these assets to the company's well being. how the assets should be valued. and what changes have taken place in the value of the assets. As I said earlier. under SOX. the company must certify to the value and/or impairment of both tangible and intangible assets.
Section 404 of SOX requires companies to document and certify their internal financial reporting procedures and controls. including any self-assessments of the business risks. Under this section the company and its officers must certify that they have procedures in place which they are following such as identifying all the IP. assigning values to it. and measuring any impairment to those values. A multi-disciplinary IP audit team including IP counsel is necessary in order to do this successfully.
Editor: The Sentencing Guidelines require that there be employee compliance training. Also. Sarbanes-Oxley would require such training since it requires control systems to protect important assets. Should there be specialized employee compliance training programs to alert employees to the necessity for protecting and preserving IP assets?
Friedman: As a result of SOX. there has to be training for those at the company who are charged with developing. identifying and assessing the value of IP.
A firm like ours. with experience in handling IP issues for sophisticated companies and employee training. is well-equipped to help clients devise. implement and execute the procedures that are necessary to comply with SOX insofar as intangible assets. like IP. are concerned. This subject matter needs to be taught to research and development personnel. including scientists and engineers. financial personnel. and those involved in management. There are many different legs beneath the table of SOX compliance.
Editor: What about other company personnel who are involved only tangentially with technology. such as those involved in protecting the systems from viruses?
Friedman: This multi-disciplinary IP audit team. tasked with the mission of identifying and assessing IP. must be aware of viruses and other problems that may affect the value of intellectual property. Even if you are with a company that is merely licensing technology from another party. this technology also has to be identified. valued. disclosed. and if there is any impairment. this would have to be disclosed.
Editor: In the case where a company receives a notice that products it is selling may have used processes in their manufacture which may be in violation of another party's patent and the company chooses to ignore the notice. would this be a violation of SOX?
Friedman: Failure to disclose the notice would. in some instances. be a SOX violation.
Editor: Is your firm involved in helping clients adopt comprehensive training systems so that these various bases in the law are touched?
Friedman: Outside counsel. such as our firm. who represent publicly held companies are encouraging our clients to do so. Publicly held companies are slow to move in this area since there is a cultural abyss to be spanned. Auditors and executives who are used to dealing with non-IP assets may not be able to identify IP assets that are not covered by issued patents or trademarks such as IP that may reside in an engineer's notebook.
A knotty problem also arises under SOX in cases where a patent pending application is involved. implicating many issues - such as trade secret issues and attorney-client problems. For example. what happens under SOX if you have to report on a pending patent application as well as any impairment thereof?
What if you have a pending patent application on key technology and you receive an office action from a patent examiner who says: "Look I am rejecting claims #1. 6 and 12"? How do you comply with SOX requirement 302 or 409? This is uncharted territory.
Editor: If you do not have state-of-the-industry security for your systems. such as allowing your trade secrets to walk out the door each day in someone's laptop. what kind of breach of SOX might this trigger?
Friedman: The Company has to certify as to its internal controls. The safeguarding of IP should be part of a set of those controls that must be certified to.
Editor: While the main thrust of commentary on SOX has been primarily concerned with accounting controls. what you are telling me is that all assets and processes within a company are covered by the Act - anything which exposes a material weakness that could affect the finances of a company long-range.
Friedman: If SOX requires you to disclose and certify information regarding important assets and risk factors related to those assets. and if one agrees with the proposition that many publicly held companies have IP that is among their most important assets. then those disclosures are required. systems must be installed and executed to ascertain that information. and the appropriate disclosures under SOX made. This is truly a stealth issue. People are starting to wake up to the view that IP assets increasingly influence a company's financial health. And like other tangible and intangible assets. these assets must be identified. valued and any impairments to value disclosed.
Editor: How important is it to have in-house or outside counsel interface with management involved with IP and technology issues? Do you consider it important to have someone embedded in these management groups dealing with these issues competent to assess legal risks. including the possibility of litigation or of excessive damages. in looking at an intellectual property problem?
Friedman: Here is an example that makes your point: you and I are the executives of a company that owns a particular valuable and important technology which we believe is proprietary. Suppose in a pending patent infringement action. in which we are not a party. the patentee alleges that someone who has technology similar to ours is infringing its patent. Would not that be something that could impair the value of our IP even though our company is not a party to that proceeding?
This underscores the need for companies to create an interdisciplinary team consisting of management. scientists. researchers. and IP lawyers who create the controls so the company can make the analyses and disclosures required by SOX.
As a result of SOX. IP lawyers must be drawn right into the mix. The risk of not doing so is too great for any responsible corporation. its officers and directors to ignore.
Editor: How important is speed in analyzing a problem once in-house counsel senses one is brewing?
Friedman: You cannot be an ostrich. The moment any corporate attorney. executive or director. or employee senses that there could be a problem. it is critically important that SOX counsel be contacted. Early intervention is necessary for a good recovery. You must assemble a competent team of inside and outside professionals to quickly preserve the information. evaluate it and then chart a course of compliance. This will reduce the likelihood of a SOX violation.
Editor: Do you foresee a number of situations emerging that will require these rescue operations?
Friedman: I'm not so sure you are going to see a groundswell of enforcement actions or litigation related to the failure to identify. value and describe the impairment of IP assets because it is only now that people who are deeply involved in this are beginning to say. "What are the IP implications of SOX?" I can foresee a stockholders' suit against the company on the basis of its documents' failure to disclose a substantial impairment of value of one of its key IP assets.
Editor: You have a vast body of plaintiffs' counsel waiting to seize upon product failures.
Friedman: It may be an explosion waiting to happen.
Editor: Does it make sense for a company to document its state-of-the-art internal controls and compliance record?
Friedman: In my view. SOX requires that a company document and certify to its IP controls. There is no substitute for creating a record of not only compliance but also exemplary conduct. One should practice exemplary corporate conduct as an end in itself. This is a brave new world - Aldous Huxley would have been at home in 2005.