The Secret of Trade Secrets and Reputation

This Kat is in the process of preparing a speech on the role of trade secrets in IP management. I thought that I had done a reasonable job in raising all the main issues that make the subject such a fascinating one, being, as it is, the IP outlier in so many ways. But then, last week, this Kat's paws ran across a short Reuters report (thank you, Kindle subscription!), dated June 21st and entitled "Exclusive: BlackRock discloses Doll's models not all his own" here. After reading it, I realized that there was one area of trade secrets that I had never really thought about very much before, namely the connection between trade secrets and goodwill. What exactly do I mean? Read on.

BlackRock, Inc. here is one of the top-tier financial houses in the world, with a preeminent position in several of its areas of expertise. One of its best known fund managers is Bob Doll, whom I have heard interviewed numerous times on various business broadcasts. Both Mr Doll and BlackRock have stellar reputations in their field. Against that backdrop, this Kat was fascinated by the news item, which noted a small but significant change in its literature for three of its funds.

Thus, the article reported, "In previous prospectuses, the New York-based firm said a "proprietary multi-factor quantitative model" formed the investing strategy for its $3.7 billion Large Cap Series funds, managed by retiring Chief Equity Strategist Bob Doll. This year's fund literature said the investing model used "quantitative factor models generated by third-party research firms. Typically such a change indicates a shift in a fund's methodology. But there was no shift in the investment process. Instead, the new description came after the funds' board of directors learned that the investment models used for Doll's funds were never proprietary and had been based on other firm's models,..."

Doll, for his part, replied to Reuters as follows: "In some cases, I had the models customized for us to reflect my view of key input factors," Doll said. "I then applied a relative weighting to these models. We used these outputs as one part of my investment process, which also included a fundamental analysis." Moreover, according to Doll, this had been the case for many years.

So what was the problem here? From the investors' point of view, the issue seems to be that, while they believed that were invested into a Bob Doll-only strategy (perhaps that was the reason that they chose to put their money in the fund), it appears that what they were getting was a Bob Doll-tweak to results obtained from off-the-shelf models. That said, not everyone was convinced that something untoward had happened here. According to various other professionals in the field, they did not find the matter to be "that big a deal." For them, there was nothing that unusual in the way that Mr. Doll carried out his investment activities.

This Kat in not in the position to evaluate the pros and cons of the debate from the investment point of view. I would, however, like to comment on the interplay between trade secrets and reputation, as it seems to have taken place here. By its very nature, the owner of a trade secret cannot directly take reputational advantage of his proprietary information. If he did, he would first need to disclose the trade secret and thereby lose the protection accorded it by virtue of its confidentiality. Compare this with a patentee, who can proudly point to his published patent in support of his claim that his patented invention has resulted in the most significant improvement in widgets in the last century. By contrast, the owner of a trade secret does not have this luxury. Rather, he needs to resort to second-order indicia to point to the value of his trade secret.

Thus, Coca Cola can point to the taste of its soft drinks and attribute this quality to its proprietary formula. The public is not in the position to evaluate the formula itself; either one likes the taste of the product or not. Presumably, the goodwill and reputation enjoyed by the product and its brand are inextricably linked to the the assertion that there is a secret, proprietary formula that lies at the heart of the product. If, tomorrow, the formula and all the surrounding know-how connected with the product were made fully available to the public, it is possible that the reputation enjoyed by the product would take a serious hit. At the least, one could expect price pressure on the product in the face of the challenge to maintain customer loyalty. Part of the product's ability to claim premium status is tied to the perception that there is something secret and therefore unique in the product.

Let us carry this over to the BlackRock situation, which appears slightly more nuanced. As set out in the article, there seems to have been some caché for BlackRock in being able to claim that the model used in connection with the Doll-managed funds was proprietary. Stated otherwise, the fact that the model was a form of trade secret belonging to the company seemed to have contributed to whatever reputation the fund and its manager enjoyed. Seen in this light, there was some connection between the existence of the alleged proprietary information and the reputation of the fund.


Or not. One can also argue that the issue of whether or not the model was proprietary was, in this instance, a matter of securities law and the requirements for disclosure of material information (in this case, who owns the model on which the investment research is based). Indeed, the entire question of what is proprietary in such a mixed situation is unclear, when off-the-shelf programs are mixed with input from the fund itself. Unlike the discussion above, where the hypothetical disclosure of the formula threatened to impair the reputation created in part by the claim that it was based on use of the confidential model, here there is no disclosure of the model itself, but merely a restatement regarding the absence of any proprietary model. At the end of the day, what matters is the performance of the fund (nb the funds in question appear to have underperformed in recent years.) In such a case, the connection between the presence or absence of the trade secret and the reputation of the fund is less certain.

The moral of the tale seems to be that, when one talks about trade secrets and reputation, much depends upon the specific circumstances. This is especially so because the measure of the trade secret is only indirectly related to the object or service to which it refers and there is no direct way to evaluate the trade secret itself.