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IP fraud

We see more financial fraud every week than most companies see in a year. We deal with more financial fraud in a month than most government agencies are likely to encounter in a decade. Because of this, we spend a lot of time thinking about financial fraud: It is our business. We are also heavily involved in the identification, valuation, and protection of critical information and intellectual property.

When looking at loss of intellectual property and critical information we must distinguish among two types of information. The first is that which is publicly available in the form of copyrighted material, trade and service marks, and patents. Misuse of these is dealt with by attorneys and accountants, with some security measures, like generally-ineffective copy protection on CDs and DVDs. There are a host of competent companies that provide expertise in this area of intellectual property.

The second is information that you would prefer not to be public. This would include trade secrets, proprietary processes, customer lists, sales figures, marketing plans, travel plans, and a host of other information. This class of information is of benefit to a company in part because it is not known to competitors and adversaries. Losses in this area come from competitive intelligence, economic espionage, theft, plus from simply giving the information to your competitors and adversaries. These losses are dealt with via counter-intelligence, which is an area in which neither your attorneys, nor your accountants, nor your consultants are likely to have training and expertise. Counter-intelligence is LUBRINCO’s area of specialty, and there are only a handful of private-sector companies playing in this ball park.

Like most, we thought of financial fraud and loss of critical information and intellectual property as two different things. Of late, however, because we are so active in both fields, it has become clear to us that loss of money because intellectual property has been compromised falls into the category of fraud. Unfortunately, the terms we use in describing fraud, and the way we think of both fraud and intellectual property, don’t quite fit reality. They are parallel universes, if you will.

For a start, financial fraud is a zero-sum game: What the fraudster takes you no longer have. With loss of intellectual property, however, the game changes substantially. What you have lost is not the IP itself, but, rather, the exclusivity of access to your intellectual property.

In a 19th and 20th century view of economics, this did not seem important, because the focus was on things and money. Thus, if you speak with the PCAOB about accounting for intellectual property, you will discover something that your accountants already know: Intellectual property developed in-house has no book value. It is magically folded into goodwill.

In the late 20th and early 21st centuries, intellectual property grew rapidly, and now represent over 70% of the value of a modern business entity. And yet, this intellectual property still has no book value! Thus, while IP fraud is estimated – in our opinion under-estimated – to have reached half the value of traditional financial fraud, it all involves loss of something that has no book value.

In addition, many of the techniques set by CPAs to facilitate your bookkeepers and accountants in dealing with financial fraud are not responsive when dealing with intellectual property fraud. Intellectual property fraud requires the implementation of an OPSEC program by an OCP. (The OPSEC Certified Professional is the IP equivalent of a CPA.) This creates a set of expertise barriers. Your CPA and counsel can help you deal with financial fraud, but you need an OCP to deal with IP fraud, and you probably don’t have one on your staff. You don’t even have an OAP (OPSEC Associate Professional, one step below the OCP) to help run the program designed by the OCP.

The good news is that the SEC recognizes the importance of tracking losses from fraud, and has said this specifically includes losses caused by economic espionage and information theft, which, by definition, includes losses to competitive intelligence. The bad news is that most companies are not yet equipped to deal with IP fraud.

This will change once there is a shareholder suit in which senior managers and directors are found to be personally liable, with this liability being uncovered by D&O policies.

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