INFORMATION & TECHNOLOGY LAW

The Intellectual Property Audit:
A Treasure Hunt for Hidden Corporate Assets

By Jon M. Garon*
As published in Interface Tech News, November, 2001

No one wants to be audited. The term audit evokes visions of small gray men in dark gray suits shaking their heads as they read financial records or tax returns. A treasure hunt, in contrast, suggests an adventurous frolic into the unknown, exploring hidden dens in search of unexplored riches. The intellectual property audit can transform itself into just such a treasure hunt for corporate jewels.

Like the treasure hunt, the IP audit has the opportunity for both good and ill. When the explorer clears the door to a hidden cave, he may find a long-lost treasure, a chamber of angry bats, or clues to another chamber hidden further up the path. The audit may similarly reveal treasure in the form of new patents, business secrets ascending on unsecure e-mail like the angry bats, or clues to more serious issues lurking just ahead. A thoughtful approach to intellectual property management requires the company to plan for both positive and negative contingencies. The audit — the corporate treasure hunt — is the first step in this management plan.

Common misconceptions on the need for an IP audit

Perhaps the most important misconception to overcome is that these audits are only needed by companies developing complex, industrial patents, or perhaps those that rely heavily on sophisticated trade secrets. The reality is that in today's information economy, virtually every business relies on a broad array of intellectual property assets — copyrights, trade secrets, trademarks, and software licenses. Equally important, these assets are no longer stored in the research and development department. Instead, every area of the corporation is involved in the use of intellectual property, including human resources, IT, marketing, sales, and research.

A second common misconception is that IP audits are valuation tools, designed exclusively to recalculate the dollar amounts assigned (or not assigned) to intangible assets. While this is a significant part of the audit process, this aspect of it is most important only when the audit is conducted as part of a fundamental corporate change. Since many intangible assets do not appear on accounting balance sheets, these assets must be separately identified and justified so that they can be calculated in the proper valuation of the company. While the use of the IP audit is critical when the balance sheet fails to tell the complete story, this is only one of many times the IP audit should be used.

In addition to valuation, IP audits are designed to identify those opportunities to exploit assets being under-utilized, to identify those areas where funds are being spent unnecessarily, and to correct those situations where legal or financial liability may be developing as a result of misuse of the intellectual property owned by third parties.

Saving $1 million is the same as earning $1 million in profit, which typically translates to between $10 million to $20 million in revenue. In today's tightening economy, these savings can result in the ability to avoid layoffs or even bankruptcy. The savings can come from reducing cost, as well as avoiding liability.

Assets under review — policies and content

The types of assets covered by the audit fall into three broad categories. First, are those assets created by the company itself. This includes any patents owned or in development; copyrighted materials (advertising materials, handbooks, product documentation, etc.); trademarks, trade names, and service marks used in conjunction with the company's business whether registered or not; trade secrets, including secret formula, nondisclosure agreements, non-competition agreements and other confidential data such as business lists and pricing information; and data subject to privacy or security agreements, whether by contract or by legal requirement. These are the gems that should be taken out of the vault regularly to see if the time has come to enhance their usage.

The second category of material is that which is acquired without an express license. This may include the use of competitor's trademarks in advertising, incidental photocopying, e-mail, employee data, client data (both data about the company's clients and data held on behalf of the clients). This category tends to hold the "angry bats" hidden in the cave. The IP audit should include a review of the policies for creating and holding such data. For example, if a company has never had an e-mail policy and avoided review of employee's e-mail, the discovery of pornography distribution or inappropriate workplace comments may come far too late to avoid substantial legal costs and settlement payments. Similarly, co-mingling client data with the corporation's own data can create liability, particularly if assets are being sold in bankruptcy.

The third category is comprised of the intellectual property assets used by the company under a contract or license from another party. This has been the area with most significant growth in the past five years. These include the myriad of software licenses necessary for operation of PCs, servers, networks, Web sites, Web hosting, offsite storage, disaster recovery, equipment licenses, etc. This category most often contains the clues to future hidden gems and angry bats that must be analyzed to anticipate both problems and opportunities.

Preparing for an IP audit

With the scope of the audit identified, the first step is scheduling the audit to begin. For most companies, no audit has ever been conducted. For these, now is the time to start. For those with some history of IP audits, new updates are necessary whenever any of the following events occur.

For all companies, mergers, acquisitions, and sales of significant corporate assets should trigger new audits. Certain negative events have the same effect. The audit should be used as a planning tool in advance of any filings for bankruptcy, significant plans for employee layoffs, business closure, or elimination of significant lines of business.

The second step in the audit process should focus on what assets are involved in the audit process. Given the intangible and rapidly shifting nature of intellectual property, the scope of the audit should be broad and highly flexible. The initial planning for the audit should include individuals throughout the organization, not just from any particular department.

The third step involves gathering the information and asking sufficiently leading questions to reveal useful information. A quick, e-mailed survey is likely to gather only superficial comments. Policies can be read by the audit team, but if the policies are not followed, they provide little protection. A discussion of trade secrets will reveal far less than a quiz about what information the company most wants to keep from the competition.

Personnel surveys and direct observation must also be used to better compare policy compliance with the underlying policy. In a similar manner, software licenses are reviewed and the terms must be applied to the actual usage. For example, if a software license provides for 100 computers, then the count should be checked. If staff reductions mean that only 15 machines operate the software, then the license should be renegotiated rather than merely renewed. The information gathering process is the heart of the IP audit.

The fourth step results in comprehensive, written analysis. Identified contracts should be cataloged, patents listed, trade secrets categorized, and copyrighted materials indexed. As the body of information grows, the analysis will identify those ideas or materials that have not been given sufficient protection or value. It will also begin to identify where the company is out of compliance under contracts or intellectual property laws.

The fifth step is to create and implement a response plan. Good ideas should be reduced to patentable devices, publishable materials registered with the Copyright Office, and commonly used terms protected as trademarks. Policies need to be revised to better protect the trade secrets and business information used throughout the organization, updated to take into account the increasing importance of privacy and data security. Within the "to do" list generated by the audit, priorities must be set. The corporation should put those steps that are the most valuable and those that are easiest to accomplish on the top of the list. The remainder may not be scheduled for today, but they should be calendared, rather than forgotten.

The fifth step never completely ends. The "to do" list will serve as a starting point for the next audit, scheduled when another major event befalls the organization or more than a few years pass.

Whether viewed as a valuable opportunity or a time-consuming burden, the IP audit remains an important planning and organizational tool for all companies. For some, the treasure hunt may even yield its own rewards. After all, you never know just what you'll find.

*Jon M. Garon is admitted in New Hampshire and California.

See Part II: IP Audits and the Philosopher's Stone

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