How to protect innovation in FinTech - The role of trade secrets

16 minute read
09 February 2022

Author(s):

Technical innovations in FinTech, digital banking platforms, trading strategies and the like are typically a combination of code, algorithms, data analytics, machine learning through to business methods and processes.

As such, much of the innovative subject matter falls outside of what can be protected as an 'intellectual property right'. Many of these innovations fall within matter that is excluded from patentability in major jurisdictions. While copyright will subsist in original software code, there are serious limitations with regard to copyright protection, as it protects only the form of expression rather than the idea itself. With software this means that the rights owner can prevent copying of the code but not copying of a program's or platform's functionality.

Given the above, the most effective way to protect innovation in the sector is often by exercising strict controls over it, keeping it confidential as a trade secret. There can be challenges in doing so (and once secrecy is lost it cannot generally be recovered) but with careful management of trade secrets and with suitable policies and procedures, it is achievable.

Before we address trade secrets management further below, we first look at a recent (and perhaps all too familiar) example of an innovator's rights in the FinTech sector apparently being under threat by a departing employee.



East West Bank (EWB) v Shanker and Aeldra Financial, Inc.

The case in point is East West Bank (EWB) v Shanker and Aeldra Financial Inc. (Aeldra)[1], a recent case (July and October 2021) from the Northern District of California where EWB sought a preliminary (interim) injunction against its ex-employee and his new start-up business.

The first defendant, Sukeert Shanker, was part of the development team for the "Velo" software application at EWB. Velo is a global digital banking service said to be the first of its kind that, among other things, allows non-resident non-US citizens to open a new US bank account without a social security number or an in-person bank visit. EWB claimed to have invested significant money, time and effort in developing Velo, which was launched in the US and China in May 2019, and subsequently in several other major jurisdictions.

Shanker's employment at EWB was terminated in April 2019 after what was described as a breakdown in their relationship over performance and bonus. What became subsequently apparent was that, towards the end of Shanker's tenure, he had forwarded various EWB documents about Velo to his private personal email account.

In October 2019, Shanker incorporated Aeldra and a year later in October 2020, he announced the launch of Aeldra's mobile banking platform, which offered the service of enabling non-US citizens to open a bank account with a cell phone application, a similar service to and in direct competition with Velo. EWB promptly issued legal proceedings against Shanker, alleging that Shanker had, among other things, misappropriated EWB's trade secrets to create Aeldra. However, it did not issue its motion for a preliminary injunction until May 2021.

EWB's claim for the injunction particularised 16 specific trade secrets alleged to have been taken, including information such as architecture diagrams; algorithms and processes; product features and designs; and various strategy documents. EWB argued that it was likely to succeed on the merits and would suffer irreparable harm if Shanker and Aeldra were not immediately stopped from unfairly competing by using EWB's trade secrets information.

Shanker and Aeldra defended on the basis that (i) EWB had failed to sufficiently particularise any trade secrets; (ii) that, although admitting that Shanker had forwarded various Velo documents to his personal email, the defendants did not in fact use any of EWB's alleged trade secrets; and (iii) EWB did not take 'reasonable steps' to protect its information so it did not have any trade secrets to enforce[2].

The District Judge rejected the first defence, finding that all 16 of the pleaded trade secrets were sufficiently particularised. He rejected the second defence, after summarising various aspects of evidence (not least the similarity between the platforms), because he considered there was enough evidence at this interim stage to support EWB's case (which would be fully tested at trial).

The third line of defence is interesting as it illuminates a key challenge that a trade secret owner may face when it comes to enforcement. The defendants gave various reasons why reasonable steps had not been taken by EWB to keep the information confidential. These arguments ranged from the allegation that the confidentiality agreements it got its employees to sign were not, in fact, legal contracts; that EWB's network was not secure, as evidenced by employees working on Velo routinely emailing documents to their private personal email accounts; and that the office doors were regularly propped open without a receptionist present, creating public access to areas where EWB posted information about Velo including things like its value proposition, app design, and account-opening procedures.

The thrust of the defendants' arguments seemed to be that, because the existence of each of confidentiality contracts; securing the network; and physical security measures, had in previous cases been good evidence of 'reasonable steps', their alleged absence here was a basis to argue that EWB had not taken reasonable steps and hence the information did not qualify as trade secrets. The Judge rejected this argument, being content that at this interim stage EWB had done enough, but that this was an area that could be explored in much more detail at full trial.

EWB, having made good on its case of irreparable harm (the Judge agreeing that its market position would suffer irreparable loss), secured the preliminary injunction.

The matter did not end there: within a month Shanker and Aeldra had filed motions to compel EWB to arbitration and to lift the injunction based on new evidence, and a further hearing took place in October 2021.

Regarding arbitration, on entering employment with EWB, Shanker had signed an arbitration agreement with EWB (that EWB asked its staff to sign so that employment disputes would be handled via arbitration rather than court) but on the same day (13 minutes later), he also signed EWB's employee handbook which contained a different arbitration agreement. The existence of the second arbitration agreement seemed to take EWB's lawyers by surprise, and unfortunately for EWB, it only allowed the parties to seek interim orders from a court in circumstances of urgency. As EWB had waited several months to issue for the injunction, and as the second arbitration agreement was deemed the one in force, that route was closed to it and hence the Judge dissolved the injunction.

EWB, when seeking its preliminary injunction, had also failed to disclose a number of its published patent applications (it later argued that they were irrelevant to the preliminary injunction motion) but as it happened, these patent publications did concern its non-resident/non-citizen bank account opening process. The Judge considered this failure to disclose as "glaring", and that it was for the arbitrator to consider the merits of the respective arguments on whether or not the patent applications disclosed the alleged trade secrets.

The Judge concluded that, had EWB disclosed the arbitration agreements and the published patent applications at the injunction hearing, he would not have issued the preliminary injunction in its current form, if at all.

The most recent development in the case came in December 2021, where the defendants secured an order that EWB pay them almost $500,000 by way of reimbursement of legal fees incurred, based upon a costs shifting provision in the arbitration agreement.

How to protect your trade secrets

So what can those active in FinTech take from the above? Although on the facts the case may have taken a few unfortunate turns for EWB, the case was not wholly unusual: the story of an employee leaving and setting up in competition is familiar, and the defences that were run were fairly typical, albeit the signing of the second arbitration agreement added some very pertinent and specific facts to the matrix. However, there are some important themes that come out.

Firstly, the need to act quickly. The fact that EWB had its injunction dissolved in this case was due in part to the fact it had not acted in urgency. Admittedly this became an issue after the event because of the second arbitration agreement, but in many jurisdictions (including the UK) an interim injunction is generally a non-starter unless issued as soon as possible.

Secondly, and without knowing the full details, it does appear that EWB might have been somewhat disorganised in how it managed its employee terms and contracts [3]. The existence of the second arbitration agreement in the employee handbook that contradicted the arbitration agreement that was signed earlier the same day did come back to haunt EWB, with the injunction being dissolved three months after it was issued and with a costs penalty.

The existence of the (previously undisclosed) patent applications that were alleged to make public significant aspects of the asserted trade secrets information highlights an ongoing tension between protecting innovations via patents or via confidentiality (or a combination of both) that needs to be actively managed. There was no detailed analysis of just how much overlap there was, but the failure by the plaintiff to disclose them was significant to the Judge when considering whether the injunction should be lifted. It does highlight that not putting all of the relevant facts in the hands of the Court at the injunction hearing can cause trouble. It may be better to explain upfront why the published documents do not disclose the trade secrets, rather than allow the failure to disclose and to deal with it at the time, give cause for a preliminary injunction to be lifted.

Finally, there is the issue of whether the information qualifies as a trade secret in the first place on the basis of reasonable steps having been taken to protect it. 'Reasonable steps' may not be a very high hurdle, but there was a clear attack in this direction by the defendants in this case and, should the matter continue in arbitration, one assumes these points will be fought out at the full arbitral hearing. Although the Judge thought EWB had demonstrated sufficient steps to get them home on the merits at least at the interim stage, the allegations from the defendants, particularly around the 'leakiness' of the network and lack of physical barrier security to the premises would, if true (and we stress that we do not know the full merits of the parties' respective cases in this regard), raise some alarm bells.

It is certainly the case that defendants have succeeded in defending against trade secrets owners by challenging that reasonable steps have been taken. A salutary example of this in the financial services sector is the case of Opus Fund Services (USA) LLC v Theorem Fund Services LLC[4] where a court in the Northern District of Illinois dismissed the complaint, finding that the (alleged) trade secret owner had done "nothing to differentiate its protective measures for the alleged proprietary trade secrets from those imposed on any other corporate information."[5]

Network and physical security measures, including defending against employee non-compliance such as sending to private email accounts for example, are some of the more straightforward procedures to implement as part of protecting trade secrets, and, importantly, demonstrating that steps have been taken.

The case of EWB highlights the importance for any organisation actively innovating in the FinTech sector to take trade secret protection seriously, and to ensure that robust trade secret policies and procedures, spanning employment issues right through to technical security measures, are in place. Similarly they should make sure that valuable trade secrets – the crown jewels - are treated as such, with further protective measures applied over and above the basics used to protect the generality of business confidential information.

This will help problems arising in the first place but, equally importantly, it helps the innovator easily and quickly establish that the information is, legally speaking, an enforceable trade secret when it comes to the sharp end of protecting its innovations.

If you have any questions, please contact Jonathan Ball.

Footnotes:

[1East West Bank vs Sukeert Shanker and Aeldra Financial, Inc - 20-cv-07364-WHO (N.D. Cal. Jul. 22, 2021);
[2] The US and the UK (the UK having implemented the EU Trade Secrets Directive) have statutory trade secrets laws that require, in order to qualify as a trade secret, that the owner must have taken 'reasonable measures' or 'reasonable steps' to keep the information secret. Exactly what amounts to reasonable steps is not always clear though and this has been a key point of contention in numerous US cases.
[3] As an aside, in jurisdictions where they are enforceable, time limited non-compete and similar restrictive covenants on departing employees can be effective tools in the hands of the employer to help defend against some of the harm an employee departing with trade secrets can inflict, at least for a time.
[4] Opus Fund Services (USA) LLC v Theorem Fund Services, LLC et al 1:17-cv-00923
[5] The UK has of course for some time hosted some of the most innovative developments in FinTech but the 'reasonable steps' requirement in the UK's statutory law governing trade secrets is fairly new (implemented June 2018). It will be important to see how the UK courts, and indeed those of the EU Member States, interpret what 'reasonable steps' means, but the rich case-law history on this from the US courts is very informative to draw upon.


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