By Kevin Kalinich – Global Collaboration Leader, Intangible Assets Solutions, & Kristin Kraeger – Managing Director, National Directors & Officers and Fiduciary Product/Practice Leader, Financial Services Group, Aon Risk Solutions
In July 2019, Apple agreed to purchase most of Intel’s modem internet of things (IoT) business for $1billion, which includes 17,000 wireless technology patents.
The announcement is the latest in a trend of increasing investments in intangible assets, including disruptive technology, such as 5G, machine learning, artificial intelligence, robotics, cloud computing, IoT/connectedness, quantum computing, big data/predictive analytics and blockchain/distributed ledger. The evolution to intangible asset focus is rapid and spans nearly all industries, geographies and size organisations.[1] However, intellectual property ideas are not new.
As far back as 1926, the inventor Nikola Tesla, said: “When wireless is perfectly applied the whole earth will be converted into a huge brain, which in fact it is, all things being particles of a real and rhythmic whole. We shall be able to communicate with one another instantly, irrespective of distance. Not only this, but through television and telephony we shall see and hear one another as perfectly as though we were face to face, despite intervening distances of thousands of miles; and the instruments through which we shall be able to do this will be amazingly simple compared with our present telephone. A man will be able to carry one in his vest pocket.”
What is new is that there is greater pressure on organisations to figure out how to allocate resources and measure intangible investment, returns and risk exposures.[2] In today’s economy, the value provided by intangible assets must be captured in enterprise valuation. Organisations have to expand the range of data sources and techniques they use in valuation and develop methodologies that are suitable to the intangible asset being valued for more reliable valuation results. Such methodologies provide new perspectives on various cost, market and income approaches and can be integrated with an analysis of non-GAAP (generally accepted accounting principles) key performance indicators and other conceptual frameworks.[3] Identifying and valuing intangible assets is critical, not only in an active management framework, but also in investing (i.e. insurance protection to backstop a loan based on intellectual property collateral) and quantitative modelling in passive strategies that rely on financial statements data and that may need adjustments for comparability. On 22 May 2019, Moody’s rating agency downgraded to ‘negative’ the outlook for Equifax due to Equifax’s lack of adequate cyber resiliency that resulted in a loss in excess of $1billion.[4] Apple and Equifax are not alone. There are all sorts of significant intangible asset stories in the headlines, for example:
- Uber’s self-driving truck subsidiary, Otto, was accused of stealing trade secrets from Google’s autonomous driving subsidiary, Waymo, and settled in February 2018 by providing Google with a $245million equity stake in Uber, all while maintaining its innocence[5]
- AstroTurf, maker of synthetic grass products, filed for bankruptcy protection in 2016 after a $30million patent infringement loss to rival product manufacturer Tarkett[6]
- Kraft Heinz, which combined Kraft Foods and H.J. Heinz in a 2015 merger, wrote down its assets by $15.4billion on 21 February 2019, including $7.1billion of goodwill and $8.3billion in intangible assets (the merger put a $47.8billion value on intangible assets)
- McDonald’s lost its European Union trademark registration for BIG MAC pursuant to a January 2019 decision by the European Union Intellectual Property Office
- D&O insurer was not obligated under a policy exclusion in its directors and officers’ liability insurance policy to defend a travel agency charged with misappropriating trade data, says a federal district court[7]
- After an Amazon health startup was accused of trade secrets theft, a Massachusetts federal judge ruled on 22 February 2019 that a former employee of UnitedHealth unit Optum Inc. could continue his role with the company Berkshire Hathaway Inc and JP Morgan Chase after a ruling that Optum had not shown the two companies were likely to be rivals anytime soon[8]
This paper will focus on a subset of intangible assets: intellectual property.
Who is responsible for valuation, strategy and risk management of intellectual property?
Ultimately, the board of directors is responsible for the valuation, strategy and risk management of any and all issues that could be sufficiently material to investors that they may be required to be disclosed in public securities filings. How much information is vital to investors depends a lot on who is defining what information is material and what is immaterial. Generally, according to the US Securities and Exchange Commission, information is material if it ‘limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered’.
In the US, directors are held to standards of fiduciary duty, loyalty and care, with the business judgement rule as a defence against many allegations of wrongdoing.
Irah H. Donner in Fiduciary Duties of Directors When Managing Intellectual Property, says: “The law covering corporate director duties pertaining to management of intellectual property assets is evolving, making it important for directors to remain up-to-date on any and all changes in management procedures and best practices. Generally, courts treat intellectual property assets like any other corporate asset, which means directors must approach intellectual property with the same due care as they would any other asset.”[9]
The ability to demonstrate that directors have appropriately discharged their duties often dictates the ability to successfully rebut claims made against such individuals.
Outside of the US, the standard to which corporate leaders are held in many cases
is higher. For example, in a recent case, The Hague Court held individual directors liable for a company’s trademark and copyright infringement.[10]
‘Many organisations become paralysed because of the lack of valuation and accounting standards with respect to intangible assets’
A new age is dawning on the nature of class action securities litigation. Today, companies and their directors and officers face myriad allegations from an active plaintiffs’ bar, claiming corporate mismanagement following a negative event in connection with the company’s operations. Commonly dubbed ‘event-driven’ litigation, this new rendition of securities litigation results when a press-worthy event happens (think cyber breach, sexual harassment allegation, or products that cause cancer), the ‘Street’ reacts and the company’s stock price falls precipitously, finally followed by a lawsuit alleging the company should have disclosed the negative operational event earlier. Each of the above listed intellectual property ‘event’ could fall into this category. IPOs are another common premise in the event-driven litigation involves mismanagement – corporate mismanagement in connection with the company’s business operations. Whether the allegations relate to intellectual property valuation, strategy or risk management; they almost always claim any previous statements the company made relating to the alleged operational problem were misleading for failing to disclose the event. Those statements could be, among other sources, a part of the risk factors the companies describe in their financial statements or statements made by management in public press releases, analyst or investor forums. Any statements are fair game for inclusion in an event-driven complaint, particularly statements following the disclosure of the event. Post-event statements will be held out by plaintiffs as a presumption of mismanagement – meaning bad news must equal bad behaviour.
It remains to be seen what the success rate will be with this new style of class action securities litigation. Regardless, and rightfully so, corporations and their directors and officers will undoubtedly look to their directors and officers (D&O) policies to backstop the cost of defending the litigation, either through a successful dismissal or settlement. It is paramount that today’s vintage of D&O policy has the expansive coverage offering, especially on terms that will be tested by event-driven litigation, such as: broad definitions of derivative demands and loss, narrow conduct exclusion and severability provisions, less ridged reporting requirements and flexibility for defence arrangements.
What can directors and officers do?
The first step is to become educated on intellectual property issues relative to other material issues via an IP audit in order to develop informed strategies:
- Identify what IP you own and use
- Determine your IP’s usefulness, whether it is enforceable, and whether it conflicts with any third-party IP rights
- Conduct an IP valuation
While intangible assets are increasing in value and potential loss exposure compared to tangible assets, such as equipment and structures from fires and weather, organisations are failing to keep up with maximising and protecting the value of intangible assets.[11] Despite the greater average potential loss to information assets of $1.08billion compared with $795million in property, plant and equipment, the latter has much higher insurance coverage (60 per cent versus 16 per cent). Although few companies have a trade secret theft insurance policy and/or a patent liability policy, by having a greater understanding of the value of their intangible assets compared to their tangible assets, organisations will adjust their allocation of resources accordingly to insure what’s most valuable to them – their intangible assets[12] (see the Investment in Intellectual Property Products chart, below). 
Investment in intellectual property now represents 33.41 per cent of total US gross domestic investment in 2018, up from 30.95 per cent at year-end 2012. Over the same period, investments in structures as a percentage of total US gross private domestic investment have remained flat, while investments in equipment have fallen (see the Investment in Intellectual Property Products chart, below).
Many organisations become paralysed because of the lack of valuation and accounting standards with respect to intangible assets. Others restrict strategy and risk management decisions to those assets and risks modelled via 25 years of actuarial benchmarking, which is not available with respect to innovative intangible assets, such as intellectual property.
Nate Silver, in The Signal and The Noise, sums it up well “The most calamitous failures of prediction usually have a lot in common. We focus on those signals that tell a story about the world as we would like it to be, not how it really is. We ignore the risks that are hardest to measure, even when they pose the greatest threats to our well-being. We make approximations and assumptions about the world that are much cruder than we realise. We abhor uncertainty, even when it is an irreducible part of the problem we are trying to solve.”
The key for directors and officers is to become informed with the most accurate, comprehensive and in-context information, given an organisation’s unique circumstances. It is possible to model the potential upside and downside of intellectual property valuation, strategy and risk management. As more data is collected for the models, the models improve. Collaboration between the key stakeholders is critical.
Furthermore, the board should consider the cost-benefit analysis of each possible intellectual property solution. High-value intangible assets that are proprietary and confidential to an organisation include trade secrets and unpublished patent applications.[13] If such information is leaked, deleted or used by a competitor there would be material negative consequences,[14] such as loss of market share, reputational damage,[15] loss of customers and business partners, diminishment of advantage and the time and expense associated with incident response.
The board and management must create a culture from top down that protects
the company’s intellectual property, including corporate policies, training and enforcement regarding:
A. Use of company technology
B. Restricted access to computer systems and data
C. Prohibitions of unlicensed software
D. Copyrighted materials
E. Social media
F. Use of company email (no outside media)
G. Why the C-Suite and IP Should Talk[16]
Intellectual property rights, including patents, trade secrets, copyrights, trademarks and service marks can provide a substantial competitive advantage if properly valued, protected and exploited. In fact, proper valuation, strategy and risk management of intellectual property results in increased profitability and market capitalisation while lowering the total cost of risk. Making informed decisions with the most accurate, comprehensive and in-context information, will go a long way to satisfying the board of directors’ duties with respect to intellectual property issues.
About the Authors:
Kevin Kalinich leads Aon’s global practice to identify exposures and develop insurance solutions related to intangible assets, including Intellectual Property, Technology Errors and Omissions, Miscellaneous Professional Liability, Media Liability and coordination of multiple lines of insurance related to cyber. A 2007, 2008, 2009, 2010, 2011, 2012(Finalist), 2014 and 2016 (Finalist) Risk & Insurance “Power Broker,” Kevin writes frequent articles, blogs and the cyber insurance book chapter for two books in 2017: “Cyber Insurance For Law Firms and Legal Organizations,” Chapter 15 of The American Bar Association Cybersecurity Handbook: A Resource for Attorneys, Law Firms, and Business Professional (2nd Edition); “Treating Cyber Risks – Using Insurance and Finance.” Chapter 10 of John Wiley and Sons Book: The Cyber Risk Handbook: Creating and Measuring Effective Cybersecurity Capabilities
Kristin Kraeger is a Managing Director and the National D&O and Fiduciary Product/Practice Leader within the Financial Services Group. Kristin works directly with the senior legal and underwriting leadership with our insurer partners on manuscript policy language and Aon exclusive contract terms. She is directly involved with the brokering/[policy negotiation of many of our Fortune 500 D&O accounts. She serves as a senior legal resource advocating for our client on complex corporate claims. Kristin also is the national leader on the exclusive endorsement of Aon as the Biotechnology Industry Organization’s (“Bio”) broker offering an executive liability business solution for Bio and it’s state affiliates’’ member base. Kristin has over twenty years of legal experience, primarily insurance defense and particularly directors’ and officers’ liability. Previously she practiced in the litigation department at one of Boston’s oldest and largest law firms where she worked in the firm’s litigation department on complex Directors’ and Officers’ coverage and liability actions, as well as, cases involving securities and employment law. Her practice included work with both for profit (public and private) and not-for-profit companies across the country. Her D&O liability experience also includes over 10 years of advising clients on IPO placements and risks. She has advocated for clients on hundreds of class action securities litigation and regulatory investigations. Her work has also included providing legal advice to directors’ and officer’ on the subject of corporate governance.
Footnotes
1.“Capitalism Without Capital: The Rise of the Intangible Economy.” Jonathan Haskil and Stian Westlake (Princeton University Press 2018)
2.What Ideas Are Worth: The Value of Intellectual Capital and Intangible Assets in the American Economy. Kevin Hassett and Robert Shapiro (Sonecon 2011). https://www.sonecon.com/docs/studies/Value_of_Intellectual_Capital_in_American_Economy.pdf
3.The Intangible Valuation Renaissance: Five Methods https://blogs.cfainstitute.org/investor/2019/01/11/a-renaissance-in-intangible-valuation-five-methods/
4.Equifax May 13, 2019, 8-K: https://www.sec.gov/Archives/edgar/data/33185/000003318519000014/exhibit99120190331.htm
5.https://www.newyorker.com/magazine/2018/10/22/did-uber-steal-googles-intellectual-property
6.https://www.wsj.com/articles/astroturf-files-for-bankruptcy-protection-1467219617
7.Benjamin & Brothers LLC v. Scottsdale Indemnity Co. https://www.businessinsurance.com/article/20190321/NEWS06/912327424/Scottsdale-wins-in-directors-and-officers-litigation-based-on-intellectual-prope
9.Irah H. Donner, Fiduciary Duties of Directors When Managing Intellectual Property, 14 Nw. J. Tech. & Intell. Prop. 203 (2016). https://scholarlycommons.law.northwestern.edu/njtip/vol14/iss2/3
10.Novomatic cs v. Bluemay Enterprises NV. 27 June 2018 (ECLI: NL:RBDHA: 2018:7746).
11.Understanding the Strategy, Valuation and Risk of Intangible Assets: https://www.aon.com/thought-leadership/ponemoninstitutereport2019.jsp
12.2019 Intangible Assets Financial Statement Impact Comparison Report: https://www.aon.com/forms/2019/strategy-valuation-and-risk-of-intangible-assets.jsp
13.It’s Time to Prepare for the IP Monetization Revolution. (2019 January 21). https://www.iam-media.com/law-policy/ip-monetisation-teeters-brink-disruption.
14.IP Operations Are Facing Increased Risk and Growing Demands. https://clarivate.com/wp-content/uploads/2018/06/IP-Operations-Trends-Report.pdf
15.Reputation Risk in the Cyber Age: The Impact on Shareholder Value. Pentland Analytics. https://www.aon.com/getmedia/2882e8b3-2aa0-4726-9efa-005af9176496/Aon-Pentland-Analytics-Reputation-Report-2018-07-18.pdf
16.https://gowlingwlg.com/en/insightsresources/articles/2019/why-the-c-suite-and-ip-team-should-talk/
