ESG – environmental, social and governance – has become a major issue for U.S. companies, particularly for companies in the energy sector. In recent years, many large investors and policy makers have demanded companies do more to improve the environment as well as the relationship with the communities where they work and with respect to corporate governance. More recently, Russia’s invasion of Ukraine has caused many of these investors to change some of their ESG strategies.
The companies competing for these institutional investors’ funds now rely on executives to coordinate ESG strategies. As one Bloomberg headline blared recently, “Private Equity Propels Top ESG Hires Into 7-Digit Pay League.”
As ESG executives become more valuable, rival employers compete for their services. Can one company’s hiring of an ESG executive from a competitor trigger a lawsuit for misappropriation of trade secrets?
In answering this question, this article addresses (1) ESG’s role in companies’ competition for investment capital; (2) an overview of what ESG professionals do to maximize their employers’ ESG performance; and (3) the risk of trade secret liability that ESG executives face when they leave a competitor and that their new employers face when hiring them from a competitor.
The ESG executives’ role in developing strategies in the timing and scope of ESG disclosures illustrates the common fiduciary duty origins of trade secrets law and insider trading under state and federal securities law. And because insider trading involves misappropriation of internal corporate information in advance of its release to the public, the case law arising out of insider trading helps explain why ESG strategies, which have become central to companies’ communications with public investors, can give rise to trade secret claims.
ESG’s role in companies’ competition for capital
Energy companies compete vigorously for investor dollars, and investors have increasingly directed their investment dollars to companies with superior ESG ratings and programs. Investors, such as the trillion-dollar fund manager BlackRock, contend that “climate risk is investment risk” and that companies with strong ESG programs generally outperform companies that have weak ESG programs. Thus, companies compete neck and neck with respect to ESG performance to attract investor capital. But the metrics for ESG are complex and ever-changing. Numerous entities have issued ESG metrics and standards, including the Global Reporting Index, Sustainability Accounting Standards Board, Task Force on Climate-Related Financial Disclosures, the United Nations Sustainable Development Goals and others. The varied set of metrics complicate the ability for investors to compare ESG programs across companies and industries.
Furthermore, the scope of ESG issues changes frequently.Issues that seemed tangential in the recent past have become more important now. Most notably, just as ESG consciousness reached its peak during the Covid-19 pandemic, ESG investors reassessed their policies following Russia’s invasion of Ukraine in February 2022. For example, BlackRock has announced that, following the war in Ukraine, it will likely oppose rather than support ESG proposals from environmental advocacy groups and others that appear to “micromanage companies” or that “address matters that are not material to how a company delivers long-term shareholder value.” BlackRock states that “[n]et exporters of energy are likely to be required to increase production” of oil and gas and that the reduction in reliance on Russian energy will “drive a need for companies that invest in both traditional and renewable sources of energy.” Meanwhile, at least one upstart fund manager, Strive Asset Management, has announced its formation and mission of “leading companies to focus on excellence over politics” and of “[d]epoliticizing corporate America” to solve what it contends to be a “fiduciary problem” of large firms like BlackRock in their pursuit of ESG and other aspects of so-called “stakeholder capitalism.”
Nevertheless, in March 2022, the Securities and Exchange Commission proposed a rule that would mandate public companies to provide investors with climate-related disclosures. These geopolitical developments, shifting investor sentiment and regulatory uncertainty have formed a vortex that magnifies the role that high-level ESG executives play in public companies.
What do ESG executives do?
ESG strategy requires companies, with guidance from their ESG executives (and growing legions of outside professionals), to achieve a balance among three goals of “profit, people, and the planet,” comprising the “triple bottom line,” terms that reportedly first appeared in 1994.Balancing these competing interests means that a company may solve one issue at the expense of one or two of the others. In large multinational companies, these issues multiply across a wide range of products, services and geographical regions. For major energy companies, for example, annual reports to shareholders on ESG (often described as “corporate responsibility” or “sustainability” reports) can rival the size of those same companies’ year-end annual reports that they file as Forms 10-K with the Securities and Exchange Commission.
What risks does ESG present for misappropriation of trade secrets?
The increasing importance of ESG strategy creates the possibility that a departing employee misappropriates secret business information pertaining to existing or recent ESG work of a former employer. That employee and the new employer can face liability for misappropriation of trade secrets.
The substantially similar definition of trade secrets under both the federal Defend Trade Secrets Act and the Texas Uniform Trade Secrets Act includes:
[A]ll forms and types of information, including business, scientific, technical, economic, or engineering information, and any formula, design, prototype, pattern, plan, compilation, program device, program, code, device, method, technique, process, procedure, financial data, or list of actual or potential customers or suppliers, whether tangible or intangible and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if:
A. The owner of the trade secret has taken reasonable measures under the circumstances to keep the information secret; and
B. The information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information. [Emphasis added.]
This broad definition can include a combination of previously disclosed trade secrets. Nothing in the DTSA or TUTSA contains a heightened specificity requirement. As the Fifth Circuit has observed in GlobeRanger Corp. v. Software AG, “Texas law does not require great detail in the definition of a trade secret.”
Reasonable measures and independent value derived from secrecy
To claim trade secret protection, a plaintiff must show that it took “reasonable measures to keep such information secret.” In ResMan, LLC v. Karya Property Management, U.S. District Judge Amos Mazzant explained that “[r]easonable use of a trade secret including controlled disclosure to employees and licensees is consistent with the requirement of relative secrecy” and that “secrecy need not be absolute.” Common indicia of secrecy include trade secret covenants in employment agreements; detailed policies and procedures establishing trade secret protection; third-party storage with sufficient security certifications; and password protections for key documents, systems and technology platforms.
The definition of a trade secret also requires that such information “derives independent economic value, actual or potential, from not being generally known to and not being readily ascertainable by proper means by other persons who can obtain economic value from its disclosure or use.” As Judge Mazzant’s opinion in ResMan explains, evidence of independent value deriving from secrecy can include information that gives the new employer a “massive head start” or helps the new employer avoid “reinventing” competitive systems.
Trade secret misappropriation and insider trading
Trade secret litigation generally involves employment and intellectual property lawyers; insider trading disputes involve corporate and securities lawyers. Yet they share similar legal ancestry, and that shared ancestry becomes more apparent in cases involving ESG professionals. Under both the DTSA and TUTSA, a defendant misappropriates a trade secret if, subject to specific details, the defendant acquires, uses or discloses the trade secret through improper means and/or knows that the trade secret was subject to efforts to maintain its secrecy or limit its use. The concept of misappropriation of trade secrets has its roots in longstanding case law “condemning the employment of improper means to procure [trade secrets],” as the Texas Supreme Court observed in its 1958 opinion, K & G Tool Co. v. G & G Fishing Tool Services. As that court noted, this rule arises from the “well-recognized objective of equity” to remedy “wrongful disregard of confidential relationships.”
Because the role of ESG executives involves the formation of strategies to satisfy investors, ratings agencies and regulators, these strategies also fall within the definition of inside information under the securities laws. Under what the securities case law describes as the “traditional” or “classical” theory, insider trading occurs when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a “deceptive device” under the securities laws because “a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation,” as the Supreme Court observed in Chiarella v. United States.
Misappropriation of trade secrets thus resembles the fiduciary duty rationale underlying insider trading law; indeed, as leading securities scholar Marc Steinberg has remarked, “in formulating principles of insider trading liability under federal law,” the Supreme Court has “rather ironically” applied principles of fiduciary duty liability under state law. For example, in United States v. O’Hagan, the court observed that “[a] fiduciary who ‘[pretends] loyalty to the principal while secretly converting the principal’s information for personal gain … ‘dupes’ or defrauds the principal. A company’s confidential information …qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information, in violation of a fiduciary dutyconstitutes fraud akin to embezzlement. …”
The O’Hagan court relied heavily on Professor Barbara Aldave’s article, “Misappropriation: A General Theory of Liability for Trading on Nonpublic Information,” which in turn discussed a 1942 case, United States v. Proctor & Gamble Co., in which the government charged Proctor & Gamble with mail fraud for paying bribes to employees of a competitor in exchange for trade secrets. As that court explained, “[t]he normal relationship of employer and employee implies that the employee with be loyal and honest in all his actions with or on behalf of his employer, and that he will not wrongfully divulge to others the confidential information, trade secrets, etc., belonging to his employer.”
Consider further the trade secrets at issue in a landmark insider-trading case, 1968’s SEC v. Texas Gulf Sulphur Co. The executives bought shares while in possession of material inside information. That inside information involved knowledge that the executives’ company, Texas Gulf Sulphur, had discovered the probable existence of valuable minerals in certain Canadian real estate. The SEC sued the executives and prevailed against most of them for their trading on this information before it became known to the public. As a famous account of the case in John Brooks’ Business Adventures: Twelve Classic Tales from the World of Wall Street explained, the enforcement action reflected “[f]or the first time in the history of the world, the effort would have to be made, in Wall Street, to conduct a stock market without the use of a stacked deck.”
Little question exists that the inside information in Texas Gulf Sulphur constituted trade secrets, as prominent fiduciary-duty scholar Tamar Frankel and others have observed in their analyses of this seminal decision. If the insiders in Texas Gulf Sulphur had left their jobs, joined a competitor and used that knowledge to buy up that real estate in their new employer’s name, this would have constituted a “use” of those trade secrets constituting misappropriation under DTSA and TUTSA. If these former employees shared this inside information with their new employer as a competitor, that sharing would constitute a misappropriation under the “disclosure” provisions under DTSA and TUTSA. And if the competitor procured the information through corporate espionage (whether or not from employees of the first company), that conduct would constitute misappropriation under the “acquisition” provisions of the DTSA and TUTSA.
Thus, just as the nonpublic geological information at issue in Texas Gulf Sulphur can constitute trade secrets, so too can the growing categories of ESG information and strategies emerging in today’s capital markets in which fierce competition exists for investor capital. For example, a company may develop multiple separate ESG initiatives including a transition away from diesel-powered fleet to a natural-gas-powered one, a relocation of facilities from areas at risk for flooding from climate change, and opening a healthcare facility in a developing nation in which it does business. The company may formulate a strategy to time its announcement of these divergent initiatives for maximum impact with investors and ESG rating agencies. Imagine an employee knowledgeable about these strategies who decides to leave and share this information with a competitor before it becomes public. That employee risks facing a trade secret lawsuit for misappropriation through “use” of this information and “disclosure” of it to his or her new employer.
These acts of misappropriation under trade secret law resemble “tipper” liability in insider trading law, so long as the “tipper” receives some sort of benefit, defined broadly in cases such as Salman v. United States. And the employee’s new employer risks becoming a defendant for “acquiring” and “using” that sensitive strategic information, becoming, in the language of insider trading law, the functional equivalent of a “tippee” – the recipient of a “tip.” As the U.S. Supreme Court noted in Dirks v. SEC, “a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing this information to the tippee and the tippee knows or should know that there has been a breach.” And the tipper must “personally… benefit, directly or indirectly, from [her] disclosures.”
Moreover, trade secrets law, just like insider trading law, includes nontechnical strategic information and not merely computer data, chemical formulae and the like. For example, a 2021 Dallas Court of Appeals decision, Retail Services Corp. v. Crossmark, Inc., describes how “playbook” and other “strategy” information, in the words of a witness for the plaintiff, “would give a competitor insight into what we’re working on and an opportunity to cut corners and create a shortcut to allow them to be able to compete effectively and potentially even, you know, take it further faster than we are.”
In sum, depending on the value of the secret information, a company that “acquires” or “uses” confidential ESG information from a competitor could gain a “massive head start” and avoid the burden of “reinventing” its own ESG strategy – playing with a “stacked deck” – because it would mimic that of its competitor thanks to the misappropriation of the employee. In the right circumstances, ESG can become a trade secret.
David Bissinger is a founding partner of Bissinger, Oshman, Williams & Strasburger in Houston. He devotes his practice to complex commercial trials, arbitrations and investigations. A substantial portion of his practice involves trade-secret, employment-covenant, securities and fiduciary duty disputes.