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Customer List: Not Necessarily a Trade Secret

In a recent opinion, the Arizona Court of Appeals reaffirms that "only those secrets 'affording a demonstrable competitive advantage' will qualify" as a protected trade secret

It is most business owners' nightmare: An employee with access to customer lists leaves the company to join a competitor, or to go into business for himself, and begins soliciting his ex-employer's customers. With its future possibly at stake, what trade secret protection is available to the victimized company?

As the recent Arizona Court of Appeals ruling in Calisi v. United Financial Services confirms, the law affords little protection if the former employer has not taken appropriate steps to ensure that its customer list qualifies as a "trade secret."

Background

For three years, Michael Calisi, CPA, was an employee in a Phoenix-area office of United Financial Services (UFS), a multi-state firm that provides tax return preparation, financial planning and other professional services.

On January 28, 2009, Calisi left UFS (whether he resigned or was fired was a matter of dispute) and became the in-house CPA at an Arizona mortgage company owned by Daryle Messina. For much of the time of Calisi's employment, UFS maintained a mutual referral arrangement with Messina's company. Five days after leaving UFS, Messina's company sent out a mass email to more than 2,000 clients to announce Calisi's arrival and to offer discounted tax preparation services. Among the recipients of the email were some clients of UFS.

Later, Calisi left Messina and started a tax services firm. Calisi also sued UFS for unpaid commissions and other compensation. UFS countersued, alleging various claims against Calisi, including misappropriation of trade secrets related to his alleged use of UFS's customer list.

Before trial, the court ordered Calisi to produce a list of former UFS clients who had moved their business from UFS to Calisi's firm. The list consisted of 48 clients who had paid Calisi approximately $50,000 after he left UFS. At trial, Calisi testified that he had directly worked with several of them while he was at UFS.

After a three-day bench trial, the court ordered UFS to pay to Calisi the improperly withheld compensation totaling almost $44,000. At the same time, the court found that Calisi had misappropriated UFS's customer list and ordered him to pay UFS $51,600 on UFS's trade secret claim.

Appeal

Calisi appealed the trial court's order on the trade secret claim, arguing that UFS failed to present any evidence that he had misappropriated a legally enforceable trade secret, i.e., UFS's customer list.

The Court of Appeals agreed with Calisi. In reversing the trial court's ruling on the trade secret issue, and noting that making such a determination "is a mixed question of law and fact," the Court provided a useful set of criteria for determining when and whether the third-party use of a customer list constitutes misappropriation of trade secrets. Here are some of the highlights:

Under the Uniform Trade Secrets Act (UTSA), which Arizona has adopted, a "trade secret" is information that:

  • "derives economic value … from not being generally known to, and not being readily ascertainable by … other persons who can obtain economic value from its disclosure or use;" and

  • "is the subject of [reasonable] efforts … to maintain its secrecy."

Stated more simply, the subject matter must be a secret, and the owner must have tried to keep it a secret.

Specific to customer lists, the Court cited several factors to determine whether a customer list qualifies as a trade secret.

  • A customer list may be entitled to trade secret protection when it represents a "selective accumulation of detailed, valuable information about customers – such as their particular needs, preferences, or characteristics – that naturally 'would not occur to persons in the trade or business.'"

In other words, a qualifying customer list must be something more than a list of names, addresses and phone numbers. It must contain information that a company compiles by virtue of its relationship with the customer, not simply by gathering required contact information or purchasing a commercial list of prospects that meet the profile of the company's customers.

  • A customer list may also be entitled to trade secret protection if the company that owns the list shows that it compiled the list by "expending substantial efforts to identify and cultivate its customer base, such that it would be difficult for a competitor to acquire or duplicate the same information."

  • A related factor is whether the information contained in the customer list "derives independent economic value from its secrecy, and gives the holder of the list a demonstrable competitive advantage over others in the industry."

  • In addition, courts have considered the extent to which the company divulged its customer list externally and internally, i.e., to people outside of its business as well as to its own employees. If the company does not treat the list as confidential, then neither will the courts.

In the Calisi case, UFS's claim for trade secret protection was hamstrung by the fact that, at trial, UFS did not present evidence actually describing the confidential customer information it argued constituted a trade secret. UFS attempted to cross-sell financial products to its tax clients by using information gleaned from their tax returns, but the company failed to show that it had actually acquired any specialized, valuable information about its customers, such as information concerning their financial requirements, tax strategies, investment objectives, and risk and investment preferences, that could give rise to trade secret protection under the law.

The Court noted that the record was "completely silent" about "the cost, time, frequency and success rate" of UFS's advertising and marketing methods. The Court therefore found that, because UFS did not explain what unique and original information it had acquired in the course of its business, or show it had invested substantial time and effort to acquire information unknown to its competitors, it failed to meet its burden of proving its customer lists were a trade secret.

Citing its 1999 ruling in Enterprise Leasing Co. of Phoenix v. Ehmke, the Court reaffirmed that "not every commercial secret will be a trade secret; only those secrets 'affording a demonstrable competitive advantage' will qualify."

Further undermining UFS's position was its failure to demonstrate that it had actually treated its customer lists as a secret. As evidence of the lack of secrecy, Messina had testified at trial that he knew the identity of several UFS clients, in part through the years-long mutual referral arrangement that his company and UFS maintained. Their joint marketing efforts resulted in an overlap in clientele, and he had included these overlapping clients in the mass email he sent out announcing Calisi's association with his company. Further, at trial Calisi testified that Messina had "flagged" customers in his database who were also UFS clients. Thus, Calisi could have readily and independently ascertained UFS clients through Messina.

The Court noted, "although secrecy does not need to be absolute, the claimant must nevertheless show 'it made reasonable efforts to maintain the secrecy of the information such as to ensure that it would be difficult for others to discover the information without using improper means.'"

Protection

To gain trade secret protection for its customer list, a company would be prudent in taking these cues from the Court's Calisi ruling:

  • Include in the customer list more than mere contact information. Other fields might include types of services provided, notes from client meetings and phone calls, billing histories, reminders about client preferences regarding how they are to be served and communicated with, notes about plans for future products and services to be purchased, etc.

  • Gathering the additional information should be the result of an intentional process that goes beyond basic, routine information gathering.

  • Maintain records of the marketing methods used to build a client list as well as the success rate of those methods. By having a record of the expense and effort that goes into building a client list, a company will be in a better position to protect that list as a trade secret.

  • Communicate to all employees the secret nature of client information and ensure that only those employees requiring the information to perform their functions are granted access. Such communication should be included in the employee manual, new employee training, periodic reminders, and continuing education.

  • Vendors and consultants should be required to sign an acknowledgement regarding the confidentiality of customer information to which they may be exposed.