Thursday, March 19, 2015

Regulating Secrecy

Guest Blogger

Nicholson Price

For the Innovation Law Beyond IP 2 conference, March 28-29 at Yale Law School

Many inventors who wish to protect their inventions from imitators are faced with a choice: do they rely on trade secrecy or patents?  The literature has explored how inventors make this choice—when they are likely to choose trade secrecy, when they should choose trade secrecy from an individual perspective, when we as a society would prefer that they choose patents (or trade secrecy)—and how to shape incentives and the rules of trade secrecy and patentability to help drive that choice in socially optimal directions.  But trade secrecy and patent law do not operate in a vacuum, and one strong interaction that has been underexplored is how these incentives are affected by regulatory oversight, and how that oversight can change the incentives to choose between the two.  In particular, I argue that way regulation strengthens trade secrecy is complex and is overlooked in current policy debates, and that regulatory regimes should act deliberately to reduce secrecy in heavily regulated industries.

When I say “regulatory oversight,” I am thinking principally about heavily regulated industries, with strict oversight and, typically, a market gatekeeper (though I think the insights may also apply in other regulated contexts).  The paradigmatic example is the Food and Drug Administration’s oversight of new drugs: the FDA determines which drugs can be examined in clinical trials and allowed onto the market.  It also regulates when and how drugs are manufactured, how drugs are marketed, when they can be removed from the market, and when and how competitors can enter the market.  Other similarly regulated regimes include pesticides, medical devices, and biologics, and to a lesser degree, aerospace, nuclear energy, and military tech/procurement.

In these contexts, IP protection often becomes more powerful by its link to the regulatory benefit under three conditions:

  1. When the regulator defines some aspect of a product;
  2. When that regulatory definition is tied to a regulatory benefit (or the absence of a regulatory cost);
  3. and when that aspect is protected by either patents or trade secrecy.
This more powerful protection is often unnoticed and socially unhelpful. The most common example of this pattern is patent protection for FDA approved drugs.  As Ben Roin and others have argued, one reason patents on drugs are so powerful is because the FDA pre-approval regime makes it very costly to invent around those patents: using a similar but not identical chemical requires going through the whole costly approval process again. 

When regulation strengthens patents as in the FDA example, it’s usually relatively transparent, so we sometimes see policy interventions designed to undo this strengthening interaction.  For drugs, the Hatch-Waxman Act takes three steps to balance this strengthening:
  1. It makes it attractive for generic companies to challenge drug patents;
  2. It immunizes firms from patent infringement lawsuits while they prepare for FDA submission; and
  3. It creates an easier regulatory approval path for generic drugs.
But the interaction of regulation with trade secrecy is harder to see and harder to address.  When a trade-secret aspect of a product—whether a product characteristic itself or a manufacturing process that results in a hard-to-duplicate product characteristic—is kept as a trade secret, and a powerful regulatory definition is linked to that aspect, the trade secrecy is similarly empowered.  For instance, when a drug’s manufacturing characteristics (e.g., dissolution speed or molecular weight profile for complex mixtures) result from secret manufacturing methods, demonstrating similarity to the FDA requires cracking a trade secret.

More generally, regulation can remove some of the limitations of trade secrecy (like challenges in enforcement) and build upon some of its benefits (like indefinite duration), which may push firms away from patents and toward secrecy.  Dealing with this type of interaction is harder, because everything is, unsurprisingly, secret.  As a result, policy reactions are absent.

One way around this is to mandate disclosure in heavily regulated industries.  Regulators have some advantages in driving disclosure; they demand and receive candor more than obfuscation, especially powerful regulators like FDA.  This also helps get around the disclosure problems in patents, as regulatory disclosure is likely to be more useful in actually disclosing innovation-facilitating information.

Disclosure in heavily regulated industries can also have some ancillary benefits, such as general transparency, distributed oversight, and even increased labor mobility.  In terms of incentives and political economy, regulatory disclosure could be coupled with regulatory exclusivity, whether mandated or voluntary.  In essence, if regulation is creating innovation problems, regulation can also provide the potential solution of regulator-facilitated disclosure.

Nicholson Price is Assistant Professor of Law at the University of New Hampshire School of Law.  He welcomes comments on this ongoing project and can be reached at nicholson.price at


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