FTC finds Negotiated Data Solutions liable based on Section 5 of the FTC Act.

Invoking its authority under the FTC Act to prevent unfair methods of competition and deceptive practices, the Federal Trade Commission (FTC) has voted 3-2 to accept a settlement with Negotiated Data Solutions LLC (N-Data), the owner of patents for Ethernet technology. According to the complaint, N-Data violated Section 5 of the FTC Act by attempting to collect high royalties on its Ethernet technology patents even though the previous patent holder had made a commitment to a standard setting body to license its patents for a lower, one-time royalty.

Significantly, the FTC did not make a concurrent finding that N-Data’s conduct constituted a Sherman Act violation, but rather found N-Data liable based on Section 5 of the FTC Act alone. The majority emphasized that its challenge of N-Data’s behavior is appropriate to prevent exploitation by patent owners of industry lock-in to particular technologies.

Chairman Majoras and Commissioner Kovacic disagreed with the majority, finding that the facts do not support a finding of antitrust liability or justify the use of the FTC’s stand-alone Section 5 authority. As Chairman Majoras emphasized, the FTC has traditionally limited the scope of its authority under Section 5 to conduct that falls just short of a Sherman Act violation. In this case, however, there is “substantial question” as to whether N-Data possesses market power, let alone monopoly power, and there are no allegations that the former patent holder used improper conduct to encourage the adoption of its technology in the relevant standards. Thus, Chairman Majoras cautioned that the majority has not articulated meaningful guidelines to put parties on notice of what conduct constitutes an unfair method of competition under Section 5 of the FTC Act.

Background

The Ethernet patents at issue were previously owned by National Semiconductor Corporation (National). The FTC’s complaint alleges that in 1994, National committed to the Institute of Electrical and Electronics Engineers (IEEE), an electronics industry standard setting organization, that if its “NWay” Ethernet technology was incorporated into the IEEE’s Ethernet standard, National would offer to license its technology for a one-time royalty of $1,000. The IEEE subsequently relied on this representation and adopted a standard in 1995 based on the NWay technology; since then, the standard and technology have been incorporated into hundreds of millions of computers and equipment.

As the complaint alleges, N-Data was familiar with National’s licensing commitment when it acquired the patents. Nevertheless, N-Data allegedly demanded royalties for its technology substantially greater than the one-time, $1,000 fee that National previously offered.

Harm and Violations Alleged

The FTC found that even if N-Data’s conduct is not a Sherman Act violation, it threatened to raise prices for consumers of products employing NWay technology and to undermine the viability of the standard setting process. The complaint alleges that N-Data’s conduct harms competition because it decreases the incentive of equipment manufacturers to participate in the development of standard setting activities and decreases industry members’ willingness to rely on standards adopted by standards setting organizations.

N-Data’s conduct, the FTC claims, violates the FTC Act’s prohibition against unfair methods of competition and unfair acts or practices affecting commerce. See 15 U.S.C. § 45(a)(1). The FTC determined that N-Data’s efforts to seek higher royalties for its Ethernet technology are “coercive” and “oppressive” with respect to firms that are effectively locked into the Ethernet standard. The FTC also stated that while merely reneging on a licensing commitment does not constitute an unfair practice under the FTC Act, the FTC considered the standard setting context in which National made its licensing commitment to be an important factor in its decision to lodge a complaint. Recognizing that some will criticize the FTC’s broad application of its authority under the FTC Act, the FTC stated: “the cost of ignoring this particularly pernicious problem is too high. Using our statutory authority to its fullest extent is not only consistent with the Commission’s obligations, but also essential to preserving a free and dynamic marketplace.”

FTC Chairman Majoras disagreed with the majority’s finding, stating that the conditions for using the FTC’s Section 5 authority to find an unfair method of competition and deceptive practice were not present. She noted that unlike prior cases in which the FTC exercised its Section 5 authority, here there were no allegations that National engaged in exclusionary or improper conduct to induce IEEE to use the NWay technology in its Ethernet standards. Further, Chairman Majoras raised doubts about whether N-Data had market power, even after its technology was adopted by the IEEE standard. She pointed out that the NWay technology was an optional technique under the standard and that despite N-Data’s licensing efforts, only one company has paid materially more than the original $1,000 licensing fee. N-Data’s conduct, then, did not closely approach a Sherman Act violation. Chairman Majoras cautioned: “If the majority’s theory is that the evasion of contractual price constraints triggers liability under Section 5 without a concurrent determination that the conduct violates the Sherman Act, then we are headed down a slippery slope, and I take no comfort from the majority’s representation to the contrary.”

In addition, Chairman Majoras maintained that the FTC’s treatment of N-Data’s conduct as an unfair act or practice is inappropriate because N-Data’s actions did not result in harm directed at consumers, as contemplated by Section 5. Rather, any harm was directed at sophisticated computer manufacturers, that, Chairman Majoras asserts, should not be considered consumers under the statute.

Settlement

Pursuant to the settlement between the FTC and N-Data, N-Data will be prohibited from enforcing its Ethernet patents unless it has first offered potential licensees a patent license agreement based on the terms offered in 1994, that is, a paid-up, royalty-free license in exchange for a one-time fee of $1,000. The FTC’s order is now subject to public comment for 30 days, following which the FTC will determine whether to make it final.