The still commonly used but politically incorrect “patent troll” epithet was barely heard throughout eight hours of lively dialogue at this past Monday’s FTC-DOJ Workshop on Patent Assertion Entity Activities. The day was devoted to an exploration of “the impact of patent assertion entity (PAE) activities on innovation and competition and the implications for antitrust enforcement and policy”; the workshop was organized to “examine the economic and legal implications of PAE activity, as distinguished from prototypical ‘non-practicing entity’ (NPE) activity, such as developing and transferring technology.”[1] Put another way, the targets or potential targets of attack excluded universities, garage inventors and other such engines of innovation. The focus was upon entities that only purchase patents from existing owners and thereafter seek to maximize revenues through licensing or litigating against manufacturers that are already using the patented technology.

Those PAEs were well represented and robustly defended by a fair share of thirty-two speakers at the event. So were, however, operating companies -- large and small -- that deem themselves victims of PAE predations. Speakers included distinguished academics who have done extensive research into this phenomenon as well as patent and antitrust practitioners who have confronted PAEs in litigated cases. By day’s end, the agencies had before them a record that may well invite and support provocative antitrust interventions against some of the most harmful PAE practices that have surfaced within the past two or three years.

Here is my brief summary of the highlights and observations on them:

  1. Speakers who have studied PAE developments presented data showing a dramatic rise in both absolute numbers of PAE lawsuits and their share of all patent enforcement activity in recent years. According to one prominent study, for example, PAE-initiated patent suits increased from 569 new cases in 2006 to 2544 new cases in 2012 through December 1; and from 19% of all new patent suits in 2006 to more than 60% of all new patent suits in 2012 through December 1.[2] FTC Chairman Jon Leibowitz, in his opening remarks, cited an estimate to the effect that “PAE-generated revenue cost defendants and licensees $29 billion in 2011, a 400% increase from 2005”; the source of that estimate calculated that “no more than 25% of this flowed back to innovation. Almost like lobbying in Washington, D.C., 75% was deadweight loss!”[3] He then provocatively raised the question whether PAEs are “driving us off a patent cliff.”[4]
  2. Notwithstanding those initial fighting words, two prominent scholars -- Colleen Chien and Carl Shapiro -- set the stage for more balanced perspectives that characterized most of the presentations over the rest of the day. As they presented the analytical framework, the fundamental issue is whether the net effect is good or bad for innovation generally. A proposed theme was “follow the money” -- which parties bear most of the costs, which parties garner most of the benefits.[5] On the one hand, PAEs efficiently “monetize” patents, particularly for the benefit of inventive start-ups and smaller companies lacking the resources to undertake their own enforcement efforts. PAEs achieve “economies of scale” in patent evaluation, licensing and associated litigation activity. On the other hand, PAEs also assert their patents against small companies lacking the resources to resist the demands and threats they face. PAEs also attack large companies with nuisance suits that divert resources away from R&D budgets. Their tactics and indeed whole business model simultaneously lower costs of assertion and raise costs of defense.
  3. These scholars also highlighted the fact that, since PAEs are not operating companies that make and sell their own products, their litigation and other assertion incentives are not constrained by exposure to counterclaims or reputational effects of abusive practices. They concentrate upon older patents and situations where the technology at issue is deeply entrenched in existing products, thereby enabling “ex post holdup” license demands. They have effectively exploited longstanding flaws in the patent system, particularly ambiguities in patent scope; they have also learned how to manipulate large patent portfolios to facilitate enforcement of weak patents and how to multiply successful holdup demands by dividing up those aggregations with the benefit of obfuscation regarding what is included in each resulting subaggregation.
  4. There was a major panel discussion on “Realities of Licensing and Litigation Practices” among representatives of both operating companies and PAEs. It evolved into a spirited exchange of contrasting narratives. So, for example, on the operating company side:
  • Hewlett-Packard’s Cynthia Bright reported that PAEs account for 60% of HP’s current docket of 50 pending patent suits. She was particularly critical of PAEs’ resort to the International Trade Commission for exclusion orders, which “doesn’t make any sense” since PAEs only care about license revenues so the orders are pursued solely “for holdup leverage.” Her take was that “the ITC needs to reform itself,” the PTO needs to continue its focus on patent quality and the antitrust agencies should continue their focus on abusive remedies.
  • Cisco’s Neal Rubin reported that his company spends twice as much on PAE litigation as it spends on R&D. He urged an FTC/DOJ focus on three emerging “anticompetitive” trends in PAE assertion strategies: (a) going after operating companies’ downstream customers; (b) demanding total portfolio licenses with overhanging threats of seriatim suits, particularly when the portfolios are a combination of standard-essential patents (SEPs) and non-SEPs; and (c) refusing to disclose what patents the PAE owns, exacerbating uncertainties as to whether the operating company is getting what it needs for patent peace.[6]
  • Rackspace’s Mary Stich presented her company as a prime example of the way PAEs attack smaller companies that cannot afford to litigate. She reported that 90% of Rackspace’s 2012 litigation expense was on PAE suits; and she opined that PAE lawsuits “are the single greatest threat to open source innovation.”

From the PAE side:

  • Intellectual Ventures’ Peter Detkin described his enterprise as one that “invests in inventions,” raising funds to support the innovation efforts of its operating company partners. He agrees on the need for reform of remedies and more work on improving patent quality and believes those priorities should not be diluted by unhelpful focus upon the form or identity of the party responsible for an assertion.
  • Mosaid’s Scott Burt described his enterprise as focused upon “IP management” on behalf of operating company partners such as Nokia in particular. Indeed, Nokia’s Paul Melin was also on the panel and he supported that Mosaid description. He said Nokia sees PAEs such as Mosaid as important to its ability to monetize its own patent investments. He estimated that 70-80% of proceeds that Nokia receives from PAEs go back into innovation investments. In this light, “the patent system is working the way it is intended to work.”
  • RPX’s Mallun Yen described his enterprise as in the business of “defensive patent aggregation” that should not be lumped together with PAEs. RPX buys up patents to keep them out of the hands of PAEs that might otherwise acquire and assert them against RPX’s 125 company members. Every such member receives licenses to all patents acquired and RPX does not assert its patents against outsiders. He described this as a form of “insurance” that reduces patent infringement risk.
  1. The afternoon session began with remarks from Stuart Graham, Chief Economist for the U.S. Patent and Trademark Office. He discussed the PTO’s current initiatives to increase transparency on patent ownership and on ownership transfers. He emphasized that “markets operate most efficiently when buyers and sellers can find each other” and the PTO itself needs better information regarding “real parties in interest” on applications as well as on issued patents. He called attention to the PTO’s planned January 11, 2013, roundtable on how to collect and disseminate this information, a program for which the PTO remains open to requests for participation. As noted above, Cisco has challenged the way PAEs “hide the ball” on this front. Several other speakers also complained about this transparency problem; indeed FTC Chairman Leibowitz even suggested that PAEs’ refusal to disclose meaningful ownership information could amount to an “unfair” or “deceptive” act or practice under Section 5 of the FTC Act and could, therefore, be subject to an FTC rulemaking proceeding.
  2. Much of the rest of the afternoon was consumed by speakers and associated panels elaborating upon potential benefits versus potential harms from PAE activity. This was a bit repetitive of the morning presentations but did provide some additional perspectives on each side of the PAE equation. Speakers, for example, identified lower search and bargaining costs as among the efficiencies of PAEs’ portfolio aggregation efforts; the way PAEs increase patent “liquidity” and thereby increase innovation incentives; PAEs’ role as “arbitragers” that increase competition in the patent market; and the need for PAEs to overcome the common refusal of large technology companies to negotiate with startups or other smaller patent owners. On the other side, speakers discussed the negative effects of systematic overcompensation, resource diversion and “unpooling”; how the difficulty of knowing what many patents cover makes markets ripe for PAE abuses; and how those abuses are prevalent in particular with regard to inherently vague software and business method patents.
  3. The headline for the final session was on “How Does Antitrust Apply to the Potential Efficiencies and Harms Generated by PAE Activity” and that was surely the central question on all or most attendees’ minds from the outset of the workshop. Several speakers over the course of the day commented that antitrust cannot fix longstanding flaws in the patent system that PAEs have so successfully exploited or observed that “mere assertion” of a patent claim cannot be an antitrust violation. Speakers in the final session, however, focused in particular on PAEs’ patent acquisition activity and related agreements between PAEs and the operating companies selling the patents to them. These elements may trigger application of both Section 7 of the Clayton Act, which prohibits acquisitions that may substantially lessen competition, and Section 1 of the Sherman Act, which prohibits agreements in unreasonable restraint of trade.
  4. Several hypotheticals or “scenarios” were presented for discussion of those possibilities. One focus was on a PAE’s acquisition of a substantial patent portfolio from an operating company that thereby enabled the PAE to exercise market power through aggressive patent enforcement to an extent beyond what the operating company could exercise on its own: the operating company was constrained by its vulnerability to counterclaims and reputational effects; the PAE was free of those constraints. The acquisition thereby conferred both ability and incentive upon the PAE to “raise rivals’ costs” -- the rivals of the operating company -- to an extent materially beyond the pre-transaction ability and incentive of that company. The panelists were divided on whether that effect would suffice for a Section 7 violation. Several speakers, however, endorsed that theory as consistent with recent vertical merger enforcement cases that have relied on merger-specific changes in ability and incentive to exclude or discriminate against competitors in an affected market space.[7]
  5. Another scenario: two or more operating companies agreeing on a plan under which they share in the rewards of a substantial patent transfer to a PAE amenable to following their directions on its patent enforcement strategies. There was a strong consensus among the panelists that this is a scenario readily susceptible to scrutiny under both Section 7 of the Clayton Act and Section 1 of the Sherman Act, particularly if the operating company participants are competitors of each other in an affected product or technology market. In essence, this entails horizontal coordination to raise rivals’ costs and potentially to exclude rivals altogether. One speaker argued that this scenario captures the essence of a recently constructed arrangement among Microsoft, Nokia and Mosaid under which both Microsoft and Nokia transferred ownership of major wireless device patent portfolios to Mosaid subject to revenue-sharing on Mosaid’s enforcement activity directed at wireless device competitors. Google has reportedly complained to the antitrust authorities in both the United States and Europe about this arrangement.
  6. One variation upon that picture is two or more operating companies jointly creating a PAE whose interests align with those companies and to which patent portfolios are transferred, again aimed at a raising rivals’ costs result. While not mentioned in the workshop discussion, the consortium formed among Apple, Microsoft, RIM and others to acquire 6,000 patents from the Nortel bankruptcy estate would seem to fit that bill. DOJ cleared that transaction this past February in reliance upon Apple’s and Microsoft’s pledges to adhere to Nortel’s existing RAND commitments to standard-setting organizations (SSOs) in connection with a large array of standard-essential patents (SEPs) in the portfolio.[8] But only 2,000 of the 6,000 patents have been transferred to the consortium owners. The CEO of the consortium, which retains ownership of the other 4,000 patents and is thus now a powerful PAE, has publicly disavowed any allegiance to those RAND pledges and sees his mission as maximizing revenues for the consortium owners.[9]
  7. What about simpler but nonetheless threatening scenarios under which a PAE makes its own series of patent acquisitions from several different owners, thereby creating a huge portfolio that enables aggressive enforcement activity beyond anything possible prior to that aggregation exercise? Some of the speakers alluded to the possibility of applying Section 7 -- or Section 5 of the FTC Act -- to that activity. There is at least one provocative precedent in this regard that is referenced in a speech delivered by DOJ’s Chief Economist, Fiona Scott-Morton, five days before the agencies’ workshop. Most of the speech was about anticompetitive uses of standard-essential patents but, as she stated, “[p]atents that are not essential to practice a standard are numerous and vary greatly in strength”; “[t]hose with market power can be used in anticompetitive ways”; and “acquisitions of patents can violate the antitrust laws.” She then cited to an FTC complaint and consent order regarding the 1997 Ciba-Geigy/Sandoz merger, challenged because it would “‘heighten barriers to entry by combining portfolios of patents and patent applications of uncertain breadth and validity, requiring potential entrants to invent around or declare invalid a greater array of patents.’”[10]
  8. In the final hour there were myriad references to other agency actions and statements in recent years that could also support innovative challenges to an array of PAE activities. One reference was to the FTC’s use of both prongs of its Section 5 authority -- “unfair methods of competition” and “unfair acts or practices” -- to challenge an acquirer of standard-essential patents that sought to repudiate license commitments made to an SSO by the original owner.[11] Another was to the whole array of recent agency oppositions to demands for injunctive relief or ITC exclusion orders by owners of standard-essential patents subject to RAND commitments.[12] Perhaps the most provocative reference was to a 2008 statement by FTC Commissioner Tom Rosch urging a challenge to Ovation’s acquisition of a drug from Merck because it eliminated “reputational constraints” that would have prevented Merck from dramatically increasing the drug’s price, as did occur after the acquisition.[13]

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The agencies are inviting written comments from all interested parties on all of the issues discussed in the course of the workshop with a deadline of March 10, 2013. All indications are that both agencies want to develop and pursue enforcement strategies that will meaningfully address anticompetitive aspects of PAE activity.