Forbes: Will patent reform aid or cripple companies and investors?, by Christopher Versace
This article originally appeared in Forbes on November 12, 2013.
One would think that developing, manufacturing, marketing and distributing a product and doing it well would ensure at least some measured degree of success. However, as products become increasingly digital, containing an amalgamation of patented technology, changes in patent laws are creating new uncertainty for investors and if some in Congress have their way, it could get worse.
A great example of this has been the smartphone market. As the mobile industry transitioned from the mobile phones, which was dominated by Nokia , Samsung, Motorola (now Motorola Mobility owned by Google), and LG, to the smartphone industry, a slew of new technologies were developed while others were incorporated. Wireless technologies, such as WiFi, 3G and soon 4G technologies, but also camera and related zoom technologies developed by the likes of Eastman Kodak, Internet browsing, push email, over the air synchronization, and so on.
As the smartphone became the technology equivalent of the Swiss Army knife, companies that developed some of these technologies, capabilities and processes felt they should be compensated for their intellectual property. Historically wireless technology companies cross-licensed technology and patents from one another, but my view was that as mobile devices embedded a greater array of capabilities and technologies (connectivity, imaging, sound and the like) patent infringement cases would escalate. And it did. Soon we had companies like Apple, Samsung, Google, Motorola, Blackberry, Nokia, InterDigital, Eastman Kodak and a host of others filing suit against one another.
Companies also started to bulk up on their patent portfolio. In July 2011 a consortium led by Apple, Blackberry, Microsoft and included Sony , Ericsson and EMC agreed buy from the bankrupt Nortel Corp. access to more than 6,000 patents covering key telecommunications technologies, from Internet services to wireless data networking. In total, that group paid $4.5 billion for that patent pool.
More recently, Google acquired Motorola Mobility for $12.5 billion. While some thought Google bought the company to improve its overall position in the smartphone market, the real target was Motorola’s patent portfolio. That portfolio and Google’s ability to use that portfolio as an umbrella for those companies offering Android powered devices was a key strategic factor behind the Motorola Mobility acquisition.
There are a few reasons why these companies have bulked up. One is to hinder new product introductions by competitors. We’ve seen plenty of headlines back and forth between Apple and Samsung to that effect. Another is the simple fact that there is big and wildly profitable money to be made. According to Nomura analyst Rick Sherlund, Microsoft is generating $2 billion per year in revenue from Android patent royalties with a 95% margin.
From an investor perspective, patent lawsuits are not only be a distraction, but the outcome is uncertain. Following the sale of Nortel’s patent portfolio, the management team of InterDigital put the company into play, but ultimately no transaction was had, which implies there was a mismatch between the value of its patent portfolio assigned by the company and the marketplace. During that short period, InterDigital’s shares rose to $75 from $35 before settling back around $40.
Apple lost a lawsuit against a patent- licensing firm VirnetX Holding and was ordered to pay $368.2 million in damages in late 2012, which pooped the shares. VirnetX Holding sued Apple for infringing on its collection of network patents that Apple has been accused of incorporating into products like FaceTime. This past March, however, VirnetX lost an infringement trial against Cisco Systems over virtual private network inventions and its shares fell to just over $16 from $35.
Around the time of Nortel’s patent auction, Congress passed the America Invents Act, a major update to patent law. This law moved America from a “first to invent” system to a “first to file” system. First to file is the international standard but it opened the floodgates to what has come to be known as “patent trolls”. These entities buy up unused or unenforced patents for the express purpose of generating copyright infringement litigation. According to PWC’s 2013 Patent Litigation Study, the number of patent lawsuits spiked by 20% in 2012 to 5,000.
While companies should be able to defend the use of their inventions and intellectual property, the offensive shift in how patents are used has had several negative impacts including slowing the speed of innovation, stifling competition and mounting legal fees to battle patent trolls that could have been used to add employees that have made it a drag on the economy. Boston-based mobile payments firm LevelUp is currently in the middle of three separate patent infringement lawsuits brought by patent trolls. Because the company has been forced to allocate hundreds of thousands of dollars to legal fees it has had to forego hiring more employees.
It’s not just LevelUp. According to a recent National Venture Capital Association study, over one-third of start-up companies have faced patent assertion litigation. In addition, over 70% of venture capitalists surveyed claimed to have faced IP-related pressure. While the IT industry was the frontrunner in this, the runner-ups were the life sciences and clean tech industries.
The heyday of patent trolls, however, could be coming to an end. Congressman Robert Goodlatte (R-VA), Chairman of the Judiciary Committee has introduced legislation, The Innovation Act that would transition the U.S. to a “loser pays” system in a patent suit. The act targets patent-licensing businesses that use infringement lawsuits as a major source of potential revenue. The bill requires companies suing for patent infringement to identify the patents and claims infringed in their initial court pleadings, making it harder for patent holders to file broad infringement claims. The legislation would also require patent holders filing lawsuits to disclose what groups have financial interest in the patent.
These changes that could bring more certainty and clarity to investors and that is a good thing. There are, however, factions seeking to widen the scope of the legislation that would actually offset these improvements and worsen the situation. Section 18 of 2011’s America Invents Act created a special, temporary program, called the Covered Business Method (CBM) review process by which certain limited financial services related patents could be challenged beyond the standard nine-month period. CBM was established for a limited time period in response to concerns that some technology in use in the financial services sector had been patentable since 1997.
As it is currently written, H.R. 3302 contains a provision that would expand CBM to cover all software containing “business processes” and makes it a permanent program. Most any software program contains business processes as defined by United States Patent and Trademark Office (USPTO). As a result, passing this provision would make most any technology patent open to challenge at any time during the full life of the patent. This would obviously be a source of uncertainty for investors but it’s not the worst of it.
The CBM review process creates a standard procedure that USPTO must follow when a review is requested. Part of that process is a standard 18-month review of the validity of the patent. During this review, all infringement claims and enforcement mechanisms are halted. These processes favor patent infringers by giving them an administrative safe harbor of 18 months. Patent owners–and investors–can only sit and watch while competing companies use their technology to gain market share and profit for at least a year and half. Rather than stopping patent trolls, this provision weakens the ability of legitimate patent holders to defend their inventions and creates unprecedented uncertainty for investors by creating yet another avenue for the offensive use of patents.
The Innovation Act is set to be considered in the Judiciary Committee later this month. Congress has an opportunity to remedy this by removing the Section 18 language and hopefully they will. However, this issue is one that investors will need to continue to monitor.
Representative Darrell Issa and Judy Chu, both of whom represent California, recently introduced a bill separate from the Goodlatte bill, but similar, that would expand the categories of patents that can be reviewed in cases of patent litigation. The Issa-Chu measure mirrors proposals by Sen. Chuck Schumer and the White House. Schumer’s bill includes software in the “covered business method” provision, and the White House has recommended adding a broader category of “computer-enabled patents” and permitting a wider range of challengers to petition for review of issued patents.
From smart phones to clean energy products, innovation and new product development is a key driver of growth. As we have seen with Apple’s iPhone and a number of key technologies included in that device, innovation will continue to be driven by patentable technology and processes. Odds are Congress is likely to continue tinkering with patent law. In some instances such as addressing patent trolls this will help investors. In others such as the attempt to expand CBM, it could hurt. For companies like VirnetX Holding VHC, Vringo, and Acacia Research, it could make the shares even more volatile than they have been in the past.
As always, it pays for investors to keep an eye on governmental and regulatory actions. In the case of CBM, a hand has been tipped and gives investors a direction to watch.