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Wednesday, April 10, 2013

Tom Ewing on Patent Assertion Entities

Posted by Tom Ewing

Which factors in the patent system and high-tech economy have led to the increase in PAE activity? Who has benefited?

Tom Ewing (Avancept LLC)

The contemporary increase in PAE activity arises from the combination of several complementary factors.  The factors that will be discussed below are:

  1. The maturity of the PAE business model.
  2. The acceptance of intellectual property as an asset class.
  3. The surge of patent issuances in the pro-patent era.

Many of these contributing factors themselves arose from the exuberance of the early pro-patent era that began in the early 1980s.  The factors often cited for the rise of the pro-patent era are: 1) the creation of the Court of Appeals for the Federal Circuit with its exclusive jurisdiction over patent appeals, 2) the Bayh-Dole Act that simplified the process for universities to own patents arising from government-funded research, and 3) anecdotal stories about companies like Texas Instruments using patent licensing campaigns against competitors to return themselves to profitability.

The primary beneficiaries of increased PAE activity are the managers of PAEs and their investors.  Patent litigators on both plaintiff-side and defendant-side have also benefited, especially since PAE litigation now comprises such a heavy share of overall patent litigation.

1. The maturity of the PAE business model

The viability of the PAE business model was proved by the mid-1990s.  Most of the early PAEs began with limited capital resources.  These pioneers evolved a licensing/litigation scheme in which reasonable returns could be obtained with minimal cash expenditures. 

These early pioneers worked out how to exploit patents on a budget using contingency fee lawyers. They tended to hire licensing agents paid on a commission basis.  They also tended to take on small investors to handle litigation fees.  These steps dramatically reduced the out-of-pocket expenses for royalty collection while still leaving adequate returns for the effort.  For the early PAEs who already owned patent assets, this was just about all they needed to work out. 

The success of these early PAEs encouraged newer entrants who did not already own or control patents.  This next group worked out a revenue share model with patent owners, which allowed for the development of the modern PAE business model.  This second group also evolved patent targeting/acquisition techniques in order to obtain the set of patents that would provide the best returns during a licensing/litigation campaign.

The strengths of the PAE model comprise:

a)     Invulnerability to countersuit,

b)     No reputational considerations among other corporate actors,

c)     The expense of the US patent litigation system,

d)     The distractions caused by patent litigations among corporate actors,

e)     The ability of corporate actors to pass IP costs onto consumers,

f)      The corporate fear of severe consequences (e.g., injunction) for losing a patent
litigation, &

g)      The generally favorable view of patents by courts during the pro-patent era.

By the time the mass patent aggregators arrived in the early 2000s, the PAE business model had been completely worked out and ironically was not itself protected by IP.  The mass patent aggregators provided scale to the PAE business model which made the business model more attractive/available to investors.

This final step – the attraction of investment – ensured that the PAE business model would grow ever upwards, as it has.

2. The acceptance of intellectual property as an asset class

Promotion of the notion that intellectual property, particularly patents, comprised an asset class worthy of investment seems to have arisen in the early 1990s.  The result of this effort has become increasing interest by investors and their financial advisors in patents as a means for generating returns comparable to other investments.  A few wheel-healed investment firms have created their own initiatives involving intellectual property.  However, the primary result has been an increase in intellectual property investments by institutions.  Institutional investors tend to seek investments across all asset classes as a means for attaining a diversified portfolio.

Intellectual property is undoubtedly a separate asset class from other types of assets, e.g., stocks, bonds, real property, etc. However, prior to the pro-patent era, the IP asset class was not considered to be the type of asset class that an investor would necessary need to have in a diversified portfolio.  The IP asset was likely used more as a means for sorting wealth into categories for purpose such as tax treatment.  In other words, a few people have always made money from patents, but they tended to be the inventors or original owners of the patents and not third parties who specifically sought out patents as a means for diversifying their assets into the available classes.

Once an institutional investor becomes aware of an asset class in which he holds no assets, then the investor is essentially compelled to make some form of investment in the asset class in order to demonstrate a diversified portfolio.  This likely explains why disclosures in the Xilinx litigation revealed that investors in Intellectual Ventures included institutions like the University of Texas, the University of Pennsylvania, Brown University, Stanford University, the Mayo Clinic, Reading Hospital, the Rockefeller Foundation, and the World Bank’s International Bank for Reconstruction and Development.  This also likely explains the investment by mutual funds like Oppenheimer, Fidelity, and Vanguard in public companies like Acacia Research.  The funds provided by these groups of investors to PAEs are likely mirrored by private investors, although the amount of their investments would be difficult to determine.

In short, the evolved PAE business model has not suffered from a lack of capital although the evolved PAE model essentially has fairly low capital requirements.

3.  The surge of patent issuances in the pro-patent era

Others have written about the surge of patent issuances during the pro-patent era.  Some of this
increased activity no doubt reflects greater attention to research and development during this period.  However, a sizeable portion of the surge arises from the filing, particularly by corporations, of patent applications for inventions that in the past would not have been protected.  In other words, patent applicants became less picky about the sorts of inventions for which they file patent applications. 

The increase in patent issuances provided more fuel for PAEs activities.  In addition, many corporations themselves came to view their patent assets more as liabilities since significant expenditures were made to obtain and hold the increased patents they obtained during the pro-patent era.  Only a relatively small number of patents are typically necessary to use against a direct competitor.  Consequently, corporations became interested in obtaining revenue from their patent portfolio, which has provided PAEs with greater opportunities for attaining licensable patents.

If the patent allowance rate of the 1963 to 1980 era had stayed in effect through the pro-patent era, there would be roughly 2 million fewer issued patents today. That means we would have 6 million U.S. patents as opposed to the current 8 million plus.

The U.S. Patent Office issued its first patent in 1790.  Patents issue sequentially.  On March 26, 2013, the USPTO issued patent 8,407,811.  Thus, the “halfway point” for US patents was 4,203,905 which issued on May 20, 1980.  So, half of all granted U.S. patents were issued after May 20, 1980 – 190 years of R&D on one side of the midpoint line and 33 years on the other … and the midpoint line moves closer to the current date each Tuesday when then USPTO issues another batch of patents.

Patent Chart (2013)
 
Of course, some of this growth resulted from heightened R&D funding. But much of it traces to companies simply filing for patents more often. That means more opportunities for PAE activity.

This surge in patenting is sometimes blamed on software patents and business method patents. While there may be some truth to this, the larger truth is that more patents are filed across more technical areas than was previously the case. 

Antennas, for example, do not immediately present themselves as being software inventions.  However, using patent filing data, one could conclude that we are living in the great antenna revolution.  For IPC class H01Q (aerials) from 1978-2000, some 7,958 patents were issued in the US.  For IPC H01Q from 2000-2012, some 13,269 patents were issued.  So, one 22-year period produced less than 8,000 patents while the more contemporary 12-year period produced more than 13,000 patents. 
For the 1978-2000 period, antenna patents issued on an annual average of 361.73 patents/year.  For the 2000-2012 period, antenna patents issued on an annual average of 1,105.75 or three times the rate of the earlier period. 

While much of the surge in antenna-patenting undoubtedly resulted from increased R&D related to antennas during the growth of wireless communications, one should really question the premise that increased R&D should necessarily lead to increased patent issuances.  While the patent system tends to favor incremental advances, it was absolutely not intended to favor minor advances within the abilities of an ordinary technician, and with so much prior art in the antenna field, the raw number – 13,269 patents in 12 years – raises questions about non-obviousness over the whole group. 

A more detailed analysis of how the Patent Office processes applications would provide a useful discussion but will have to wait for another time.  In short, in a variety of ways, the Patent Office was not prepared or adequately equipped to handle the surge of patent filings brought on by the pro-patent era.

Conclusion

Contemporary PAE activity results from the combination of a number of complementary factors.  Many of these factors themselves arose from the exuberance of the early pro-patent era that began in the early 1980s.  Some of the major factors leading to the present increase in PAE activity are the maturity of the PAE business model, the acceptance of intellectual property as an asset class, and the surge of patent issuances in the pro-patent era.

 

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