Call on the FTC to Fix the Patent Litigation Mess and Patent Privateering

Patent privateering changes the dimensions and threat of patent litigation. In the patent ecosystem, firms may be reluctant to sue or may reach efficient accommodations with other firms that possess IP because of the threat of countersuit -- which could lead to mutually assured destruction.
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When President Obama, Republican and Democratic Congressman and major enforcement officials all agree that there is a problem, people must take notice. All of our key leaders are in agreement that our patent system is off balance because of the actions of patent assertion entities (PAEs) (or patent trolls), firms that engage in aggressive litigation tactics to secure damages rather than promote innovation. The majority of newly filed intellectual property (IP) cases are by trolls and the costs of these cases exceed $29 billion annually. This is a tax on economic growth the country cannot afford.

Fortunately the Administration and Congress as well as the Justice Department (DOJ) and the Federal Trade Commission (FTC) are beginning to use their tools to address the problem of patent trolls. A number of bills have been introduced into Congress to deter abusive patent litigation and improve patent quality; these are legislative changes we cannot wait for. At the same time, when patent trolls hurts consumers, competition and innovation it is also welcoming to see scrutiny from our antitrust agencies. The Justice Department and FTC have held hearings on the subject and in a major address last week FTC Chairman Edith Ramirez outlined the issues surrounding the troll problem and suggested the FTC should use its power to do special studies (known as a 6(b) study) to evaluate the impact of trolls.

The Chairman appropriately focused on the problem of "patent privateering": the practice of operating firms transferring patents to non-practicing entities in order to bring patent litigation against their rivals. As Chairman Ramirez observed

"Privateering, as used here, refers to a situation where an operating company transfers patents to a PAE that may read on a competitor's products. The sale may be structured in a way that encourages the PAE to target the original owner's downstream rivals. The operating company benefits indirectly if the PAE raises its rivals costs."

This Trojan horse approach allows companies to accrue the benefits of the egregious troll conduct without incurring any of the risks. And more often than not it is used as a competitive weapon to try to raise costs and dampen competition from rival operating companies.

Patent privateering changes the dimensions and threat of patent litigation. In the patent ecosystem, firms may be reluctant to sue or may reach efficient accommodations with other firms that possess IP because of the threat of countersuit -- which could lead to mutually assured destruction. But when privateering occurs the operating company transfers the patents to a troll in order to harm its rivals. As the Chairman observed "this emerging strategy allows operating companies to exploit the lack of transparency in patent ownership to win a tactical advantage that could not be gained in a direct attack." Moreover, a patent holder can split its portfolio among several trolls, which as the Chairman observes "may have the effect of increasing licensing fees and further burdening rivals."

Chairman Ramirez further described how antitrust concerns are raised when operating companies enter into sweetheart deals with patent trolls.

"Antitrust concerns may arise with respect to ... the assembly of a patent portfolio through one or more acquisitions - or the assertion of a portfolio once assembled. ... The assertion of patent rights by a [troll] may also raise antitrust concerns, especially if the troll is effectively acting as a clandestine surrogate for competitors. The antitrust analysis of agreements involving trolls and operating companies will of course need to be fact specific, and the issue of market power will likely be key to any evaluation. But hybrid [troll] activities may fall within the scope of antitrust enforcement where there is evidence of harm to competition and consumers."

What can the FTC (and the DOJ) do to address the problem of privateering?

First, there is enforcement. Patent acquisitions can be challenged under Section 7 of the Clayton Act. And a patent acquisition that creates or enhances market power and creates a likelihood of anticompetitive effects will raise significant concerns. Indeed the Department of Justice has already used this power in 2011 to prevent Microsoft from acquiring Novell's patents to which Microsoft already had a license. This agency action was made to prevent a transfer whose only logical purpose was to attack open source software. The government can continue to use its Section 7 power to block transfers to patent trolls and it can challenge these transfers before they inflict harm.

The Section 7 power should be fully utilized. The National Restaurant Association and Food Marketing Institute have suggested that the agencies need to increase their scrutiny of patent transfers to PAEs and they offer an important tool. They suggest that the FTC and DOJ adopt regulations to make more of these transfers reportable under the Hart Scott Rodino Act. As Chairman Ramirez observes the lack of transparency is one of the weapons that makes privateering work. Greater notice of transactions would give the agencies far stronger tools to fully investigate and challenge privateering.

There are other enforcement tools that can be used as well outlined in a recent article by Mark Popofsky and Michael Laufert. It is a must read for the antitrust cops.

But there is more. As Chairman Ramirez observed the Commission has special powers under Section 6b to conduct studies and she suggested this power can be used to develop a better understanding of the troll model and the costs and benefits of troll activity. The 6b power can be used to examine a broad range of patent transfers especially transfers to trolls. The 6b power will enable the FTC to secure the underlying documents, including strategic documents to explain the purposes of the transactions.

This study will hopefully enable the FTC to document the true costs and benefits of privateering. It will also enable them to get an inside look at the purpose and likely results of these transfers. This will better inform potential enforcement actions and broader regulatory and legislative reform.

David Balto is a former policy director of the Federal Trade Commission, attorney-adviser to Chairman Robert Pitofsky, and antitrust lawyer at the U.S. Department of Justice. He has been a Senior Fellow at the Center for American Progress and has worked with the International Center on Law and Economics, both of which receive funding from many organizations including Google. Mr. Balto has also published research and authored scholarship for Google on technology policy topics.

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