Monday, 30 June 2014

Low Valuations at the Heart of Tax Avoidance IP Schemes – An IP Solution?

Professor Andrew Blair-Stanek of the University of Marlyand, Francis King Carey School of Law, has published an article on SSRN titled, “Intellectual Property Law Solutions to Tax Avoidance” (forthcoming 62 U.C.L.A. Law Rev. __).  The article helpfully explains how transferring IP can result in substantial tax savings for IP owners and why initial low valuations of IP are at the heart of tax avoidance schemes.  He focuses his proposal on addressing tax avoidance schemes by using substantive IP law, as well as procedural rules involving IP cases, to incentivize IP owners to make initial valuations of IP closer to their “actual value.”  He provides a hypothetical example of the problem involving Google and licensing:

When Google’s California-based engineers develop a promising invention, Google owns the rights to all patents that can be obtained on the invention. Corporate ownership of employee-created IP is common practice.

Google then quickly licenses all the patent rights to a subsidiary in a tax haven like Ireland. Licensing allows the future profits from the patents to accrue to the Irish subsidiary, while the legal ownership remains with Google itself in the U.S., with its robust protection for IP owners.  This license is respected, since Google and its Irish subsidiary are separate corporate entities, and IP can be freely licensed.

U.S. tax law requires that Google receive “arm’s-length” royalties from its Irish subsidiary for the patent license.  The “arm’s-length” price is defined as the price that would have been charged if Google had instead been dealing with an unrelated party under the same circumstances.  The “arm’s-length” principle for cross-border transactions is deeply enmeshed in not only U.S. tax law, but also the numerous bilateral tax treaties that the U.S. has signed with its trading partners, including Ireland.  Google must pay U.S. corporate tax of 35% of these “arm’s-length” royalties.  

Herein lies the mischief. Google does not transfer its promising IP to unrelated parties, so there is no observable “arm’s-length” price. Valuing IP – particularly brand-new IP – is difficult and subjective. Unlike a mass-produced machine or a ton of aluminum, each piece of IP is unique and its economic potential is difficult to predict. Treasury regulations provide detailed econometric methods to estimate IP values, but these are extremely imprecise, often leading to a wide possible range of acceptable prices.

Google must hire appraisers (oftentimes economists) to ascertain an “arm’s-length” price for the transfer to Ireland, and to support that price with extensive contemporaneous documentation.  But Google chooses and pays these appraisers, who are inclined to err towards lower valuations. As a leading tax practitioner recently observed, “appraisers tend to agree with their paymasters on [valuation] questions.”

After the transfer to Google’s Irish subsidiary, the patented technology is incorporated into a new Google device.  The Irish subsidiary oversees a Chinese contract manufacturer’s building of the new devices.  The Irish subsidiary then sells the devices for a full markup that includes the value of the IP to Google distribution subsidiaries worldwide, who then sell them to consumers. The substantial profits from the IP remain in Ireland, typically not subject to Irish tax, and not subject to U.S. tax as long as the cash is not returned to the U.S.

He also discusses why meaningful change in tax laws is unlikely to happen which leads to his IP focused proposals.  Why is the solution unlikely to be based in tax law?  He provides, at least two reasons: nearly impossible coordination of tax law between many countries; and information asymmetries between multinationals and government tax authorities.  In describing the information asymmetry problem, he states that:

First, information asymmetry refers to the fact that the taxpayer inherently knows far more about the characteristics, potential, and value of its IP than does the IRS [U.S. Internal Revenue Service] (or any appraiser). For example, Google understands how its new invention could fit profitably into a new smartphone in a way that neither a team of IRS experts, nor a team of private appraisers, ever could. When the IRS challenges a low transfer price in court, the taxpayer has a depth of understanding of its own IP that gives it a large advantage in refuting the IRS challenge.

Largely as a result of this information asymmetry, the IRS has lost both high-profile IP transfer-pricing cases litigated in the past decade. A quote from one of those opinions encapsulates the problem: “Taxpayers are merely required to be compliant, not prescient.” Taxpayers can fully comply with the law by disclosing all facts to their appraisers who must determine the “arm’s-length” transfer price. Any outsider (including judges) will not be able to discern its profit potential. But the multinational can determine its profit potential, which materializes after the IP is safely in Ireland.

His proposals for change (or perhaps, in some cases, suggestions for interesting arguments) essentially focus on using the initial low valuation position taken by the IP owner against it later in litigation (when the relevant information is likely discoverable) and licensing.  For example, he states:

First, the defendant should argue that the artificially low price is evidence that the patent was obvious at the time of invention, and hence is invalid.  Patent law recognizes that non-technical “secondary considerations” such as commercial success and licensing success are evidence for or against the validity of a patent. The artificially low price fits nicely into this rubric, because it demonstrates with a hard figure that, immediately after the invention, Google did not see the patent as being a substantial innovation. Additionally, the expert documentation justifying the low price may include damaging language downplaying the patent’s innovativeness.

Second, the defendant should argue that, even if the patent is valid, it has a narrow scope. Courts give innovative patents a broad scope that allows finding infringement whenever the infringer uses a close equivalent to the claimed invention. By contrast, less-innovative patents are given a narrower scope. The low transfer price is evidence that Google did not perceive the patent as particularly innovative, and thus should receive a narrower scope. Again, the expert documentation justifying the low price will often include damaging language downplaying the innovation.

Third, even if the court finds the patent valid and infringed, the defendant should be able to point to the low transfer price as evidence that damages should be correspondingly low. After all, a patent’s price reflects its potential to generate profits and royalties, and patent damages replace the patentholder’s lost profits and royalties.

Fourth, patent plaintiffs typically request a preliminary injunction against infringement and, if they prevail on the merits, then request a permanent injunction. But a low price for the patent suggests that infringement is unlikely to cause Google “irreparable harm,” which is required for injunctions. The low price also suggests Google does not come out ahead on the “balance of hardships,” another requirement for injunctions. Additionally, as discussed earlier, the low transfer price is evidence of invalidity and narrower scope, both of which suggest Google has a lower “likelihood of success on the ultimate merits,” a requirement for a preliminary injunction.

Finally, even if the court finds Google’s patent valid and infringed, the defendant should be able to argue that Google’s tax avoidance was “patent misuse.” When a court finds that a patentholder used the patent in a way that violates public policy, it will refuse to award damages or injunctive relief, at least until the misuse has been remedied. Misuse does not require that the patentholder harmed the defendant, only that the patentholder used the IP in a way that violated public policy. If the court finds Google’s tax avoidance sufficiently egregious, it could refuse relief to Google until it has repaid the U.S. Treasury the taxes it improperly avoided.  

Professor Stanek also discusses how copyright and trademark law have similar doctrines, such as copyright fair use, strength of the mark and secondary meaning, and damages that could be used to incentivize valuations closer to “actual valuation” and how the theories underlying IP protection support his proposals.  Notably, he states that usage of the initial transfer valuation could be used to undermine the IP holders royalty negotiation position if his proposals are adopted.  Do readers know of situations where the initial transfer valuation has been used in negotiating royalties, arguing damages, or in arguments concerning the scope or validity of IP?  (Hat tip to Professor Paul L. Caron’s (Pepperdine University) Taxprof blog for a lead to the article). 

Wednesday, 25 June 2014

Measuring the Success of Technology Transfer Offices (and the field)

There is a glaring critique of the university technology transfer enterprise and perhaps the underlying Bayh-Dole Act in the United States.  That critique is based upon the fact that many university technology transfer offices fail to bring in enough funding through licensing or other activities to cover their own costs let alone make money for the university.  Indeed, only a handful of U.S. universities appear to make substantial amounts of revenue.  An additional criticism of the university technology transfer field generally has been that technology transfer offices (and really, the administrators above them) have been too focused on using revenue generated as a metric for success.  This focus arguably can distort the universities’ general mission directed to the public good, including skewing the incentives for academics.  For example, academics can be pushed to adopt research agendas focused on solving practical problems instead of engaging in basic science, which may ultimately have broader public benefits.  At the confluence of these two critiques is the issue of what should be the proper metric(s)for judging success for the technology transfer office and the field in general.  For sure, U.S. universities are feeling the “pinch” of less government monies for research and are looking for alternative funding sources, such as crowdfunding for academic research.  However, even with that pressure, adminstrators and faculty should judge the success of their technology transfer office based on criteria that flow from the mission of the university and that are aligned with its objectives.  So, when is it a success or not?  What are the right metrics?

Valerie Landrio McDevitt, Joelle Mendez-Hinds, David Winwood, Vinit Nijhawan,Todd Sherer, John F. Ritter, and Paul R. Sanberg, have authored a paper titled, “More than Money: The Exponential Impact of Academic Technology Transfer.”  The paper sets forth the benefits of technology transfer beyond revenue alone and perhaps provides the starting point for the development of additional metrics to judge the success of technology transfer offices.  Here are the benefits described by the authors:

Revenue generation

Unrestricted funds to institution from license income

Direct personal financial benefit to inventors and authors

Increased opportunities for funding

Eligibility for funding by compliance with federal regulations requiring a technology transfer program

Increased opportunities for interinstitutional and interdisciplinary grants

Outreach, licensing, and facilitation of new startups yield new funding partnerships

Increased opportunities for funding sources requiring a commercial partner, for example, SBIR and STTR

Facilitates establishment of international research relationships

Promotes a culture of entrepreneurship and innovation

Successes increase university brand and prestige

Enhances university fundraising efforts

Opportunities to strengthen donor ties by engagement with startups

Positively factors into high level recruitment efforts

Positively affects retention of high-producing and high-potential faculty

Student success

Provides opportunities to participate in real world translational research

Provides exposure to the process of obtaining intellectual property protection

Strengthens prospects of finding jobs and being successful

Public benefit

Fulfills the university’s larger missions to address social, medical, environmental, or technical problems

Improves the quality of life

Economic development

Revenue from university licensing positively affects the US economy

Brings money into the state or region

Aids in the retention of local talent

New university startups create high-wage jobs

It may be difficult to measure some of these “benefits.”  But, what do you think of some of these as potential metrics?  For sure, some of the most beneficial programs often bring to the table attributes that are difficult to measure.  And, surely, metrics such as revenue generation, invention disclosures, patents granted, patents applied for, patents licensed, number of start-ups and other traditional metrics still have some place in the game.  (Hat tip to Technology Transfer Tactics for a lead to the paper.) 

Sunday, 22 June 2014

Alice in Valueland

Alice in WonderlandThere's been a lot of comment in the blogsphere over the past few days about the US Supreme Court decision in Alice Corp vs CLS Bank. It's not the purpose of this piece to review the points made by the justices. This has been done excellently over in the Scotus Blog by David Kappos, former Director of the US PTO, in his analysis here and over on the Patenlyo Blog here. The court's decision can be found here.

Given that many of the IP transactions over the past years have related to patents that might be broadly considered to be software patents, it's interesting to look at how this latest decision might affect valuation of intellectual property. As most commentators seem to have noted, the Supreme Court rejected clearly the opportunity to declare software unpatentable. The justices affirmed the revocation of Alice's patent, but they did so not on a basic principle that software is unpatentable. On the contrary, they repeated in essence their previous position set out in the Bilski case that abstract ideas are not patentable. The court repeated the test set out in Mayo in which they first looked at the elements of the claims to see whether these were directed to a patent-ineligible abstract idea and then whether the claims as written transformed the abstract idea into a patent-eligible invention. The court concluded that was not the case for Alice Corp's patent.

This is clearly good news for intellectual property holding companies. There was always a risk that the Supreme Court might chose to go further in rejecting the concept of software patents - and indeed some amicus curae briefs submitted to the court advocated that the court do exactly that. Any valuation of IP in the last few months has needed to take this uncertainty into account. The fact that the court chose not to do this - and indeed issued a decision which is entirely consistent with their previous positions - means that the validity of many patents relating to computer-implemented inventions has been confirmed. At least one risk factor can be eliminated. Indeed the impact of the decision is probably more wide-ranging since the court has concluded, at least implicitly, that a patent couched in software terms is no different from one that is implemented using traditional mechanics. There is nothing inherently different (or even "wrong") in claiming an invention that is implemented in software. This may even encourage more such patents to be filed.

One further factor that will also affect the valuation of the patent is the court's comments that the claims "did not purport to improve the functioning of the computer itself", nor "do they effect an improvement in any other technology or technical field". This language is consistent with the European Patent Office's standard rejections for computer-implemented inventions that are deemed not to meet the EPO's tests for patentability. We seem to be seeing a convergence in thinking on what constitutes an acceptable patent for a computer-implemented invention in the US and in Europe. Another uncertainty factor in valuing software patents is being eliminated. The debate probably is not yet over. No doubt the legislatures in Europe and in the United States will be called upon "to take action" and "defend our rights". That will require greater hurdles than persuading nine judges to declare a whole gamut of ip rights to be null and void.

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Friday, 20 June 2014

How much can we rely on forward patent citations?

This blogger recently summarized, here, the findings of Christopher Cotropia, Mark Lemley and Bhaven Sampat in their article, “Do applicant patent citations matter” (Research Policy 42 (2013) 844-854). The gist of the article is that US patent examiners tend to pay scant attention to applicant-submitted prior art, preferring to rely on the examiner’s own patent searches. An interesting by-product of their findings is considered at the end of their article. Based on their findings that “[m]ost of the art that appears on the face of the patent played no substantive role in the examination of that patent”, the authors go on to consider what they describe as “[i]mplications for use of patent citations as economic indicators”.

The background to the authors’ question is the cottage industry that has grown up around research by economists that focuses on the analysis of patent citations. Generally speaking, researchers have used the number of citations that a patent receives in subsequent patents, which they call “forward citations” and which serve as a proxy measure for the “private” value of the patents for the owners. Elaborating on this notion of the private value of patents, researchers have taken patent citation counts as indicating the “quality”, “importance” and “impact” of these patents (though there does not appear to be any single agreed-upon understanding of what they these terms mean). Lurking behind this research is the assumption that there “ought to be a relationship between citations and value.” As stated by a leading figure in this field, Professor Manuel Trajtenberg, here, in a seminal 1990 paper on the topic, “[t]he presumption that citation counts are potentially informative of something like the technological importance of patents is thus well grounded.”

The authors question whether this presumption has in fact been shown by focusing on the assumption that patent examiners are in fact taking into account all (or at least a critical mass) of the submitted citations. Thus, as Campbell and Nieves concluded in a pioneering paper in 1979, patent citations are a better proxy for indicating patent quality that are citations in scientific publications because the examination citation is “evidence that the particular piece of prior art was examined as a possible reason for rejecting the patent applications in the first place and yet the patent application was accepted.” But how much of this assertion stands if there is reason to believe that applicant-submitted citations may not in fact to large extent by the examiner.

Because of this, the authors are of the view that there is more “noise” in citations than the leaders of citation analysis appear to have recognized (although what precisely the authors mean by “noise” is not further stated in the article). They then go on conclude that “while our results call into question of the assumptions in patent bibliometrics—that citations are carefully vetted—it is not obvious whether violation of this assumption would bias common citations based measures, or simply add noise.” It is regretted that the authors do not elaborate on their observations, especially given the popularity of patent bibliometrics in academic research, particularly in IP management programs.

This is even more so given, as the authors note in a footnote,
“[a]s a practical matter, most validation studies find a positive association between forward citations and measures of value”. Although, in the battle of footnotes, the authors also observe that “[r]ecent work has also raised questions about the use of citations as indicator, because many of those patents turn out to be invalid and the process of adding those citations is quite complex” (citations omitted). 
 All in all, given that size and momentum enjoyed by the patent citation cottage industry, it seems that it will take a lot to undermine its legitimacy.

Thursday, 19 June 2014

What Impact on the General Consuming Public Does the TTAB Football Team’s Decision Have?

Wow!  I don’t know if I have ever seen so much reporting on a decision than the recent Trademark Trial and Appeal Board’s decision in the Blackhorse v. Pro-Football case in the U.S. involving the Washington DC R_____s.  From the local radio stations, to websites for newspapers and magazines, to local and national television news coverage, this decision is getting a ton of press.  Perhaps the timing and subject matter linkage of this controversy to the Sterling/Los Angeles Clippers controversy (and especially the National Basketball Association’s stern measures taken against LA Clippers owner Don Sterling) has propelled the R_____’ controversy to new heights. 

The role of race/ethnicity and its importance in U.S. society is likely one of the most divisive issues in the U.S. spanning debates involving health care, affirmative action, immigration, privacy (see Sterling), the role of government in our lives and distributive justice issues (and on and on).  And, here it is in all its glory—in an intellectual property law case—trademarks no less.  The public’s framing of the issue: Is the government going to be able to make wealthy Dan Snyder (and many adoring R_____’ fans) change his team’s name despite decades of use and the establishment of goodwill?  To some, this question strikes at the heart of what it is to be an American (oh liberty, we love you so).  Of course, the issue is not that simple, for so many reasons.  And, despite the TTAB’s decision, there will be an appeal and, oh of course, despite press accounts, Dan Snyder can keep using his mark and can enforce it under common law and even perhaps under federal law.  What?  Really?  Yes, really.  Should Dan Snyder change the name?  Yes, see the IPKat’s thoughtful counsel here.  I’ve also written a few posts on the subject and here is one. 

Time Magazine just published an article about 600 more federally registered trademarks that use Native American imagery.  The article helpfully includes images of those marks along with a naming of the owners of those marks.  Of course, the TTAB’s decision doesn’t directly impact those registered marks.  But, does all of the (negative) press about the TTAB’s decision indirectly (maybe directly) impact the value of those marks?  Will the general consuming public now believe that because a knowledgeable federal agency has “cancelled” the Washington R_____’ mark and essentially declared it “disparaging” to Native Americans that all of these other marks are also of a “disparaging nature”?  Does this mean that other companies owning “Native American” type marks should change their marks to something like a tree (those folks are smart)?  Will consumers be less interested in Land O Lakes butter?  I think the issues are more complicated than all that and require an inquiry into the nature of the goods and services and the exact mark at issue (and maybe its historical use).  Is the problem with the R_____’ mark the exact name itself along with association with a relatively violent sport?  Will the general consuming public be so discerning?  What should “Native American” mark owners do? 

[P.S.  I’ll be praying for England today—may Wayne Rooney find the back of the net for a hat trick (yes, a total misapplication and misunderstanding of my religion--and don't be confused, I'll pray more for the U.S. and Mexico).  With apologies to Uruguay.]

Wednesday, 18 June 2014

No woman no cry: misattribution of authorship doesn't save income stream

Earlier this month, in BSI Enterprises Ltd and another v Blue Mountain Music Ltd [2014] EWHC 1690 (Ch), 4 June 2014, the Chancery Division of the High Court, England and Wales, handed down a significant and, in this blogger's opinion, sadly overdue ruling on the ownership of some of the late reggae star Bob Marley's copyrights.

Sitting as a Deputy Judge, Richard Meade QC had to construed the scope of a 1992 agreement that purported to assign the copyright in certain songs written by Bob Marley. The purported assignor was Marley's record company and the assignee was Island Logic, a company controlled by Chris Blackwell (historical note: Blackwell's record label Island Records launched Marley's international career in the 1970s). Marley had however misattributed a number of songs in dispute in this action (including the hit No Woman No Cry) to other artists (this was itself the subject of litigation in 1984, but the court in that action made no finding as to the ownership of the misattributed songs) in order to retain a stream of income from them. The main question raised by the present claim was whether the definitions of "Compositions" and "Catalogue" in the agreement included the misattributed songs.

Richard Meade QC, sitting as a deputy High Court judge, held that the words "Compositions" and "Catalogue" in the agreement did indeed include those which had been misattributed: those definitions referred to all existing musical compositions written by Marley; indeed, it would have made no sense for the parties to agree not to include them. This was because Island Logic would have wanted to buy everything it could in order to have a complete catalogue, while the seller would have wanted to seize its best opportunity to monetise the misattributed songs, over which there was still a question mark. For the parties to agree to leave out the works in question without saying so in terms, and so maximise future uncertainty over their ownership, seemed, in the judge's own words at [99], "little short of ridiculous".

Richard Meade QC added that, even if he were wrong about the interpretation of the March 1992 Agreement, Island Logic still had grounds for a reasonable, even if mistaken, belief that it had acquired both ends of the dispute over the misattributed works. The situation was therefore similar to that of Fisher v Brooker [2009] UKHL 4 the A Whiter Shade of Pale case), so that Island had had a gratuitous licence to exploit the works which was terminated only with the issue or service of the claim form. He therefore dismissed the claim for restitution of royalties historically paid to the wrong party.

Benchmarking of employee inventor awards and incentives:a survey is launched

Great invention-- but what does he receive
in addition to his basic salary ...?
According to a media release that it has just been published, "ipPerformance Group Initiates Inventor Rewards and Recognitions Study", a concerted attempt is being made to benchmark employee inventor benefits in the United States -- a jurisdiction that has no statutory schemes relating to the allocation of patent rights as between inventor and employer and no statutory guidelines relating to how much, in terms of money and non-financial benefits, an employee inventor might be entitled to receive. The media release reads as follows, in relevant part:
"ipPerformance ... announces a study on Inventor Rewards and Recognitions Program Best Practices. ipPerformance Group is conducting this study to better understand new trends and best practices in inventor reward and recognition programs. It will cover a range of topics, including financial and non-financial awards, program management and communications, award effectiveness, key objectives and performance metrics.

Information for the study will be gathered via an online survey, which is open to corporate organizations [it would be great if a parallel survey could be opened to employee inventors, as a reality check -- but this would be a very different type of survey, requiring a very different methodology, even if its findings did open up new opportunities to market one's consultancy skills in this field]. The final report will examine the following areas: which program elements have the greatest impact in increasing innovation ideas and patents; methods of managing and rewarding inventors in locations with inventor remuneration laws; and the drivers, impediments, benefits and trends in inventor rewards and recognition programs. The survey ... takes about 25 minutes to complete. Says Robert Williamson, president of ipPerformance Group:
"... We know from previous ipPerformance Group benchmark studies, and from our own extensive experience with implementing effective inventor reward programs, that global inventor reward programs are evolving [given that some countries in which US corporations operate and do R&D have compulsory statutory schemes, it would be good to know what "global" means in this contect]. The major reasons for incentivizing inventors are to maintain inventor interest, increase volume of invention disclosures, and gain better cooperation and responsiveness to patent questions. The aim of this study is to gain insights on which rewards are working well for businesses, where there is room for improvement, methods for handling inventor remunerations in countries that have inventor remuneration laws and what practices are the most effective in improving the impact of incentive programs."
The study investigates the types of recognition and actual financial amounts being used for invention disclosure, initial patent filings, patent grants, design patents, trade secrets, publications, provisional patent applications and licensed-in technology".
The results of this study should be of interest not only to business employing inventors, but to other businesses that might be contemplating a merger or acquisition and which need to get a clear handle on the target company's assets and liabilities, whether because inventor pay-outs might be a deal-breaker or because they need to know how much to borrow to complete the transaction.

To participate in the study, click here. The study closes on 15 July 2014.

Friday, 13 June 2014

Judge Randall Rader Retires

The U.S. Court of Appeals for the Federal Circuit Judge Randall Rader will retire on June 30, 2014.  The IPKat discussed, in detail, the circumstances surrounding Judge Rader's decision to step down as Chief Judge.  We thank Judge Rader for his service and wish him the very best.  I suppose the question now is which law firm will Judge Rader join. 

"IP and Intangible Capital: Corporate Reporting & Valuation Issues From Theory to Action": a free webinar

Together with Stefano Zambon (Professor of Accounting at the University of Ferrara), our friend and one-time IP Finance contributor Roya Ghafele (Oxfirst) is running a free webinar this coming Tuesday on accounting and IP: "IP and Intangible Capital: Corporate Reporting & Valuation Issues From Theory to Action". Stefano is the Chair of Accounting and Business Economics and Director of the CFO M.A. Programme at the University of Ferrara, Italy, President of the ‘Collège des Experts de l’Immatériel’ set up by the French Government, and formerly Vice-President of the International Association for Accounting Education and Research (IAAER). Says Roya:
Today we live in a paradox. There is a universal consensus that intangibles are important, if not crucial, for competitiveness and growth, but at the same time we do not have shared and commonly accepted criteria for managing and reporting on these resources, for properly and systematically informing shareholders and other stakeholders on them, for putting a value thereon.

The Webinar will seek to explore both the reasons underlying this situation and some ways forward to address such a paradox, which shows the limits of our current understanding of, and the boundaries of our capacity to face, the challenges of this new phase in the evolution of capitalistic society and economy.
The webinar takes place on 18 June 2014, 13.00 GMT (U.K. Time). To join, send an email with your name, affiliation and email address to to receive an invitation containing log in contacts for this event.

Is first mover advantage still a relevant trade secret strategy?

One of the more tricky aspects in assessing the strategic advantages of relying on trade secret protection is the circumstance in which the party reasonably believes that the trade secret will eventually be reverse-engineered, but not before, say two years from the time that the product reaches the market. So the question then becomes: should I rely on that window of opportunity or seek some other way to protect my rights? The stock reply tends to be that, if the person believes that the likely period of secrecy of the technology provides him with a reasonable basis to establish first mover advantage, either e.g. by locking up superior distribution or manufacturing capabilities or building up strong brand recognition, reliance on trade secrets to protect the technology is a reasonable approach. That is how we have tended to present the issue in a stripped-down fashion when addressing it in management education.

Against this backdrop, I was unnerved a bit this week in listening to the words of the manager of a venture capital fund, financed by the Bloomberg group and dedicated to making smallish investments in a large number of companies at their very outset. Unlike most other VC operations, this fund bets that it can identify winning companies from certain indicia that precede any real operations by the companies. In that connection, the interviewee baldly stated that the fund did not seek companies with a reasonable likelihood of first mover advantage, but rather “best mover advantage”. In supporting his position, reference was made to the interview comments made by the President of Stanford University, who stated that almost anyone who comes up with a technology will find himself in short order with a number of competitors who have, in effect, copied the technology. The question then becomes who can best parlay this technology into a successful business plan.

Given this, do I need to revise my view about whether reliance on trade secrets is a valid strategy if it can reasonably offer one first mover advantage? Upon reflection, I don’t think so. Pearson Education, here, describes the advantages and challenges of first-mover advantage as follows:
If the business is first into a market, so the thinking goes, it can establish what the military thinkers would call 'defensible ground'. First, it can capture market share much more easily without having to worry about rivals trying to capture the same customers. Second, when the rivals do come along – as they inevitably will – the first-mover and its management team will have advantages in the ensuing competition, such as familiar products, brand loyalty, the best retail outlets, up-and-running distribution systems, and so on. By beating rivals into the market, the first-mover can consolidate its position and compete more effectively, not only defending its previously acquired share but even continuing to expand.
Stated otherwise, “a company's only sustainable competitive advantage may be its ability to learn faster than its competitors.”

Based on these observations, it seems that the notion of meaningful first mover advantage has built in it a time function. Yes, there can be such an advantage, but only if there is sufficient time to allow the person to achieve a critical mass of the factors described above. But with the availability and potentially instantaneous dissemination of information, has the compression of this function reached a stage where it is simply not feasible for this critical mass of factors to take root? That seems to be behind the observation from the Bloomberg-related venture capitalist that what is relevant is no longer the “first mover”, but the “best mover”; there is simply not enough time for the first mover to secure the advantage that efficient exploitation of the time function would previously allow.

My response to that is that it may be true, but only if there are no real barriers to entry or another factors that can slow down the otherwise relentless compression of time. Trade secrets provide one such factor. By slowing down the dissemination of the knowledge and technology to third parties, it potentially enables the person to seek and develop the various aspects of first mover advantage that may confer upon him a meaningful competitive advantage. As such, I still feel comfortable advising that trade secret protection is a reasonable measure to achieve first mover advantage, unless the time function for maintaining secrecy is unusually and severely compressed.

Wednesday, 4 June 2014

Plunging into a Safe Harbour from SEP Injunctions

The European Commission’s antitrust agency is striking a cunning compromise between divergent views on whether or not and under what circumstances injunctions may be sought for patent infringements where patentees have agreed to license patents, they have declared as potentially essential to the UMTS (WCDMA) standard, on fair, reasonable and non-discriminatory terms. EC press releases announce competition rule infringement by Motorola and commitments given by Samsung on this matter. The Motorola decision creates a competition rule infringement ‘remedy’ which “provides a ‘safe harbour’ for standard implementers who are willing to take a licence on FRAND terms. If they want to be safe from injunctions based on SEPs by the patent holder, they can demonstrate that they are a willing licensee by agreeing that a court or a mutually agreed arbitrator adjudicates the FRAND terms.”  Commitment decision details for Samsung are a practical illustration of the safe harbour principles in the Motorola decision.
The Commission’s Vice President in charge of competition policy Joaquín Almunia said: "The so-called smartphone patent wars should not occur at the expense of consumers.”  However, the Commission has not presented publicly, through the publication of the Samsung decision (the full Motorola decision is yet to be made available) or its public statements, any evidence or diagnosis of actual abuse or harm versus the countervailing positions of others in the smartphone and tablet markets A Q&A memo accompanying the decision announcements simply states that “the Commission’s aim is to prevent SEP holders from using SEP-based injunctions in an anticompetitive way, in order to extract licensing conditions that may restrict competition and ultimately harm consumers.

To the contrary, there is abundant published evidence and analysis showing consumers and smartphone markets are doing rather well with vigorous competition despite various theories of abuse and harm. The Commission is well aware of this, but has intervened nevertheless. Mr Almunia's spokesperson Antoine Colombani remarked last year that "[t]he markets for smartphones and tablets are very dynamic, innovative and fast-growing. Samsung's growing market position and the success of Google's Android platform are good reasons to believe that competition is strong on these markets."

FRAND licensing terms negotiated or determined by arbitration or the court in the safe harbour must be on the basis of a packaged approach, according to the Licensing Framework set out in the Samsung decision. Notably, recognising that it would be impossible to assess infringement, validity, essentiality for every patent, even in modest-sized portfolios, and that this is not the way license negotiations work in the real world, the EC's approach is not on these basis of individual assessments of these issues on a patent-by-patent basis or in multiple jurisdictions. In other words, if a licensee wants to enter the safe harbour and protect itself from the threat of injunctions for all Mobile SEPs, it must accept that all such SEPs are within the safe harbour and this requires a timely and efficient approach to determining FRAND terms for all those Mobile SEPs. The quid pro quo with the removal of the threat of injunctions in the safe harbour framework is that licensees cannot pull things apart and challenge many or every patent to delay and fragment the licensing process.

It is quite perverse that the availability of injunctions or even seeking them should be an antitrust issue. My detailed analysis of the Commission's decisions including the safe harbour, Licensing Framework, testing for willingness, dominance and abuse, and inter-jurisdictional conflicts can be found here.