UK and US Hewlett Packard v Autonomy litigation: highlights corporate technology, intangibles and IP rights accounting standards and reporting reform

IP Finance is pleased to have this guest post from Dr Janice Denoncourt, professor at Nottingham Law School.  

One of the biggest British tech deals involved Autonomy, a software company created in 1996 by former Cambridge University academic Mike Lynch.  The British and American litigation that ensued highlights the need for wider discussions regarding reforms to accounting for nebulous intangible assets such as software, copyright and licences.  How are these valued, accounted for and reported in company annual reports?   

With hindsight, the evidence showed that the sale of Autonomy to behemoth Hewlett Packard (HP) in August 2011 over a decade ago was unfortunately rather unsuccessful.  Within a year of purchasing Autonomy and with it, access to its knowledge management software, HP identified concerns regarding Autonomy’s accounting practices – alleging serious accounting irregularities including misrepresentation and disclosure errors. HP subsequently wrote down the goodwill value by billions.  In other words, HP overpaid for Autonomy.  HP found that Autonomy's intellectual property rights and perceived overall value were worth much less than its due diligence was able to confirm.  Litigation ensued on both sides of the Atlantic.

The UK’s Serious Fraud Office eventually terminated its criminal investigation into Autonomy due to ‘insufficient evidence for a realistic prospect of conviction’. 

Meanwhile HP was sued by its own disgruntled shareholders under the UK Companies Act 2006.  HP in turn successfully sued former Autonomy former CEO Mike Lynch and former Chief Financial Officer Sushovan Hussain in civil proceedings before the UK High Court to recover its financial losses.   In his defence, Mr Lynch submitted that misunderstandings as to accounting differences between the UK and the US were the problem, not deliberate fraud.  Namely, there were differences between international financial reporting standards (IFRS) use by Autonomy, and the generally accepted accounting principles (GAAP), the financial reporting standards used for US-based companies. Nevertheless, in January 2022, the Court held Mr Lynch and his CFO guilty of fraudulently inflating Autonomy’s value by misleading JP about its performance: Autonomy and others v Michael Richard Lynch and another (17 May 2022) High Court of Justice Business and Property Courts England and Wales.  At paragraph 40 of the judgment, the Court identified the alleged improper practices included:

40.1. artificially inflating and accelerating Autonomy’s revenues;

40.2. understating Autonomy’s costs of goods sold by characterizing such costs as sales and marketing expenses so as to protect gross margins;

40.3. misrepresenting Autonomy’s rate of organic growth; and

40.4. misrepresenting the nature and quality of Autonomy’s revenues as well as overstating its gross and net profits.

The damages award in favour of HP is pending and will likely be circa £4billion.  Autonomy’s auditors were also subject to civil legal proceedings.  The UK Financial Reporting Council (FRC) fined accounting firm Deloitte £15million for auditing failings of the Autonomy accounts between 2009-2011 related to hardware sales and software licences to value-added resellers, rather than to end customers. 

In the United States, the Department of Justice (DoJ) initiated a criminal investigation. In contrast to the UK’s civil judgment, the US court has now found Lynch and Hussain ‘not guilty’ of all 15wire fraud and securities fraud charges. Lynch had been extradited from the UK to San Francisco where he was under home confinement having posted a $100USD million bond. 

Decade long litigation history aside, the wider issue is that this type of financial hole calls into question the contemporary law and practice of corporate governance, financial reporting and accounting standards to the ability of professional auditors, accountants and lawyers during the due diligence phase to identify over-valuation more readily.  Further, how should the system improve standards and practices related to accounting for intangible assets to better assist auditors, purchasers and investors?

Generally speaking, the disclosures of Autonomy's intangible assets, namely, software (copyright protected) and licensing are by their nature more difficult to value than tangible assets, leading to both over and under valuation.  Accounting standard setters such as the International Financial Reporting Standards (IFRS), the European Accounting Association (EAA), and the UK Endorsement Board (UKEB) as well as academic researchers are working on how to categorise different types of intangibles, introduce taxonomies of common terminology and make recommendations to aggregate or disaggregate type of assets in order to elicit higher quality decision-useful information. This article distils the need for a new research agenda to tackle contemporary accounting in terms of granularity and comparability for intangibles, IP rights and licences to a wider audience. 

Company directors should be interested in how accounting ‘faithfully presents’ intangible assets in their own country, and when the company trades internationally.  Dr Lynch was the President of Autonomy, Inc. and subsidiary ASL and he owed legal duties as a company director.  Directors are required to sign off the audited accounts.  The CFO, Mr Hussain was held to be a de jure director of all three relevant subsidiaries, Autonomy Inc, Zantaz and ASL, and owed duties to all three. 

Company directors, auditors, internal accountants and corporate governance professionals are in an increasingly difficult position.  Intangible assets are prolific yet traditional approaches for valuing tangible assets such as computer hardware or plant and equipment do not map well to intangibles.  Therefore, the risk of litigation for misrepresentation (innocent, negligent or fraudulent) is evident.  Valuation and reporting of intangible assets is the new normal yet, intangibles is the term for a huge category of diverse corporate assets.  One sub-set of intangibles is intellectual property (IP) rights.  For example, Autonomy’s software may protected as a copyright work under the Copyright Designs and Patents Act 1988 if it meets certain legal criteria. It is usually valued by the amount of copyright licensing revenue generated. The first allegation was that Autonomy's hardware sales was 'mischaracterised' as licence revenue. The legal issue is whether this was deliberate or not.  It was alleged that both Autonomy's CEO and Finance officer had fraudulently (with knowledge) inflated the figures reported.  

However, the outcome of a series of civil and criminal court cases in two jurisdictions over 13 years turned on the applicable standard of proof. The criminal standard, proven ‘beyond a reasonable doubt’ was too high a hurdle for the prosecution to meet in the US. However, the UK High Court civil judgment decided ‘on the balance of probabilities’ handed down by the Honourable Mr Justice Hildyard stated at paragraphs 101-102:

              101. This has been an unusually complex trial, 93 days long. Dr Lynch was cross-examined for 20 days. There was a database of many millions of documents from which there was extracted a trial bundle containing more than 28,000 documents. These documents have been the most reliable source of evidence. But there were also hundreds of pages of hearsay evidence, largely comprised of transcripts from previous proceedings in the United States, both civil and criminal.

              102. Nevertheless, I have reached clear conclusions in these proceedings on the civil liability of Dr Lynch and Mr Hussain for fraud under Financial Services and Markets Act (FSMA), common law, and the Misrepresentation Act 1967, applying, of course, the civil standard of               proof of the balance of probabilities.

From HP's perspective how the numbers added up in their valuation of the relatively young Autonomy technology firm mattered. Setting fraud aside, the system needs to support stakeholders as to new norms and standards of transparency and disclosure expected for reporting on corporate intangible assets. However, even the accounting standard setters themselves are not sure ‘Which Way to Go?’ with respect to International Accounting Standard (IAS) 38 Intangibles.  International academic researchers such as the IFRS-EAA Intangibles Research Group were commissioned to produce a literature review and are currently working on evidence to underpin policy as how best improve the accounting rules related to intangible assets.  A key component involves when to formally 'recognise' revenue of intangible assets during the business lifecycle and where such material figures and information should be reported - in the accounts, notes to the accounts or in additional narrative 'disclosures' where the company directors give explanations? The research group is also evaluating court cases to study how best to ensure an appropriate governance and stewardship standard to reduce the risk of fraud to promote financial stability and the needs of our modern technology ecosystem. 

Dr Janice Denoncourt

Associate Professor

ORCID ID 0000-0003-2176-8935

IFRS-EAA Intangibles Research Group

Director IP Research Group

Nottingham Law School

Nottingham Trent University

United Kingdom

Was the U.S. National Institutes of Health conflicted during the COVID-19 pandemic period?

Jon Cohen at Science has an interesting and informative article titled, “Accusers’ bad math: NIH researchers didn’t pocket $710 million inroyalties during pandemic,” published on June 5.  The article addresses allegations that government scientists made $710 million in royalties on COVID-19-related technologies.  Those allegations raise an interesting conflict of interest issue. 

The article is definitely worth a read to provide some clarity to the controversy.  The article does note that government researchers did receive around almost $37 million in royalties during a three-year period that were mostly related to COVID-19-related technologies.  The article also states that there is a significant limit on the amount of royalties an NIH researcher can receive a year: $150,000.  I guess the math adds up to around a maximum of $450,000 over a three period for an individual researcher.  How long will they receive those royalties?  Do we have an issue with this or is this type of system which provides an incentive for government researchers to try to invent useful and valuable inventions for the public a very good thing?  Does the yearly limit effectively eliminate the conflict of interest issue? 

Licensing Executives Society Silicon Valley Webinar: Data Monetization and Valuation in the Age of AI

The Silicon Valley Chapter of the Licensing Executives Society is holding a webinar on Wednesday, July 17 at noon to 1:00 pm US Pacific Time titled, “Data Monetization and Valuation in the Age of AI.”  The speaker is Efrat Kasnik, LES-SVC Chair, LES Board Member and President of Foresight Valuation Group.  Here is a registration link: FREE REGISTRATION. The following is a description of the webinar and speaker bio:

Program:
Want to leverage your data and other digital assets for funding, growth and exit? In the age of AI, data is one of the most valuable assets for technology companies, and yet companies are often struggling with how to monetize and leverage those assets to raise funding or to increase valuation.

In this webinar we will be exploring the intersection of data (and other digital assets) and corporate value. Based on her experiences as a valuation expert, start-up advisor and Stanford Lecturer, Efrat Kasznik will provide practical insights, frameworks and case studies focused on valuing data as a business asset. Some of the topics that will be covered include:

• Data & Digital Asset definitions
• Regulatory and ownership issues
• Data monetization business models: 2-way and 3-way models
• Data valuation metrics
• Case studies across industries, such as life sciences, fintech and gaming

Speaker:
Efrat Kasznik, LES-SVC Chair, LES Board Member, President, Foresight Valuation Group   
Efrat is an IP valuation and strategy expert with more than 25 years of consulting experience assisting clients with the valuation, strategic management and monetization of their intellectual property and technologies. She is president of Foresight Valuation Group LLC – a Silicon Valley-based IP valuation and litigation consulting firm – as well as a start-up advisory firm. Efrat is also an appointed lecturer on IP management at the Stanford Graduate School of Business (GSB), where she lectures on IP issues at the GSB’s MBA and executive education programs. Efrat specializes in analyzing IP and technology portfolios for a range of business transactions, including mergers and acquisitions, financial reporting, technology commercialization and business liquidations. She frequently testifies as an expert witness in legal cases involving damages or valuations of intellectual property and start-ups, as well as in high net worth divorce cases involving the valuation of intangible assets and technology startups. Efrat has been listed on the IAM 300 list of World Leading IP Strategists every year since 2013. She is actively involved in leadership roles with LES USA-Canada, where she currently serves as a board member, in addition to serving as Chair of the LES Silicon Valley chapter.

Fool’s errand with fallacies in administrative essentiality checking

This is my second article on some topics discussed by my panel on “transparency” and in other sessions at the Patents in Telecoms and the Internet of Things conference in London recently. My first article, also published here, was on how value and royalty costs in standards and SEPs are passed along the supply chain to consumers.

The European Commission’s proposed essentiality checking and patent counting at the EUIPO is troubling. While parties are entitled to present whatever methods and studies they wish to imply Standard Essential Patent (SEP) portfolio strength in licensing negotiations or to the courts in litigation, the proposed registry with mandatory essentiality checking on random samples of patents will give a false sense of security on the applicability, accuracy and reliability of such checks, measures and any royalty charges derived from them. Essentiality determinations and patent counts provide a poor and unproven gauge of patent portfolio strength. Methods fail a key integrity test for any evaluation or measurement system because results are not reproducible. Despite the EUIPO being ordained the official authority on determining patent essentiality, its checking will be as contestable technically as for private evaluators and their studies that already check essentiality, count patents and invariably disagree with each other. Nevertheless, even though determinations are non-binding they will have significant sway with the courts.

A European Parliament press release issued following a January 2024 Legal Affairs Committee vote to adopt “New rules to promote standard-setting innovation in new technologies” states that “in 5G almost 85% of the standard essential patents are in fact non-essential. The new essentiality test will stop the occurrence of over-declaration”.

Some studies do indeed indicate essentiality rates of only 15% (i.e. 100%-85% = 15%) or even less in some cases—which might well be correct—but there is no evidence to support the latter contention that checking will improve the declaration behaviour of patent owners. There is no shame or sanction for over-declaration. Bias in essentiality checking—that is most severe at such low essentiality rates—means that the effects of over-declaration can only be somewhat moderated by checking. Over-declaration can never be anywhere near eliminated. The bias incentivises over-declaration despite checking. Rather than stopping over-declaration, institutionalized checking by the EUIPO will likely motivate patent owners to game the system by declaring even more patents of dubious essentiality.

Essentiality is subjective and only one among various factors affecting patent strength

Patent strength is a function of validity, infringement and technical contribution, as well as essentiality to the standards. While some parts of standards go unimplemented, are rarely used, become obsolete or are peripheral to where standards provide most innovative value, other parts are fundamental to very significant improvements with new technologies such as 5G. For example, various radio access network technology improvements have increased network speeds and capacities one hundred thousand-fold (e.g. from 10 kbps to 1 Gbps) since the introduction of 2G data in the mid-1990s.

Some characteristics can be objectively, reliably and reproducibly checked, others cannot. Patent essentiality and validity are matters of judgment where different assessors will often disagree about what are ostensibly yes-no decisions. As stated by the judges’ decisions in Unwired Planet v Huawei and TCL v Ericsson, respectively:

“Based on my assessment of both experts, I am sure the disagreement represents cases in which reasonable people can differ.” (Paragraph 335.)

“Given the somewhat subjective nature of these determinations, ‘disagreements’ is probably a more accurate label than ‘error.’" (Footnote 16.)

By way of analogy: on the one hand, selections of beauty pageant and international song contest winners are also subjective tasks that can be swayed by judges’ predilections and do not have reproducible results with different assessors; on the other hand, and in marked contrast to all the above, checks such as the UK’s annual car roadworthiness MOT test is highly objective and reproducible. Two different test centres would reliably come up with the same pass-fail result for the same car after verifying that brakes work, turn indicators flash, and measuring that tyre tread depth is sufficient, among other checks.

Determining true essentiality is made more difficult by the fact that patent counters have very different objectives to those agreed by consensus in Standard Setting Organizations. ETSI merely wants to ensure standards such as 5G are not blocked by demanding patent owners declare whether they believe a patent might be or might become essential. ETSI never checks essentiality and does not want to do so. Essentiality declarations such as those in ETSI’s IPR database were never intended to be used for royalty rate determinations in Fair, Reasonable and Non-Discriminatory (FRAND) licensing, as sought by the Commission with the EUIPO’s registry and additional steps of essentiality checking and patent counting.

Only the courts can definitively determine which patents are truly essential, which are not invalid and valuate portfolios. Cases in litigation illustrate how uncertain everything is and how expert opinions differ. The challenges in assessing essentiality were extensively discussed at the conference. Issues include interpretation of patent claims and that the scope of these can be entwined with validity. Prosecution history can be pertinent in making determinations. As patents are amended to cover the standard they can include what has been contributed to the standard by others. With many patents being found invalid by the courts, validity should not be ignored on the path to determining value, as it is in the Commission’s proposed checking. Validity can be the most significant factor affecting SEP value.

In FRAND litigation, highly experienced top minds including judges, experts and those representing the parties spend many months at multi-million dollar costs evaluating and deliberating—with various disagreements on essentiality and validity of litigated patents prior to judgment—even though typically only a few patents are examined.

If all that work including analysis of claim charts and patent prosecution histories is actually required to do a proper job on only a few patents, how can we trust the accuracy of the EUIPO’s experts examining orders of magnitude more patents and whose determinations ignore the crucial issue of validity? While the courts tend only to have the resources to do the required assessments on no more than a handful of patents in each case, there are many tens of thousands of patents and patent families declared essential to standards such as 5G. It is unsurprising that the UK courts have tended to reject patent counting as a means of determining FRAND royalties, except in some cases as a cross-check for determinations primarily based on comparable licensing agreements.

Unscalable checking

One proposed way dealing with the insurmountable task of checking all a standard’s declared patents is to check only random samples of them. The hope is that it would be possible to check a manageably small number of them very thoroughly and accurately. Consensus is that accuracy can best be achieved with the preparation and use of claim charts.

However, there are several problems with this approach, as illustrated in my empirical research in 2021 and 2022:

• Even when claim charts are used to assist in determining essentiality, different assessors still disagree widely in their determinations with agreement on only around 83% of them. That’s not as good as it might seem when one considers that different assessors can be expected to agree on precisely 50% of them if one assessor was making determinations randomly based on the flip of a coin. If two assessors disagree in their determinations, at least one of them must be wrong. However, if two different assessors are in agreement, that does not mean the determination is correct.
  
  
• Inaccurate determinations cause a substantial upward systematic bias in essentiality rates derived after checking. My empirical research shows that the proportion of false positive essentiality determinations will greatly outnumber false negatives at essentiality rates of 15% or less.
  
  
• Sample sizes need to be large (e.g. >1,000) if true essentiality rates are at 15% or below and if, for example, accuracy within ± 15% at the 95% confidence level is required. Sampling error as a proportion of true essentiality rate increases at lower and lower levels of true essentiality.
  
  
• Sampled patents cannot be appealed and reassessed without destroying the integrity of the sample. For example, if one in ten patents is sampled the determination has a 10x effect implied in the entire population count. With inevitable selection bias in appealed patents, “corrected” determinations will have a distorted and magnified effect implied in the overall population.
  
  
• However, it would be to deny justice not to allow some kind of appeals procedure on determinations made by a public authority. This issue could weigh heavily in FRAND dispute litigation.
  
  
• It’s very costly. Ericsson testified in TCL v Ericsson that it took 50 man-hours per patent to prepare claim charts.

What the Commission is seeking to concoct at the EUIPO will produce yet more patent counting studies, somewhat like what PA Consulting has been producing regularly for years and that several other firms have published from time to time. PA’s studies are widely used because others use and seemingly take heed of their results—not because they are proven to be accurate and reliable, because it is impossible to prove that. Here’s what Justice Smith had to say in the Optis v. Apple judgment:

“So, as with validity – but for different reasons – making a judgement about levels of essentiality in the stack is unreliable and unsafe.

My conclusion is that – accepting entirely that PA Consulting seeks to do a careful job – for the purposes of a judicial determination of what is fact, the PA Consulting/Optis approach to determining Stack size (or the figure for the denominator) is not to be relied upon.

I accept that were a reliable qualitative assessment to be possible, that might well be preferable. But an unreliable qualitative assessment – especially where even the magnitude of the error is unknown – is not (in my judgement) an acceptable metric to use when seeking to answer the FRAND Question.

I cannot use the PA Consulting data as a metric in answering the FRAND Question.”

Patent counting is simplistic

Even checking both essentiality and validity is woefully insufficient in determining patent value. It’s widely recognized that different patents vary in value enormously—by orders of magnitude from virtually worthless to some real gems. The significance of a patent’s technical contribution to a standard and value in implementation can vary from being seldom used or of marginal worth to being fundamental functionality that might enable major cost savings or increases in customer utility or revenues to be generated. Convenience aside, there is, therefore, no basis for assuming that portfolio value is in proportion to any kind of patent count (i.e. of declared, found essential or found not invalid patents). On the contrary, some patent owners likely have a much larger proportion or number of gems than others. However, even approximately how much more is an unanswered empirical question.

Ministry of Patent Counting and Red Tape

The Commission’s proposals for registering, checking and counting patents, among other demands in the proposed legislation, is also in conflict with the stated objectives of European leaders.

French and German leaders Emmanuel Macron and Olaf Scholz recently co-wrote an op-ed in the Financial Times setting out some laudable objectives:

“With an ambitious industrial policy, we can enable the development and rollout of key technologies of tomorrow, such as AI, quantum technologies, space, 5G/6G, biotechnologies, net zero technologies, mobility and chemicals.

We call for strengthening the EU’s technological capabilities by promoting cutting-edge research and innovation and necessary infrastructures.

We call for an ambitious bureaucracy reduction agenda to deliver on simpler and faster administrative procedures and cutting bureaucratic burdens for businesses of all sizes. We welcome the European Commission’s initiative to reduce reporting obligations for our companies by 25 per cent.” (hyperlink added)

The Commission’s proposed demands for patent registration at the EUIPO, together with preparation and submission of additional information such as patent claim charts will substantially increase administrative burdens for European companies such as Ericsson and Nokia that remain dependent on SEP licensing income. These new burdens will cause friction, delays and diminution in the well established, highly effective and self-sustaining innovation loop in which licensing fees are used to fund further R&D, leading to the creation of yet more valuable new technologies.

Better to have scarce and costly technical experts innovating and prosecuting their own patents, or designing and testing new products, rather than tying up hundreds of them generating additional information for checkers and in doing the checking—at patent owners and at the EUIPO, respectively.

Transparency about what?

There was consensus at the conference that greater transparency could help with FRAND licensing for SEPs. However, rather than burdening licensees with voluminous disclosures on patent claims and with delays while conciliators deliberate about aggregate royalties and technical experts check patents for essentiality, it would be better to have licensors and licensees disclose more about actual licensing. This should include terms in licensing agreements and information on licensed trade including volumes and prices. If parties are unwilling to make such information public, then it could be disclosed to a confidential repository with limited access, information anonymised and other safeguards. Let’s find out more about what’s happening already and rely on that, rather than trying to make things up with top-down rate setting.

In Q&A under the Chatham House Rule, I asked another panel whether a modicum of accuracy and reliability can be achieved in essentiality checking to determine patent portfolio strength. Bad news — no. Good news — it’s probably not necessary because most licences get agreed, regardless.

While I believe it would be best for the Commission to abandon is proposed checking and rate setting, if it does proceed it should consider recommendations about how to do that competently and with recognition of limitations, as explained in my publications cited with hyperlinks in this article.


Keith Mallinson, founder of WiseHarbor, has more than 25 years of experience in the telecommunications industry as a research analyst, consultant and testifying expert witness.

Measuring value and royalty costs in standards and SEPs passed along the value chain to consumers

An economist in the audience asked my panel on “transparency” at the Patents in Telecoms and the Internet of Things conference in London recently about achieving this by demanding detailed company financial disclosures. This is my first of two articles on topics in my wheelhouse that were addressed at this superlative biennial event. 

Rough judgments

Companies are generally unwilling to reveal such accounting figures that would help show how royalty costs are passed on and where profits are generated. Furthermore, some major value transfers are non-monetary and would not show up in these measures. Nevertheless, it is possible to surmise where most economic value is generated, captured or passed through, and where royalty costs are passed on in supply chains to customers.

Aggregate royalties paid of around five percent of handset revenues are very modest in comparison to total value in standards and the consumer welfare derived by several billion people using devices such as smartphones for many useful purposes.

Most of the value created in technology standards such as 4G and 5G is passed through to consumers. How much and where the rest of it is harvested across the supply chain and in the broader ecosystem is more complex and subtle.

Royalties paid and passed on can have a significant bearing on the financial performance of individual companies where competitors are paying and absorbing different amounts.

My analysis here includes some unashamedly qualitative assessments, as well as my usual quantitative support. But first, some definitions and background.

Economic pie sharing

Economists describe value created, for example, from technology innovation, as a total “surplus” that’s divided between producers and consumers. Producer surplus is obtained where the price received is higher than the minimum at which the producer is willing to sell. Consumer surplus is where the price paid is lower than the maximum the consumer is willing to pay. However, in the real world, it’s more complicated than this binary split with various different players in the ecosystem benefiting from standards such as 4G and 5G including standard-essential patents (SEPs).

Those who derive value from standards including SEPs, and share the total surplus include patent licensors, device OEMs, device ODMs (i.e. contract manufacturers), network equipment OEMs,  MNOs and MVNOs (i.e. physical and virtual mobile network operators), Big Tech Internet platforms and software publishers as well as end-users. Suppliers that generate no more than their cost of capital might be regarded as not capturing surplus, but superior returns and deficient returns can be generated in various ways. Reasons that possibly explain weak or strong profitability include (in)efficiency and other business activities. For example, Apple is by far the most profitable smartphone OEM and has accounted for between 70 percent and 80 percent of total handset profits over many years because it has a lot going for it. It is a more specific empirical question to what extent its superior returns result from it paying less than economic value or harvesting surplus in other ways in use of the cellular standards including SEPs.

Upstream creation, downstream consumption

Communications standards such as 4G and 5G are enormously valuable overall. This is resoundingly indicated by more than five billion mobile phone users (i.e. unique subscribers) and with rapid uptake of new standards. In addition to using mobile devices for calling and text messaging, with the vast majority of devices now being smartphones these are the primary or only means of accessing the Internet for most of these people. For a large and increasing proportion of them, these devices are also the dominant means of receiving news, sharing photos, paying for purchases, navigating and even watching video.

Some of the surplus created by standard-technology developers is retained or used to subsidize product business in network equipment or devices; but most of it flows to consumers within a few years of new technologies becoming commercially available. In between, a few major OEMs are likely retaining significant surplus. However; most OEMs and ODMs that are paying their dues in patent licensing fees are probably not keeping much of the surplus at all. Various Over-The-Top (OTT) players are taking significant value indirectly—in competition with MNOs and in information exchange barter trading with consumers, as explained below.

Fruits of competition and dominance

Vigorous competition bringing innovation and rapidly-declining quality-adjusted prices has delivered exceptional growth in new higher-performance services and network traffic growth. By the mid-2000s, unsubsidized new mobile phones could be purchased in most nations for under $50 and for as little as $20 in developing nations. By 2010, around half the world’s population had a mobile phone. Now, for example, there are plenty of 4G Android smartphone models on sale in India in the price range of RS5,000 to RS10,000 ($55 to $110) that include at least 4GB of RAM, front and rear cameras and 6 inch or larger displays that can stream video and deliver location-based services. Consumer surplus is clearly high in use of these, despite the relatively low willingness or ability to pay much higher prices in nations with modest income-per-capita such as India.

Meanwhile, the prices of high-end smartphones have increased. For example, many consumers happily pay more than $1,000 for various iPhone and Android models. Apple thus appears to be deriving significant producer surplus. While much of that arises from its strong brand, favored designs and manufacturing cost control, it also seems likely that a significant proportion of that is from standards-based technologies, after its payment of SEP royalties. It’s notable from recent FRAND decisions in the UK (i.e. in Interdigital v. Lenovo and Optis v. Apple) that large OEMs—such as Apple, Samsung, Xiaomi and Huawei—paying royalties in large lump sums up-front spend relatively low amounts per unit, and as percentages of unit selling prices, in comparison to many smaller OEMs paying running royalties. The larger OEMs are evidently receiving deep discounts of up to 80% for volume and prepayment.

In comparison to Apple and Samsung, most handset OEMs are in a rather more commoditized (i.e. less product-differentiated) and price-competitive market segment. Marginal costs also tend to be passed on to customers in the latter, but with little scope to increase prices much above costs no matter what goodies become available (to all) in the standards. The contract manufacturer ODMs also operate on thin margins. While owing their existence to the new technologies that fuel handset market growth and replacement, most manufacturers do not appear to be making exceptional profits in doing so.

Even some major OEMs have failed financially in the face of competition, regardless of ever-improving and increasingly valuable standards. It’s notable that despite Nokia being the handset market leader commanding the vast majority of the sector’s profits in the 2000s, and with peak financial performance around 2008, the firm’s floundering smartphone business at the beginnings of the 4G era was divested to Microsoft in 2014 and then subsequently closed with declining sales a couple of years later. With LG’s market share falling from 9% to 2% during the 2010s, it stopped selling smartphones in 2021.

All being things equal, one would expect costs including royalties to be fully passed on by suppliers in their prices. One would also expect that prices could be elevated little more—despite standard-technologies creating more total surplus than is paid for them in royalties—due to fierce downstream price competition among OEMs. Given the many competing suppliers at the commodity end of the market, one way a supplier might retain substantial supplier surplus would be if that company was avoiding royalty payments (e.g. through hold-out) while its competitors were incurring those costs and passing them on to customers. Alternatively, if that supplier was the only one, or if few are, paying such royalties, it might be unable to fully pass-on such costs to its customers without diminishing its sales volumes and market share.

Quid pro quos

MNOs and MVNOs do not pay directly to use the standards or SEP technologies that have kept them competitive in generating their service revenues. Instead, MNOs pay for new standards-based technologies in their network equipment purchases that are licensed with payment of patent fees by the manufacturers. MNOs and MVNOs commonly subsidize consumer purchases of new handsets that also employ these manufacturer-licensed technologies.

The fortunes of MNOs worldwide vary significantly: however, with a few exceptions such as US market leaders AT&T, Verizon and T-Mobile in recent years, profitability is generally modest or meagre. For example, Vodafone and 3 in the UK are hoping their proposed merger will improve lacklustre financial performance in competition with two other MNOs.

While some MNOs may have been able to capture some of the economic surplus in 4G and 5G, it seems that the MNOs and MVNOs overall are not major hoarders of surplus. Instead, consumers benefit, for example, by getting more and more data for around the same expenditure as for much less data previously. While global MNO revenues have been rather flat over many recent years, MNOs are supplying exponential network traffic growth of 1,000x over fifteen years since 2010. Fierce competition among operators is causing all the cost-per-gigabyte reductions and increased value MNOs receive from technological improvements to be passed through downstream to consumers with an unrewardingly constant unitary elasticity in the market demand curve.

In contrast, Big Tech Internet platforms are making money hand over fist in comparison to most MNOs, even though surging mobile data now accounts for almost 60% of all Internet traffic. Google (Android, Google Play Store, YouTube), Meta (Facebook, Instagram, WhatsApp) and Apple (iOS and App Store) are indirectly appropriating some of the surplus generated by standards and SEPs. For example, as WhatsApp is free for end-users, it cannibalizes the higher profits mobile operators could otherwise make on picture messaging, international calls and roaming calls. Even though consumers pay for mobile data so they can use this app, MNOs’ supplier surplus is diminished by these substitution effects. And, there’s is no free lunch for consumers: the Faustian bargain in using WhatsApp is in allowing Meta to access personal phone contact information. Consumer surplus is thus diminished and Meta’s supplier surplus is increased by this payment made in-kind.

Big Tech is also taking significant slices of the surplus from OEMs. For example, when you browser search or ask Siri for an Internet search on your iPhone it uses Google’s search engine. Payments by Google to Apple, to be the default search engine on iPhones, reportedly accounts for 14 to 21 per cent of Apple’s profits.  Payments were expected to be between $18 billion and $20 billion annually by 2021. That’s not all economic surplus from the value of communications standards and SEPs, but a significant proportion of it surely is given that Google, like Meta, also harvests value from consumers’ personal information including use—such as location—of mobile devices.

And, what about the SEP licensors who also develop the standards in the first place? Some of them are probably obtaining some producer surplus and using it to support their complementary product businesses in communications processor chips, network equipment and devices. Nevertheless, with aggregate royalties paid only around five percent of handset revenues, a much lower percentage when also including MNO and mobile OTT revenues and declining over the last decade, the remaining surplus passed through downstream in a vibrant and innovative ecosystem where almost everyone now is a major consumer is much, much more.

Keith Mallinson, founder of WiseHarbor, has more than 25 years of experience in the telecommunications industry as a research analyst, consultant and testifying expert witness.

U.S. Government Accountability Office Report on Impact of 2020 Trademark Modernization Act and Fraud

Pursuant to the 2020 Trademark Modernization Act (TMA), the U.S. Government Accountability Office (GAO) released a report examining fraud at the U.S.Trademark Office.  The GAO made recommendations to the Trademark Office to reduce the number of fraudulent trademark registrations.  The GAO reviewed the impact of changes made by the TMA and stated:

Based on our analysis of USPTO data for the period December 21, 2021, through June 27, 2023, we found that the USPTO Director and trademark attorneys representing their clients used the TMA’s new expungement and reexamination procedures to remove 2,615 falsely or inaccurately claimed goods and services from trademark registrations. Specifically: • Reexamination proceedings accounted for 1,955 of the removals compared to 660 removals resulting from expungement proceedings (see fig. 4). • Director-initiated proceedings accounted for 592 of the removals and third-party petitions accounted for 2,023 of the removals.

The GAO recommendations provide:

Recommendation 1: The Commissioner for Trademarks should plan and conduct regular fraud risk assessments of the trademark register to determine a fraud risk profile that aligns with leading practices in the Fraud Risk Framework. Specifically, this process should include (1) identifying inherent fraud risks to the trademark register, (2) assessing the likelihood and impact of inherent fraud risks, (3) determining fraud risk tolerance, (4) examining the suitability of existing fraud controls, and (5) documenting the fraud risk profile. Recommendation 2: The Commissioner for Trademarks should identify and implement improvements to current data systems to strengthen trademark data analytics for stronger fraud risk management.

The report also discusses other methods the U.S. Trademark Office uses to detect fraud such as post registration audits. 

Japanese Universities Having Trouble with Tech Transfer

Nikkei Asia has published an article by Kenjiru Suzuki titled, "Japan's Universities Fail to Make the Most of Intellectual Property: Due to Lack of Support, Patents Only Make 2% Compared to U.S. Schools."  The title provides a nice summary of the article's findings.  Research has pointed to differences between countries and their innovation systems as to why a specific country may not experience the relative success of U.S. universities in technology transfer.  For example, there may be differences in university culture, laws concerning taking a company public, corporate formation laws, laws concerning mergers and acquisitions, tax law, amount of available funding, expected licensing terms, skilled workforce, specific IP and data rights laws, networks of support and engagement, university researcher buy-in, and availability of capital (among other things).  I confess I am surprised that Japan has not realized more success in this area.  

US Department of Treasury Sanctions Commercial Spyware Entities

The U.S. Department of Treasury has sanctioned individuals and entities responsible for commercial spyware.  The Press Release states:

WASHINGTON — Today, the Department of the Treasury’s Office of Foreign Assets Control (OFAC) designated two individuals and five entities associated with the Intellexa Consortium for their role in developing, operating, and distributing commercial spyware technology used to target Americans, including U.S. government officials, journalists, and policy experts. The proliferation of commercial spyware poses distinct and growing security risks to the United States and has been misused by foreign actors to enable human rights abuses and the targeting of dissidents around the world for repression and reprisal. 

“Today’s actions represent a tangible step forward in discouraging the misuse of commercial surveillance tools, which increasingly present a security risk to the United States and our citizens,” said Under Secretary of the Treasury for Terrorism and Financial Intelligence Brian E. Nelson. “The United States remains focused on establishing clear guardrails for the responsible development and use of these technologies while also ensuring the protection of human rights and civil liberties of individuals around the world.”  . . .

PREDATOR SPYWARE SOLD TO CUSTOMERS AROUND THE GLOBE

Since its founding in 2019, the Intellexa Consortium has acted as a marketing label for a variety of offensive cyber companies that offer commercial spyware and surveillance tools to enable targeted and mass surveillance campaigns. These tools are packaged as a suite of tools under the brand-name “Predator” spyware, which can infiltrate a range of electronic devices through zero-click attacks that require no user interaction for the spyware to infect the device. Once a device is infected by the Predator spyware, the spyware can be leveraged for a variety of information stealing and surveillance capabilities—this includes the unauthorized extraction of data, geolocation tracking, and access to a variety of applications and personal information on the compromised device. 

The Intellexa Consortium, which has a global customer base, has enabled the proliferation of commercial spyware and surveillance technologies around the world, including to authoritarian regimes. Furthermore, the Predator spyware has been deployed by foreign actors in an effort to covertly surveil U.S. government officials, journalists, and policy experts. In the event of a successful Predator infection, the spyware’s operators can access and retrieve sensitive information including contacts, call logs, and messaging information, microphone recordings, and media from the device.    

PRESIDENTIAL DIRECTIVE TO PROMOTE ROBUST COMMERCIAL SPYWARE STANDARDS TO PROTECT NATIONAL SECURITY AND UNIVERSAL HUMAN RIGHTS 

As described in E.O. 14093 and the White House Fact Sheet, commercial spyware has proliferated in recent years with few controls and a high risk of abuse.  A growing number of foreign governments around the world, moreover, have deployed this technology to facilitate repression and enable human rights abuses, including to intimidate political opponents and curb dissent, limit freedom of expression, and monitor and target activists and journalists. Misuse of these powerful surveillance tools has not been limited to authoritarian regimes. Democracies also have confronted revelations that actors within their systems have misused commercial spyware to target their citizens without proper legal authorization, safeguards, and oversight. 

This Presidential Directive has identified that the United States has a fundamental national security and foreign policy interest in countering and preventing the proliferation of commercial spyware that has been or risks being misused, in light of the core interests of the United States in protecting U.S. government personnel and U.S. citizens around the world; upholding and advancing democracy; promoting respect for human rights; and defending activists, dissidents, and journalists against threats to their freedom and dignity. 

To advance these interests and promote responsible use of commercial spyware, the United States has established robust protections and procedures to ensure that any U.S. government use of commercial spyware helps safeguard its information systems and intelligence and law enforcement activities against significant counterintelligence or security risks; aligns with its core interests in promoting democracy and democratic values around the world; and ensures that the U.S. government does not contribute, directly or indirectly, to the proliferation of commercial spyware that has been misused by foreign governments or facilitate such misuse.

KEY ENABLERS OF THE INTELLEXA CONSORTIUM

Tal Jonathan Dilian (Dilian) is the founder of the Intellexa Consortium, and is the architect behind its spyware tools. The consortium is a complex international web of decentralized companies controlled either fully or partially by Dilian, including through Sara Aleksandra Fayssal Hamou.   

Sara Aleksandra Fayssal Hamou (Hamou), is a corporate off-shoring specialist who has provided managerial services to the Intellexa Consortium, including renting office space in Greece on behalf of Intellexa S.A. Hamou holds a leadership role at Intellexa S.A., Intellexa Limited, and Thalestris Limited.  

Intellexa S.A. is a Greece-based software development company within the Intellexa Consortium and has exported its surveillance tools to authoritarian regimes. Intellexa S.A. was added to the Department of Commerce Entity List on July 18, 2023, for trafficking in cyber exploits used to gain access to information systems, threatening the privacy and security of individuals and organizations worldwide. 

Intellexa Limited is an Ireland-based company within the Intellexa Consortium and acts as a technology reseller and holds assets on behalf of the consortium. Intellexa Limited was added to the Department of Commerce Entity List on July 18, 2023, for trafficking in cyber exploits used to gain access to information systems, threatening the privacy and security of individuals and organizations worldwide. 

Cytrox AD is a North Macedonia-based company within the Intellexa Consortium and acts as a developer of the consortium’s Predator spyware. Cytrox AD was added to the Department of Commerce Entity List on July 18, 2023, for trafficking in cyber exploits used to gain access to information systems, threatening the privacy and security of individuals and organizations worldwide. 

Cytrox Holdings Zartkoruen Mukodo Reszvenytarsasag (Cytrox Holdings ZRT) is a Hungary-based entity within the Intellexa Consortium. Cytrox Holdings ZRT previously developed the Predator spyware for the group before production moved to Cytrox AD in North Macedonia. Cytrox Holdings ZRT was added to the Department of Commerce Entity List on July 18, 2023, for trafficking in cyber exploits used to gain access to information systems, threatening the privacy and security of individuals and organizations worldwide. 

Thalestris Limited is an Ireland-based entity within the Intellexa Consortium that holds distribution rights to the Predator spyware and acts as a financial holding company for the Consortium.   

Dilian, Hamou, Intellexa S.A., Intellexa Limited, Cytrox AD, Cytrox Holdings ZRT, and Thalestris Limited are being designated pursuant to Executive Order (E.O.) 13694, as amended by E.O. 13757, for being responsible for or complicit in, or having engaged in, directly or indirectly, cyber-enabled activities originating from, or directed by persons located, in whole or in substantial part, outside the United States that are reasonably likely to result in, or have materially contributed to, a significant threat to the national security, foreign policy, or economic health or financial stability of the United States and that have the purpose or effect of causing a significant misappropriation of funds or economic resources, trade secrets, personal identifiers, or financial information for commercial or competitive advantage or private financial gain.

SANCTIONS IMPLICATIONS

As a result of today’s action, all property and interests in property of the designated persons described above that are in the United States or in the possession or control of U.S. persons are blocked and must be reported to OFAC. In addition, any entities that are owned, directly or indirectly, individually or in the aggregate, 50 percent or more by one or more blocked persons are also blocked. Unless authorized by a general or specific license issued by OFAC, or exempt, OFAC’s regulations generally prohibit all transactions by U.S. persons or within (or transiting) the United States that involve any property or interests in property of designated or otherwise blocked persons. 

In addition, financial institutions and other persons that engage in certain transactions or activities with the sanctioned entities and individuals may expose themselves to sanctions or be subject to an enforcement action. Prohibitions include the making of any contribution or provision of funds, goods, or services by, to, or for the benefit of any designated person, or the receipt of any contribution or provision of funds, goods, or services from any such person. 

The power and integrity of OFAC sanctions derive not only from OFAC’s ability to designate and add persons to the Specially Designated Nationals (SDN) List, but also from its willingness to remove persons from the SDN List consistent with the law. The ultimate goal of sanctions is not to punish, but to bring about a positive change in behavior. For information concerning the process for seeking removal from an OFAC list, including the SDN List, please refer to OFAC’s Frequently Asked Question 897 here. For detailed information on the process to submit a request for removal from an OFAC sanctions list, please click here.

Click here for more information on the individuals and entities designated today.

US DOJ Announces Indictment of Former Google Employee and PRC National for AI Trade Secret Theft

US Department of Justice announced the indictment of former Google employee for stealing AI related trade secrets.  The press release states:

A federal grand jury indicted Linwei Ding, aka Leon Ding, charging him with four counts of theft of trade secrets in connection with an alleged plan to steal from Google LLC (Google) proprietary information related to artificial intelligence (AI) technology. . . .

According to the indictment, returned on March 5 and unsealed earlier today, Ding, 38, a national of the People’s Republic of China and resident of Newark, California, transferred sensitive Google trade secrets and other confidential information from Google’s network to his personal account while secretly affiliating himself with PRC-based companies in the AI industry. Ding was arrested earlier this morning in Newark.

“The Justice Department will not tolerate the theft of artificial intelligence and other advanced technologies that could put our national security at risk,” said Attorney General Garland. “In this case, we allege the defendant stole artificial intelligence-related trade secrets from Google while secretly working for two companies based in China. We will fiercely protect sensitive technologies developed in America from falling into the hands of those who should not have them.”  

. . . “In the one year since its inception, the Disruptive Technology Strike Force has been relentless in protecting advanced U.S. technologies, like artificial intelligence, from malign actors,” said Assistant Secretary Matthew S. Axelrod of the Commerce Department’s Office for Export Enforcement. “Let today’s announcement serve as further warning – those who would steal sensitive U.S. technology risk finding themselves on the wrong end of a criminal indictment.”

According to court documents, the technology Ding allegedly stole involves the building blocks of Google’s advanced supercomputing data centers, which are designed to support machine learning workloads used to train and host large AI models. According to the indictment, large AI models are AI applications capable of understanding nuanced language and generating intelligent responses to prompts, tasks, or queries. The indictment describes how Google developed both proprietary hardware and software to facilitate the machine learning process powered by its supercomputing data centers. With respect to hardware, Google uses advanced computer chips with the extraordinary processing power required to facilitate machine learning and run AI applications. With respect to software, Google deploys several layers of software, referred to in the indictment as the “software platform,” to orchestrate machine learning workloads efficiently. For example, one component of the software platform is the Cluster Management System (CMS), which functions as the “brain” of Google’s supercomputing data centers. The CMS organizes, prioritizes, and assigns tasks to the hardware infrastructure, allowing the advanced chips to function efficiently when executing machine learning workloads or hosting AI applications.

According to the indictment, Google hired Ding as a software engineer in 2019. Ding’s responsibilities included developing the software deployed in Google’s supercomputing data centers. In connection with his employment, Ding was granted access to Goggle’s confidential information related to the hardware infrastructure, the software platform, and the AI models and applications they supported. The indictment alleges that on May 21, 2022, Ding began secretly uploading trade secrets that were stored in Google’s network by copying the information into a personal Google Cloud account. According to the indictment, Ding continued periodic uploads until May 2, 2023, by which time Ding allegedly uploaded more than 500 unique files containing confidential information.

In addition, the indictment alleges that Ding secretly affiliated himself with two PRC-based technology companies. According to the indictment, on or about June 13, 2022, Ding received several emails from the CEO of an early-stage technology company based in the PRC indicating Ding had been offered the position of Chief Technology Officer for the company. Ding allegedly traveled to the PRC on Oct. 29, 2022, and remained there until March 25, 2023, during which time he participated in investor meetings to raise capital for the new company. The indictment alleges potential investors were told Ding was the new company’s Chief Technology Officer and that Ding owned 20% of the company’s stock.

According to the indictment, unbeknownst to Google, by no later than May 30, 2023, Ding had founded his own technology company in the AI and machine learning industry and was acting as the company’s CEO. Ding’s company touted the development of a software platform designed to accelerate machine learning workloads, including training large AI models. As alleged in the indictment, Ding applied to a PRC-based startup incubation program and traveled to Beijing, to present his company at an investor conference on Nov. 24, 2023. As set forth in the indictment, a document related to Ding’s startup company stated, “we have experience with Google's ten-thousand-card computational power platform; we just need to replicate and upgrade it - and then further develop a computational power platform suited to China's national conditions.” 

The indictment alleges Ding’s conduct violated his employment agreement as well as a separate code of conduct that Ding signed when he became a Google employee. Further, the indictment describes measures that Ding allegedly took to conceal his theft of the trade secrets. For example, he allegedly copied data from Google source files into the Apple Notes application on his Google-issued MacBook laptop. By then converting the Apple Notes into PDF files and uploading them from the Google network into as separate account, Ding allegedly evaded detection by Google’s data loss prevention systems. Likewise, the indictment describes how in December 2023 Ding allegedly permitted another Google employee to use his Google-issued access badge to scan into the entrance of a Google building – making it appear he was working from his U.S. Google office when, in fact, he was in the PRC.

Ding is charged with four counts of theft of trade secrets. If convicted, Ding faces a maximum penalty of 10 years in prison and up to a $250,000 fine for each count. A federal district court judge will determine any sentence after considering the U.S. Sentencing Guidelines and other statutory factors.

The FBI and Commerce Department are investigating the case.

The U.S. Attorney’s Office for the Northern District of California and Justice Department National Security Division’s Counterintelligence and Export Control Section are prosecuting the case.

Today’s action was coordinated through the Justice and Commerce Departments’ Disruptive Technology Strike Force. The Disruptive Technology Strike Force is an interagency law enforcement strike force co-led by the Departments of Justice and Commerce designed to target illicit actors, protect supply chains, and prevent critical technology from being acquired by authoritarian regimes and hostile nation-states.

An indictment is merely an allegation. All defendants are presumed innocent until proven guilty beyond a reasonable doubt in a court of law.