Why tech vendors fund patent 'trolls'

Experts say it's about protection from lawsuits and access to a large pool of patents

Major technology vendors are financing the activities of so-called patent trolls, according to experts, court documents and patent and other legal filings, a Computerworld investigation has found.

Patent "trolls" -- more politely called mass patent aggregators, nonpracticing entities or, as the Federal Trade Commission defines them, patent assertion entities (PAEs) -- litigate more than they innovate. These companies derive the bulk of their income, if not all of it, from licensing the huge libraries of patents they hold and from the money they make by suing companies that use their patents without permission.

A love-hate relationship

Companies including Apple and Micron have historically spoken out against patent trolls, only to wind up doing business with PAEs anyway.

Recently retired Apple intellectual property chief Richard J. Lutton spoke out bitterly against the practice of patent litigation for dollars in testimony he gave before the U.S. House of Representatives in April 2005.

In that testimony, Lutton said, "The IT industry, like so many others, is encountering the enormous costs of dealing with poor quality patents. We are also faced with a growing cottage industry of patent assertions, orchestrated by entities with no business other than acquiring and asserting patents."

He went on: "Increasingly, [these companies] use the uncertainties of the civil litigation system as their primary bargaining chip. The result is that bad patents can cause... substantial litigation risks and costs. Defendants in these suits now must spend an average of $5 million defending themselves and, in some courts, the average is more like $8 million."

Yet patent records show that Apple later provided at least two patents -- via a company named Cliff Island -- to Digitude Innovations , a Virginia-based patent aggregator that has as its major stakeholder Altitude Capital Partners, a New York-based venture capital firm.

The two patents that Apple transferred -- Patent Nos. 6,208,879 and 6,456,841 -- form half the basis of Digitude's February 2012 lawsuit (PDF) against Motorola Mobility Holdings, which alleges patent infringement, according to records in the U.S. Patent and Trademark Office patent-assignment database . Google has made an offer to purchase Motorola Mobility and is waiting for legal approval.

Nor is Apple the only tech vendor to say one thing publicly and then do another. The late Micron CEO, Steve Appleton, also lashed out at "patent trolls" in his March 2009 testimony (PDF) during a Senate Judiciary Committee hearing on the Patent Reform Act.

U.S. patent law has encouraged abuse of the system, Appleton complained, since the law has been interpreted to award royalties based on entire market value and not simply based on a company's share of that market -- for example, the value of all mobile phones and not only those that use a specific platform involved in a patent dispute.

Such awards can "exceed the infringer's entire profit on the infringing product or service -- making clear that the entire standard has no basis whatever in economic reality," Appleton said. "Such a royalty is by definition unreasonable, because a product manufacturer would stop making the product rather than pay it. But this legal rule authorizes NPEs to pursue irrational damages demands with impunity..."

Unlike companies that make or sell products, "NPEs cannot be deterred from asserting opportunistic and unjustified patent claims by the counter-threat of infringement claims asserted by defendants back against them -- their lack of any products or services prevents the assertion of such claims," Appleton said.

"Because the patent system was designed with product manufacturers in mind, not NPEs, the NPEs are able to exploit the lack of clarity of the reasonable royalty standard in a way that manufacturing companies cannot."

Just nine months later, in December 2009, Micron sold at least 20% of its patent portfolio to Round Rock Research LLC , a Mount Kisco, N.Y.-based patent aggregator. Micron's patents are the only ones that Round Rock holds, according to the U.S. Patent and Trademark database. Appleton was still Micron's CEO when this sale occurred, a post he held until the time of his untimely death in February 2012 .

Apple and Micron refused to comment for this story.

The bottom line for both consumers and IT professionals is that the costs of defending patents are passed along to consumers in the form of higher product prices, and the lawsuits hamper technology innovation, experts say. Some tech vendors -- including Apple and Micron -- rail against the concept of patent 'nuisance' lawsuits, only to fund or otherwise support some of the patent aggregators. (See sidebar.)

In a May 2011 report, Citigroup analyst Walter Pritchard said that phone maker HTC pays Microsoft $5 for every Android phone sold as part of a patent settlement reached in April 2011. By those numbers, HTC paid Microsoft somewhere between $35 million and $45 million in the first quarter of 2011 for patent fees alone.

Patent litigation has increased by more than 230% over the past 20 years, according to Article One Partners, a patent organization. Further, Article One says, in 2008, some 2,896 patent infringement actions were filed -- only 179 fewer than in 2004, the peak year.

"Most of the major tech companies are backing a troll in some way, probably financially," says Thomas Ewing, an attorney who has authored reports on what he calls " patent privateering " and whether patent "giants" are dangerous for American innovation.

One example, according to patent attorneys and other experts, is Intellectual Ventures (IV) -- a patent-licensing firm founded in 1999 by former Microsoft executives Nathan Myhrvold and Ed Jung, among others. According to a court document (PDF) that IV filed in April 2011 and then fought to keep secret (PDF), IV investors include Adobe Systems, Apple Inc., Cisco Systems, eBay Inc., Google, Intel Corp., Microsoft Corp., Nokia, Nvidia International Holdings, SAP America Inc., Sony Corp., Verizon and Xilinx, Inc.

Each of these tech companies made a financial investment in IV; all except Google and Adobe went for more than one round of funding. IV has raised at least $5 billion from investors, including tech firms.

The practice of tech vendors and other entities funding PAEs is common but relatively unpublicized, in part because at least one major aggregator goes to great lengths to keep its dealings private. One tactic is the practice of creating over a thousand companies that have different legal names and no obvious link to the aggregator that created them. (See sidebar, below.)

Tech investors in Intellectual Ventures

Source: Lawsuit filed on May 16, 2011: Xilinx vs Intellectual Ventures Investment Fund I, L.P. et al (PDF)

All the technology companies named as IV investors were contacted multiple times for this story; none except Verizon would comment for attribution. Nor would IV comment on the record about its Who's Who list of investors, which also includes universities and charitable foundations.

Nat Goldhaber, managing director of the venture firm Claremont Creek Ventures, explains that "all these companies are using Intellectual Ventures as a patent pool to avoid suit and [have the ability to] cross-license" the patents in the pool.

In January, attorney Ewing and Robin Feldman, a professor at the University of California's Hastings College of Law, published a comprehensive report in the Stanford Technology Law Review that among other things detailed the intricate linkages between some technology vendors and PAEs.

"Big companies aren't just doing this for troll litigation chump change," Ewing explains. "They're doing it for strategic reasons of protection... or [to] cause competitive disruption and do so in a way that avoids showing they're obviously involved." The evidence for all this is "hidden," he says, "but it is hidden in the public record in plain sight."

In that January report, Feldman and Ewing acknowledge that PAEs could "potentially have positive effects." Among other things, they say PAEs could ensure that individual inventors receive the compensation due to them, and could create "a powerful weapon stream" to deter lawsuits.

Another benefit to joining up with aggregators is the notion of cross-licensing under the PAE's umbrella -- members using each other's patents without fear of being sued.

However, the report goes on to say that "the activity of mass aggregation brings its own potential harms." Among these are "potentially reducing future innovation and productivity." Most important, the report says, "the basic business model of mass aggregation is troubling."

Under the radar

The situation is so secretive that very few sources, and especially those in companies involved directly with any PAEs, agreed to be quoted on the record for this story. Instead, almost all spoke on the condition of anonymity, but Computerworld verified information in this story by looking at court documents, applications with the U.S. Patent and Trademark Office, filings with the U.S. Securities and Exchange Commission (SEC), and other legal documents.

Corporate structure, IV-style

Intellectual Ventures (IV) conducts its business of transferring patents through more than 1,000 businesses that the company characterizes as "holding companies" but which some allege are "shell companies" specifically meant to confuse and serve to make it difficult to counter-sue IV.

Tom Ewing, a patent attorney who has done extensive research into IV's corporate structure, says, "It is one of the strangest corporate organizations ever created -- in fact, this is what IV seems to have invented that is most unique." He adds that it looks like the organization was "built to obfuscate."

An IV spokeswoman, Michelle Craig, responds: "Using distinct holding companies as a way to house investments is nothing new. The use of holding companies in relation to IV has been reported for years now... it's frankly surprising that it is still of interest."

Ewing disagrees. "Imagine if every company -- say, a fast food company -- were created in such a way. If you wanted to sue such a company for creating burgers with radiated meat," a corporate structure such as the one created by IV would provide no central entity to sue and no one individual to hold accountable, Ewing says.

Indeed, Intuit and Verizon, according to SEC filings and sources speaking not for attribution, paid, respectively, $120 million and $350 million to IV in exchange for access to some part of the 35,000-plus patents in its collection. Also, Verizon was missing from the lineup of mobile service providers that Intellectual Ventures I LLC and Intellectual Ventures II LLC sued on Feb. 16 (PDF). On that date, IV sued five mobile carriers -- Sprint, AT&T, Nextel, T-Mobile and SBC Internet Services -- for patent infringement.

Robert Varettoni, a Verizon spokesman, responds: "Our comment [about IV] is in our 10K" -- the SEC document Verizon filed in 2008 that references the $350 million figure.

Here's an excerpt from Verizon's 2008 SEC filing:

"During 2008, we entered into an agreement to acquire a non-exclusive license [IP License] to a portfolio of intellectual property owned by an entity formed for the purpose of acquiring and licensing intellectual property. We paid an initial fee of over $100 million for the IP license, which is included in [other] intangible assets and is being amortized over the expected useful lives of the licensed IP."

Additionally, the SEC filing said, Verizon invested $250 million "to become a member in a limited liability company" that gives Verizon rights to "certain intellectual property" in return for an annual license fee.

Verizon had no further comment on the matter. "The bottom line is Verizon has nothing to do with IV's attempts to license its patents to other companies or the lawsuits it filed," Varettoni adds.

For its part, Intuit refused comment.

An aggregator's response

Like fellow PAEs, which include Round Rock and Acacia Research Group LLC , IV says it provides a service for individual and small inventors -- helping these innovators secure their intellectual property by getting access to patents they can use to protect their work.

Patent licensing is huge business. Acacia, a public company, is not secretive about its activities, and it returns a profit to its vendors. Firms such as Allied Security Trust are self-described patent defense firms that buy up and resell valuable collections of patents and give members including Oracle, IBM, Hewlett-Packard, Intel and Philips access to their broad portfolios.

IV's Myhrvold declined to comment for this story. But in a March 2010 Harvard Business Review article that Myhrvold wrote , he said, "My company, Intellectual Ventures, is misunderstood. We have been reviled as a patent troll, a renegade outfit that buys up patents and then uses them to hold up innocent companies.

"What we're really trying to do is to create a capital market that supports startups and the private equity market that revitalizes inefficient companies. Our goal is to make applied research a profitable activity that attracts vastly more private investment than it does today so that the number of inventions soars."

Further, some might not consider IV a 'pure-play' PAE; it has invented at least one product it's disclosed publicly: a laser-based bug zapper created with the Bill & Melinda Gates Foundation to help fight malaria.

Google: In, then out

Google , also, refused to comment about multiple sources and public documents showing that it invested money (PDF) in one of the companies related to the fund known as the Invention Investment Fund I.

A highly placed source close to Google confirmed that Google did originally invest in IV as a member, but only once. There has since been a bitter parting of ways, that source says. "As soon as they started suing people," Google "wanted out," the source says.

Google initially joined because it wanted to have access to a broad number of patents, but it later decided not to associate with a company that turned out to be mostly about lawsuits, he says. Two other sources close to or inside Google have corroborated this account.

Were the Wright brothers the first patent trolls?

The Wright brothers are esteemed for their invention of a flying craft. But they might also go down in history for being among the earliest people to sue over patent issues.

In 1903, they patented a technique of side-to-side wing control they never built themselves. The design was, according to NASA historians , a "wing warping" technique of lateral control in which the wings were actually twisted in opposite directions to create a differential lifting force that would keep an airplane afloat.

And then the Wright Brothers -- though they never manufactured their wing for sale -- started suing. Some consider the Wright Brothers the first known PAE because they litigated on a patent that they owned but never used in manufacturing their own products, even if others did.

The Wrights sued American inventor Glenn Curtiss, who claimed his wings were fundamentally different from the Wrights' invention. He refused to pay patent fees to the Wrights. But Curtiss lost in court, became a patent activist and spent a great deal of his time trying to show that manned heavier-than-air flight had been possible before the introduction of the Wright invention.

After Wilbur Wright died in 1912, Orville Wright eventually sold the patent for more than $1 million to a company that had been paying for the rights to use it.

That company became Wright-Martin, and it notified other early 20th century aircraft makers that they'd have to each pay a royalty of 5% on every plane sold.

The bottom line: The search giant made an investment of well into the tens of millions of dollars in 2008 in the IV entity known as IV IP I, the source said, and refused to go for a second round. Google and Adobe are the only technology companies among the current IV backers that didn't invest at least twice.

It's important to keep in mind, however, that none of these practices is illegal. It is endemic to the patent system in the U.S.

There are more than 2 million active patents in the U.S. alone, Ewing says, but only "a tiny fraction" of them are used commercially, either through licensing or through litigation, he explains.

"The aggregation model stands to increase the number of patents in play by one to two orders of magnitude," Ewing says. "I suspect the truth is that no one really knows what the net commercial impacts will be."

Based in San Francisco, Gina Smith is a New York Times best-selling author and a veteran tech and science journalist specializing in news, news analysis and investigative work. She's also the editorial director of the geek site aNewDomain.net . You can email her at Gina@aNewDomain.net .

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