FTC releases report on PAE Activity, recognizes important role of enforcing patents

On September 27th, 2013, the Federal Trade Commission (FTC) announced that it had voted to collect public comments and gather information on 25 companies known as patent assertion entities (PAEs). The study was intended to shed more light on the PAE business model and create a better understanding of how their patent litigation activities affect innovation and competition in the U.S. economy. As defined by the FTC, PAEs are companies that do not produce, manufacture or sell goods but rather acquire patents from third parties which the PAE monetizes through negotiating licenses or litigating against an alleged infringer.

On October 6th, 2016, the FTC released the long-awaited findings of this report, titled Patent Assertion Entity Activity: An FTC Study, which includes analysis of 22 PAE respondents and more than 2,500 affiliates and related entities conducted between January 2009 and mid-September 2014. The report’s findings and recommendations for legislative and judicial reform were intended to “balance the needs of patent holders with the goal of reducing nuisance litigation,” according to a quote attributed to FTC Chairwoman Edith Ramirez in the FTC’s official press release. Specifically, the FTC had concerns about the ex post nature of PAE patent transactions, in which licenses or settlements occur after a demand letter target has already developed a technology for marketing.

In what could be considered a positive, and perhaps surprising step in the right direction from the perspective of patent owners, the FTC’s acknowledged in this report that the term “patent troll,” which has widely been used to vilify all patent owners and not just those committing abuses of the patent litigation system, wasn’t helpful.

“In the Commission’s view, a label like ‘patent troll’ is unhelpful because it invites pre-judgement about the societal impact of patent assertion activity without an understanding of the underlying business model that fuels such activity,” the report reads. So the FTC officially took a stand against the use of the term “patent troll” despite how loudly that phrase has echoed on Capitol Hill in recent years.

There weren’t many surprises in the report according to Todd Dickinson, former Director of the United States Patent and Trademark Office and current partner with Polsinelli PC. “The exception, and the one interesting new takeaway, is the FTC separating PAE’s into the two big categories: Portfolio PAE’s and Litigation PAE’s, and then demonstrating that the ‘bad assertion/bad litigation phenomenon’ is largely confined almost exclusively to the latter,” Dickinson explained when reached for comment. “Having the FTC no longer paint all PAE’s with the same negative brush would seem to validate the Portfolio PAE’s and their business model.” Dickinson would go on to tell IPWatchdog that he wonders if this report might potentially cause lawmakers to focus any future patent litigation reform on a smaller subset of bad actors, which may make it more easy to achieve an industry consensus.

Indeed, as Dickinson points out, one of the FTC’s key findings recognizes two distinct business models in the PAE sector: portfolio PAEs and litigation PAEs. Portfolio PAEs were identified as those businesses which acquire patents and negotiate licenses without first suing the infringer. By contrast, litigation PAEs typically file suit for patent infringement first before settling with a license agreement. Nearly two-thirds of portfolio PAEs negotiated licenses which generated more than $1 million in royalties per license, whereas 77 percent of litigation PAEs signed license agreements netting less than $300,000 per license. 96 percent of the patent infringement cases filed and analyzed in the FTC report came from the litigation PAEs. Although litigation PAEs accounted for 91 percent of reported licenses, those licenses only amounted to 20 percent of the total revenue earned by PAEs through patent enforcement activities. “Given the relatively low dollar amounts of the licenses, the behavior of Litigation PAE is consistent with nuisance litigation,” the report reads.

Along with litigation, the FTC also took a look at PAE activities related to the sending of demand letters asserting patent rights against an alleged infringer. The FTC found that PAEs weren’t successful in generating low-revenue licenses by sending a demand letter without also suing the target. “This suggest that demand-letter reform, on its own, would not fully address the potential negative repercussions of PAE activity,” the report reads. Indeed, the FTC noted a high percentage of litigation that preceded licensing activities, especially among litigation PAEs. Overall, litigation preceded 87 percent of PAE licensing agreements, but it preceded 93 percent of litigation PAE patent licenses while only preceding 29 percent of portfolio PAE patent licenses.

The PAE report also found a strong correlation between the patents acquired by PAEs and the industrial sectors to which those patents were related. A full 88 percent of the patents held by PAEs analyzed in the FTC report fell under the Computers & Communications or Other Electrical & Electronic category of technologies. More than three-quarters of the patents surveyed were software-related patents. Despite the heavy focus on software and IT technologies, the FTC found that these patents were asserted against firms operating across a broad range of industries. For example, 17 percent of demand letter recipients and 13 percent of the licensees were operating in the Retail Trade industry, including those operating fixed-point brick-and-mortar stores and online retailers alike. This suggested to the FTC that PAEs asserted patents not only against manufacturers but also end-users of the technology.

A finding that patent owners are enforcing patents against those that use technology, such as large retail giants like JC Penney, for example, is hardly surprising.

In recent years the patent laws have been so significantly tilted in favor of infringers that it has become virtually impossible for patent owners to license their innovations to the entities that create and manufacture the infringing technologies. Without the ability to seek reasonable compensation for ongoing infringement through licensing that means patent owners have increasingly had to turn to litigation. Whenever litigation is the choice, or here the only possible resolution mechanism, everyone who is liable must be sued. Indeed, it would be malpractice for a lawyer or law firm not to sue all liable entities. Because the patent grant provides the patent owner the right to prevent others from making, selling, offering for sale, importing, or using technologies that infringe, those that use must be sued because of the recalcitrant, efficient infringement strategies employed by those who make, sell and import the infringing technologies. 

Nevertheless, computer and electronic product manufacturers were found to be the most common targets of demand letters and lawsuits among PAEs in the study. Companies in that sector accounted for more than half of the firms which either received the most demand letters from PAEs, were sued the most often or paid the largest royalties to PAEs. While 73 percent of all assertion targets were defendants in only one lawsuit brought by a PAE, 2 percent of firms received more than five demand letters and one firm received as many as 17 demand letters.

Part of the FTC’s report looked specifically at patent assertion activities in the wireless chipset sector and attempted to see how those activities differed among PAEs, manufacturers and non-practicing entities (NPEs). The FTC defines NPEs as “patent owners that primarily seek to develop and transfer technology” The FTC found that both NPEs and manufacturers in the wireless chipset space sent three times as many demand letters as all of the PAEs in the study. Litigation PAEs, specifically, brought almost two-and-a-half times as many wireless patent infringement lawsuits as wireless manufacturers, NPEs and portfolio PAEs combined.

One of the findings, which the FTC PAE report could not pin down precisely, was the revenue shared by PAEs with inventors to determine the amount of patent monetization supporting further innovation. Although the FTC requested data from PAEs describing how licensing revenue was shared with outside parties as well as the costs of patent assertion activities. Responding PAEs presented different data-keeping methods describing revenue sharing and costs which made a meaningful comparison between firms impossible. For example, some PAEs counted payments to outside counsel as a cost of patent assertion while others categorized such payments as revenue sharing under the rationale that counsel often received a portion of licensing royalties. “Due to this limited data, this report does not address the efficiency of PAE business models,” the report reads.

The FTC did, however, include a number of recommendations for legislative and judicial reform to reduce “nuisance litigation,” or patent infringement litigation resulting in licenses which were valued less than the estimated cost of defending a patent lawsuit through the end of discovery. One recommendation was to develop rules and case management practices addressing the cost asymmetries in PAE litigation, especially related to discovery costs. “Because PAEs do not invent, develop, or manufacture products incorporating their patented technology, they generally have less discoverable information than the party accused of infringement,” the report reads. “A PAE may thus be able to subject a defendant to exhaustive discovery requests while itself facing a relatively light discovery burden.” Specifically, the FTC notes that changes to Federal Rule of Civil Procedure 26 regarding discovery in civil actions could help by requiring early disclosure of asserted claims of infringement and invalidity contentions or limiting discovery prior to preliminary motions. Amendments could also be made to Federal Rule of Civil Procedure 7.1 to expand upon the disclosure requirements of business relationships in order to overcome difficulties in identifying instances where judicial disqualification is likely on the basis of financial information. The organization of litigation PAEs with multiple affiliates makes such identification difficult. The FTC report also called for Congress to enact provisions that would stay a lawsuit filed against an end-user when a similar infringement suit is also filed against the manufacturer. Such a “customer stay” provision is included in patent reform legislation introduced into both houses of Congress.

The FTC PAE study has been expected for some time. In March, FTC Chairwoman Ramirez told a subcommittee of the Senate judiciary committee that this report was expected to come out in the spring of 2016, not October. Suzanne Munck, the FTC’s chief counsel for IP, said that the extra time ended up being required to make sure that the agency was carefully reviewing the information presented. “When we do a study like this and we have access to confidential information, we have to make sure that we’re sharing that in the right way with the public and that takes time,” Munck said. She added that the agency hoped that the report would provide more information to policymakers by providing empirical data in place of anecdotal information. Whether a study that analyzes the activity of 22 entities can be seen as empirical evidence for an entire sector of the U.S. economy is perhaps for someone else to decide.

Despite the softer-than-expected tone of the FTC report, there were still industry groups who weren’t keen on the agency’s findings. The Innovation Alliance released a statement from Brian Pomper, the organization’s executive director, which voiced concerns over flawed methodologies used in the study leading to misguided policy recommendations, such as the customer stay provision. “In filings with the Office of Management and Budget, the FTC itself has admitted that the study’s findings are ‘not generalizable to the universe of all PAE activity’ and that the work should only be viewed as a ‘case study’ that could inform the development of future research,” Pomper is quoted as saying. He adds that patent law and economic experts have questioned the usefulness of the FTC’s study in light of the small sample size and inadequate survey questions which missed key information from licensing firms. “These experts have resoundingly concluded that the FTC study should not be used to determine patent policy or serve as a basis for making patent system changes,” Pomper said.

There is little doubt that Pomper is correct regarding the small sample size, an issue IPWatchdog.com has pointed out in previous articles leading up to today. Indeed, it seems this report should be characterizes as less a “study” and more anecdotal evidence from a surprisingly small subset within the industry. With such a small sample size it seems impossible for the study to represent anything more than a starting point with respect to avenues of further investigation.

Still, despite what many thought were the intentions of the FTC going into this project, the FTC did acknowledge the important role patent enforcement plays within the patent system, specifically and directly acknowledging in the press release issued today that “infringement litigation plays an important role in protecting patent rights.” It is also particularly noteworthy that the FTC recognized that the term patent troll is unhelpful because it inappropriately prejudices the patent owner from the start, without any consideration of business model or the legitimate and rightful attempts to enforce property rights. All-in-all, probably a much better report than most had anticipated.

Editorial Note: The FTC report is some 269 pages in length. There is much to digest. We will continue to pursue this issue in the coming days and weeks.