Smartflash v. Apple: A poster child of the current ills wrecking the U.S. patent system

“Apple Inc, Mac, Apple Store, Store” by matcuz. Public domain.

On April 14th, 2017, a petition for a panel hearing and a rehearing en banc was filed at the U.S. Court of Appeals for the Federal Circuit (Fed. Cir.) by plaintiffs Smartflash LLC and Smartflash Technologies Limited. Smartflash is asking the full Fed. Cir. to rehear its case against consumer electronics giant Apple Inc. (NASDAQ:AAPL) to resolve an intra-circuit conflict regarding patent eligibility standards for software inventions. Smartflash also argues that the exceptionally important nature of its case against Apple warrants an en banc rehearing. Many readers may remember that Smartflash won a $533 million damages award from Apple in February 2015 after a jury in the U.S. District Court for the Eastern District of Texas (E.D. Tex.) found that Apple had willfully infringed upon the patents asserted by Smartflash.

Smartflash’s petition for an en banc rehearing follows the March 1st decision handed down by the Fed. Cir. in the case, in which the Fed. Cir. panel found that the patents asserted by Smartflash are directed at subject matter which is patent-ineligible under 35 U.S.C. Section 101. Applying the same Alice test which the Smartflash patents went through during the E.D. Tex. trial, the Fed. Cir. based its decision on the fact that those patents, which claim a handheld multimedia terminal, were analogous to claims invalidated in 2014’s Ultramercial, Inc. v. Hulu, LLC, including claims directed at a method for distribution of products over the Internet.

One reason why this case might warrant an en banc rehearing includes the fact that the case was decided by a different judicial panel than the panel which heard Smartflash’s arguments in the case. The March 1st decision was handed down by a panel which included Chief Judge Sharon Prost, Judge Pauline Newman and Judge Alan Lourie. An order entered in the case last June, however, lists a Fed. Cir. panel which includes Judge Jimmie Reyna, Judge Richard Taranto and Judge Kara Stoll. It appears to be unclear why a wholesale change of judicial panel was made leading up to the March 1st decision of the Federal Circuit.

The entire timbre of the case also seems to have changed along with the panel switch. The order entered last June by the Reyna panel was to deny Apple’s jurisdictional objection to its own appeal in the case. Apple had tried to argue that E.D. Tex. hadn’t granted Smartflash’s request to limit its own relief to damages and thus Fed. Cir. did not have jurisdiction to hear the case. Given the legal gymnastics required to reach such a conclusion, one would expect that Apple has appealed many aspects of E.D. Tex.’s decision in favor of Smartflash. However, Apple has not appealed several important grounds of the decision in E.D. Tex., namely, that Apple infringed upon Smartflash’s patents, that the infringement was willful, that Apple had knowledge of the Smartflash patents and that Apple had induced others to participate in the infringement. Apple’s appeals in the case, in the context of what the company hasn’t appealed, would seem to suggest that the company knows that it stole technology but is trying to get the case thrown out without having any appellate judges look too closely at the E.D. Tex. trial.

“From the earliest days at Apple, I realized that we thrived when we created intellectual property. If people copied or stole our software, we’d be out of business. If it weren’t protected, there’d be no incentive for us to make new software or product designs. If protection of intellectual property begins to disappear, creative companies will disappear or never get started. But there’s a simpler reason: It’s wrong to steal. It hurts other people. And it hurts your own character.” – quote from Steve Jobs in Steve Jobs, by Walter Isaacson (Simon & Schuster, 2011)

We’ve obtained a transcript of the oral testimony heard in E.D. Tex. in the case of Smartflash v. Apple and there are some interesting takeaways from those hearings. First of all, despite the media widely lambasting Smartflash as a patent troll, inventor Patrick Racz actually created a company called Internet plc “to develop, manufacture, and commercialize the invention”; Smartflash was created as an entity to hold the intellectual property. So while the Smartflash entity was technically non-practicing, Racz’s court testimony indicates that he always intended on manufacturing and commercializing his invention of a system implemented on a device with memory and functionalities for authenticating a device on a network and payment for content distributed on that network.

This ability to pay for access to content on a network through a device is a basic function of all smartphones and Racz came up with it in 1999, in the heyday of Napster-style peer-to-peer online piracy and nearly a decade before Steve Jobs introduced the iPhone. It solved a major problem in the music industry at the time, namely the reticence of music and media executives against releasing digital content because of the ease of piracy; Racz’s system created a secure way in which content publishers could get paid when others accessed digital content which they published to a network.

Although Racz did have 10 years’ manufacturing experience in a different industry, he realized that he needed an electronic design engineering firm. One of the companies which Internet plc partnered with to commercialize the handheld multimedia terminal invention was a French firm called Gemplus. According to Racz’s testimony, he worked closely with several important Gemplus officials, including the chairman, founder and major shareholder of the company. Racz shared design models with Gemplus, including one which incorporated the invention into a device with a touchscreen.

And then Gemplus started cutting Internet plc out of the picture and began claiming the technology as its own. Around mid-2001, Racz discovered that Gemplus was taking images of product models developed by Internet plc with another firm and deleted the trademarks from those other firms, presenting the technology as its own. Racz testified that Gemplus had invested heavily in his company and he wasn’t in a position to break his business relationship with Gemplus at that time. In October 2002, a Gemplus official contacted Racz to inform him that Gemplus was no longer able to work with Internet plc.

“Picasso had a saying: ‘Good artists copy; great artists steal.’ And we have always been shameless about stealing great ideas.” – Steve Jobs interview (1994)

A few years later, the head research and development at Gemplus was hired by Apple to serve as its head of digital rights management (DRM), reporting directly to Steve Jobs. According to his LinkedIn profile, Augustin Farrugia was strategic program director at Gemplus from June 1997 to December 2002, two months after Gemplus officially cut its ties with Internet plc. Since April 2005, Farrugia has served as a senior director at Apple. In his court testimony, Farrugia acknowledged that he serves as the senior director of DRM at Apple. Despite testifying in his deposition that this was his first job in DRM, Farrugia was hired directly into the role of director of DRM technologies at Apple and worked on updates to Apple’s FairPlay DRM technology, which at the time of his hiring had significant security vulnerabilities.

Given Farrugia’s close ties to Gemplus, and Racz’s testimony that Gemplus was the entity that stole his technology, it would seem to be very damaging to Apple’s defense if Farrugia couldn’t keep his story straight on the circumstances which led to his hiring by Apple. Farrugia testified that, between 1999 and 2002, he was a director at Gemplus. In his July 2014 deposition, Farrugia said that he worked at two different companies before coming to Apple, firms called JetEye and Young Generation. However, in a different deposition given by Farrugia on December 8th, 2010, he said that he quit Gemplus and found an opportunity at Apple. In that testimony, Farrugia stated that Gemplus was his most previous employer before Apple:

“Q. Mr. Farrugia, which time under oath were you telling the truth?

A: Both are the truth. I was not employed by Young Generation. I was helping a friend. My last employer was Gemplus.

Q: So you were still in the employ of Gemplus?

A: My last employer was Gemplus. And when I was at Young Generation, I was helping a friend, which was not my employer.

Q: Do you agree that you quit the Gemplus job to find an opportunity at Apple?

A: Yes, sir.

Q: Do you recall telling us earlier you did not have much experience in digital content security when you started at Apple?
A: Yes, sir.

Q: Nevertheless, you applied for a job as director of digital rights management, specifically to help provide protection for content, correct?

A: Yes, sir.

Q: Mr. Farrugia, does it make any sense to you that Apple would hire somebody with no digital content protection experience to create the new position of director of digital rights management?

A: Yes, sir.

Q: In 2005, it was hard to find somebody with that kind of experience, wasn’t it?

A: I believe so.

Q: And, in fact, Apple wanted to hire you specifically because of the skill set you could bring from your Gemplus days, didn’t it?
A: No, sir.

Q: Mr. Farrugia, do you think Apple recognized you had any special acumen or skill set that interested them?

A: Yes, sir.

Q: And that skill set was an expert in making digital content protected, correct?

A: No, sir.

Q: That wasn’t the skill set — the special acumen or skill set that interested Apple?

A: They under — they understand my skill in security.

Q: Okay. Mr. Farrugia, my particular question is: Was the special acumen or skill set that interested Apple, the fact that you were an expert in making digital content protected?

A: I don’t know. I cannot answer this question, sir.”

Shortly after this exchange, Farrugia would again be directed to his own testimony from the 2010 deposition, given three years before the Smartflash case was first filed. He was shown where he said in that testimony that his experience in security, specifically as an expert in making digital content protected, was the skill set which Apple recognized that lead to his hiring at Apple. Later, during Apple’s redirect, Farrugia again testified that he worked at JetEye and Young Generation in the two-year period between Gemplus and Apple, but that he received no salary for that work during that time. As well, Farrugia’s LinkedIn profile currently lists Mobicom as his employer between January 2003 and April 2005, so Farrugia’s employment status during those two years continues to look suspect.

“We applaud them for finding Samsung’s behavior willful and for sending a loud and clear message that stealing isn’t right.” – Tim Cook’s official statement following August 2012 victory in patent case against Samsung

Patrick Racz invented something valuable. That valuable technology was stolen by Gemplus and an R&D director from that firm was hired soon thereafter by Apple. That director then gave conflicting testimony in court as to why Apple decided to hire him. A jury in a federal district court decided that Apple willfully infringed and induced infringement on the patents covering Racz’s invention. Numerous Section 101 invalidity challenges at the district court led that court to state that “[t]he § 101 issue has already received full and fair treatment.” Apple then appeals the case to the Federal Circuit and receives a favorable Section 101 ruling after the judicial panel is completely changed without notice. The panel issues the ruling as a nonprecedential decision despite Smartflash’s arguments that the court’s finding of patent-ineligibility directly conflicts with previous decisions of the court in BASCOM Global Internet Services v. AT&T Mobility Corp., McRO, Inc. v. Bandai Namco Games America Inc. and Amdocs Limited v. Openet Telecom, Inc. Smartflash also argues that the case is exceptional given that this is one of only two times where the Fed. Cir. has issued a decision of patent-ineligibility under Section 101 to overturn a jury verdict of infringement. “The panel never explained how a technological invention may be patentable – novel and nonobvious – yet nevertheless ineligible because it merely claims generic implementation of an abstract idea,” Smartflash’s motion for rehearing en banc reads, noting that the Texas federal jury had already considered novelty and nonobviousness and found that Smartflash’s patents cleared those standards.

“Whoever came up with that phrase [“patent troll”] should get a special bonus because they manage to mischaracterize anyone who goes to court to assert patent rights as a troll… What I came to understand was one man’s patent troll was another man’s assertion of a patent right which they fought for and worked for for years which is now being infringed upon by some giant.” – Sen. Dick Durbin (D-IL), Senate Judiciary Committee hearing dated 4/25/17

It would be nice to see major news outlets engage in this kind of factual reporting of a patent infringement case based on actual court documents, or to even reach out for a comment from the entity challenging Apple. But to the mainstream media, is Patrick Racz an innovator who solved a major economic problem facing an industry, only to watch others steal that technology, claim it as their own and profit wildly in the smartphone market? No. To Fortune, Racz is “an 8th-grade dropout patent troll.” Bloomberg has also called Smartflash a patent troll. News report after news report after news report has parroted Apple’s description of Smartflash as a patent troll. These media reports were so galvanizing to readers that Racz described receiving several anonymous death threats in a piece he wrote which was published on HuffPost UK.

Smartflash is a poster child for the current woeful state of the U.S. patent system. We’ve already reported on how Smartflash’s patents have been overturned at the Patent Trial and Appeal Board (PTAB) following petitions from Apple in proceedings which have been conducted despite a potential conflict of interest among one of the judges serving in those cases. Upon further review of the case, it appears that Apple has engaged in not just infringement but almost outright theft. Yet Apple’s mainstream status as a consumer tech darling leads to scads of favorable press coverage and a surprisingly flexible Federal Circuit. Anyone who honestly cares about justice ought to be outright disgusted with how Apple has been able to play the system to engage in illicit activities to profit at the expense of a true innovator.