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The FTC PAE Report: PAEs no longer the poster child for patent reform?

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Patent Assertion Entities—businesses that monetize patents acquired from third parties—have been a convenient poster child illustrating the need for patent reform. The narrative goes like this: PAEs, less charitably known as “patent trolls,” are a major source of excessive and wasteful litigation, often involving patents of dubious value. Some trolls send out hundreds or even thousands of “demand letters” to small businesses and others with the aim of collecting a large number of small settlements. PAEs make money by obtaining settlements from defendants whose principal motivation is to avoid potentially large litigation costs, regardless of the validity of the PAE’s patents or the merits of its infringement case. Very little of the money finds its way back to inventors. In sum, PAEs produce little of economic value and their activity constitutes a “tax” on innovation. But how much, if any, of this caricature is accurate?

To answer some of these questions, the Federal Trade Commission produced a study on PAE activity. Much, if not most, important data on litigation activity is subject to confidentiality agreements or otherwise not publicly available. Unlike existing studies of PAEs, which had to rely on publicly available litigation data, the FTC uses confidential business data, which it collects under its authority in Section 6(b) of the Federal Trade Commission Act.

The report does not, for the most part, support the patent troll caricature and, for better or worse depending on one’s point of view, diminishes the utility of PAEs as a poster child for reform. In particular, the FTC found no evidence of large-scale demand letter campaigns for low-revenue licenses, one of the elements of the patent troll narrative. The FTC also found no evidence that PAE patents are low quality as evidenced by their receiving more citations than the average patent. [1]

The FTC study took several years, was carefully done and produced a wealth of data that will add to our knowledge and provide leads for further research. Nevertheless, the study cannot be considered definitive. Much work remains to be done before we have a good understanding of PAE activities.

Because the study focuses on litigation activity, it has little to say about the key questions regarding PAE’s economic functions and value. Are PAEs an important part of the secondary market for patents? Do PAEs promote more efficient utilization of patents? Do PAEs incentivize innovation and investment by providing startups (and their funders) a way of salvaging some value if they fail? Do they help small inventors enforce their rights? Or are they, as their detractors assert, a tax on innovation?

The report acknowledges that its results are not generalizable since the lack of data on the universe of PAEs makes it impossible to draw a statistical sample. To the extent the data are descriptive of PAEs generally, they do not lead to unambiguous policy recommendations, although the report makes several.

A major recommendation is to reform the discovery process in a way that addresses what the authors believe to be an asymmetry in costs that disadvantages defendants. The report finds that a category of PAEs called Litigation PAEs typically settled for less than $300,000—a number that approximates the lower bound of early-stage defendant litigation costs. The report concludes that this behavior “is consistent with nuisance litigation.”

While the $300,000 settlement figure may be “consistent with” nuisance suits, it does not necessarily follow that these suits are nuisance suits. They may be meritorious suits that have a relatively low value. The data presented do not speak to that question. Thus, while lowering the relative cost of defending a patent infringement claim, as the report recommends, may deter nuisance suits, it also may deter meritorious suits.

The study includes three other procedural reform recommendations:

  • Provide defendants and courts with more information on the ownership structure of multi-affiliate PAE plaintiffs;
  • Encourage courts to stay infringement claims against end users where the manufacturer is also being sued; and
  • Ensure that the infringement claims provide better notice of the factual allegations involved.

These recommendations seem relatively modest, especially when compared to other measures that have been part of patent reform discussions, and may all be reasonable and even beneficial. As many reviewers have noted, however, the proposals do not follow from the rest of report.

More importantly, we do not know if the proposed reforms would be beneficial because they have not been subject to any sort of benefit-cost analysis. This is especially important because the reforms would appear to apply to all patent litigation (not just PAEs) and perhaps even other types of litigation.

Some of the issues addressed by the recommendations have also been addressed by recent court decisions, potentially affecting the benefits of the recommendations. The authors of the report should demonstrate that, on the margin, their recommendations will produce net benefits. New policies often involve some tradeoffs and the possibility of unanticipated consequences. These should all be examined and taken into account before the recommendations are acted on.

 

[1] Although patent quality is a complex issue, the report noted that “A large body of empirical literature has found that highly cited patents are, on average, more valuable than less frequently cited patents. For this reason, patent citations are often seen as a proxy for patent quality.”