If you can’t beat patent trolls, join them

By Tam Harbert, Contributing Editor - September 9, 2008

After failing to get Congress to pass a patent reform bill, some large technology companies have decided that if they can’t beat the patent trolls, they can at least use some of the trolls’ own weapons against them.

Called different names—patent trolls, non-practicing entities (NPE), third-party patent holding companies—depending on who’s talking, trolls typically buy patents and then try to extract license fees from large corporations that they allege infringe on those patents. They have long been a thorn in the side of companies with successful products and deep pockets. But in the last five years, the problem has gotten worse as more money has flowed to NPEs (see sidebar, "Trolling for dollars").

In response, groups such as the Coalition for Patent Fairness—comprising large tech companies—lobbied Congress to change the patent laws. But other groups, such as the Innovation Alliance—which includes well-known tech firms like Qualcomm and Tessera that base their businesses on royalty revenue streams—opposed the changes on the grounds that they would dampen innovation.

Trolling for dollars
Is patent trolling the scourge of the universe or a valid business model? It’s an ongoing, emotion-charged debate in the high-tech industry.

But whatever your opinion, the practice of aggregating IP has gained popularity over the last several years, said Keith Bergelt, CEO of the Open Invention Network (OIN), which promotes Linux by buying open-source software patents and granting free licenses to those who agree not to assert their patents against Linux.

Some are doing that defensively. AST is collecting patents to protect companies, for example, and OIN is doing it to protect the open-source industry. On the offensive side, hedge funds and other financial heavy hitters have started either aggregating patents themselves or funding patent-troll companies, driven by the desire to make money from the patents.

“They have left financial services and structured products … and are coming to esoteric assets like IP in search of higher returns,” said Bergelt. Among them are Rembrandt IP Management, which has a $150-million fund; Altitude Capital Partners, which has a $250-million fund; and Coller IP Capital, with a $200-million fund.

Bergelt has an extensive background in IP strategy both within corporations and in the investment world. In fact, he established one of the first funds that focused on IP as collateral. When he worked in finance, he was routinely approached by IP trolls who wanted loans so they could buy patents, he said. “We didn’t lend them any money but there is a lot of interest from hedge funds in doing that.”

McCurdy has been quoted as calling such groups “the arms merchants of the new patent wars,” but it can be hard to draw bright lines between the good guys and the bad guys. First of all, not all large companies think patent trolls are threats, said Richard Taffet, partner and co-chair of the intellectual property litigation and patent prosecution group at Bingham McCutchen LLP. It simply depends on a given company’s business strategy. Companies that rely on high-volume product sales for most of their revenue, for example, are much more likely to feel victimized by trolls. But companies that rely on revenue from licensing intellectual property and groups that don’t have the financial resources to commercialize a technology, such as universities and independent inventors, defend it as a valid business practice, he said.

In fact, some large operating companies even finance trolls and/or use trolls to their own advantage, according to Steve Hoffman, CEO of ThinkFire. Although he won’t name any names, he said he knows of some operating companies that sell their patents to trolls so the trolls can do the dirty work—asserting the patents against competitors without the operating company being involved.

Stuck in apparent stalemate on the legislative side, large companies have formed two new organizations—Allied Security Trust (AST) and PatentFreedom LLC—that use market forces rather than laws to ward off trolls. Both entities emerged from discussions among large companies and IP experts, particularly at ThinkFire, an intellectual property advisory firm that counts Hewlett-Packard and Cisco Systems among its clients. Those two companies as well as others formed AST last year. Then in April Dan McCurdy, CEO of ThinkFire, left ThinkFire to launch PatentFreedom. In August, he also became CEO of AST, after its original CEO, Brian Hinman, left to become vice president of intellectual property at Verizon Communications.

Two complementary organizations

McCurdy said the two groups are complementary, representing different prongs of a new defensive strategy for “operating companies,” the term he uses for the large corporations that are typically targets. (Participation in both groups is limited to operating companies; members must have at least $100 million in annual revenue, excluding revenue from licensing, sale or enforcement of patents.)

AST, a Delaware statutory trust, was launched in March 2007, but just came out of stealth mode in July, according to Hinman. The trust buys patents on the open market, grants licenses to its members, and then sells the patents—with those licenses attached—back into the market.

“What we are trying to do is make a pre-emptive strike” at NPEs by buying potentially strategic patents before the NPEs get their hands on them, according to Hinman, who was interviewed before he left the CEO post. The group is purely defensive and does not intend to enforce or make money from the patents, he notes. AST members include Verizon, Google, Cisco, Telefon, Ericsson and HP, according to the Wall Street Journal. The newspaper also reported that member companies pay $250,000 to join the group and each contribute about $5 million into escrow to be used for patent purchases. Hinman declined to confirm what companies were members or to say how much money was in the trust, but said that figures in the Journal story were “in the ballpark.”

PatentFreedom, a limited liability company, is a subscription service that provides detailed information on NPEs. As McCurdy sees it, operating companies are at a disadvantage because of the secretive nature of trolls. While NPEs can gather all sorts of information about the large well-known public companies that are their targets, the targets often have very little information on the NPEs.

PatentFreedom’s goal is to correct this “asymmetry of information,” said McCurdy. The company had a dozen subscribers as of August and McCurdy expects that number to triple by the end of the year. Annual subscriptions range from $50,000 to $75,000 a year, a drop in the bucket for operating companies. The company also has a lower cost “pay-as-you-go” model for those companies that aren’t frequently targeted by NPEs.

PatentFreedom has identified more than 125 entities with some 800 subsidiaries holding more than 9,000 patents. “And we are confident that there are more than 20,000 US patent families now owned by trolls,” said McCurdy. “We just haven’t found them all yet.”

What’s more, individual subscribers can contribute non-confidential information to the database. If a company gets a letter asserting a patent from a particular NPE, for example, that company can put that information into the system and then possibly find out whether other companies are being approached by the same company regarding the same patent.

PatentFreedom also plans to uncover the NPEs’ sources of funding. In the last several years, big money has flowed to NPEs as their business models have proven capable of producing big returns (see sidebar, "Trolling for dollars"). Funding sources include investment banks, hedge funds, private equity, pension funds, and even other operating companies. If a company that is targeted by an NPE knows where the NPE is getting its money, then it can “force a discussion” with the investor, noted McCurdy. If a financial firm that handles an operating company’s pension fund is also investing in an NPE that is asserting a patent against the operating company, for example, “that operating company is probably not going to be all that happy,” he said.

McCurdy thinks providing such information helps even the playing field. “It’s all about transparency,” he said. “The greater the amount of transparency, the better the market can assess what it’s going to do.”

Intriguing approach

Richard Taffet, partner and co-chair of the intellectual property litigation and patent prosecution group at Bingham McCutchen LLP, finds the new approach interesting. “In some respects AST is in competition with the NPEs,” he said. According to Taffet, as long as AST is making the technology available rather than just locking up patents, it shouldn’t run into anti-trust problems. And he thinks it’s even pro-competitive, because AST will be out there buying patents and providing capital for small inventors, universities and others that sell their patents on the open market.

Even some of the operating companies’ former foes in the patent reform fight see the groups as a positive development. “I think AST is another way of establishing value for these patents,” said Taraneh Magahme, VP of mergers and acquisitions and government relations for Innovation Alliance member Tessera. “These guys are creating a market for buying those patents, which is precisely what they have been criticizing other folks for doing.”