PAE business models have two types, FTC says in long-awaited study

7th October 2016. By Xiumei Dong

The US Federal Trade Commission capped more than two years of research by releasing a report Thursday that illuminated previously invisible workings of a patent assertion industry that has driven a surge of expensive litigation in recent years in the software and electronics technology.

The report and its proposed reforms predictably drew criticism, as well as praise, for proposing a new view of the industry that separates patent assertion entities into categories, one focused on aggregating and licensing large patent portfolios, and a second, more problematic category of PAEs that the FTC said focuses on acquiring small sets of patents in order to file abusive “nuisance” litigation aimed at prompting defendants to settle rather than fight.

To complete the long-awaited report, the FTC served information requests on 22 PAEs, and obtained information not only about the PAEs, but about more than 300 of their affiliated entities and more than 2,100 related entities that held, but didn’t assert patents.

Speaking at an event in Washington, DC, FTC Chairwoman Edith Ramirez acknowledged that the agency didn’t collect information about every PAE operating in the US, or even a statistically representative subset, citing insufficient information to select such a subset.

Rather, she said, the study sample included “PAEs likely responsible for a greater proportion of assertion behavior during the period between 2009 and 2014 — in other words, those that held the most patents and those that sued the most defendants.”

“We estimate that our study captured between 14 percent and 46 percent of all lawsuits filed by PAEs in the United States during the study period, depending on which litigation data one relies,” she added.

The FTC study dubbed the two PAE business models ‘Portfolio PAEs’ and ‘Litigation PAEs,’ reflecting how they made their money.

The licenses reported by Portfolio PAEs made up only 9 percent of the licenses in the study, but accounted for 80 percent of the licensing revenues, the FTC study said. “Portfolio PAEs funded their patent acquisitions with capital from investors, and they frequently licensed their patents without filing a lawsuit,” Ramirez said.

Conversely, the licenses reported by Litigation PAEs made up 91 percent of all licenses in the study, but only accounted for 20 percent of the reported licensing revenues. Litigation PAEs, whose model involves settling quickly for smaller royalties — typically less than $300,000 — “tended to be thinly capitalized, relying on agreements to share future licensing revenues with others to fund their operations,” Ramirez said.

Portfolio PAEs seldom filed lawsuits but experienced a higher degree of success that Litigation PAEs when they actually did litigate, and all of their cases that concluded during the study period led to licenses, the FTC study said. Only 76 percent of such cases filed by Litigation PAEs led to a license.

“The fact that Litigation PAE lawsuits in our study typically settled relatively quickly and for sums under $300,000, an amount that may be less than the lower end of the AIPLA-reported range of defense costs through the close of discovery, suggests some of these settlements were for nuisance value,” Ramirez said.

The FTC proposed four areas of judicial reform aimed at Litigation PAEs. Those reforms would seek to address the cost of evidence discovery for defendants, to provide courts and defendants with more information about the PAE bringing the suit, to streamline multiple cases brought on the same theories of infringement, and to provide sufficient notice of these infringement theories as courts continue to develop heightened pleading standards in patent litigation.

“We are focusing on litigation reform because we saw a significant amount of litigations in the study,” said Suzanne Munck, FTC Deputy Director and Chief Counsel for Intellectual Property.

Munck said, however, that the fact that there is a focus on litigation reform does not mean Portfolio PAEs are getting a pass.

“There are a number of issues with respect to portfolio licensing that are legitimate; there are also issues with the respect to portfolio licensing that can raise questions, so I think those are thing that you have to take one at time,” she said.

The FTC study found that a majority of the patents acquired by PAEs in the study are not standard-essential patents, which means they are not subject to a preexisting commitment to license on fair, reasonable and non-discriminatory, or FRAND, terms.

The study also found that none of the PAEs in the study sample, or the more than 300 affiliated entities, engaged in large-scale demand letter campaigns threatening to sue numerous targeted firms, in which majority of them get settlements through filing lawsuits.

“The FTC followed the money and found that patent trolls do indeed have business models that extract large sums of money from productive sectors of the economy,” said CCIA president Ed Black. “These practices are a significant drag on both innovation and the performance of the U.S. economy. The FTC study revealed patent trolls frequently target the computer and communications industry. In fact, 88 percent of the patents in the study were from that sector of the economy.”

While the study covered a significant period of time, Ramirez said that the purpose of the report is not to include all the problems but to provide a market study of the industry, and acknowledged that they couldn’t cover everything they’d set out to.

“I want to acknowledge that we were not able to answer all the questions that we had set out to address with this study,” she said “As a result, there are some nonpublic aspects of PAE activity … we were unable to bring out to the degree we wished.”

With assistance from Can Celik and Mike Swift

	Eliot Gao

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