David Kappos, former director of the USPTO, currently a partner at Cravath, Swaine & Moore LLP

Former USPTO director David J. Kappos spoke at the International Symposium on Standards, SEPs and Competition Laws, held recently at National Taiwan University. Kappos gave a spirited defense of standard-related incentives in the patent system, taking aim at seven myths which he said lead to false assumptions about the US patent system and which are born of a misreading of the history of innovation:

Myth Number 1: SEPs Lead to Licensing Holdup

Kappos stated that this is a myth designed to justify robbing innovators of the royalties from their inventions and to deny companies any payback for significant R&D costs in developing new technology. He cited the low prices prevalent in the mobile phone industry despite the rapid developments in technology as proof that standard essential patents (SEPs) are not preventing innovation, but rather aiding it:

“[…] we have seen the mobile phone industry evolve over the last two decades from Motorola’s launch of the $1,000 single-function StarTAC in 1996 to $100 for an off-brand full Internet, streaming video, high definition camera-enabled smart phone today.”

He suggested that the real problem holding back innovation today is holdout by those companies seeking to hijack technology developed by others without investing in R&D themselves or acquiring a license to use it. He suggested that antitrust authorities were overstepping their bounds in this regard and allowing holdout to stifle innovation:

“Enabled by inexpensive components and turnkey product development kits that permit new market entry with little investment cost, and encouraged by the counterproductive activities of misguided antitrust authorities, some manufacturers, with no R&D investment of their own, have simply refused to license patents of good faith innovators. Instead, implementers openly infringe patented technologies and brazenly dare patentees to file suit.”

Although Kappos did not make any specific reference to China, Professor Fujio Kawashima from Kobe University stated that Kappos’ comments seemed to be directed at the recent antitrust case against Qualcomm in the country, in which the company was fined US$975 million by China’s National Development and Reform Commission (NDRC) for antitrust “violations”. Qualcomm was one of the sponsors of the symposium.

Kappos stated that if antitrust authorities continue to overstep their bounds, there are likely to be job losses, a reduction in profits across the board and a slow-down in GDP growth.

Myth Number 2: FRAND is broken

FRAND is an acronym for Fair, Reasonable and Non-Discriminatory” – a licensing obligation which standard setting organizations (SSOs) normally require of those who want to take part in standard setting. “Fair”, refers to pro-competitive, “Reasonable” refers to reasonable royalties and “Non-Discriminatory” refers to each licensee being treated similarly.

Kappos stated that FRAND works well as is, citing the framework established by the Huawei v. ZTE SEP injunction case by the Court of Justice of the European Union (CJEU) and how it was applied in Sisvel v. Haier. This judgment essentially suggests that in certain circumstances a company may be found to have violated competition rules if it seeks an injunction against another company after agreeing to license its technology on FRAND terms if the second company has agreed to license the technology in good faith. Kappos stated that the judgment allows for a balance between the interests of the standard implementers and patentees and does not automatically assume wrongdoing by any party.

Kappos also suggested that although “mythmakers” have been calling for the disclosure of all licensing agreements to ensure that they are “non-discriminatory”, FRAND terms do not and should not mean the same price for every licensee and that this would run counter to market principles. The difference in price for parties depending on their business relationship with the patent holder and the number of patents licensed in one deal was akin to a customer buying 50 computers being offered a discounted price compared to one customer buying just one computer, he suggested. He stated that imbalance of information has always played a big role in price-setting and that market principles should apply to SEP negotiations too. He stated that FRAND is actually the main driving force that allows innovation to continue as opposed to being an obstacle to it.

Kappos also addressed one of the main arguments put forth by FRAND critics, that court cases in which courts set royalties at levels lower than the company had originally proposed are evidence of the failure of FRAND, by stating that the only reason the courts had been able to reach these judgments was because the companies had agreed to FRAND terms and that otherwise there would be no commitment to lower prices.

Myth Number 3: Royalties stack and impede implementation of standards

Again citing the example of mobile phones, Kappos said that the idea of royalty stacking is belied by the reality of the market. He stated that royalty arrangements work well and allow companies to engage in negotiation and long-term agreements. Prices have not inflated as one might have expected if this myth were to be true. He said the market works against royalty stacking and stated that innovators deserve to get rewards for technology they have developed. He also stated that many SEPs are purely aimed at providing ancillary or incremental functions and are not necessary to be in line with the standard as a whole, which provides companies complying with standards some breadth of choice as to which to adopt.

Myth Number 4: Patent thickets obstruct innovation

Kappos stated that throughout the history of innovation there have been countless examples of inventions that have thrived despite multiple patents which this myth would suggest would be impossible, including the sewing machine, airplanes, DVD and smartphone technology.

He stated that despite initial difficulties in the development of the sewing machine, it was when competitors developed patent pools and cross-licenses that the technology was able to take off. He said that counter intuitively “patent thickets” actually work to forward innovation, given the value markers they provide in negotiations, which he called “synthetic trust”.

He suggested that the idea that patent thickets lead to antitrust violations and monopolistic behavior was contradicted by a study carried out by Boston Consulting Group that found that the cost per megabyte for the average mobile subscriber decreased by 99% between 2005 and 2013 despite 4G technology including more SEPs than 2G technology.

He argued for the prioritization of intellectual property laws over anti-trust laws, given the static and backward looking nature of the latter and its focus on the status quo of an industry at one fixed point of time, as opposed to dynamic forward-looking intellectual property laws. He said that given the rapid pace of technological development, parties are incentivized to resolve disputes as rapidly as possible, in order to secure profits before the technology is made obsolete. Pooling and cross-licensing are tools that allow for efficient resolution of patent thickets, but these tools are defeated by anti-trust intervention, he stated.

He said that ultimately abuse of antitrust laws threatens the pace of innovation that consumers have come to expect.

Myth Number 5: In the world of damages calculations, the SSPPU is king

SSPPU stands for smallest salable patent practicing unit and refers to the smallest component that practices a patent within a larger multi-component device. Kappos suggested that the use of the SSPPU model for determining royalties, as established in a case between Cornell University and Hewlett Packard, cheats innovators out of the royalties owed them. He stated that those who disseminate this myth are largely looking to forward the interests of implementers by attempting to apply an evidentiary rule created for the specific context of jury trials to all patent infringement damage determinations, including SEP licensing contexts.

The SPPUU damages calculation method had a specific context and is not fit for extension to general damages principles, he stated. He also suggested that calculating damages in this way makes for an impossible level of red-tape for the companies involved, given the size of most patent portfolios and the application of one single SEP to multiple devices. Using this method of calculating damages is a sure way to reduce the incentives for companies to engage in R&D, according to Kappos.

Myth Number 6: IEEE’s historical standard-setting process was ineffective

Kappos stated that the decision by SSO the Institute of Electrical and Electronics Engineers Standards Association (IEEE-SA) to change their regulations to include reference to the SSPPU just after the successful implementation of the Wi-Fi standard, is something that he found puzzling. He said that the effects of the new rules may not become clear immediately but that they could have a substantial effect on innovation, given that they are now firmly in the interests of implementers, not innovators. He said that this will result in innovators seeking other platforms for standards, or a dip in innovation. He attributed the change to advocacy by lobby groups and said that the new rules allow implementers to use delay tactics, which are increasingly harmful in the context of the ever-shortening half-life of technology. He said that the new standards had also been adopted by China’s Electronic Intellectual Property Center, which he stated was an ominous sign of things to come.

Myth Number 7: Patents stifle growth

The final myth Kappos took on was a broader attack on the patent system as a whole, suggesting that the ability to patent inventions stifles innovation. In response to this, Kappos stated,

“Balance will always be disparaged as imperfection by interested parties. This is as much the case today as it was in previous centuries – in which a great many inventors survived and flourished.”

He also stated that innovation is unlikely to flourish if those who innovate unable to reap fair reward for their inventions or cover the cost of further R&D:

“It is additionally difficult for individuals to conjure the notion of a world in which our currently prized devices, methods and tools were never invented because innovators were not offered sufficient incentives.”

He stated that it may also be a problem of perspective. As it is easier to complain of the exclusive rights granted to a patent holder when the invention is already in the public sphere, but quite another when the innovation stalls due to the lack of motivation to innovate.

He then asked people to consider the alternative to a strong patent system, which would be to go back to the trade secrecy of the medieval era and its guilds. He stated that this would lead to even less access to new technology and less impetus for innovation. He added that patents are a key way in which startup companies can secure a place for themselves in an already saturated market. He also suggested that the system’s current structure has in turn influenced the way company’s formulate their business practices and that simply hypothesizing on an alternative without adjusting this metric is not practical.

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