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FTC Details the Business of ‘Patent Trolls’

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The Federal Trade Commission released a first-of-its-kind report about the breadth of the “patent troll” business on Thursday. It detailed two distinct business models for patent trolls and provided empirical evidence that regulators or the courts can use to limit the industry’s negative consequences on innovation.

The most surprising finding is that the lesser known of the two patent troll business models — the one that functions almost exclusively outside of the court system — brings in almost all of the revenue.

Patent trolls are firms that buy up patents with the intention of deploying them against companies that use technologies associated with the patent. Patent trolls will often demand those firms pay a licensing fee and threaten lawsuits or pursue litigation against companies that do not comply.

Anecdotal evidence suggests patent trolls disproportionately target information technology firms and electronic device manufacturers, an assumption supported by empirical data in the FTC report. Many advocacy groups say those lawsuits hinder innovation in the tech industry.

FTC Chairwoman Edith Ramirez laid out the findings of the federal study — the first to move beyond anecdotal evidence and empirically examine the patent troll industry — during a luncheon hosted by the Computer and Communications Industry Association and the American Antitrust Institute.

The report studied 349 patent trolls and affiliates that the FTC believes were likely responsible for the greater part of “patent assertion behavior” — or trolling — between January 2009 and mid-September 2014.

The FTC found that patent troll firms divided into two distinct categories. The FTC dubs the lesser known type as “portfolio” patent trolls. These companies acquire aggregated patents into large portfolios — often containing hundreds of thousands of patents — before sending out demand letters to affected companies in a bid to negotiate licenses out of court.

Portfolio patent trolls usually do not file lawsuits against their targets. They generate 80 percent of the reported revenue, or around $3.2 billion.

“Litigation” patent trolls are more familiar to regulators and the industry. These firms typically sue companies first for patent infringement over a small patent portfolio, typically fewer than 10 patents. The licenses they receive from those lawsuits typically yield total royalties of less than $300,000.

Those small amounts, the FTC points out, approximate the lower end of early-stage legal costs to defend against an infringement suit. The low-yielding royalties accepted by litigation patent trolls, and their close tracking with the defense’s legal costs, suggest that litigation trolls often pursue “nuisance lawsuits.” The goal is to drive the defendants to pay a license fee rather than pay more money to go to trial on a case they would likely win.

Those types of patent trolls earn just 20 percent, or around $800 million, of the reported revenue.

During a panel following Ramirez’s speech, some patent experts expressed surprise at the stark breakdown between the two types of patent trolls.

“I was startled by this,” said Mike Godwin, director of innovation policy and general counsel at the R Street Institute. “I didn’t really know there was such a clear split until I saw the report today.”

“The taxonomic distinction between portfolio [patent trolls] and litigation [patent trolls] is very important,” Godwin said. “In some ways, it’s the central insight here.”

The report also offers several suggestions about how courts or Congress can cut down on these nuisance lawsuits. Even though they represent a smaller part of the industry, Godwin said litigation patent trolls “are also the tail wagging the dog.”

“When you are a portfolio [patent troll], and you really want to proceed with demand letters and license your full portfolio, you know that in the back of their minds — especially with these retail end users — the cost of litigating these patents is scary,” Godwin said.

If that litigation threat becomes less imminent, the theory goes, portfolio patent trolling will also be less attractive.

In particular, the FTC recommends that courts pursue rules and case management practices to reduce the cost of evidence discovery on firms targeted by patent trolls. The report shows asymmetric discovery costs between patent trolls and the companies they sue — with the companies bearing the large burden — and argues that evening out that score could lead to fewer nuisance lawsuits.

A bipartisan group of lawmakers attempted to pursue patent reform legislation, but the effort stalled in mid-2015 and has been unable to regain much steam since.

Patent experts hope the new report will inspire a second look at patent troll legislation.

“I wish I’d had this report in hand in January of 2015, with the introduction of efforts to reform patent litigation,” Godwin said.