I’d like to start off today with two true stories.
The first is about my great-great-grandfather, Carlton Gardner Lutts, an inventor, entrepreneur and metallurgist. Between 1929 and 1954 while working at the Boston Navy Yard, he developed and patented several improved methods of manufacturing anchor chains. That’s a diagram from one of his later patents below.
With the royalties he earned from licensing the patents, he and my great-grandmother were able to buy Cabot Farm (named after the previous owners) in Salem, Massachusetts. Today, the farm is home to 30 of their descendents—as well as a big anchor connected to a pile of his chains.
My second story today is about another patent, patent number 7222078.
Patent 7222078, titled “Methods and Systems for Gathering Information From Units of a Commodity Across a Network,” was filed on December 10, 2003, by Daniel H. Abelow.
The patent is 89 pages long (Carlton Lutts’s longest patent application was 7 pages long), including 39 pages of illustrations. The patent is for an invention called a Customer-Based Design Module, abbreviated in the patent as a CB-DM. An example of such a module is pictured below, in an illustration from the patent:
Over the course of the 89 pages, the CB-DM is described as a device that can be built into or attached to a piece of consumer electronics, or distributed on a stand-alone basis, to collect feedback from customers.
The patent describes several examples of how this device could be used. My favorite involves building a CB-DM into an electronic typewriter and programming it to print out a series of user-feedback questions every 10th or 100th time the typewriter is turned on. The user could answer the questions by typing his replies, then the CB-PD module could “print the address for the Customer to mail in the replies; or print folding instructions and then the address right at the bottom of the replies, so they could be folded closed and mailed.”
Other examples include feedback devices embedded inside rental cars and VCRs. It’s not a terrible idea, although I do think customer feedback technology was already more advanced than this in 2003—but this patent is a “continuation” of an earlier, very similar, patent that was filed in 1994.
But the reason I’ve chosen to make an example of this particular patent isn’t its datedness, or its dubious utility, or even its unnecessary length and wordiness. (It includes the sentence, “Can a society even consider approaching perfection?”) As far as I’m concerned, inventors can file all the useless, long-winded, poorly-written patents they like. This particular patent’s insidiousness lies not in the patent itself, but in how it is being used.
When Daniel Abelow submitted patent 7222078, he assigned it to a Las Vegas-based company named Ferrara Ethereal LLC. (In the U.S., corporations can’t submit patents, but inventors can, and often do, “assign” patents to corporations.) He also apparently sold or assigned the LLC his prior patents, on which 7222078 was based. The oddly-named Ferrara Ethereal was actually a shell corporation of a larger company named Intellectual Ventures.
Intellectual Ventures (or IV) was founded and is led by Nathan Myhrvold, formerly Microsoft’s chief technology officer. The company says it’s in the business of invention, but its main business is buying, holding and licensing patents.
It does employ some of its own inventors, and have its own lab, and file some of its own patents. But the 1,000 or so patents IV has received on its own inventions are dwarfed by the 30,000-plus patents it has bought. And while IV’s inventors produce some neat stuff in its lab—like a mosquito-zapping laser and a cooler that can keep vaccines cold for months—the company has never produced a single one of its inventions commercially. The “Products & Services” tab on its website contains three services: “Licensing,” “Value Added Solutions” and “Contact Licensing.”
While it owned patent 7222078, Intellectual Ventures apparently managed to license it to American Express, Apple, Google, Hewlett-Packard, Intuit, Microsoft, Nokia, Sony, and six other companies. Why would these corporations be interested in licensing a patent for an outdated system of gathering consumer feedback that had never even been created?
Most likely, they weren’t. Intellectual Ventures holds thousands of patents, and its modus operandi is licensing them to big companies in huge, million-dollar deals. Intuit and Intellectual Ventures struck a $120 million deal in 2009, for example. The companies that license IV’s patents aren’t interested in using them—I suspect most of the patents don’t even get read. The only thing they’re interested in buying from IV is protection.
What is IV selling them protection from? Mostly itself.
On May 13 of this year, a software developer named James Thomson received a stack of legal documents via FedEx. The documents were from a company named Lodsys, and they informed him that the calculator app he’d made for the iPhone violated one of their patents: patent 7222078. Throughout the day, other iPhone app developers reported receiving similar deliveries. The letters gave the developers 21 days to negotiate a licensing agreement with Lodsys to avoid legal action.
What had these developers included in their apps that infringed on Dan Abelow’s conceptual Customer-Based Design Module?
All the apps Lodsys targeted included a button that allowed users to upgrade the app. In the case of James Thomson’s calculator app, it was a button that prompted users to upgrade from the free to the paid version of the app. When users clicked on the button, they would be taken to Apple’s App Store, where they could download Thomson’s paid calculator app.
I’ve read (most of) patent 7222078, and it is not a patent for an upgrade button in an iPhone app. It does suggest ordering upgrades as a potential use of the CB-DM, and the CB-DM is often portrayed as having buttons, but you can hardly say that that makes it a patent for an upgrade button. That’s like saying the patent for the hand-cranked cotton gin was also a patent on hand cranks. It seems obvious that any reasonable judge would say the same thing. But that would require Lodsys’ suits against the developers to actually get to a judge. And most of the developers Lodsys chose to sue don’t have the time or money to fight this case in court. Which is exactly what Lodsys was banking on all along.
Lodsys is what’s known as a non-practicing entity, or NPE. It doesn’t appear to have any employees or any business, and when producers from NPR’s This American Life visited its listed address—104 East Houston Street, Marshall, Texas, Suite 190—for a recent segment on patents, all they found was a hallway of locked doors. It’s hard to tell if Lodsys is actually a shell company of Intellectual Ventures—a lawyer interviewed for the This American Life segment estimates that IV has close to 1,300 shell companies—but they seem to have very close ties, at the very least. Lodsys is what’s known pejoratively as a patent troll. The company’s entire business is acquiring patents and using them to extract money from people and companies who are making things. Just like they’re doing with patent 7222078.
The This American Life episode told the story of another patent, patent 5771354, for “an online back-up system.” The show’s producers asked a company that assesses patent quality for governments and corporations to run a scan on patent 5771354’s uniqueness. Their software found 5,303 other patents that appeared to have significant overlap with patent 5771354. The company’s founder, who ran the scan for them, was unsurprised. According to his research, about 30% of patents issued in the U.S. today are for “inventions” that have already been patented.
Intellectual Ventures owned patent 5771354 as well. And in June 2010, they did the same thing with it that they did with Abelow’s patent—sold it to a shell company called Oasis Research, which in turn sued 16 tech companies for infringing on it. Oasis Research’s address is not only also in Marshall, Texas, it’s also 104 East Houston Street, Marshall, Texas, Suite 190. The same street, building and suite as Lodsys.
Patents were developed to encourage innovation. The Constitution gives Congress power “To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” And when they work, they do just that. Patents encouraged my great-grandfather to develop half-a-dozen new ways to make chains, which both moved chain technology forward and helped him buy a farm. And patents have raised the standard of living of people around the world by encouraging inventors to make their inventions public in exchange for licensing fees.
But as we saw above, patents can also be used to impede the progress of science and useful arts. When patent trolls like Lodsys buy existing patents and use them simply to extort money from people and companies that actually make things, they’re not enriching inventors, the public or anyone but themselves.
And the problem is getting worse: between 2004 and 2009, patent infringement lawsuits increased by 70%. And requests for licensing fees—like the ones Lodsys sent out—increased by a whopping 650%.
Faced with this rising threat, big companies have begun devising ways to protect themselves. In addition to licensing huge numbers of patents from companies like Intellectual Ventures, they’ve also started buying up patent portfolios themselves. In June, a consortium made up of Apple, Microsoft, Research In Motion, EMC, Ericsson, and Sony paid $4.5 billion for Nortel’s patent portfolio. Google’s deal to acquire Motorola Mobility was, by its own admission, partly motivated by desire for the Motorola’s huge patent portfolio.
Motorola Mobility owns approximately 5,000 U.S. patents and has 1,500 pending patent applications. Google had previously criticized Apple, Microsoft, Oracle and other companies for using “bogus patents” to attack Google’s Android mobile operating system, but it has clearly decided that it’s time to play ball. And now, speculation is heating up that Kodak could generate some much-needed dough by selling its own patent portfolio.
It’s too bad that the leaders of the tech industry have decided to play this patent game, even if they are just buying patents for “defensive” purposes, as they claim. Even buying patents for defense is a game of mutual assured destruction: if you sue me, I’ll sue you. The only thing a game of MAD ever gets you is a costly arms race—in this case, to buy up all the patents you can. And it’s not as if no one is getting hurt: patent trolls’ attacks on small developers are equivalent to the U.S.S.R. or the U.S. threatening to nuke small countries unless they hand over some “protection” money. And these attacks are tacitly endorsed by larger companies who use patents in the same way. (Although, in their defense, Apple and Google have come to the defense of the developers being threatened by Lodsys.)
It doesn’t have to be like this. Remember patent 5771354? The one for “an online back-up system” that overlapped with 5,303 other patents? That patent should never have been issued. No one would have ever bought or sold it. No one would have paid anyone a dime to license it. No one would have ever threatened to sue anyone for infringing on it. And with respect to Daniel Abelow, I’d say the same thing about patent 7222078.
There have been a number of suggestions made to fix the state of our patent system. We could hire more patent clerks so that patents get reviewed more carefully to see if they really are for a new invention. Or we could limit the length of patent submissions so patent clerks don’t have to wade through ruminations on perfect societies to figure out if a patent is valid. One idea I like is for the tech industry to create a non-profit group to buy patents that would be used to protect all its members. But I believe that in this case the best solution is the most elegant—and the simplest. Yes, surprisingly, there’s a very simple way to fix this problem: abolish software patents. That sounds extreme, and when the idea was first presented to me, I thought it sounded like throwing the baby out with the bathwater. But I listened because of who proposed the idea to me: two software developers.
If anyone benefits from software patents, it’s software developers. When it comes to software patents, they’re the inventors who Intellectual Ventures is so insistent that it’s protecting. And here were two of them—talented, successful developers who have made plenty of software, both for companies and on their own—telling me that software patents just shouldn’t exist. And they convinced me. Here’s why.
Software is code. If you ever see a software developer at work, you’ll see they’re writing. They’re writing in code—something like HTML or C++ or Java—instead of plain English, but they’re essentially writing. And guess what! We already have a very good system for protecting writing in this country: it’s called copyright. And copyrighting something is infinitely easier than patenting something: all you have to do is follow it with a little (c). (And even that step is optional: this email doesn’t have a copyright symbol at the end of it, but if you copy it and pass it off as your own, you’re still infringing on my copyright.) You don’t have to pay any bureaucrats to review it and you don’t have to wait four years to hear back from them. And if you do think someone copied your code, you can still enforce your copyright in court.
It turns out, this view is not nearly as extreme as it sounds. In polls, a majority of software developers say software patents should be abolished. And the This American Life segment I mentioned earlier found the same thing. From the show:
“The Patent Office used to be very reluctant to grant patents for software. For decades, it considered software to be like language. Software programs were more like books or articles. You could copyright them. But you couldn’t patent them. They weren’t inventions, like the cotton gin. But then the federal courts stepped in and started chipping away at this interpretation. There was a big decision in 1994, and another one in 1998, which rejected the Patent Office’s view. The Patent Office got the memo and a flood of software patents followed. A lot of people in Silicon Valley wish that that had never happened, including a very surprising group — software engineers.”
Adding more evidence to the case against software patents is the fact that they are much less common in the rest of the world, including Europe. Under the European Patent Convention, you can patent a computer program that solves a technical problem in a unique way, but you cannot patent “programs for computers.” So while some software patents are still granted in Europe, their scope is much smaller.
In the U.S., by contrast, the scope of software and programming that is considered patentable is almost unlimited. The programmers I spoke to about this gave the example of Amazon.com’s “1-Click” patent. If you’ve saved your shipping and billing information with Amazon, a button shows up on many of their product pages offering “1-Click” ordering. Click the button, and the item is ordered, billed to your card and shipped to your house. Amazon has a patent on that. So even if you have some programmers write a completely different script that allows one-click buying on your website, you can’t use it without paying Amazon a licensing fee.
Barnes & Noble found that out the hard way in 1999, when Amazon sued it for putting an “Express Lane” button on its site that placed an order with one click. After a judge issued an injunction ordering Barnes & Noble to stop using the “Express Lane” button, the company added a second click to the process. Amazon’s patent was challenged again in 2006, and reconfirmed by the Patent Office last year. Now, any other company that wants to let customers buy products with one click has to pay Amazon a licensing fee, even if they independently developed the technology. (Apple pays Amazon a fee to use one-click buttons in the iTunes store.)
There are already two bills dealing with patent reform making their way through Congress. They would abolish patents on tax strategies, switch our system from first-to-invent to first-to-file and make it easier to challenge patents on business methods. But I’d like to see Congress take an even bigger step: abolishing software patents altogether. It won’t be popular with the tech giants who have spent billions on patents, but it would save them from spending billions more in the future. And it will actually encourage innovation, which is exactly the opposite of what software patents do now.
Of course, since it involves Congress, I don’t expect that to happen anytime soon. In the meantime, you could try to make some money off this ridiculous situation. I suggest following Google’s lead and buying (a piece of) a company with a strong portfolio of mobile communications patents.
VirnetX Holding Corp. (VHC) was recommended in the latest Investment Digest by Christian DeHaemer, editor of Crisis & Opportunity. Despite its name, VirnetX is a real company, that invents and makes things. Its specialty is mobile network security, and it is an undisputed leader in that field. The company has received 21 U.S. and 18 foreign patents and has over 100 more pending. That may not sound like a lot, compared to Motorola Mobility’s (now Google’s) 5,000 patents, but they’re distinguished by their quality—these are patents on groundbreaking technology that VirnetX has developed, not antiquated gobbledy-gook they acquired. The stock is also high-quality, if volatile: it’s up over 200% in the past year. (Despite its recent 40% fall from the new 52-week high it set in July.)
Here’s part of Christian DeHaemer’s recommendation from Crisis & Opportunity:
“Another undervalued company with a strong patent portfolio is VirnetX Holding Corp. The company owns the patents to 4G Internet security. As you know, this is a booming market segment. It is expected to grow from two billion users to 20 billion by the end of 2020. Ericson’s CEO predicted 50 billion Internet-connected devices by the same time. VirnetX makes encryption software for 4G technology including smartphones, IP phones, WiFi, etc. ... The big news this year was that they won a case against Microsoft and successfully defended their patents against other tech firms. This has occurred both in the United States and Europe. ... Given its patent portfolio, it is a good possibility that VHC becomes the standard for the next wave of wireless Internet. Market cap is $955 million. The company lost money in its most recent quarter, but has a trailing P/E of 23.50 on revenue of $64 thousand. The company has 60 million in cash and zero debt. The float is 36 million shares, which is small enough to launch the stock on positive news. Major investors include BlackRock and Vanguard. The company is speculative and has gotten crushed back to support levels over the past few weeks. This is a good time to take a flyer in this ‘baby with the bathwater’ stock. Buy VirnetX Holding Corp. under $20. Put your stop in under $15 with a two-year price target of $60.”
Wishing you success in your investing and beyond,
Chloe Lutts
