Federal Trade Commission Releases New Report on PAEs

The Federal Trade Commission has released a long-awaited report on “patent assertion entities” (PAEs). As defined by the FTC, a “patent assertion entity” is a company that, as a primary business function, acquires patents from third parties and seeks to generate revenue by asserting them against accused infringers. These firms typically generate revenue by licensing these patents or, more rarely, through successful patent litigation. Such firms also typically open patent license negotiations by immediately demanding payment or filing a patent infringement suit.

The FTC made use of its subpoena power to obtain data on more than 2000 patent holding companies that it determined fit the PAE mold. It found that only a small minority of these PAEs had ever asserted their patent rights in court. The FTC found that, generally, these companies could be separated into two different categories: “portfolio PAEs” and “litigation PAEs.”

“Portfolio PAEs” assembled large portfolios, often containing hundreds or thousands of patents, and received most of their money through licensing. Typically, they were able to do this without first suing the alleged infringers. While “portfolio PAEs” accounted for only a small portion of the licenses in the study (around 9%), these licenses accounted for an overwhelming majority of the total revenue of all licenses looked at in the study (around 80%, or approximately $3.2 billion in licensing revenue). These entities typically received most of their initial startup capital from investors, which included institutional investors and manufacturing firms.

“Litigation PAEs” typically operated by suing potential licensees and using the threat of prolonged litigation to induce defendants to settle and take licenses. These companies typically operated using small portfolios, usually containing fewer than ten patents. The typical charge for these licenses was just under the lower bound of early-stage costs for defending against a patent suit; as a result, the FTC has concluded that such lawsuits are “consistent with nuisance litigation.” However, while these litigation PAEs represented most of the litigation activity within the FTC’s study (around 96%), and were responsible for most of the licenses examined by the study (around 91%), these PAEs only received around 20% of the total licensing revenue.

Several interesting results came out of the FTC study. First, it did not appear that many (if any) patent defendants negotiated patent licenses when faced with a demand letter from a litigation PAE, and that in essentially all cases, the PAE had to file suit against the defendant to bring them to the negotiating table.

Second, while a large number of the patents that were asserted by PAEs had to do with either information and communications technology (ICT) or computer software, most of the litigation PAE targets were not in the software industry; instead, it appeared that the largest plurality of PAE targets were in the consumer retail industry. These targets included, for example, store retailers that operated fixed point-of-sale operations and non-store retailers (such as Internet sites) that directly sold products.

The FTC’s findings also suggest that many of the solutions put in place with the stated goal of curbing the abuses of litigation PAEs, such as legal fee shifting, may not be as effective as hoped. Most litigation PAEs are small companies with few assets, and most PAE litigation appears to settle early, before an award of fees is considered. The FTC has prepared some of its own ideas, such as discovery reform, which may help to curb the abuses of litigation PAEs where past reform efforts have failed.

Specifically, the FTC noted that the discovery process is structured so as to be incredibly expensive for patent defendants early on in a litigation. In PAE litigation, the reverse is not true; because PAEs, as defined, do not invent, develop, or manufacture products that incorporate the patented technology and typically are not at any real risk of being countersued, they generally have much less discoverable information than the accused infringer. This is used by many litigation PAEs to grab the upper hand in a settlement; since discovery is so expensive and so one-sided, it is usually cheaper for a patent defendant to settle for a relatively small amount rather than pay even more money to continue through the discovery process.

As such, the FTC has proposed developing rules and case management practices directed at addressing this discovery burden and other cost asymmetries in PAE litigation. Specifically, the FTC has urged courts to develop, under Rule 26 of the Federal Rules of Civil Procedure (FRCP Rule 26), plans for discovery that specifically take into account the disparity in discovery requirements in PAE litigation. For example, The FTC recommends crafting discovery plans so as to limit the scope of discovery before certain preliminary motions have been resolved, and so as to require early disclosure of claim, infringement, and invalidity contentions in PAE litigation. The FTC also proposes amending Rule 26 to codify its suggestions into the Federal Rules.

The FTC has also proposed greater initial disclosure requirements for patent plaintiffs. For example, the FTC recommends requiring patent plaintiffs to provide early disclosure of what damages theories they intend to be using in the remainder of the case. The FTC also notes that patent pleading requirements have recently changed, such that patent infringement pleadings now require that a patent plaintiff allege with greater specificity how a defendant infringes their patent; the FTC notes that this maps with the general thrust of its recommendations for patent litigation reform.

The FTC has also proposed streamlining the process for determining the ownership and control of a litigation PAE. Specifically, it proposes amending FRCP Rule 7.1, which requires all nongovernmental corporate parties to identify “any parent corporation and any publicly held corporation owning 10% or more of its stock” in its “first appearance, pleading, petition, motion, response, or other request addressed to the court,” to be broader. The FTC proposes, among other examples, adopting language similar to that used in the Civil Local Rules of the Northern District of California, which requires parties appearing before the court to disclose any known financial interest of a third party in the litigation.

One final proposal from the FTC is intended to halt or reduce the practice of patent plaintiffs suing the customers of a manufacturer for infringement, based on the customers’ use of an infringing product made by the manufacturer. It appears that some litigation PAEs have allegedly used this as a tactic to gain leverage over manufacturing companies against which they have brought patent litigation. Others have done it to take advantage of the fact that a manufacturer’s customers are far less well-equipped to defend against a patent suit than the manufacturer would be, as the manufacturer is likely to have a much better understanding of the disputed technology. Therefore, in cases involving simultaneous infringement lawsuits directed against manufacturers and customers, the FTC proposes allowing, and encouraging, district courts to stay actions against the customers until the manufacturer suit has been resolved.

The FTC’s comments are likely to influence future patent reform. The FTC has been known to carry a great deal of influence in Congress with regard to legislation in which it has an interest, and has devoted a significant amount of effort and expense to preparing this report and is not expected to let it go easily. As such, while a number of patent reform bills introduced into Congress in the past, such as the Innovation Act and the PATENT Act, have stalled because of an apparent lack of interest, the same will likely not be true for any bills that may be introduced that implement some or all of the FTC’s proposals, which will most likely be supported by aggressive lobbying from the FTC. Because of this, the findings of this report should be given ample consideration.

Apple Inc. Patent Revived After Federal Circuit Reverses PTAB Decision

On September 19, 2016, the Federal Circuit issued an opinion in In Re: Lemay, in which it reversed the Patent Trial and Appeal Board’s (“PTAB”) denial of Apple Inc.’s patent application directed to a method of streaming online videos to a portable device.  The Federal Circuit’s opinion addresses the topic of claim construction.



The patent application at issue, filed back in December 2007, recites a method of interacting with a graphical user interface primarily through finger contact and gestures on a touch-sensitive display.[1]  A USPTO examiner rejected the application as obvious over various combinations of prior art, mainly US. Patent No. 7739271 (“Cook”) and U.S. Patent Publication No. 2007/0024646 (“Saarinen”). The PTAB affirmed the rejection on the majority of claims, agreeing with the Examiner that one skilled in the art would have recognized that the combination of Cook and Saarinen teaches or suggests the disputed limitations of the invention. Specifically, the PTAB’s final written decision found all but two of the disputed claims to be unpatentable in view of the cited prior art references.  Apple subsequently filed an appeal, contesting, among other issues, the PTAB’s rejection of claims as obvious and arguing the USPTO’s “sparsely reasoned” decisions ignored important evidence.

In a split decision (2-1), the three-judge Federal Circuit panel found there was not enough evidence to support the PTAB’s determination that Cook and Saarinen teach the subject elements of the disputed claims. The opinion acknowledged that the ultimate determination of obviousness is a question of law, but noted that the determination is based on underlying factual findings.[2] The Federal Circuit reviews the PTAB’s factual determinations for substantial evidence and its legal determinations de novo.[3] The ruling focused its analysis on the first claim of the patent application, as the parties agreed it would be representative of the rest. As noted in the opinion, a claim is considered representative when the arguments presented in support of that claim apply to other claims grouped with such so that all grouped claims rise and fall based on the representative claim.[4]


No Substantial Evidence Supports the PTAB’s Finding that Cook and Saarinen Teach Each and Every Limitation of the Claimed Invention

The first issue presented was whether the Cook reference taught the element recited in the final clause of claim 1, which requires “that ‘in response to detecting (1) a finger gesture on a respective icon in the plurality of icons, displaying, on the touch screen display of the portable electronic device, (2) a corresponding list of information about online video items.” Simply put, the invention claims the use of touch screen icons like “Most Viewed” and “Featured” to bring up corresponding lists of YouTube and other website videos. According to Lemay, the tapping of the user’s finger, for example on the “Most Viewed” icon, and the resulting display of video titles and associated information illustrate the two elements in the final clause of claim 1, respectively.

The Federal Circuit determined that the USPTO erred in its finding that Cook teaches these elements (in combination with Saarinen, which teaches a touch screen and finger gestures). The Court explained that the USPTO cited two distinct “list[s] of information” corresponding to an icon when the claim had earlier provided the antecedent basis for “the plurality of icons” and their corresponding lists of information. In particular, the Court noted “if the ‘list of information’ corresponding to an icon is represented by album titles, artist names, and release dates generated as the results of the search query, the same list cannot also be represented elsewhere as a list of track titles.”

The second issue presented was whether the Cook reference taught “displaying . . . a first list of information about online video items in a plurality of lists of information about online video items,” as is recited in the first clause of claim 1.  Appellants argued that the use of the word “items” indicates that “the first list of information must be about multiple online video items.” The USPTO, on the other hand, argued that Lemay’s argument “misses the mark” because the “sample(s)” illustrated in Cook Figure 3B are the “items” referred to in claim 1, and the “list of information” corresponding to these items is the list of search results illustrated in Figure 3B.

The Federal Circuit sided with the Appellants, finding the USPTO’s reasoning to be “internally inconsistent.” Specifically, the majority explained that “[i]f each of the three sets of title, artist, and price information constitutes one of the ‘lists of information,’ it cannot also be correct that the search results as a whole … constitute one of the lists.” The majority therefore disagreed with the PTAB’s conclusion that Cook discloses “a first list of information about online video items…” The majority additionally noted that “if each of the three sets of title, artist, and price information constitutes one of the lists of information, then each such list corresponds only to a single item,” rather than multiple “online video items.”

Lastly, the majority determined that there is no substantial evidence to support the PTAB’s obviousness determination for three dependent claims, as they depend on nonobvious independent claims.



In her dissent, U.S. Circuit Judge Kimberly A. Moore argues that there was substantial evidence to support the PTAB’s finding that Cook and Saarinen disclose the disputed limitations of claim 1. Unlike the majority, Judge Moore contends that the claim’s “plurality of lists of information about online video items” is a different element from the same claim’s “a corresponding list of information about online video items.” In particular, she argues that there is no antecedent basis to support limiting “a corresponding list” to one of the “plurality of lists.” She also states that the limitations themselves use different words to describe the two different lists of information. Finally, she explains that during prosecution, the USPTO gives terms their broadest reasonable construction, which, in her view, further suggests a differentiation between the terms “a corresponding list” and “the plurality of lists.”



Although the deposition is nonprecedential, the Federal Circuit’s reversal of the PTAB’s ruling takes an unusual turn in favor of the patent applicant. Typically, the standard of appellate review makes it difficult to challenge the PTAB’s factual findings as to what is taught by the prior art. These findings are upheld if supported by substantial evidence, “something less than the weight of the evidence but more than a mere scintilla of evidence.” However, in this case, the Federal Circuit sided with Apple Inc., finding that no substantial evidence supported the PTAB’s factual findings.


[1] See U.S. Patent Publication No. 2008/0320391

[2] See In re Gartside, 203 F.3d 1305, 1316 (Fed. Cir. 2000). The underlying factual findings include (1) “the scope and content of the prior art,” (2) “differences between the prior art and the claims at issue,” (3) “the level of ordinary skill in the pertinent art,” and (4) the presence of secondary considerations of nonobviousness, such as “commercial success, long felt but unsolved needs, [and] failure of others.” Graham v. John Deere Co. of Kan. City, 383 U.S. 1, 17–18 (1966).

[3] Substantial evidence is “‘such relevant evidence as a reasonable mind might accept as adequate to support a conclusion.’” In re Applied Materials, Inc., 692 F.3d 1289, 1294 (Fed. Cir. 2012) (quoting Consol. Edison Co. v. N.L.R.B., 305 U.S. 197, 229 (1938)).

[4] See 37 C.F.R. § 41.37(c)(1)(iv) (2012) (“For each ground of rejection applying to two or more claims, the claims may be argued . . . as a group (all claims subject to the ground of rejection rise and fall together).

Clarifying 35 U.S.C. § 101 in McRO, Inc. v. Bandai Namco Games America

The U.S. Court of Appeals for the Federal Circuit, in McRO, Inc. v. Bandai Namco Games America, reversed the district court’s judgment on the pleadings that the asserted claims of U.S. Patent Nos. 6,307,576 (the ‘576 patent) and 6,611,278 (the ‘278 patent) were directed to patent-ineligible subject matter and therefore invalid under 35 U.S.C. § 101. The much-anticipated decision, issued on September 13, 2016, provides greater insight into identifying patent-eligible subject matter for computer-based inventions. In particular, the court highlights the significance of claim construction and preemption in conducting a patentability analysis.


The patents-in-suit, both issued to Maury Rosenfeld, relate to a method of automatically animating lip synchronization and facial expression of animated characters. The method uses a set of rules to define values for transitioning between facial expressions as a function of sequences of sounds in the speech of animated characters. According to the patentee, the prior art encompassed a “keyframe” approach, where a human animator would manually set the appropriate “morph weights” at certain important times in the transcript instead of at every frame. The claimed invention essentially “automate[s] a 3-D animator’s task, specifically, determining when to set keyframes and setting those keyframes through rules that are applied to the timed transcript to determine the morph weight outputs.”

In 2012 and 2013, patentee McRO, Inc. filed lawsuits against various video game developers and publishers (collectively, Bandai) for alleged infringement of the ‘576 and ‘278 patents. The U.S. District Court for the Central District of California granted the defendants’ motion on the pleadings that the asserted claims were directed to patent ineligible subject matter under § 101, thereby holding the patents invalid. Although admitting the claims facially did not appear to be directed to an abstract idea, the district court nonetheless found the claims too broadly preemptive to satisfy §101. The district court reasoned that because the claims were not limited to specific rules, but rather “purport to cover all such rules,” the claims merely call for the application of the abstract idea of using rules. Ultimately, the district court found that “while the patents do not preempt the field of automatic lip synchronization for computer-generated 3D animation, they do preempt the field of such lip synchronization using a rules-based morph target approach.” The district court concluded that the claims were ineligible for patent protection because the “novel portion of [the] invention are claimed too broadly.”

McRO subsequently appealed, arguing that its patents were not directed to an abstract idea and further that the specific claimed rules did not preempt the field of using rules in speech animation. Bandai, on the other hand, maintained that the McRO patents merely amounted to an automation of a preexisting process on a general-purpose computer.

Claim 1 of the ’576 patent was deemed representative and dispositive of the asserted claims for the purposes of appeal:

A method for automatically animating lip synchronization and facial expression of three-dimensional characters comprising:

obtaining a first set of rules that define output morph weight set stream as a function of phoneme sequence and time of said phoneme sequence;

obtaining a timed data file of phonemes having a plurality of sub-sequences;

generating an intermediate stream of output morph weight sets and a plurality of transition parameters between two adjacent morph weight sets by evaluating said plurality of sub-sequences against said first set of rules;

generating a final stream of output morph weight sets at a desired frame rate from said intermediate stream of output morph weight sets and said plurality of transition parameters; and

applying said final stream of output morph weight sets to a sequence of animated characters to produce lip synchronization and facial expression control of said animated characters.


In reversing the district court’s ruling, the Federal Circuit cautioned against an oversimplification of the claims. The court noted that under the Alice test, “a court must look to the claims as an ordered combination, without ignoring the requirements of the individual steps” in determining the patentability of a method.  Here, the court determined that the claims are limited to rules with particular characteristics. Specifically, “the claims themselves set out meaningful requirements for the first set of rules: they ‘define[] a morph weight set stream as a function of phoneme sequence and times associated with said phoneme sequence.’”

Addressing the defendant’s position that the claims are abstract because they do not claim specific rules, the court explained that the claimed rules “are limited to rules with certain common characteristics, i.e., a genus.” While acknowledging a greater risk of preemption, the Federal Circuit pointed out that claims to the genus of an invention, rather than a particular species, have long been acknowledged as patentable. The preemption concern arises when the claims improperly monopolize “the basic tools of scientific and technological work.” To this end, the court shifted its attention to “whether the claims focus on a specific means or method that improves the relevant technology or are instead directed to a result or effect that itself is the abstract idea and merely invoke generic processes and machinery.” The court noted that preemption, not tangibility, is the underlying concern, and emphasized “the narrower concern here is whether the claimed genus of rules preempts all techniques for automating 3-D animation that rely on rules.”

Ultimately, the court concluded that the specific structure of the claimed rules prevents broad preemption of all rules-based means of automating lip synchronization. The court noted that the claims focused on a specific asserted improvement in computer animation, i.e., the automatic use of rules of a particular type to be rendered in a specific way. The court explained that while the rules are embodied in computer software that is processed by general-purpose computers, there was no evidence that claims would preempt all uses of rules in 3-D animation or that they even encompassed the same process previously used by animators. In particular, the cited prior art discloses that “an animator’s process was driven by subjective determinations rather than specific, limited mathematical rules.” Moreover, “motion capture animation provides an alternative process for automatically animating lip synchronization and facial expressions.”

Significantly, the Federal Circuit rejected the assertion that the claims ““simply use a computer as a tool to automate conventional activity,” noting how “the incorporation of the claimed rules, not the use of the computer” improved the existing animation process. This, according to the Federal Circuit, differentiates the present case from that of Flook, Bilski, and Alice, where “the claimed computer-automated process and the prior method were carried out in the same way.”

As a result, the Federal Circuit held “that the ordered combination of claimed steps, using unconventional rules that relate sub-sequences of phonemes, timings, and morph weight sets, is not directed to an abstract idea and is therefore patent-eligible subject matter under § 101.”


In McRO, the Federal Circuit further clarified Alice and its application to computer and software-related patents. The Court reached its holding after a detailed preemption analysis in step one of the Alice test. The Federal Circuit premised its patent eligibility determination on the construction of the asserted claims, thus emphasizing the highly fact-specific nature of the Alice inquiry.  Additionally, the Federal Circuit’s decision also underscores the importance of preemption in the §101 analysis.

The Heightened Need for Non-Infringement Opinions After Halo and Stryker

The Supreme Court recently decided two cases, Halo Electronics, Inc. v. Pulse Electronics, Inc., et al. and Stryker Corporation, et al. v. Zimmer, Inc., et al., dealing with the standard that courts must use when determining whether or not to award enhanced damages to a patent plaintiff. As an enhanced damage award can often be “treble damages” – that is, a tripling of the actual damages caused by the infringement – it is important for any company that expects to ever be on the receiving end of a patent lawsuit to be aware of this standard.

The Statutory Law

Following the award of damages by a jury or the trial judge, 35 U.S. Code § 284 gives a court discretion to increase the awarded damages “up to three times the amount found or assessed.” Historically, this has provided courts with the opportunity to consider a patent infringer’s mindset as part of the damage award, and given courts some flexibility to distinguish willful infringement from non-willful infringement in a meaningful way. While a patent defendant that has accidentally infringed a patent might only be held liable for a reasonable royalty, a patent defendant that a court considers to have more deliberately infringed the patent may be held liable for a higher award.


The prior standard establishing when enhanced damages should be awarded to a patent plaintiff was set forth in a 2007 Federal Circuit case, In re Seagate Technology, LLC, 497 F. 3d 1360 (2007) (en banc). In Seagate, the Federal Circuit set forth a two-pronged test for the award of enhanced damages under 35 USC §284. In the first prong, a patentee was required to show, by clear and convincing evidence, “that the infringer acted despite an objectively high likelihood that its actions constituted infringement of a valid patent.” If the first, objective prong was satisfied, the patentee was then required to prove “subjective recklessness,” which meant proving that the objectively defined risk was either known or should have been known to the accused infringer.

The petitioners in Halo and Stryker argued that this standard was far too strict, and that it was very rare that even a blatant infringer would be found to be liable for enhanced damages under Seagate. Even an ex post facto argument for non-infringement of the patent, or for the invalidity of the patent, would typically be enough to allow the infringer to escape the Seagate standard, so long as the argument was in some way defensible and non-frivolous. (This typically applied even if the infringer came up with the argument after the fact.)

Halo and Stryker

The Supreme Court rejected the Seagate test as inconsistent with the language of 35 USC §284. First, the Court noted that §284 allows lower courts to punish a range of culpable behavior, and is not limited to showings of both objective and subjective willfulness. As such, the inelastic constraints of the Seagate test were “unduly rigid.” The Court instead adopted a newer, more ambiguous standard, under which a lower court could exercise discretion to punish a full range of culpable behavior on the part of a patent infringer, though noting that “such punishment should generally be reserved for egregious cases.”

The Court also struck down the heightened clear and convincing standard required for enhanced damages required by Seagate as inappropriate and inconsistent with §284. It noted, instead, that “patent infringement litigation has always been governed by a preponderance of the evidence standard.” Under its reasoning, the same standard should be applied to the award of damages under §284.

Effects of Halo and Stryker

The effect of Halo and Stryker was to lower the burden on receiving treble damages in patent litigation, and increase the influence of judicial discretion on patent cases.

This case represents a rare victory for patent holders in the Supreme Court, after case after case has eroded patent rights based on the threat of so-called “patent trolls.” Under Seagate, enhanced damages were almost never awarded, but under Halo and Stryker, patent holders can expect to have a somewhat better chance at receiving them. This may be a nail in the coffin of the practice of “efficient infringement,” whereby a corporation or other entity would deliberately fail to do patent due diligence and ignore patent demand letters based on the expectation that defending against an occasional patent lawsuit would be a more efficient use of resources. Certainly, “efficient infringement” looks like far less of a favorable gamble.

However, any company that expects to be on the receiving end of a patent lawsuit may have cause for concern after Halo and Stryker. The standard set forth by the Supreme Court for when enhanced damages should be awarded is intentionally a muddy one, or, in its words, not governed by a “‘precise rule or formula.’” As such, judges have a great deal of discretion in when they can choose to award or choose not to award enhanced damages.

First, this means that a great deal of money – up to twice as much money as the actual amount of damages caused by the infringement – is now riding on the subjective opinion of the district court judge that hears the infringement case. This makes it significantly more desirable for a patent plaintiff to shop around for a favorable forum before filing suit, based on which districts or which judges are found to be more likely to grant enhanced damages based on a finding of willful infringement, or based on the size of the enhanced damages awards that they provide. This means that companies can no longer rely on being sued in one of just a few locations around the country, such as the Eastern District of Texas, and must anticipate being sued in any district where the court would have jurisdiction over the company. (For example, District Court judges that are less experienced with patent law may be more likely to see particular conduct on the part of a company as unusually egregious, simply because they would not be familiar with the patent practices of as many companies as a more experienced judge. As such, they may be more likely to give higher enhanced damage awards.)

Second, the greater likelihood of an award of enhanced damages for “egregious misconduct” and looser definition of what constitutes “egregious misconduct” means that it is now more important for companies to investigate demand letters more closely and seek non-infringement opinions. Justice Breyer noted that a jury may well find that a company behaved “recklessly” for failing to follow up on a demand letter, even a somewhat ambiguous demand letter, if the company is later found to infringe one or more of the patents that are identified in the demand letter. This may put the company at risk for treble damages. However, the greater weight that must be given to a demand letter may also encourage non-practicing entities, or “patent trolls,” to send out more demand letters of more dubious merit, knowing that a target company may have a greater incentive to settle or abandon a challenged activity if they must spend time investigating even a dubious demand letter.

Third, Halo clarified that it is most valuable to specifically seek a legal opinion on patent non-infringement from a legal practitioner. In Halo, the alleged infringer, Pulse Electronics, had sought an opinion of one of its engineers that a patent was invalid; even based on this opinion, the lower courts still found that Pulse had willfully infringed.  However, Justice Breyer’s concurrence notes that the informed opinion of legal counsel would be more helpful in reducing the probability of a finding of willful infringement. Thus, based on Halo, it appears that one of the best approaches that can be taken by a company wishing to avoid an award of treble damages for patent infringement is to seek an informed opinion of counsel, rather than an opinion of an engineer or technical advisor, early after being informed of the patent. In addition to the fact that courts are likely to give the opinion of legal counsel more weight, opinions from legal counsel are also protected by the attorney-client privilege.

Staying ahead of the pack with “Track One” Accelerated Cases

Consider filing a “Track One” case to jump to the front of the line for an extra fee. You may even get a more experienced and decisive examination by paying the additional Track One fees.

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All Eyes are on the IRS and its Review of Facebook’s IP Valuation Methods

The IRS began an investigation in 2013 examining the valuation methods used in Facebook’s transfer of intellectual property rights to a foreign subsidiary in 2010. In early July, the investigation stepped up a notch when the IRS filed a summons in federal court requesting more information on the transfer. In a common move for large software companies, Facebook transferred a large portion of its intellectual property rights to an offshore subsidiary in order to lighten its tax liabilities. Facebook sold a large chunk of critical intellectual property rights to Facebook Ireland and transferred all of Facebook’s worldwide business (minus the U.S. and Canada) to the same subsidiary. The corporate income tax burden in Ireland is a measly 12.5% compared to 35% in the United States. The IRS is investigating the price and pricing methods used by Facebook and its accounting firm, Ernst & Young (now EY), for the intellectual property rights.

The IRS is trying to determine the real value of the assets Facebook sold to Facebook Ireland. These types of sales are supposed to be done at arm’s length, which is a difficult task to achieve between parent companies and their subsidiaries. The EY approach to valuing Facebook’s assets was done on a stand-alone basis, which was contradicted by several Facebook employees explaining how the rights are interdependent and that it would be difficult to isolate user base, online platform and marketing intangibles from each other, as reported in the IRS’ declaration. Determining the value of patents is a tricky business with many factors to consider: the amount of time remaining for enforcement, how likely the patent is to stand up to invalidity claims, any current licensing agreements, any ongoing litigation, and synergies among patents to name a few important areas. The IRS investigation is focused on how the synergies between the patents transferred was valued; believing EY used a method that did not fully consider how, for example, a patent focused on Facebook’s user base could affect the value of a patent focused on marketing. By examining patents alone or in specific fields at a time and not the whole package, it is possible to find less value in the parts than the whole, just as a car engine is not too useful without a way to start the engine, or a wheel system for the engine to power. The IRS exam team’s preliminary investigation believes the valuations of the transferred intellectual property rights were understated by billions.

In early June the IRS asked Facebook for more documentation on the sale, to which Facebook did not respond, continuing a trend of playing tough with the IRS. Earlier in the investigation Facebook denied the IRS’ request for an extended statute of limitations on for their investigation by only agreeing to the extensions if the IRS gave Facebook a number of guarantees the IRS was unwilling to offer. This prompted the IRS to file their summons in federal court in San Francisco, both to compel Facebook to share the requested documents as well as to preserve the statute of limitations, which would have expired on July 31.

Facebook has remained defiant in the face of the IRS, failing to show up for a seventh summons issued by the IRS.  The results of the IRS investigation are poised to have major impacts on IP portfolio valuation and accounting strategy.


USPTO Adds New Pilot Program – Combines Features of Pre-Appeal Conference & After-Final 2.0 Program with goal of compacting prosecution

One of the more frustrating aspects of securing U.S. patent protection is the process of prosecuting a patent application after it has been drafted and filed. “Patent prosecution” is an administrative process of the United States Patent & Trademark Office (USPTO) encompassing the interaction between patent examiners and technical innovators (patent applicants and their attorneys or agents) to determine how broad or narrow the scope of protection is in a given case.

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New Maier & Maier Website

We are excited to launch the new MaierAndMaier.com website! Be sure to check back on a regular basis as we continue to update the website with valuable resources and important news related to IP law.