After a five and a half year study of patent assertion entity (PAE) activity in the U.S., the U.S. Federal Trade Commission has found that PAEs, have many unfair advantages over their alleged infringers that should be corrected by legislative or judicial reforms.

“The FTC recognizes that infringement litigation plays an important role in protecting patent rights, and that a robust judicial system promotes respect for the patent laws,” the FTC said in the Recommendations for Legislative and Judicial Reform section of its Patent Assertion Entity Activity report published Thursday. “Nuisance infringement litigation, however, can tax judicial resources and divert attention away from productive business behavior.

With this balance in mind, the FTC said it is proposing reforms to: 1) address discovery burden and cost asymmetries in PAE litigation; 2) provide the courts and defendants with more information about the plaintiffs that have filed infringement lawsuits; 3) streamline multiple cases brought against defendants on the same theories of infringement; and 4) provide sufficient notice of these infringement theories as courts continue to develop heightened pleading requirements for patent cases.

The FTC study surveyed 22 PAEs and 327 of their affiliates from January 2009 to mid-September 2014. Of the related entities, 327 engaged in active assertion behavior, namely, sending demands, suing for patent infringement, or licensing patents, during the study period.

The FTC said it examined two kinds of patent assertion entities: Portfolio PAEs and Litigation PAEs.

Portfolio PAEs negotiate licenses covering large portfolios, often containing hundreds or thousands of patents, frequently without first suing the alleged infringer.

“The value of these licenses was typically in the millions of dollars. Although Portfolio PAEs accounted for only 9% of the reported licenses in the study, they generated 80% of the reported revenue, or approximately $3.2 billion. Portfolio PAEs typically funded their initial patent acquisitions through capital raised from investors, including institutional investors or manufacturing firms.

The study also found that Litigation PAEs typically sue potential licensees and settle shortly afterward by entering into license agreements with defendants covering small portfolios, often containing fewer than ten patents.

“The licenses typically yielded total royalties of less than $300,000. According to one estimate, $300,000 approximates the lower bound of early-stage litigation costs of defending a patent infringement suit.

“Given the relatively low dollar amounts of the licenses, the behavior of Litigation PAEs is consistent with nuisance litigation. For each separate patent portfolio that they acquired, Litigation PAEs characteristically created a new affiliate entity, which often held ten patents or less.

The FTC said Litigation PAEs generally operate with little or no working capital and rely on agreements to share future revenue with patent sellers to fund their businesses. Litigation PAEs filed 96% of the cases in the study and accounted for 91% of the reported licenses, but only 20% of the reported revenue, or approximately $800 million.

The study also found that Portfolio PAE licenses generate total royalties that are much larger, on average, than those of Litigation PAE licenses.

“Seventy-seven percent of Litigation PAE licenses generated royalties of less than $300,000 per license, and 94% generated royalties of less than $1 million per license. By contrast, 65% of Portfolio PAE licenses generated royalties of greater than $1 million per license, and 10% generated royalties of greater than $50 million per license.”

The FTC said it did not observer PAEs that were able to generate low revenue from demand letters alone without the need for litigation, suggesting that demand letter reform on its own was unlikely to address the negative effects of PAEs.

Instead the FTC found that most licensing revenue was generated after an enforcement action was filed.

“Consistent with the fact that Litigation PAEs accounted for 91% of reported licenses, patent infringement suits against the eventual licensee preceded 87% of the licenses in the sample. Litigation preceded 93% of Litigation PAE licenses, but just 29% of Portfolio PAE licenses. Because a significant portion of observed PAE activity passed through the courthouse doors, further analyses of publicly available litigation data likely would be beneficial.”

The reaction to the study was decidedly mixed with many criticizing it for being out of date and therefore inaccurate in its assessment of the problem and ineffectual in its prescriptions for fixing it.

The nearly six-year timeframe for the study "is automatically a red flag," said Mark Gober, a senior director at 3LP Advisors in Silicon Valley.

"The world of patent litigation today is not what it was during the period studied. Litigation behavior has changed significantly since that period because of Alice/software patents (June 2014 ruling), Octane Fitness/fee-shifting (April 2014 ruling) and because of IPRs.

To be sure, he noted that by the very end of this study, the Alice and Octane Fitness rulings had recently come down. "We were just starting to see more of a spike in IPR filings. Patent holders have adjusted tactics since September 2014. Any conclusions made by the study relate to a past era of US patent enforcement, so we should be careful about what conclusions to draw.

Others said the FTC's recommendations were appropriate but don't really go far enough.

The FTC study "is fine as far as it goes; we would go farther," said David Pratt, a managing director at M-CAM International in Charlottesville, Virginia. "Our risk underwriting processes have been providing the financial sector and select corporations with the kind of invalidating information that is the key to stopping PAEs in their tracks."

Pratt said M-CAM officials have testified at the USPTO fact-finding hearings and supported House Judiciary Committee Chairman Bob Goodlatte's legislation on PAE activities, which proposes full disclosure of Real Party in Interest data . Pratt called Real Party of Interest data "essential."

--To reach the reporter responsible for this story, please contact Dan Lonkevich at 707 318-7899 or at dan@thepatentinvestor.com