Archives For truth on the market

Unexpectedly, on the day that the white copy of the upcoming repeal of the 2015 Open Internet Order was published, a mobile operator in Portugal with about 7.5 million subscribers is garnering a lot of attention. Curiously, it’s not because Portugal is a beautiful country (Iker Casillas’ Instagram feed is dope) nor because Portuguese is a beautiful romance language.

Rather it’s because old-fashioned misinformation is being peddled to perpetuate doomsday images that Portuguese ISPs have carved the Internet into pieces — and if the repeal of the 2015 Open Internet Order passes, the same butchery is coming to an AT&T store near you.

Much ado about data

This tempest in the teacup is about mobile data plans, specifically the ability of mobile subscribers to supplement their data plan (typically ranging from 200 MB to 3 GB per month) with additional 10 GB data packages containing specific bundles of apps – messaging apps, social apps, video apps, music apps, and email and cloud apps. Each additional 10 GB data package costs EUR 6.99 per month and Meo (the mobile operator) also offers its own zero rated apps. Similar plans have been offered in Portugal since at least 2012.

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These data packages are a clear win for mobile subscribers, especially pre-paid subscribers who tend to be at a lower income level than post-paid subscribers. They allow consumers to customize their plan beyond their mobile broadband subscription, enabling them to consume data in ways that are better attuned to their preferences. Without access to these data packages, consuming an additional 10 GB of data would cost each user an additional EUR 26 per month and require her to enter into a two year contract.

These discounted data packages also facilitate product differentiation among mobile operators that offer a variety of plans. Keeping with the Portugal example, Vodafone Portugal offers 20 GB of additional data for certain apps (Facebook, Instagram, SnapChat, and Skype, among others) with the purchase of a 3 GB mobile data plan. Consumers can pick which operator offers the best plan for them.

In addition, data packages like the ones in question here tend to increase the overall consumption of content, reduce users’ cost of obtaining information, and allow for consumers to experiment with new, less familiar apps. In short, they are overwhelmingly pro-consumer.

Even if Portugal actually didn’t have net neutrality rules, this would be the furthest thing from the apocalypse critics make it out to be.

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Net Neutrality in Portugal

But, contrary to activists’ misinformation, Portugal does have net neutrality rules. The EU implemented its net neutrality framework in November 2015 as a regulation, meaning that the regulation became the law of the EU when it was enacted, and national governments, including Portugal, did not need to transpose it into national legislation.

While the regulation was automatically enacted in Portugal, the regulation and the 2016 EC guidelines left the decision of whether to allow sponsored data and zero rating plans (the Regulation likely classifies data packages at issue here to be zero rated plans because they give users a lot of data for a low price) in the hands of national regulators. While Portugal is still formulating the standard it will use to evaluate sponsored data and zero rating under the EU’s framework, there is little reason to think that this common practice would be disallowed in Portugal.

On average, in fact, despite its strong net neutrality regulation, the EU appears to be softening its stance toward zero rating. This was evident in a recent EC competition policy authority (DG-Comp) study concluding that there is little reason to believe that such data practices raise concerns.

The activists’ willful misunderstanding of clearly pro-consumer data plans and purposeful mischaracterization of Portugal as not having net neutrality rules are inflammatory and deceitful. Even more puzzling for activists (but great for consumers) is their position given there is nothing in the 2015 Open Internet Order that would prevent these types of data packages from being offered in the US so long as ISPs are transparent with consumers.

On November 27, the U.S. Supreme Court will turn once again to patent law, hearing cases addressing the constitutionality of Patent Trial and Appeal Board (PTAB) “inter partes” review (Oil States Energy v. Greene), and whether PTAB must issue a final written decision as to every claim challenged by the petitioner in an inter partes review (SAS Institute v. Matal).

As the Justices peruse the bench memos and amicus curiae briefs concerning these cases, their minds will, of course, be focused on legal questions of statutory and constitutional interpretation.  Lurking in the background of these and other patent cases, however, is an overarching economic policy issue – have recent statutory changes and case law interpretations weakened U.S. patent protection in a manner that seriously threatens future American economic growth and innovation?  In a recent Heritage Foundation Legal Memorandum, I responded in the affirmative to this question, and argued that significant statutory reforms are needed to restore the American patent system to a position of global leadership that is key to U.S. economic prosperity.  (Among other things, I noted severe constitutional problems raised by PTAB’s actions, and urged that Congress consider passing legislation to reform PTAB, if the Supreme Court upholds the constitutionality of inter partes review.)

A timely opinion article published yesterday in the Wall Street Journal emphasizes that the decline in American patent protection also has profound negative consequences for American international economic competitiveness.  Journalist David Kline, author of the commentary (“Fear American Complacency, Not China”), succinctly contrasts unfortunate U.S. patent policy developments with the recent strengthening of the Chinese patent system (a matter of high priority to the Chinese Government):

China’s entrepreneurs have been fueled by reforms in recent years that strengthened intellectual property rights—ironic for a country long accused of stealing trade secrets and ignoring IP protections. Today Chinese companies are filing for more patents than American ones. The patent application and examination process has been streamlined, and China has established specialized intellectual property courts and tribunals to adjudicate lawsuits and issue injunctions against infringers. “IP infringers will pay a heavy price,” President Xi Jinping warned this summer. . . .

In the U.S., by contrast, a series of legislative actions and Supreme Court rulings have weakened patent rights, especially for startups. A new way of challenging patents called “inter partes review” results in at least one patent claim being thrown out in roughly 80% of cases, according to an analysis by Adam Mossoff, a law professor at George Mason University. Unsurprisingly, many of these cases were brought by defendants facing patent infringement lawsuits in federal court.

This does not bode well for America’s global competitiveness. The U.S. used to rank first among nations in the strength of its intellectual property rights. But the 2017 edition of the Global IP Index places the U.S. 10th—tied with Hungary.

The Supreme Court may not be able to take judicial notice of this policy reality (although strong purely legal arguments would support a holding that PTAB inter partes review is unconstitutional), but Congress certainly can take legislative notice of it.  Let us hope that Congress acts decisively to strengthen the American patent system – in the interests of a strong, innovative, and internationally competitive American economy.

The latest rankings of trade freedom around the world will be set forth and assessed in the 24th annual edition of the Heritage Foundation annual Index of Economic Freedom (Index), which will be published in January 2018.  Today Heritage published a sneak preview of the 2018 Index’s analysis of freedom to trade, which merits public attention.  First, though, a bit of background on the Index’s philosophy and methodology is appropriate.

The nature and measurement of economic freedom are explained in the 2017 Index:

Economic freedom is the fundamental right of every human to control his or her own labor and property. In an economically free society, individuals are free to work, produce, consume, and invest in any way they please. In economically free societies, governments allow labor, capital, and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to protect and maintain liberty itself. . . .  

[The Freedom Index] measure[s] economic freedom based on 12 quantitative and qualitative factors, grouped into four broad categories, or pillars, of economic freedom:

  1. Rule of Law (property rights, government integrity, judicial effectiveness)
  2. Government Size (government spending, tax burden, fiscal health)
  3. Regulatory Efficiency (business freedom, labor freedom, monetary freedom)
  4. Open Markets (trade freedom, investment freedom, financial freedom)

Each of the twelve economic freedoms within these categories is graded on a scale of 0 to 100. A country’s overall score is derived by averaging these twelve economic freedoms, with equal weight being given to each. More information on the grading and methodology can be found in the appendix.

As was the case in previous versions, the 2018 Index explores various aspects of economic freedom in several essays that accompany its rankings.  In particular, with respect to international trade, the 2018 Index demonstrates that citizens of countries that embrace free trade are better off than those in countries that do not.  The data show a strong correlation between trade freedom and a variety of positive indicators, including economic prosperity, unpolluted environments, food security, gross national income per capita, and the absence of politically motivated violence or unrest.  Reducing trade barriers remains a proven recipe for prosperity that a majority of Americans support.

The 2018 Index’s three key trade-related takeaways are:

  1. A comparison of economic performance and trade scores in the 2018 Index shows how trade freedom increases prosperity and overall well-being.
  2. Countries with the most trade freedom have much higher per capita incomes, greater food security, cleaner environments, and less politically motivated violence.
  3. Free trade policies also encourage freedom in general. Most Americans support free trade, and believe its benefits outweigh any disadvantages.

Follow this space for further updates on the 2018 Index.

My new book, How to Regulate: A Guide for Policymakers, is now available on Amazon.  Inform Santa!

The book, published by Cambridge University Press, attempts to fill what I think is a huge hole in legal education:  It focuses on the substance of regulation and sets forth principles for designing regulatory approaches that will maximize social welfare.

Lawyers and law professors obsess over process.  (If you doubt that, sit in on a law school faculty meeting sometime!) That obsession may be appropriate; process often determines substance.  Rarely, though, do lawyers receive training in how to design the substance of a rule or standard to address some welfare-reducing defect in private ordering.  That’s a shame, because lawyers frequently take the lead in crafting regulatory approaches.  They need to understand (1) why the unfortunate situation is occurring, (2) what options are available for addressing it, and (3) what are the downsides to each of the options.

Economists, of course, study those things.  But economists have their own blind spots.  Being unfamiliar with legal and regulatory processes, they often fail to comprehend how (1) government officials’ informational constraints and (2) special interests’ tendency to manipulate government power for private ends can impair a regulatory approach’s success.  (Economists affiliated with the Austrian and Public Choice schools are more attuned to those matters, but their insights are often ignored by the economists advising on regulatory approaches — see, e.g., the fine work of the Affordable Care Act architects.)

Enter How to Regulate.  The book endeavors to provide economic training to the lawyers writing rules and a sense of the “limits of law” to the economists advising them.

The book begins by setting forth an overarching goal for regulation (minimize the sum of error and decision costs) and a general plan for achieving that goal (think like a physician–identify the adverse symptom, diagnose the disease, consider the range of available remedies, and assess the side effects of each).  It then marches through six major bases for regulating: externalities, public goods, market power, information asymmetry, agency costs, and the cognitive and volitional quirks observed by behavioral economists.  For each of those bases for regulation, the book considers the symptoms that might justify a regulatory approach, the disease causing those symptoms (i.e., the underlying economics), the range of available remedies (the policy tools available), and the side effects of each (e.g., public choice concerns, mistakes from knowledge limitations).

I have been teaching How to Regulate this semester, and it’s been a blast.  Unfortunately, all of my students are in their last year of law school.  The book would be most meaningful, I think, to an upcoming second-year student.  It really lays out the basis for a number of areas of law beyond the common law:  environmental law, antitrust, corporate law, securities regulation, food labeling laws, consumer protection statutes, etc.

I was heartened to receive endorsements from a couple of very fine thinkers on regulation, both of whom have headed the Office of Information and Regulatory Affairs (the White House’s chief regulatory review body).  They also happen to occupy different spots on the ideological spectrum.

Judge Douglas Ginsburg of the D.C. Circuit wrote that the book “will be valuable for all policy wonks, not just policymakers.  It provides an organized and rigorous framework for analyzing whether and how inevitably imperfect regulation is likely to improve upon inevitably imperfect market outcomes.”

Harvard Law School’s Cass Sunstein wrote:  “This may well be the best guide, ever, to the regulatory state.  It’s brilliant, sharp, witty, and even-handed — and it’s so full of insights that it counts as a major contribution to both theory and practice.  Indispensable reading for policymakers all over the world, and also for teachers, students, and all those interested in what the shouting is really about.”

Bottom line:  There’s something for everybody in this book.  I wrote it because I think the ideas are important and under-studied.  And I really tried to make it as accessible (and occasionally funny!) as possible.

If you’re a professor and would be interested in a review copy for potential use in a class, or if you’re a potential reviewer, shoot me an email and I’ll request a review copy for you.

Canada’s large merchants have called on the government to impose price controls on interchange fees, claiming this would benefit not only merchants but also consumers. But experience elsewhere contradicts this claim.

In a recently released Macdonald Laurier Institute report, Julian Morris, Geoffrey A. Manne, Ian Lee, and Todd J. Zywicki detail how price controls on credit card interchange fees would result in reduced reward earnings and higher annual fees on credit cards, with adverse effects on consumers, many merchants and the economy as a whole.

This study draws on the experience with fee caps imposed in other jurisdictions, highlighting in particular the effects in Australia, where interchange fees were capped in 2003. There, the caps resulted in a significant decrease in the rewards earned per dollar spent and an increase in annual card fees. If similar restrictions were imposed in Canada, resulting in a 40 percent reduction in interchange fees, the authors of the report anticipate that:

  1. On average, each adult Canadian would be worse off to the tune of between $89 and $250 per year due to a loss of rewards and increase in annual card fees:
    1. For an individual or household earning $40,000, the net loss would be $66 to $187; and
    2. for an individual or household earning $90,000, the net loss would be $199 to $562.
  2. Spending at merchants in aggregate would decline by between $1.6 billion and $4.7 billion, resulting in a net loss to merchants of between $1.6 billion and $2.8 billion.
  3. GDP would fall by between 0.12 percent and 0.19 percent per year.
  4. Federal government revenue would fall by between 0.14 percent and 0.40 percent.

Moreover, tighter fee caps would “have a more dramatic negative effect on middle class households and the economy as a whole.”

You can read the full report here.

On November 10, at the University of Southern California Law School, Assistant Attorney General for Antitrust Makan Delrahim delivered an extremely important policy address on the antitrust treatment of standard setting organizations (SSOs).  Delrahim’s remarks outlined a dramatic shift in the Antitrust Division’s approach to controversies concerning the licensing of standard essential patents (SEPs, patents that “read on” SSO technical standards) that are often subject to “fair, reasonable, and non-discriminatory” (FRAND) licensing obligations imposed by SSOs.  In particular, while Delrahim noted the theoretical concerns of possible “holdups” by SEP holders (when SEP holders threaten to delay licensing until their royalty demands are met), he cogently explained why the problem of “holdouts” by implementers of SEP technologies (when implementers threaten to under-invest in the implementation of a standard, or threaten not to take a license at all, until their royalty demands are met) is a far more serious antitrust concern.  More generally, Delrahim stressed the centrality of patents as property rights, and the need for enforcers not to interfere with the legitimate unilateral exploitation of those rights (whether through licensing, refusals to license, or the filing of injunctive actions).  Underlying Delrahim’s commentary is the understanding that innovation is vitally important to the American economy, and the concern that antitrust enforcers’ efforts in recent years have threatened to undermine innovation by inappropriately interfering in free market licensing negotiations between patentees and licensees.

Important “takeaways” from Delrahim’s speech (with key quotations) are set forth below.

  • Thumb on the scale in favor of implementers: “In particular, I worry that we as enforcers have strayed too far in the direction of accommodating the concerns of technology implementers who participate in standard setting bodies, and perhaps risk undermining incentives for IP creators, who are entitled to an appropriate reward for developing break-through technologies.”
  • Striking the right balance through market forces (as opposed to government-issued best practices): “The dueling interests of innovators and implementers always are in tension, and the tension is resolved through the free market, typically in the form of freely negotiated licensing agreements for royalties or reciprocal licenses.”
  • Holdup as theoretical concern with no evidence that it’s a systemic or widespread problem: He praises Professor Carl Shapiro for his theoretical model of holdup, but stresses that “many of the proposed [antitrust] ‘solutions’ to the hold-up problem are often anathema to the policies underlying the intellectual property system envisioned by our forefathers.”
  • Rejects prior position that antitrust is only concerned with the patent-holder side of the holdup equation, stating that he’s more concerned with holdout given the nature of investments: “Too often lost in the debate over the hold-up problem is recognition of a more serious risk:  the hold-out problem. . . . I view the collective hold-out problem as a more serious impediment to innovation.  Here is why: most importantly, the hold-up and hold-out problems are not symmetric.  What do I mean by that?  It is important to recognize that innovators make an investment before they know whether that investment will ever pay off.  If the implementers hold out, the innovator has no recourse, even if the innovation is successful.  In contrast, the implementer has some buffer against the risk of hold-up because at least some of its investments occur after royalty rates for new technology could have been determined.  Because this asymmetry exists, under-investment by the innovator should be of greater concern than under-investment by the implementer.”
  • What’s at stake: “Every incremental shift in bargaining leverage toward implementers of new technologies acting in concert can undermine incentives to innovate.  I therefore view policy proposals with a one-sided focus on the hold-up issue with great skepticism because they can pose a serious threat to the innovative process.”
  • Breach of FRAND as primarily a contract or fraud, not antitrust issue: “There is a growing trend supporting what I would view as a misuse of antitrust or competition law, purportedly motivated by the fear of so-called patent hold-up, to police private commitments that IP holders make in order to be considered for inclusion in a standard.  This trend is troublesome.  If a patent holder violates its commitments to an SSO, the first and best line of defense, I submit, is the SSO itself and its participants. . . . If a patent holder is alleged to have violated a commitment to a standard setting organization, that action may have some impact on competition.  But, I respectfully submit, that does not mean the heavy hand of antitrust necessarily is the appropriate remedy for the would-be licensee—or the enforcement agency.  There are perfectly adequate and more appropriate common law and statutory remedies available to the SSO or its members.”
  • Recommends that unilateral refusals to license should be per se lawful: “The enforcement of valid patent rights should not be a violation of antitrust law.  A patent holder cannot violate the antitrust laws by properly exercising the rights patents confer, such as seeking an injunction or refusing to license such a patent.  Set aside whether taking these actions might violate the common law.  Under the antitrust laws, I humbly submit that a unilateral refusal to license a valid patent should be per se legal.  Indeed, just this Monday, Chief Judge Diane Wood, a former Deputy Assistant Attorney General at the Antitrust Division, stated that “[e]ven monopolists are almost never required to assist their competitors.”
  • Intent to investigate buyers’ cartel behavior in SSOs: “The prospect of hold-out offers implementers a crucial bargaining chip.  Unlike the unilateral hold-up problem, implementers can impose this leverage before they make significant investments in new technology.  . . . The Antitrust Division will carefully scrutinize what appears to be cartel-like anticompetitive behavior among SSO participants, either on the innovator or implementer side.  The old notion that ‘openness’ alone is sufficient to guard against cartel-like behavior in SSOs may be outdated, given the evolution of SSOs beyond strictly objective technical endeavors. . . . I likewise urge SSOs to be proactive in evaluating their own rules, both at the inception of the organization, and routinely thereafter.  In fact, SSOs would be well advised to implement and maintain internal antitrust compliance programs and regularly assess whether their rules, or the application of those rules, are or may become anticompetitive.”
  • Basing royalties on the “smallest salable component” as a requirement by a concerted agreement of implementers is a possible antitrust violation: “If an SSO pegs its definition of “reasonable” royalties to a single Georgia-Pacific factor that heavily favors either implementers or innovators, then the process that led to such a rule deserves close antitrust scrutiny.  While the so-called ‘smallest salable component’ rule may be a useful tool among many in determining patent infringement damages for multi-component products, its use as a requirement by a concerted agreement of implementers as the exclusive determinant of patent royalties may very well warrant antitrust scrutiny.”
  • Right to Injunctive Relief and holdout incentives: “Patents are a form of property, and the right to exclude is one of the most fundamental bargaining rights a property owner possesses.  Rules that deprive a patent holder from exercising this right—whether imposed by an SSO or by a court—undermine the incentive to innovate and worsen the problem of hold-out.  After all, without the threat of an injunction, the implementer can proceed to infringe without a license, knowing that it is only on the hook only for reasonable royalties.”
  • Seeking or Enforcing Injunctive Relief Generally a Contract Not Antitrust Issue: “It is just as important to recognize that a violation by a patent holder of an SSO rule that restricts a patent-holder’s right to seek injunctive relief should be appropriately the subject of a contract or fraud action, and rarely if ever should be an antitrust violation.”
  • FRAND is Not a Compulsory Licensing Scheme: “We should not transform commitments to license on FRAND terms into a compulsory licensing scheme.  Indeed, we have had strong policies against compulsory licensing, which effectively devalues intellectual property rights, including in most of our trade agreements, such as the TRIPS agreement of the WTO.  If an SSO requires innovators to submit to such a scheme as a condition for inclusion in a standard, we should view the SSO’s rule and the process leading to it with suspicion, and certainly not condemn the use of such injunctive relief as an antitrust violation where a contract remedy is perfectly adequate.”

I didn’t know Fred as well as most of the others who have provided such fine tributes here.  As they have attested, he was a first-rate scholar, an inspiring teaching, and a devoted friend.  From my own experience with him, I can add that he was deliberate about investing in the next generation of market-oriented scholars.  I’m the beneficiary of that investment.

My first encounter with Fred came in 1994, when I was fresh out of college and working as a research fellow at Washington University’s Center for the Study of American Business.  I was trying to assess the common law’s effectiveness at dealing with the externalities that are now addressed through complex environmental statutes and regulations.  My longtime mentor, P.J. Hill, recommended that I call Fred for help.  Fred was happy to drop what he was doing in order to explain to an ignorant 22 year-old how the common law’s property rights-based doctrines could address a great many environmental problems.

After completing law school and a judicial clerkship, I took a one-year Olin Fellowship at Northwestern, where Fred was teaching.  Once again, he took time to help a newbie formulate ideas for articles and structure arguments.  But for the publications I produced at Northwestern, I probably couldn’t have landed a job teaching law.  And without Fred’s help, those publications wouldn’t have been nearly as strong.

A few years ago, Fred invited me to join as co-author of the fifth edition of his excellent antitrust casebook (co-authored with the magnificent Charlie Goetz).  How excited was I!  My initial excitement was over the opportunity to attach my name to two giants in the field.  What I didn’t realize at the time was how much I would learn from Fred and Charlie, both brilliant thinkers and lucid writers.

Fred and Charlie’s casebook continually emphasizes the decision-theoretic approach to antitrust – i.e., the view that antitrust rules and standards should be crafted so as to minimize the sum of error and decision costs.  As I worked on the casebook, my understanding of that regulatory approach deepened.  My recently published book, How to Regulate, extends the approach outside the antitrust context.

But for the experience working with Fred and Charlie on their casebook, I may never have recognized the broad applicability of the error cost approach to regulation, and I may never have completed How to Regulate.

In real life, people don’t get the sort of experience George Bailey had in It’s a Wonderful Life.  We never learn what people would have been like had we not influenced them.  I know for sure, though, that I would not be where I am today without Fred McChesney’s willingness to help me along the way.  I am most grateful.

This week, the International Center for Law & Economics filed an ex parte notice in the FCC’s Restoring Internet Freedom docket. In it, we reviewed two of the major items that were contained in our formal comments. First, we noted that

the process by which [the Commission] enacted the 2015 [Open Internet Order]… demonstrated scant attention to empirical evidence, and even less attention to a large body of empirical and theoretical work by academics. The 2015 OIO, in short, was not supported by reasoned analysis.

Further, on the issue of preemption, we stressed that

[F]ollowing the adoption of an Order in this proceeding, a number of states may enact their own laws or regulations aimed at regulating broadband service… The resulting threat of a patchwork of conflicting state regulations, many of which would be unlikely to further the public interest, is a serious one…

[T]he Commission should explicitly state that… broadband services may not be subject to certain forms of state regulations, including conduct regulations that prescribe how ISPs can use their networks. This position would also be consistent with the FCC’s treatment of interstate information services in the past.

Our full ex parte comments can be viewed here.

It’s been six weeks since drug maker Allergan announced that it had assigned to the Saint Regis Mohawk Tribe the patents on Restasis, an Allergan drug challenged both in IPR proceedings and in Hatch-Waxman proceedings in federal district court.  The unorthodox agreement was intended to shield the patents from IPR proceedings (and thus restrict the challenge to district court) as the Mohawks would seek to dismiss the IPR proceedings based on the tribe’s sovereign immunity.  Although Allergan  suffered a setback last week when the federal court invalidated the Restasis patents and, in dicta, expressed concern about the Allergan/Mohawk arrangement, several other entities are following Allergan’s lead and assigning patents to sovereigns in hopes of avoiding IPR proceedings.

As an example, in August, SRC Labs assigned about 40 computer technology patents to the Saint Regis Mohawk Tribe.  Last week, the tribe, with SRC as co-plaintiff, filed lawsuits against Microsoft and Amazon for infringement of its data processing patents; the assignment of the SRC patents to the tribe could prevent a counter-challenge from Microsoft and Amazon in IPR proceedings.  Similarly, Prowire LLC, who has sued Apple for infringement, has assigned the patent in question to MEC Resources, a company affiliated with three tribes in North Dakota.  And state universities (whom the PTAB considers to be arms of the sovereign states, and thus immune to IPR challenges) are in discussions with lawyers about offering their sovereign immunity to patent owners as a way to shield patents in IPR proceedings.

These arrangements that attempt to avoid the IPR process and force patent challenges into federal courts are no surprise given the current unbalance in the IPR system.  Critical differences exist between IPR proceedings and Hatch-Waxman litigation that have created a significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges.

The PTAB applies a lower standard of proof for invalidity in IPR proceedings than do federal courts in Hatch-Waxman proceedings. In federal court, patents are presumed valid and challengers must prove each patent claim invalid by “clear and convincing evidence.” In IPR proceedings, no such presumption of validity applies and challengers must only prove patent claims invalid by the “preponderance of the evidence.” In addition to the lower burden, it is also easier for challengers to meet the standard of proof in IPR proceedings.  In federal court, patent claims are construed according to their “ordinary and customary meaning” to a person of ordinary skill in the art.  In contrast, the PTAB uses the more lenient “broadest reasonable interpretation” standard; this more lenient standard can result in the PTAB interpreting patent claims as “claiming too much” (using their broader standard), resulting in the invalidation of more patents.

Moreover, whereas patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This has given rise to “reverse patent trolling,” in which entities that are not litigation targets, or even participants in the same industry, threaten to file an IPR petition challenging the validity of a patent unless the patent holder agrees to specific pre-filing settlement demands.  The lack of a standing requirement has also led to the  exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

Finally, patent owners are often forced into duplicative litigation in both IPR proceedings and federal court litigation, leading to persistent uncertainty about the validity of their patents.  Many patent challengers that are unsuccessful in invalidating a patent in district court may pursue subsequent IPR proceedings challenging the same patent, essentially giving patent challengers “two bites at the apple.”  And if the challenger prevails in the IPR proceedings (which is easier to do given the lower standard of proof and broader claim construction standard), the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision.

Courts are increasingly recognizing that certain PTAB practices are biased against patent owners, and, in some cases, violations of underlying law.  The U.S. Supreme Court in Cuozzo Speed Technologies v. Lee concluded that the broadest reasonable interpretation claim construction standard in IPR “increases the possibility that the examiner will find the claim too broad (and deny it)” and that the different claim construction standards in PTAB trials and federal court “may produce inconsistent results and cause added confusion.”  However, the Court concluded that only Congress could mandate a different standard.  Earlier this month, in Aqua Products, Inc. v. Matal, the Federal Circuit held that “[d]espite repeated recognition of the importance of the patent owner’s right to amend [patent claims] during IPR proceedings— by Congress, courts, and the PTO alike—patent owners largely have been prevented from amending claims in the context of IPRs.”   And the Supreme Court has agreed to hear Oil States Energy Services v. Greene’s Energy Group, which questions whether IPR proceedings are even constitutional because they extinguish private property rights through a non-Article III forum without a jury. 

As Courts and lawmakers continue to question the legality and wisdom of IPR to review pharmaceutical patents, they should remember that the relationship between drug companies and patients resembles a social contract. Under this social contract, patients have the right to reasonably-priced, innovative drugs and sufficient access to alternative drug choices, while drug companies have the right to earn profits that compensate for the risk inherent in developing new products and to a stable environment that gives the companies the incentive and ability to innovate.  This social contract requires a balancing of prices (not too high to gouge consumers but not too low to insufficiently compensate drug companies), competition law (not so lenient that it ignores anticompetitive behavior that restricts patients’ access to alternative drugs, but not so strict that it prevents companies from intensely competing for profits), and most importantly in the context of IPR, patent law (not so weak that it fails to incentivize innovation and drug development, but not so strong that it enables drug companies to monopolize the market for an unreasonable amount of time).  The unbalanced IPR process threatens this balance by creating significant uncertainty in pharmaceutical intellectual property rights.  Uncertain patent rights will lead to less innovation in the pharmaceutical industry because drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.  Indeed, last week former Federal Circuit Chief Judge Paul Redmond Michel acknowledged that IPR has contributed to “hobbling” our nation’s patent system, “discourag[ing] investment, R&D and commercialization.” And if IPR causes drug innovation to decline, a significant body of research predicts that consumers’ health outcomes will suffer as a result.

In her distinguished tenure as a Commissioner and as Acting Chairman of the FTC, Maureen Ohlhausen has done an outstanding job in explaining the tie between robust patent protection and economic growth and innovation (see, for example, her Harvard Journal of Law and Technology article, here).  Her latest public pronouncement on this topic, an October 13 speech entitled “Strong Patent Rights, Strong Economy,” also makes a highly valuable contribution to the patent policy debate.  Ohlhausen’s speech centers on two key points:  “First, strong patent rights are crucial to economic success.  And, second, economically grounded analysis will reveal the right path through thickets of IP [intellectual property] skepticism.”  Ohlhausen concludes with a reaffirmation of the importance of having the United States lead by example on the world stage in defending strong patent rights:

Patents have been at the heart of US innovation since the founding of our country, and respect for patent rights is fundamental to advance innovation.  The United States is more technologically innovative than any other country in the world.  This reality reflects, in part, the property rights that the United States government grants to inventors.  Still, foreign counterparts take or allow the taking of American proprietary technologies without due payment.  For example, emerging competition regimes view “unfairly high royalties” as illegal under antitrust law.  The FTC’s recent policy work offers an important counterweight to this approach, illustrating the important role that patents play in promoting innovation and benefiting consumers.     

In closing, while we may live in an age of patent skepticism, there is hope. Criticism of IP rights frequently does not hold up upon closer examination. Rather, empirical research favors the close tie between strong IP rights and R&D.  This is not to say that changes to the patent system are always unwarranted.  Rather, the key to addressing the U.S. patent system lies in incremental adjustment where necessary based on a firm empirical foundation.  The U.S. economy stands as a shining reminder of everything that American innovation policy has achieved – and intellectual property rights, and patents, are the important cornerstones of those achievements.

Ohlhausen’s remarks are, as always, thoughtful and well worth studying.