The great American humorist, Mark Twain, is said to have coined the phrase, “Lies, Damned Lies, and Statistics”, when speaking of numerical arguments that don’t seem to add up. In recent years, we have been regaled with numbers showing the great damage caused by patent trolls, and the need to reduce trolling activity. Do these numbers make sense?

The first problem, and it’s not trivial, is to determine what the damage actually is. In recent years, there have been several estimates, but a consensus seems to be forming around the sum $80 Billion – $90 Billion per year[1], with a total damage to the U.S. economy, to date, of about $750 Billion[2]. It is a noble effort to try to quantify possible damage of patent litigation, but as a general matter, quantifying the exact damage is simply impossible. Nevertheless, we can make three comments about this emerging consensus of about $750 Billion in damage from patent trolls.

First, the number appears very high. In particular, the evidence to date of this magnitude of damage seems to be fuzzy. Many categories of damage have been proposed for the $80 – $90 Billion annual estimate, including a decrease in applied product innovation[3], diversion of management resources from productive activity, shutting down production and sales during litigation, customers stop buying products, reworking or abandoning products, decrease in complementary investments, threats against customers and suppliers, decline in revenues by 1/3, and absence of new products while litigation pending.[4] Even given this list of terrible consequence, do the numbers make sense?

In the period 2006-2012 inclusive, Patent Assertion Entities (“PAEs” for short) initiated about 7,400 infringement lawsuits.[5] Given current trends in patent litigation, the number as of year-end 2013 must be over 10,000, including suits filed in the period 1990 – 2005 and in 2013.[6]

Questions:

(1) Is it reasonable that 10,000 lawsuits have cost the U.S. economy $750 Billion? Is it reasonable that each lawsuit has cost the U.S. economy, on average, about $75 Million?

(2) The damage estimate is only for publicly traded stocks. The current value of U.S. traded stocks, as of early January, 2013, is about $19.7 Trillion. So, the total cost is about $750 Billion /19.7 Trillion = 3.8% of all value of all publicly traded stocks in the U.S., wiped out by 10,000 patent lawsuits initiated by PAEs. Is this reasonable?

(3) Actually, until recently, almost all of the lawsuits were directed at high-tech companies in particular. These make up about 15% of the U.S. economy as of the start of 2014. So a loss of 3.8% on 15% is actually more than 25%. Is it reasonable that 25% of the value of publicly traded high-tech stocks has been lost due to 10,000 PAE lawsuits?

(4) Some of the champions of the $80 – $90 Billion estimate have been pointed out that only 9% of the loss to defendants is actually captured by PAE plaintiffs, the rest being dissipated – slightly among attorneys and litigation fees, but mainly due to the various decisions to halt or retard innovation. [7] In other words, of the loss, almost 90% seems to be friction, since it does not go to the companies sued or the suing companies involved in the litigation. Is it reasonable, that year after year, corporate executives suffer a loss of 90% in order to fight litigation that generates about 10% revenues to someone else? In these circumstances, shouldn’t the sued corporations settle the disputes, presumably for a fraction of what it will cost if they pursue the disputes to judicial decision?

(5) Is it reasonable that investment advisers, mutual funds, hedge funds, and other sophisticated investors expect that the corporate executives will continue to lose 10X the money they seem to lose to PAEs in litigation, and that they expect that corporate executives will continue to do this year after year? (It must be year after year for the losses to be permanent.)

Here is the answer to all these questions: “Maybe, but the case has not yet been made.”

Second, let’s assume the answer to all the questions above is YES, and that this yes can be documented with proof. Even so, is it necessarily a bad thing that PAE lawsuits are costing the economy $80 – $90 Billion per year?

One commentator lists some of the negatives of PAE litigation (patent holdups, raising costs, and foreclosing markets), but also lists some of the positives (reducing IP theft, establishing reasonable royalties, increasing innovation, preventing free riding).[8] Other commentators, in a direct attack on the cost model, state that “transfers to patent holders are the contemplated reward of the patent system”[9], which seems to say, “If defendants are infringing and that can be proved, then the plaintiffs must receive their reward for innovation, whatever the cost to the defendants”. There is a strong intuition of justice – the inventors of patents should be rewarded, which they can do by suing in their own name or by selling their patents to other entities, perhaps PAEs, which will then sue as the new patent holders.

The comments here suggest mixed results, some positive and some negative, so that we can say that at least part of the loss is offset, and we definitely cannot say that all of the market loss of infringers is bad. Third, given an assumed YES to the questions of the first argument above (that is, assuming the elements of damage occurred and in the magnitude stated), and given that some results appear to be bad while others good, how is it possible to reduce or eliminate only the unjustified harm of PAE litigation (the bad) while retaining the benefits of PAE litigation (the good)?[10] To this question we must respond, “We currently don’t know, but we do know that the U.S. has had the most technologically and entrepreneurially innovative society over the past century. Patent protection, and the knowledge that an inventor could protect invention against much stronger entities, almost certainly had something to do with this.”

In an oft-quoted comment, President Lincoln said, “the patent system adds the fuel of interest to the spark of genius.” We should think twice, and perhaps three times, before taking action to dampen the interest, lest we extinguish the spark. This definitely does not mean that problems of patent quality should be ignored – there are such problems, and they should be addressed, as explained in Part II of this blog, but remedies must recognize that much economic good is produced by patents and patent litigation.

Notes:

[1] “The Private and Social Costs of Patent Trolls”, James Bessen, Jennifer Ford, and Michael J. Meurer, Regulation, Winter 2011-2012, pp.26-35, with an estimate of $83B/ year at p.31.

[2] Id., at p.30, notes a total decline in stock market value of $501B-$579B through 2010, but also continuing losses at the rate of about $83B/year, which suggest total loss by year’s end 2013 of $750B-$800B. This aggregate estimate is the believed loss of market value of public companies, caused by the patent infringement lawsuits of trolls. As the authors say at p.31, “berceuse this total is only for publicly listed firms, it likely understate the true loss of wealth resulting from NPE lawsuits”.

[3] “Patent Trolls and Technology Diffusion”, Catherine Tucker, March 26, 2013, available at http://ssrn.com/abstract=1976593. This article suggests that lawsuits by patent trolls in the medical imaging industry cause a drop in the number of new products, due to primarily to the fear of infringement litigation. This is a ground-breaking study because it begins to point at exactly the kind of evidence that would be required to quantity economic damage. The article suggests rather than proves its point, and the damage implied from this one study cannot even begin to approach the damage enumerated in the emerging consensus, but this study is a start.

[4] “The Private and Social Cost of Patent Trolls”, op.cit., at p.31.

[5] “Patent Trolls by the Numbers”, Colleen Chien, printed in Patent Law Blog (PatentlyO), March 14, 2013. Professor Chien says there she invented the term “PAE” to mean businesses that assert patents as their main activity, thereby excluding universities, startups, and presumably individuals. The 7,400 lawsuits filed by PAE’s in he period 2006-2012 is taken by Professor Chien from RPX Corporation.

[6] We are missing information for PAE lawsuits in 2013. If we take only the same number of PAE lawsuits filed in 2012, which was 2,914, and add that to the period 2006-2012, we are already over 10,000. It seems very likely that the total number of PAE lawsuits is slightly more than 10,000. I have used 10,000 here.

[7] “The Private and Social Costs of Patent Trolls”, op.cit., suggesting 9% of defendants’ losses went to the plaintiffs (p.32), “a few percent” to lawyers and expert witnesses (p.32), and the [8] “The Brothers Grimm Book of Business Models: A Survey of Literature and Developments in Patent Acquisition and Litigation”, Anne Layne-Farrar, Journal of Law, Economics & Policy, Vol.9:1, 2012, pp.29-57, at p.55.

[9] “Analyzing the Role of Non-Practicing Entities in the Patent System”, David L. Schwartz and Jay P. Kesan, October 31, 2013, Cornell Law Review , Forthcoming, available at http://ssrn.com/abstract=2117421, pp.101-129, at p.108.

[10] “The Brothers Grimm Book of Business Models”, op.cit., at p.56.