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Each firm has lost business in, and has reduced investment in and output of United States equity research as a result of the free riding by Fly and other services. This is a bread-and-butter case of hot-news appropriation.

Benjamin Marks to US District Judge Denise Cote: via Bloomberg.

The case of Barclays v. Theflyonthewall.com provides a recent test of the hot news doctrine in the investment research industry. Claims that Fly on the Wall was just reporting the news from the free marketplace of ideas would not protect them. Instead, Judge Denise Cote’s findings of facts and conclusions of law following the March 8-11 bench trial would institute an injunction that embargoed recent headlines and materials from the plaintiffs from publication by Fly on the Wall. The news of her decision has lathered the industry into froth over whether Thomson/Reuters and Bloomberg may be next. But its application may be greater than that. Though the opinion ruled in an industry that is traditionally seen as different than the news industry – investment research – can its application in the broader news industry be far behind? Read the rest of this entry »

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Intellectual Ventures wants to define itself before someone else does. It’s been called a troll, a renegade, just another stop on shakedown street. Now, however, Nathan Myhrvold has launched a round of publicity that includes batteries from the New York Times (blogarticle) and a single shot from the Harvard Business Review. Myrhvold would have his readers believe that we are standing on the edge of a capital market for invention that will unleash and remunerate the full creative power of our economy, and Intelligent Ventures is just the firm to launch it.

Sometimes, however, a troll is just a troll. But Myhrvold is right. He’s not just a troll. Myhrvold’s ambition is greater than that. He’s planning an intellectual property cartel, and policy makers would be well-advised to monitor his project.

Myhrvold had the good fortune to work closely with Steve Lohr of the New York Times to publicize his manifesto in the HBR and share his vision. Lohr provides a patient and adulating witness to the quirky polymath. With an enterprise so shrouded in secrecy, Lohr understands that Myhrvold won’t just speak with anyone and chooses to reserve judgment and ingratiate himself with him: “white hat or black hat, Intellectual Ventures is growing rapidly and becoming a major force in the marketplace.” Lohr goes further, however, and instills the underdog spirit in Myhrvold, who exclaims, “We have to be successful,” following which Lohr warns us that the “issues surrounding Intellectual Ventures, viewed broadly, are the ground rules and incentives for innovation.” Josh Lerner, an HBS economist and patent expert, speaks up in the next sentence and says, “how this plays out will be crucial to the American economy.” Could Myrhvold’s success possibly be tied to answering crucial questions about the ground rules and incentives for innovation in the American economy? Lohr’s thoughtful organization might have you think so, and Lerner’s quote would seemingly substantiate it.

Maybe Lohr was uncomfortable with the persona he had attributed to Myhrvold, for he would couple his article with an early-morning blog post on Bits. While his print subscribers drank deeply of his David & Goliath – styled allegory on patent-law, he quietly published a clarification of the patent litigation dilemma. Lohr frames the next phase of IV in terms of solving the free-rider problem. The label is interesting for two reasons. First, it implicitly says what it is not. For example, it is not greenmail, as Jim Huston, a former licensing and patent executive at Intel, suggested in a 2006 Business Week interview: “If you don’t invest, you’re our No. 1 target.” Second, it suggests that there must be a simple solution to an unacceptable practice. Afterall, we’ve all heard about free-riders.

Intellectual Venture’s limited partners invested to protect themselves from trolls. If Intellectual Ventures can buy up loose patents, then the LPs have a quasi-insurance policy against trolls, who could just as easily, though more threateningly, buy those patents. Myrhvold initially called it a defense fund, almost a patent poolMore money means more insurance, but there’s a quirk. It may require litigation to work.

Though litigation may make Intellectual Ventures look like a troll, be assured, it’s not. Myhrvold claims to have only a reluctant interest in litigation. “It’s a stupid and inefficient way to resolve disputes, but in a polarized world, there will be litigation,” claims Myhrvold. It’s necessary, however, to solve the free rider problem. Some people have paid into the defense fund, others haven’t. IV’s hands are tied. They have to sue, so they can protect the interests of their initial investors. It’s their fiduciary duty.

The solution: bring new members into the Intellectual Ventures project. Litigation, or the threat of litigation, Myhrvold believes, will encourage others to join. As they join, he can manage the free rider problem and assure appropriate and legal access to the trove of intellectual property already collected, thus demonstrating the value of their initial investors’ decision to work with them, while creating a market for invention capital – a market for eureka.  “Our licensing task is to go from dozens of companies to thousands,” says Myhrvold.

Myhrvold’s vision would solve the free-rider problem, but it does not mean Intellectual Ventures is not a troll. Lohr mistakenly considers the free-rider problem in isolation. Intellectual Ventures does not have a free-rider problem in the vein of a public good. It’s not the case of a shipping association that has financed and constructed a lighthouse for their benefit, but may inadvertently serve that of the brigands, castaways and competitors who happen along. Lohr’s free-rider problem exists only because Intellectual Ventures has organized a Non-Practicing Entity to collect intellectual property with the intention of monetizing it for their limited partners. The free-rider problem in this case is that which is exploited by a troll.

It wouldn’t be wrong to just say troll, but Intellectual Ventures seems to be more than that. Myhrvold’s proposal would create a troll quite unlike anything that we have seen before – a troll with a cartel-twist: an intellectual property cartel. With “thousands of members” Myrhvold would have an agreement among competing firms to coordinate prices on a vast holding of intellectual property to the disadvantage of non-members. Patents are monopolies, so non-members will have no substitutes. Its alarming size would give it substantial reach in the intellectual property market and engender a network-effect, which would cultivate market power and make membership more valuable on a per-patent-basis as it grows. The problem with this isn’t the idea of patents. The problem is the power that an intellectual property cartel would have.

Intellectual Ventures would increasingly intersect with the interests and inventions of others. When it would, it would find itself better capitalized and equipped to pursue a claim. With growing resources, Intellectual Ventures would be able to take more risks with litigation, actual or threatened. A claim, for example, may be weak, but their credible ability to marshal legal action may force concessions and settlements where none may be merited. Because of the network-effect and the lack of substitutes, settlements and membership will become more costly on a per-patent basis. Moreover, with imperfect information on the scope and character of Intellectual Ventures’ holdings, it may only take a well-phrased bluff to induce a target into membership.

What happens in this model? What is the consequence of an intellectual property cartel? It raises the price of innovation. It puts smaller firms at a disadvantage. And it places us in a world where Non-Practicing Entities can lay in wait, as a hunter in a blind, lash out without warning and stifle the work of companies that may actually be organized to accomplish something, such as provide goods or services, with their efforts. Patents aren’t bad, but these outcomes are.

—part of the quotestream around IV

If I appear to be a total milquetoast and I say I’ll never [sue], then people will rip me off totally…I say, ‘I can’t afford to sue you on all of these, and you can’t afford to defend on all these.’

Nathan Myhrvold: WSJ 2008

You have a set of people who are used to getting something for free, and they are some of the wealthiest companies on earth. I was there. I was in the meetings. This is they way this business thinks about it.

Today invention is an area that people view as too illiquid, too uncertain, and too risky, so that nobody wants to invest in it. The world has shown that if you provide capital and expertise to an area that is starved for capital and expertise.

Nathan Myhrvold, on corporate respect for patents, BW 2006. Izhar Armony, a partner at Charles River Ventures, would say, “I think that Nathan is on to something really good and important. We share a common vision of thinking of [intellectual property] as an emerging asset class.”

The appeal is twofold: the opportunity to interact with a diverse group of thinkers purely for the sake of invention, and the efficiency with which IV translates imagination into intellectual capital.

Dennis Rivet, on working at Nathan Myhrvold’s Intellectual Ventures, which started as aPatent Defense Fund against trolls: BW 2006.

Bruce Sanford and Bruce Brown commented in the WSJ on “Google and the Copyright Wars” (11/12). Many are focused on the status of orphan works in the Google Books project, but Sanford and Brown argue that the idea of fair use and its application by search engines is the controversy’s center, not orphan works. Sanford and Brown would say that a search engine’s use of the web’s content is definite and definitely unfair.

Fair use of a book’s content, a website, or even the news underpins a search engine’s ability to find and deliver websites to users of the internet. Sanford and Brown stake out a position for search engines that is similar to a public library. Just as a library can employ the contents of its archive to establish an index for its patrons, the search engine uses the contents of the internet to establish an index for anyone at all. Sanford and Brown, however, contend that search engines are not libraries, so fair use does not apply.

Sanford and Brown argue that two distinctions separate search engines from the library model. Search engines not only copy text, they reproduce it in their results as snippets. Rights of reproduction are protected for copyright holders. Second, search engines sell advertising, and the sale of advertising is contingent on their ability to copy, store and reproduce copyrighted material. These distinctions, argue Sanford and Brown, disqualify search engines from the safe harbor of any exemption made for libraries. Their remedy: legislation.

The problem is, search engines don’t find safe harbor in the library model, and legislation is not the answer. Yes, a library applies fair use in its practices, and search engines have been compared to them in the past, but not all applications of fair use are found in the confines a library. This may be why they are so quick to demand legislation to expand copyright, even though expanding copyright may drive more business to the lawyers who protect it than the websites involved.

The Ninth Circuit court framed a four factor test for fair use in the case of Perfect 10 v. Google, et al in May 2007. The test would distinguish between copyright infringement and fair use in the case of Google’s use of Perfect 10 material in its search results. The four factors comprise: the purpose and character of the use; the nature of the work, ie fact-based or creative; the amount of the work used; and the effect on the market for the work. None of them invoke the metaphor of the library used by Sanford and Brown.

When Google displayed the Perfect 10 images, the Circuit determined that all four factors weigh in its favor. The images may have been highly original, but the results incorporate “an original work into a new work, namely an electronic reference tool,” and this is highly transformative: “a search engine may be more transformative than a parody because a search engine provides an entirely new use for the original work, while a parody typically has the same entertainment purpose as the original work.” Though Google would use a degraded thumbnail version of the image, its “use of the entire photographic image [is] reasonable in light of the purpose of a search engine.” The Ninth Circuit, therefore, reasoned that Google’s use of Perfect 10 thumbnails would be considered fair use. Though it didn’t provide a decision, it did suffice to vacate Perfect 10’s preliminary injunction against Google.

Sanford and Brown mistake the metaphor of a library as the only example of fair use when alternatives, such as the Ninth Circuit’s opinion, are perfectly acceptable. Perhaps this is why, having fleshed out their metaphor, they seize on legislation as a solution. Indeed, they would have Congress assert, “once the cache is monetized for the benefit of a search engine, the line of copyright infringement is crossed.” Isn’t this a sort of Hail Mary pass to rights-holders?
Legislation could make it illegal to monetize a cache without permission, but it’s not the panacea that Sanford and Brown are driving at. If the legislation mandated payments for rights-holders, it would, but this is probably not a suggestion that would be found in the pages of the Wall Street Journal. More likely, it would not, and it would leave websites in the position of the prisoner’s dilemma. If everyone cooperates and insists on payment, it will be to their mutual advantage, but the search engines direct so much traffic that each website has an incentive to break ranks; hence, everyone reluctantly opts in for fear that they’ll be the lone hold-out. In effect, it’s as though the legislation never happened, with one important distinction: there’s a new law on the books that requires a few good lawyers to understand. Perhaps that’s what’s really driving Sanford and Brown’s comment.

There is an exception, however. Not all players are equal in this game. Some may wager that holding-out is viable regardless of legislation or whether others do. That’s exactly what News Corp has done. They have begun negotiating a possible payment from Microsoft for the exclusive right to index their content. Though derided by many on the internet, should they find an agreement, their example will prove an important experiment in the question of paying for content.

Competitive markets work not because producers capture the full social value of their output—they don’t—but because they permit producers to make enough money to cover their costs, including a reasonable return on fixed-cost investment. Even real property doesn’t give property owners the right to control social value. Various uses of property create uncompensated positive externalities, and we don’t see that as a problem or a reason people won’t efficiently invest in their property.

The goal of eliminating free riding is ill-suited to the unique characteristics of intellectual property. Treating intellectual property as “just like” real property is a mistake. We are better off with the traditional utilitarian explanation for intellectual property, because it at least attempts to strike a balance between control by inventors and creators and the baseline norm of competition.

—Professor Mark Lemley, Stanford, in the Texas Law Review, 2005

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