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The Problems with Patents and the Impact
on the Investing Publ ic
For the past two decades, an unfortunate degradation of patent quality has affected the United States and the industrialized world. In 1970, global economies acknowledged the universal value of intellectual property in their negotiation of the Patent Cooperation Treaty. Together with Congressional reforms clarifying the patent procurement process and the provision patent rights to researchers receiving federal research dollars, important legislative efforts trigger a rapid expansion of patent application filings. While the common assumption was that innovation was on an upswing, in point of fact, the increasing number of filings also spawned the growth of several business practices that were antithetical to the patent right. In the following document, M•CAM will detail the threats to the patent process and discuss both the challenges and opportunities created by these deficiencies.
Is it novel?

A valid patent application is supposed to contain an enabling disclosure of an invention in
sufficient detail for others to understand and put in practice the invention. The invention is required to be novel and non-obvious - standards that have enjoyed extensive judicial clarification. Patent law requires those substantially involved in the preparation of a patent application to perform a reasonable review of prior art - that is to say that one should establish that the invention disclosed is materially different from any other invention made and that the substance of the application is not the restatement of inventions disclosed by others in publications of any kind (including prior patents). Upon submission of the application to the United States Patent & Trademark Office (USPTO), a patent examiner is required to conduct a comprehensive examination all relevant pieces of prior art paying particular attention to patents with similar classifications as the one under review. Upon finding disqualifying prior art, an examiner is to inform the applicant of the rejection of some or all of the claims based on the existence of prior invention in the same area. This process appears to be extremely straightforward until one considers several key process deficiencies.
Prosecutorial Inadequacy

The decision to conduct thorough research prior to filing a patent application is frequently
linked to the economics of the process. In short, prior art research is undertaken if a budget provides sufficient funds for a law firm or company to conduct this tedious review of thousands of previous inventions and publications. If not, little or no research is done. While research disclosure is contained as part of a patent prosecution history, no adequacy metrics exist to ensure that either the prosecutor or examiner has done a complete review. To the contrary, many patent attorneys specifically avoid conducting a comprehensive analysis of prior art because they are duty bound to disclose what they know. If they don't look, goes the argument, there's nothing to disclose. Bear in mind that few clients will pay for NOT getting the patent they think they should get. The economic incentive for patent prosecutors to simply write a patent, irrespective of its merits, far exceeds any incentive to only file in the case of true innovation. A second problem is that of failure to cite closest references. M•CAM has found hundreds of cases where patents contain "thesaurus innovations". We use this term to describe conceptual plagiarism. An existing patent will be used as the basis for drafting new claims all the while assiduously avoiding use of the same terms so that, using a key-word or Boolean search, the ability to detect the source document is infinitely improbable. In these cases, it is common to see the prosecutor cite dozens of marginally relevant patents to obfuscate the search conducted by the examiner and lessen the probability of that examiner ever finding the plagiarized source. This practice is often used for attempts at patent life extension (trying to re-patent soon-to-be-expired patents) or for defensive engineering (allegedly owning a patent in the same or a similar environment as a competitor in an attempt to get away with infringing activities). The USPTO and its European and Asian counterparts still fail to use effective semantic computer technologies to detect these fraudulent properties and perpetuate the problem by this examination failure.
Examination Process

With over 6,000,000 U.S. Patents and over 40,000,000 international patent-related
documents, no examiner can conduct a complete prior art search. Add to the volume of patent-related documents alone the billions of non-patent literature and the problem becomes insurmountable. Resistance to the use of computers to aid in the examination process has been vigorously opposed by many patent examiners despite their growing backlog and the exponentially expanding universe of potentially relevant documents. One may conclude that the current practices are beyond repair. However, the size of the relevant art universe is not that intimidating. It only takes one case of pre-existing invention to disqualify a patent. In M•CAM's research, we have found that as many as 35% of all patents contain one or more redundant claims - claims that are identical in form and/or substance to those in other patents alone. The ability for a computer to assist the examiner in arriving at a disqualification decision is proven. However, a more sinister force is at play here as well. The USPTO and its international counterparts are largely funded off of application and maintenance fees. Once a patent is issued, the owner must continue to pay administrative fees for the life of the patent. Several former and current examiners at the USPTO have reported being instructed by their supervisors to default towards approval of patents reminding them that their salaries are paid by fees that are only collected off issued patents. Additionally, the USPTO is a performance-based organization which means that the economic model is that of a piece work shop. Capricious time guidelines are placed on everything from classification to examination of patent applications. Less than 20 hours is afforded for the review of prior art. In most cases, it is physically impossible for the examiner to actually read the cited patents, much less take the time to find un-cited relevant patents or non-patent literature. In the case of one patent owned by Aurigin Systems, to read the cited prior art would take a person over 200 hours assuming a reading rate of 150 words per minute. In this case, the patent failed to cite over 50 other relevant pieces of prior art which were not included in the final issuance decision. Given the piecemeal approach to patent examination, there is no economic incentive for quality - only for quantity. More problematic is the procedural issue of concurrent art. Concurrent art refers to one or more patents covering the same content that are prosecuted and examined at or near the same time. With a backlog of patent examination nearing 3 years in many cases, the likelihood that one or more inventions relating to identical content will be filed is a virtual certainty. M•CAM has developed the only automated process to detect concurrent art and has found that up to 40% of all U.S. patents may be limited in their enforcement due to this growing problem. This is not to say that the patents are not valid - at least one of them may be. However it does suggest that the only remedy for sorting out the true owner likely requires a judicial or administrative review - a costly exercise in either case. A senior official at the USPTO was asked if he felt that it would be beneficial for the office to have a computer system which would alert examiners to likely concurrent art during the examination process. His response was an unequivocal, "No" as this would likely lead to more work and less efficiency. That's right, rather than getting it right the first time, the desired approach is to issue weakened patents and let the judicial process sort it out later.
The SEC and the New York attorney general's office have launched an investigation into
analysts at securities firms who made recommendations for purchasing stocks which allegedly lead to significant economic loss amoung investors. It is ironic to realize that a greater economic catastrophe is looming which will impact investors far more deeply than the exuberance of the bull market. A far more damaging market tsunami is coming. Many companies have built business models around revenue derived from the licensing of patents. Notable examples include Motorola, Qualcomm, HP, IBM, Applied Materials, ECD, Rambus and most biotechnology companies. Most of these companies secured public funding and represented in S1 filings ownership of significant patent portfolios that would offer protective value in the market place. Countless law firms and securities firms issued opinion letters reinforcing the perception of value based on these "proprietary" positions. No publicly traded company in the U.S. has conducted, or has had conducted for them, a complete patent audit to determine the degree to which uncited prior art and concurrent art weaken their patent position. More importantly, most analysts fail to examine the breadth of enforceability of patents and blindly reinforce corporate earnings projections based on a presumption that the patents will be enforceable and will sustain the projected licensing revenue. States' Attorneys General and the SEC would have a field day reviewing cases where analysts have been informed of patent challenges and continued to make "Buy" recommendations on companies whose revenue is derived in part or in whole from patent licensing only to have the stock plummet when courts make the determination that the review of patent strength already suggested. The authors of opinion letters and underwriters bear a responsibility for which, to date, they have not been held accountable.
The Impact on the Investing Public

Any investor considering an investment in a company that relies upon licensing revenue
must be aware of this crisis and should demand scrutiny prior to investing. Any investor holding an interest in a company which is paying licensing fees should also be aware of the patent challenges so that licensing fees are commensurate with the value of the patents being licensed. Failure to "right-size" licensing and royalties is detrimental to the bottom line and should not be tolerated.
The IP Company
New Economy companies often rely on their intellectual property (IP) holdings to drive revenue. In some cases, these companies derive almost all of their revenue from their intellectual property, particularly patents. Companies such as Qualcomm (Nasdaq: QCOM) or Rambus (Nasdaq: RMBS) are so devoted to IP they are often referred to as “IP companies”. Some New Economy sectors that are IP-dependent include biotechnology, telecommunications, and semiconductor design.
Issues for the Average Investor
Average investors often have difficulty evaluating IP companies for several reasons. First, IP companies often rely heavily on patent licensing agreements, the details of which are often not disclosed in typical SEC filing(s). Second, the legal instruments used in these agreements, namely patents, are highly technical documents that are written for person(s) that are skilled in that particular art or science. And finally, issues such as product infringement litigation, royalty payment structures, and un-cited prior art problems can be difficult or impossible to sort-out without advanced analytical tools or analysis from trained specialists. While IP companies can be great investments, (Don’t you wish you would have bought Qualcomm at $ 5 a share back in 1998?) they can certainly pose serious risks if one does not understand the company’s underlying intellectual property position.
Patent Analytics to the Rescue
The intellectual property management company M•CAM, Inc. of Charlottesville, VA (www.m-cam.com) provides two cases that illustrate how intellectual property analysis can give the investor an edge in deciding if an IP company’s stock is worth the risk. M•CAM uses its proprietary patent analytics to identify strengths and weaknesses at the patent level— the heart of the typical IP company.
Rambus and Reliance on Royalties

Rambus investors are well aware of the pitfalls associated with reliance on patent royalties.
The company designs, develops, licenses and markets high-speed memory technology for use in computers, consumer electronics, and communications. In March, Rambus stock took a nosedive after the U.S. District Court of Eastern Virginia ruled against the company in Rambus, Inc. v. Infineon Technologies. In the case, Rambus accused the German semiconductor company Infineon Technologies (NYSE: IFX) of improperly using Rambus’ patented memory-chip technology. The Court’s ruling placed in jeopardy most of Rambus’ work in securing licensing and royalty fees for its portfolio of patents. Especially concerning synchronous dynamic random access memory or SDRAM. Moreover, the Court ruled that the company committed fraud stemming from its patent dealings in the early 1990s. Over the course of the trial, Rambus stock price went from $ 80 per share in September of 2000 to $ 10 per share in July 2001. The Rambus, Inc. v. Infineon Technologies decision in March resulted in the stock dropping from its mid-March value of $35 per share to $ 20 per share by the end of the month. Investors should be aware that IP companies like Rambus are typically engaged in litigation as a means to protect their patent portfolio. Enforcing patent rights is an important part of doing business for IP companies, and the outcomes are not always predictable. Moreover, in addition to the stock price losses that can occur from unfavorable court rulings, IP companies must pay high legal fees that often run into the millions of dollars per year. Rambus spent over $ 7 million in the second quarter of its fiscal year 2001. In this case, the Rambus stock price was heavily tied to the patent licensing and royalties derived from the company’s patent portfolio. To help investors understand Rambus’ patent position, M•CAM completed an intellectual property analysis of the Rambus patents involved in the litigation. For a free copy of this report, check out the M•CAM Patently Obvious™ report available on-line at www.m-cam.com.
Hewlett-Packard and a $ 400 million Patent Litigation Settlement

In June 2001, Hewlett-Packard (HP) (NYSE: HWP) and Pitney Bowes Inc. (NYSE: PBI)
settled their 6-year patent litigation battle over patented print technology. Both companies are important patent players, with thousands of patents between them on inventions ranging from silicon chip manufacture to methods for folding paper. Understanding the value of so many patent holdings is beyond the scope of due diligence for the average investor. However, in this case, Hewlett-Packard investors that were armed with information on the strength and defensibility of the patent in question may have properly timed their buy/sell decisions. The $ 400 million cash settlement is not small change for either company. HP recorded the settlement as a pre-tax charge resulting in an earnings drop of 12 cents per share from 15 cents to 3 cents for the first fiscal quarter of 2001. The patent under dispute in the HP case was Pitney Bowes’ U.S. Patent No. 4,386,272.

Patent Protection for Prilosec®?

Another example of the importance of understanding patent and patent portfolio strength
can be seen in the recent court decisions and ongoing litigation involving drug giant AstraZeneca PLC (NYSE: AZN). AstraZeneca holds several patents involving the formulation of the world’s top selling heartburn and ulcer medication, Prilosec®. The company has filed numerous lawsuits with other companies, such as Andrx (Nasdaq: ADRX), Indian drug maker Cipla Ltd and Genpharm, Inc. in an effort to keep them and others from producing a generic form of Prilosec®. Prilosec® is very important to AstraZeneca— in 2000, the Losec®/Prilosec® product made up 40 percent of the company’s healthcare sales. Clearly, in addition to the normal investing considerations, such as the P/E ratio and earnings growth, investors need to know if AstraZeneca is likely to succeed in their patent battles. A brief intellectual property review of the AstraZeneca patent position reveals some important patent issues that the investor should consider, such as: 1. The early Prilosec® patents were filed in the early 1980s and are expired or are due to expire in the next one to two years. Upon patent expiration, a host of
competitors will attempt to enter the market.
2. AstraZeneca holds patents on the formulation and method of preparation for Prilosec® and its key ingredient omeprazole. The company recently filed for and was issued several new patents relating to the key ingredient. New patents for the
product are an attempt to extend the monopoly position on Prilosec®.
3. AstraZeneca has built a patent portfolio of numerous patents that claim various portions of the Prilosec® product. A portfolio of patents for an innovation
makes it difficult for competitors to enter the market, especially if the
portfolio is built over time.
4. AstraZeneca has already defended some of its Prilosec® patent claims in court. Successful patent defense can be an indicator of strong patent writing and/or
substantive innovation.
It remains to be seen if AstraZeneca will adequately defend its patent position to maintain a monopoly on the formulation and method of preparation of Prilosec®. This uncertainty is all the more reason to for the AstraZeneca investor to consider the company’s overall patent position the potential impact on the company’s bottom line. Conclusion

For the knowledge economy to flourish, patents must be a bankable currency. Having a
patent must mean more than a plaque on the wall. The market impact diminished confidence in licensing revenue will strike at the core of many of today's strongest market makers and is likely to have significant downstream litigation surrounding law firms and securities firms who failed to conduct a thorough review of the IP held by companies taken public. In truth, however, the buck doesn't stop with them. While bearing some responsibility, a greater burden is borne by the USPTO who has failed to provide examiners with the tools and the training to adequately conduct application reviews and by a selective minority of patent prosecutors whose profit motives have supplanted the professional duty to only advance true inventions for patent consideration. Reliance on intellectual property, particularly patents, is pronounced in several New Economy sectors, such as biotechnology, telecommunications, and semiconductor design. Investing in these companies requires careful consideration of the company’s patent position and the patent position of its competitors. Investors should be aware of the important dangers facing companies with a large percentage of their revenue based on their intellectual property’s licensing and/or royalty payments. Some of the pitfalls include: • Infringement litigation that results in large settlements, • High legal fees that impact a company’s earnings, and • Un-cited prior art that may limit a patent’s breadth. Alternatively, there are several points to consider that may indicate a strong patent position for an IP company. Some of these include: • Holding the seminal patent or patents in a technology, • Building a patent portfolio around a technology by obtaining related patents, making strategic acquisitions, and/or arranging licensing deals, and • Defending one’s patent claims in court. The information in this report was prepared by M•CAM, Inc. (“M•CAM”). M•CAM has used reasonable efforts in collecting, preparing and providing quality information and material, but does not warrant or guarantee the accuracy, completeness, adequacy or currency of the information contained in this report. Users of the information do so at their own risk and should independently corroborate said information prior to any use of it. M•CAM is not responsible for the results of any defects that may be found to exist in this material, or any lost profits or other consequential damages that may result from such defects. The information contained in this report is not to be construed as advice and should not be confused as any sort of advice. M•CAM does not undertake to advise the recipient or any other reader of this report of changes in its opinions or information. This information is provided “as is.” M•CAM or its employees have or may have a long or short position or holding in the securities, options on securities, or other related investments of companies mentioned herein. This report is based on information available to the public.

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