Patent Profiteers

A patent, any good patent attorney will tell you, isn't a right to do something, it's a right to keep others from doing it. If your invention is a good one, they'll pay you for the privilege of using it for the patent's 20-year life. If they don't license your patent voluntarily but apply its innovation anyway, you have two choices: back off, or sue for infringement. Which way you go depends largely on how much money you've got-if you decide to go the legalistic route, you'd better have a couple of million dollars to start you on your way.

Captain Carl Elam was an inventor with more good ideas than money. Back in 1983, repelled by what kids could watch on TV, he and another U.S. Air Force officer, Dale Leavy, designed a system that would let parents block certain types of programs. Eighteen years later, the V-chip, as such a system would come to be called, hit it big when the U.S. Congress ordered that all new televisions include content-filtering technology. By then, though, out of money, the two inventors had sold their patent. They ended up with a quarter of the fees that TV manufacturers eventually paid for licenses. Raking in most of the V-chip dough was a small band of venture capitalists at a California company called Acacia Technologies Group.

For Acacia, it was just the beginning. Today, the company has an expanded portfolio of patents, the technical and business savvy to spot other valuable patents, and a small but tenacious legal staff. Most important, it has a war chest big enough to finance legal adventures that just might have as big an impact on patent law as on the future course of a host of Internet-related technologies. And it's looking for new prospects all the time.

From the V-chip, whose key patent expired last year, Acacia has moved on to the potentially much more lucrative world of streaming media, the basic technology by which sound and video is delivered to personal computers or digital televisions via the Internet or a cable box. Acacia claims to own patents that cover virtually every aspect of transferring digitally encoded media from a server to a customer. A few examples: the downloading of songs to computers and MP3 players such as Apple's iPod, the streaming of video to a PC, the digital distribution of motion pictures to hotel rooms, even the use of a TiVo digital video recorder.

If Acacia's patents are valid and as broad as Acacia thinks they are, thousands of companies-including titans like Time Warner, Disney, Microsoft, and Sony-and maybe even hundreds of millions of users will have to pay Acacia directly or indirectly. Cable, satellite, and Internet service providers, video-on-demand companies, music sites, the new Web radio enterprises, pornographers-almost anyone delivering digital video or audio across a network will be liable.

"The breadth of their claims is stunning," says one patent attorney who has followed the Acacia case closely, Bruce D. Sunstein, of Bromberg and Sunstein LLP, in Boston. "If you look at the potential targets, they include software providers like Microsoft, RealNetworks, and others, at least for contributory infringement, and possibly every cable provider and satellite provider, too. I suppose I'm a contributory infringer if I download some media content and look at it."

As a first step in testing its claims, Acacia is now pursuing a suit in the U.S. Central District Court of California against 17 small companies, all but one of them gritty little providers of what is politely called adult entertainment. These defendants eke out a living in part by streaming pornography over the Internet; none has annual revenues of more than US $1 million. Hearings began last fall, and a jury trial could start early next year.

In all likelihood, the trial will determine whether Acacia can make the jump from being an annoyance to small-time pornographers and a few other niche industries to being a force to be reckoned with in the online world. Certainly, a finding in Acacia's favor will herald the arrival of a new kind of player: a company that controls technology but doesn't create it; a firm that buys patents but that patents nothing. From its roots in venture capitalism, Acacia has morphed into something that has no real peer.

Headquartered In A Posh Shopping and office complex in upscale Newport Beach, Calif., Acacia-with a staff of 3 engineers, 3 lawyers, a vice president in charge of patent acquisitions, and 13 others-plots the alchemy that turns patent claims into gold. The engineers don't develop or build things; they evaluate patents. The lawyers don't write patents; they think about licenses and lawsuits. By its own account, Acacia is the only publicly traded company in the world that does nothing but acquire and license patents, and sue other companies over the patents it acquires and licenses.

The company had 2003 revenues of just $692 000, all from the streaming media patents. (Though the V-chip patent didn't expire until midyear, its license fees were all taken in 2001.) With more and more licensees signing up, Acacia couldn't say how much it would take in for 2004. But by February, its licenses in hand were worth $2 million per year. It was only in late 2002 that Acacia began sending out glossy folders to possible infringers, with polite letters asking them to take out licenses.

Thousands of folders have been sent so far. The biggest company to acknowledge getting one is just down the road in Burbank: the mighty, albeit beleaguered, Walt Disney Co. media empire, whose diverse activities include ESPN.com and ABCnews.com. Some recipients ignore the letter, some refuse; the 17 defendants in the current suit are among the latter. But 118 companies, at last count, have agreed to take out licenses-including Disney, two large hotel video-on-demand movie enterprises, several Internet radio stations, a distance-learning service, the publishers of Playboy and Hustler magazines, and dozens of pornographers. Reportedly, many, but not all, pay relatively modest rates-between 1 and 3 percent of some or all of their gross revenues. The hotel movie services are paying a small amount per hotel room.

According to executive vice president and general counsel Robert Berman, even without a dollar in new income, its existing $2 million annual revenue from licenses, along with its V-chip royalties and other money it has in the bank, can keep Acacia Technologies going for five or more years at its current level of expenses. Its parent company, Acacia Research Corp., with which it shares a headquarters, had $50 million in cash at the end of 2003.

The parent company was formed in 1992 when R. Bruce Stewart, a longtime venture capitalist, got tired of "putting money into technology companies and watching them squander it." So, he says, "I decided to control things myself." Stewart quickly took the company public to raise additional funds.

By the mid-1990s, Acacia Research was funding companies involved in chip design, biotechnology, and the developing dot-com arena. One of those investments was in a Greenwich, Conn., company, Soundview Technologies Inc., which by then had acquired, among other technologies, the V-chip patent from Elam and Leavy, the Air Force officers. The patent was worthless until Congress passed the Telecommunications Act of 1996. One of the more minor provisions of this huge package of regulatory reforms required that TV sets sold in the United States be capable, within four years, of screening programming by content.

TV manufacturers scrambled for a way to satisfy the law. Suddenly, Soundview's patent looked pretty good, especially after the company sent letters extolling it to all the TV makers. Six months after Acacia initiated a lawsuit, Royal Philips Electronics NV, of Amsterdam, Netherlands, broke ranks and took out a license in late 2000. Almost all the others soon followed. Soon thereafter, Acacia, which had been keeping Soundview afloat for years, bought the whole company. The patent's 20-year life expired in February 2003, but in three years' time, Acacia earned $25.6 million in royalties. At least half that money went to the litigation and to Elam and Leavy, who saw almost 25 percent of it. (Rob Berman remembers the two inventors buying new cars with their first royalty payments.)

In December 2002, as the dust settled from the dot-com implosion, Acacia Research found itself with two still-viable enterprises that were utterly dissimilar: Acacia Technologies and CombiMatrix Group, a maker of biochips to test DNA for disease or unknown substances. (CombiMatrix, in Mukilteo, Wash., is actually the larger of the two, with about 60 employees; unlike Acacia Technologies, it actually develops technology.) To avoid confusing investors, Acacia Research split its own stock listing into a pair of stocks, one for each subsidiary.

From The Start, Acacia Technologies has been an anomaly. There are plenty of other companies that don't manufacture anything based on their patents but license them instead-think Qualcomm, whose cellular telephony technologies can be found in hundreds of millions of cellphones, none of which the San Diego-based company manufactures. Then, too, there's the billion-dollar estate of inventor Jerome H. Lemelson, which exists only to enforce patents that Lemelson himself was awarded and which has thrown its weight around in patent courts for at least 20 years.

But unlike those companies, Acacia is interested in patents for technologies it did not invent or develop but which may have a future. And unlike virtually everybody else in this game, Acacia seeks to own patents outright, in contrast to the countless patent firms that exist to press other people's broad patent claims and to try to squeeze licenses out of putative infringers.

Such companies usually offer patent holders their expertise, and a few even make loans to keep them afloat. Perhaps the oldest and most successful of these is General Patent Corp., Suffern, N.Y. Founder and president Alexander Poltorak says his 15-year-old "full-service intellectual property management company" analyzes patents and assesses their value. A patent's value, Poltorak explains, is its ability to bulwark legal claims leveled against companies that are making money with a product or service that might be infringing. Like Acacia, General Patent then negotiates licenses or, if necessary, initiates lawsuits. Unlike Acacia, though, General Patent doesn't want to own or be assigned an inventor's patent; it's happy to provide services and collect fees, even a share of a litigation award. "The difference between the two companies is, we are not speculating on the patents," Poltorak says.

"No two companies are likely to stream video in the exact same way."-Spike Goldberg, Homegrownvideo.com

For Acacia Technologies, on the other hand, speculation is the heart of the game. When the V-chip patent expired last year, the company was left with only one active group of five patents, all covering the technology of rapidly conveying multimedia data to computers. To Acacia, these are the intellectual-property equivalent of the rights to drill the North Sea for oil. Owning them, the company's lawyers insist, gives Acacia a corner on the market for streaming media, the technology that lets computers, PDAs, or even, nowadays, cellphones play digital audio and video files stored on remote servers.

Given the size and scope of the pool of possible infringers, why is Acacia targeting pornographers? General Counsel Berman says the company chose them as the first defendants because the adult entertainment industry was the first to use cutting-edge technologies, like streaming media, to make money on the Internet.

But Lawrence G. Walters, an attorney with a number of pornography clients, is skeptical. "My guess is Acacia saw the adult industry as easy pickings," he says. No client of his firm, Weston, Garrou and DeWitt, in Los Angeles, is a defendant, but several of them are paying for licenses from Acacia. Noting that the defendants were sued separately but quickly formed a single defense group, Walters adds, "If so, it miscalculated. Acacia may not have understood how tight-knit the adult entertainment world is, how quickly they can organize. And they've gotten themselves excellent representation"-Fish and Richardson, a national law firm with a big patent practice.

The lead defendant is Homegrownvideo.com, in Aliso Viejo, Calif., not far from Acacia's headquarters. According to E. Michael ("Spike") Goldberg, who heads the company, its annual revenues are about a million dollars. Goldberg and his employees take pornography videotapes made by amateurs-typically husband-and-wife teams-and encode them for the Internet. A separate company also sells them in video stores and by mail. "Our expenses are a lot less than Acacia's," he says. But Goldberg, who, despite his punk-rock moniker, exudes conventional business respectability, with his short hair, button-down oxford shirt, and pictures of his wife and young son on his desk, also says that pornography isn't the lucrative industry it's often made out to be. "Baby food must have better margins," he complains.

The Patents Hanging Over The Heads of Goldberg and his colleagues defy simple analysis. The inventors H. Lee Browne and Paul Yurt envisioned a system that stored digital content for future viewing-a "Blockbuster replacement," says Rob Berman, referring to the ubiquitous video rental chain. The idea was to let people pick a movie or show from a stored library and move it to "a remote location"-their home computer, a television set-top box, or some other device. Indeed, one precious courtroom day has already been spent embroiled in just what constitutes a remote location-does it have to be merely remote from the video library or remote from the user as well? The answer will go a long way to determining how broad the patent is-and how many companies are swept up by its infringement broom.

While the press has consistently said the lawsuit is a fight over ownership of streaming media, the core patent, No. 5132992, doesn't actually distinguish between streaming and downloading. The difference is more about law than technology-in copyright law, a stream is a music "performance," while a download is a copy. Copies have additional copyright limitations, so most media-playing software makes it impossible for the casual user to permanently store streamed media. Technically, though, the difference is somewhat ephemeral.

When, for example, you want to listen to the latest Norah Jones hit, you can visit a server-a Web site such as Apple's Music Store. When you click on the link to "Feels Like Home," your browser launches a media player, such as Apple's iTunes, which then receives the bits that the server sends, uncompresses them, stores them in a buffer, and starts playing them as soon as the buffer is large enough to smooth over any transmission glitches that might occur. Or the browser grabs the bits and stores them in a local file that the media player can play whenever you want. In the first case, the music has been streamed, because you listen to the data stream more or less while it's being sent. In the second case, the song has been downloaded.

Acacia's key patent for what it calls digital media technology (DMT) see Fig.2], granted in 1991, not only doesn't distinguish between streams and downloads, it is indifferent to the mode of telecommunication. In fact, it doesn't even mention the nascent Internet of the early 1990s, instead describing a system "wherein the transceiver means receives the information via any one of telephone, ISDN, broadband ISDN, satellite, common carrier, computer channels, cable television systems, metropolitan area networks, and microwave." (Using the term "transceiver means" instead of simply "transceiver" is typical patent-speak.)

The heart of the patent is that it takes diverse pieces of technology and puts them together in a way that Acacia claims was new at the time. It starts with a library for storing media and a unique identification code for retrieving a particular item, like a video. Then it specifies a way to format, order, and compress the item before sending it to a "remote location." In its scores of claim statements and dozen process diagrams, the patent also calls for media to be sequenced into "addressable blocks," so that if multiple movies, for example, are contained in one library file, they can be found.

"Companies outsource their intellectual property departments to us-for small companies, it isn't practical to assemble a team of attorneys and engineers." -Paul R. Ryan, Acacia Technologies Group

According to patent attorney Sunstein, the meaning of each of these terms is likely to be hotly disputed. Indeed, the current series of court appearances, known as Markman hearings, are devoted to these semantic questions. "If you're the patent holder, you want a broad interpretation of these terms, so it's easier to claim infringement. The defense wants a narrow interpretation. If they lose, though, the defense can turn around and take advantage of the broad interpretation of the terms, because then more preexisting technology might qualify as prior art," invalidating the patent after all.

Indeed, patents like Acacia's run the risk of being so broad that they aren't "novel, useful, and unobvious"-the three things an idea needs in order to be patentable. In particular, critics have asked whether DMT is novel or whether there isn't-in the wealth of computer networking and cable television technology up to 1991-the "prior art." "The broader the patent, the more potentially vulnerable it is to be attacked as invalid," says Sunstein. "But you have to come up with evidence that's clear and convincing to invalidate a patent. And searching for prior art can be an expensive process."

The easiest way to avoid being hoist on the petard of prior art is to interpret your patents narrowly. But then it becomes harder to catch anyone in the net of infringement. Spike Goldberg of Homegrownvideo.com thinks that's hard to do in the field of digital video anyway. "When you're up late at night figuring out the best way to compress video and encode it so that a media player can play it, it seems like no two companies are likely to stream video in the exact same way."

Can Acacia's patents be both broad and valid? That's for the courts to say. But according to one expert opinion, that of patent research service PatentRatings LLC, they are "very strong."

Last year, PatentRatings was hired by Technology Marketing magazine to evaluate Acacia's DMT patents. The service, which, by coincidence, is located in Acacia's hometown, Newport Beach, uses a regression model and a database of four million patents to rank the relative merits of a patent. CEO Jonathan Barney told IEEE Spectrum, "Acacia's looked very solid-they're in the top 10 percentile, probably in the top 5."

Though The DMT Court Case occupies center stage at Acacia Technologies, the company has also redoubled its search for broad new patents. Basically, the plan is simple: find other patents held by inventors or smaller companies running out of money (or just patience); buy the patents; license them out.

"Companies in effect outsource their intellectual property departments to us," says chairman and CEO Paul R. Ryan. "An IBM or GE can do it themselves, but for small or even midsized companies, it isn't practical to assemble a team of attorneys and engineers to research, write, and file patents; find potential infringers; and ask them for licenses." Indeed, large companies have known for years how lucrative patents are. The most successful is IBM, whose licensing department made over a billion dollars last year. Though that's just a fraction of the company's $89 billion revenue, licensing is a low-expense, high-margin operation. (IBM will license almost any of its technologies and rarely has to go to court.)

So far, Acacia is considering patents that have been referred by investors and lawyers it already has relationships with, such as the venerable San Francisco law firm Townsend and Townsend and Crew LLP. And Acacia gets leads from its existing licensees-including one from an adult entertainment company, for a vibrating device that uses old electrotechnology in a novel way. (After examining the patent, Acacia declined to buy it.)

With its considerable assets from the V-chip and other investments, Acacia is bulking itself up with expertise. It's looking for a fourth engineer to help evaluate new patents it might buy and how they might be infringed. And in February it hired an attorney, Jennifer Hart, as a vice president whose primary responsibility is business development. In Acacia's world, that means reviewing and acquiring intellectual property.

John Roop, Acacia's senior vice president for engineering, says, "We have an almost industrial process of looking at a patent." Roop's three-man team takes the patents the business-development team finds and, he says, "sees if they make sense, whether they describe what the inventor thinks they do."

"We ask ourselves, are the claims too vague or ambiguous?" Roop continues. "Then we look at the granted claims and war-game them. If we were to assert this patent with respect to someone's business and ask them to license the patent, what would the potential licensee say? Do the claims really describe what they're doing?"

Roop's team needs to work in much the same way when Acacia considers whether to ask a company involved in streaming media, such as Hustler or Disney, to license its patents. "We start by going to the potential infringer's Web sites, seeing if they stream media," Roop says. "We need to look at the flow of information, so we might use a protocol analyzer, which is a piece of software that can look at the packets as they go from source-Hustler's Web server, say-to destination, a consumer like you or me."

"Then we look at the software the company is using, or even equipment, like a special camera-we'd look at the specs for it. We look at any hosting operations they're using and see what kind of services they offer. We compare that to the claims in our patents. With Hustler, for example, we determined they were practicing some of the claims"-that is, infringing them. "We met with them, and explained how claims in our patents describe what they do. Then comes the business and licensing discussion."

That "business and licensing discussion" is the whole point of the exercise. Critics charge that companies like Acacia cynically exploit the economics of patent infringement and defense. It can cost millions for a patent holder to press an infringement claim, especially if the putative infringer is large enough to mount a stout defense. On the other hand, the costs of defending oneself can be equally prohibitive for a mom-and-pop business, like many of the adult entertainment defendants in the current Acacia lawsuit.

Walters, the attorney who represents some of those businesses that have settled rather than fight, says, "The sole reason has been to avoid litigation. I don't think any of them have concluded the patents are valid and enforceable. This is a business decision. Patent cases are extremely expensive, some of the most expensive litigation around."

Acacia Is Far From Done Exploiting the key DMT ideas-it has hundreds of new claims pending at the patent office extending those of the existing group of patents. And it has yet to write letters to the cable industry asking for licenses for video-on-demand services. "Cable is more lucrative than the Internet-several times more lucrative," says Berman.

Patenting a key technology isn't easy, and enforcing big patents is harder still. In January, a U.S. federal court invalidated 18 patents held by the Lemelson estate. In March, a patent office reexaminer ruled invalid a major Internet patent, that of Eolas Technologies Inc. of Wheaton, Ill., when it was presented with examples of prior art not considered when the patent was issued. The question of prior art lurks in the background right now for Acacia, as the DMT patent's validity will first be tested in court and perhaps eventually reexamined by the patent office.

Sunstein, the Boston patent attorney, says about Acacia's current litigation, "The claims are very broad, so the uncertainties are as well. There are lots of thrills ahead." But whatever happens in that California courthouse over the next year or so, with millions already in the bank and more and more license fees for the DMT patents rolling in, Acacia already has deep enough pockets to acquire and enforce new patents for years to come. And if the vein of gold it's striking with streaming media proves to be wide enough, Acacia could build a war chest of Midas proportions.