On Wednesday, the Federal Trade Commission (FTC) announced the most important resolution of a standards-related enforcement action since Rambus, and possibly since its landmark settlement with Dell Computer in 1995.  At issue was whether a licensing promise made by a patent-owning participant in a standards development process is binding upon someone that later owns the same patent.  In a split 3 – 2 decision, the FTC has ruled that it does, when the later owner exploits the “lock in” of the marketplace by dramatically increasing the cost to license the patent in question.

The decision is significant for a number of reasons.  First, the marketplace has long worried over whether such promises can be relied upon in the long term.  Second, the sole business of the defendant in the action, Negotiated Data Solutions (N-Data), is licensing patents – in other words, a “troll,” in market parlance.  Trolls are viewed by vendors and end users alike as a pernicious and increasing threat.

Next, the reliance upon promises made with respect to patents is of concern not only in the standard setting context, but with respect to open source software as well.  The details of the settlement will provide significant guidance as to how the regulators would view similar conduct in an open source setting.  Moreover, in the case of N-Data, the FTC has acted aggressively while acknowledging that the actions at issue might not rise to the level of violating relevant antitrust laws.  In doing so, the Commissioners provide strong assurance to participants in standard setting that the FTC recognizes the importance of standards in the modern world.  Finally, the details of the actual settlement demonstrate a willingness on the part of the FTC to craft a detailed and savvy set of requirements that addresses the realities of actual licensor-licensee conduct in the marketplace.  

The decision is dramatic for two additional reasons:  unlike the FTC’s prosecution of Rambus (which took several years to run its course), the existence of the complaint and the terms of the settlement in the N-Data were revealed simultaneously, making the impact of the decision greater by the element of surprise.  That surprise is a welcome one, because the patents in question relate to the Ethernet standard, which is implemented in millions of computers world wide.

What happened:  The basic facts of the conduct in question are as follows:  in 1994, National Semiconductor participated in the activities of the IEEE working group that was creating a new 100 Mpbs “Fast Ethernet” standard which would  replace the original 10Mbps Ethernet 802.3 standard.  In order to ensure that devices built to the new standard would be able to interoperate with older and later equipment, it was decided to include an “autonegotiation” feature, that would permit (for example) devices implementing the old Ethernet standard to identify themselves to equipment built to the new specification, not unlike the way in which fax machines from different manufacturers “negotiate” a connection at the beginning of the transmission call.

There were several ways in which the autonegotiation could be accomplished, and the working group selected a process called “NWay” proposed by National, based in part on National’s promise to make two patents pending available.  National chose to commit to make those patents available to implementers for a flat, one time payment of $1,000, rather than simply making the usual vague RAND promise (i.e., to license on “reasonable and non-discriminatory” terms).

In July of 1995, the new Ethernet standard duly issued, and rapidly became successful.  and in 1997, the US Patent and Trademark Office (USPTO) granted the two underlying autonegotiation patents; National secured other patents abroad as well.  The following year, National assigned the two patents to a new startup called Vertical Networks, which had been launched by several of its employees.  The patents were transferred under an agreement under which Vertical acknowledged that the patents were encumbered by, and that Vertical was accepting them “subject to,” National’s promise to IEEE.

All was well until March of 2002, when Vertical decided to gain greater income from its patent portfolio.  It sought to repudiate the National promise by sending a letter to IEEE, in which it made a new RAND promise, which it said would now “supersede” the original undertaking.  It then proceeded to target specific users of Fast Ethernet, demanding far higher payments.  Some agreed to pay, while others did not.  Vertical took some of those that refused to pay to court.

In 2003, the patents were transferred once again – this time to N-Data, a company formed by Vertical’s General Counsel, who was naturally aware of all of the facts relating to the history of the patents.  N-Data, in the words of the FTC’s announcement, was a company “whose sole activity is to collect royalties in connection with a number of patents” – in other words, a troll.  One or more vendors that were contacted by N-Data and aware of the prior National  promise presumably complained to the FTC, which opened an investigation that culminated with the settlement announced two days ago. 

The proposed settlement:  Under the terms of the settlement, N-Data is not required to admit guilt, but is required to offer licenses (in a form agreed to by the FTC, and attached as an exhibit to the Consent Decree) to all implementers at the original $1,000 price.  If N-Data approaches a vendor that does not have a license, it must hold that offer open for 120 days.  The FTC Commissioners are aware, however, that many vendors receive similar demands on an almost daily basis from third parties claiming to own patents that are being infringed, and commonly ignore those demands until a threat of actual suit is made.

The Commissioners addressed this possibility in a creative and market-savvy fashion, as explained in an analysis document that the FTC simultaneously released to aid the public in commenting on the appropriateness of the settlement and its terms (the settlement will not be finalized until the end of thirty day period that will allow anyone to submit such comments):

…if an offeree has failed to accept such an offer within 120 days, the Proposed Consent Order allows N-Data to sue to enforce the Relevant Patents. At the time N-Data files suit, however, it must make a second offer. This second offer provides a prospective licensee with an opportunity to accept the patent license specified by the order in return for a payment of  thirty-five thousand dollars ($35,000). The requirement that the second offer be delivered in the context of litigation gives N-Data an incentive to pursue patent enforcement only against companies over which it has a reasonable likelihood of prevailing in court. It will also ensure that the second offer will receive the full attention of knowledgeable counsel for the offeree. A $35,000 license fee will offset some of N-Data’s costs of litigation, and it will discourage recipients of an initial offer from simply waiting to be sued, and then accepting the first offer. The offeree’s time to accept the second offer expires with the time to file a responsive pleading to the filing that accompanies the second offer. After that, the amount that N-Data can collect from an accused infringer is not limited by the order.

In concluding that it had the right to sanction N-Data, the majority of the FTC Commissioners took advantage of the unique ability of that agency to address conduct that endangers consumers, even if that conduct does not rise to the level of a clear violation of existing law.  It may only do so, however, if it finds the necessary preconditions that have been established through prior case law, which include consideration of the knowing nature of the conduct, the impact on the marketplace, whether or not there are available alternatives to those affected to avoid being harmed, and similar factors.  In this case, the majority found ample justification to sanction the conduct in question, noting:

Vertical and N-Data sought to exploit the fact that NWay had been incorporated into the 802.3 standard, and had been adopted by the industry for a number of years, by reneging on a known commitment made by their predecessor in interest. Even if their actions do not constitute a violation of the Sherman Act, they threatened to raise prices for an entire industry and to subvert the IEEE decisional process in a manner that could cast doubt on the viability of developing standards at the IEEE and elsewhere. The threatened or actual effects of N-Data’s conduct have been to increase the cost of practicing the IEEE standards, and potentially to reduce output of products incorporating the standards. N-Data’s conduct also threatens to reduce the incentive for firms to participate in IEEE and in other standard-setting activities, and to rely on standards established by standard-setting organizations.

The analysis later concludes that such conduct, where no alternative way to implement without infringement was available, constitutes the type of “patent hold-up” that is “is inherently ‘coercive’ and ‘oppressive’ with respect to firms that are, as a practical matter, locked into a standard.”

The general language used as well as the details provided in the Commissioners’ Analysis auger well for future situations involving abuse of the standards process, as the FTC acknowledges concern over the harm that can arise from:

…the possibility of opportunistic lawsuits or threats arising from the incorporation of patented technologies into the standard after a commitment by the patent holder.  As a result, firms may be less likely to rely on standards, even standards that already exist. In the creation of new standards, standard-setting organizations may seek to avoid intellectual property entirely, potentially reducing the technical merit of those standards as well as their ultimate value to consumers.

For those interested, the same document provides a detailed explanation of how its decision is justified under the specific terms of the various antitrust laws at issue, and the case law that it uses to justify its conclusions.

As earlier noted, however, the Commissioners did split on the decision, with the majority finding it appropriate for the FTC to act, notwithstanding its finding that the conduct in question did not violate statutory law, and the minority (including the Chairman of the FTC, Deborah Platt Majoras) concluding the opposite.  A statement by the majority can be found here, which closes by acknowledging:

We recognize that some may criticize the Commission for broadly (but appropriately) applying our unfairness authority to stop the conduct alleged in this Complaint. But the cost of ignoring this particularly pernicious problem is too high. Using our statutory authority to its fullest extent is not only consistent with the Commission’s obligations, but also essential to preserving a free and dynamic marketplace.

The Dissenting Statements of Chairman Majoras and Commissioner Kovacic can be found here and here, respectively.

Impact and what happens next:  The FTC’s announcement provides splendid news for those that believe in open standards.  By revealing how the regulators would view a patent transferee’s obligations under a transferor’s promise to license, the FTC has provided reassurance on a key issue.  In a larger sense, the announcement provides another ringing endorsement of the importance of standard setting and of the FTC’s willingness to support the integrity of the standard setting process.

Moreover, the various documents released (the announcement, FTC majority statement, analysis, and the two dissenting statements) provide a detailed current snapshot of the Commissioner’s views upon standard setting abuses. 

This will provide helpful guidance on how the Commissioners would analyze, for example, a situation where a vendor reneges on a “non-assertion” pledge relating to open source software.

It will be interesting to see what comments are offered during the public response period, and it is likely that there will be many, both in support as well as taking issue with the FTC’s decision.  Anyone who believes that the Commissioners have made the right decision should consider making their support known to them (as I intend to do).  The address to send your comments to is:

FTC, Office of the Secretary, 600 Pennsylvania Ave., N.W., Washington, DC 20580.  

For further blog entries on Intellectual Propery Rights issues, click here

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FTC Challenges Patent Holder’s Refusal to Meet Commitment to License Patents Covering ‘Ethernet’ Standard Used in Virtually All Personal Computers in U.S.

The Federal Trade Commission today announced a complaint and settlement with Negotiated Data Solutions LLC (N-Data), which allegedly violated federal law by engaging in unfair methods of competition and unfair acts or practices regarding its enforcement of certain patents against makers of equipment employing Ethernet, a computer networking standard used in nearly every computer sold in the U.S. The settlement will protect consumers from higher prices and ensure competition by preventing the company from charging higher royalties for the technologies used in the standard. The Commission found N-Data liable for its conduct under Section 5 of the FTC Act, alone, without a concurrent determination that the conduct rose to the level of a Sherman Act violation. The vote was 3-2 with Commissioners Pamela Jones Harbour, Jon Leibowitz, and J. Thomas Rosch in the majority and Chairman Deborah Platt Majoras and Commissioner William E. Kovacic dissenting and issuing separate statements.

According to the majority, “We recognize that some may criticize the Commission for broadly (but appropriately) applying our unfairness authority to stop the conduct alleged in this Complaint.” But the FTC’s authority to stop anticompetitive conduct that does not rise to the level of a Sherman Act violation is unique among federal agencies – and “the cost of ignoring this particularly pernicious problem is too high. Using our statutory authority to its fullest extent is not only consistent with the Commission’s obligations, but also essential to preserving a free and dynamic marketplace.”

Chairman Majoras disagreed with the majority’s determination of liability, stating that “[t]his case departs materially from the prior line [of FTC standard-setting ‘hold-up’ challenges], in that there is no allegation that [the patent holder] engaged in improper or exclusionary conduct to induce IEEE [Institute of Electrical and Electronics Engineers] to specify its NWay technology” into the relevant standard. “The majority has not identified a meaningful limiting principle that indicates when an action – taken in the standard-setting context or otherwise – will be considered an ‘unfair method of competition,’” she said, adding also, “The novel use of our consumer protection authority to protect large corporate members of a standard-setting organization is insupportable.”

N-Data, based in Chicago, is engaged in the business of licensing patents that it has acquired from inventors or other holders of patents. The patents involved in this matter were originally held by National Semiconductor Corporation (National). According to the FTC’s complaint, in 1994 National made a commitment to an electronics industry standard setting organization, the IEEE, that if the IEEE adopted a standard based on National’s patented NWay technology, National would offer to license the technology, for a one-time, paid-up royalty of $1,000 per licensee, to manufacturers and sellers of products that use the IEEE standard.

NWay technology enables two devices at opposite ends of a local area network (LAN) link to exchange information and automatically configure themselves to optimize their communication. This process is sometimes referred to as “autonegotiation.” Standardizing on a single autonegotiation technology allowed devices made by different manufacturers to work with one another and with different generations of Ethernet equipment.

As alleged in the complaint, N-Data obtained the patents knowing about National’s prior commitment and after the industry became committed to the standard, but N-Data has refused to comply with that commitment and instead has demanded royalties far in excess of that commitment. The complaint alleges that because N-Data began demanding royalties after it became expensive and difficult for the industry to switch to another standard, N-Data was able to demand higher royalties than the industry otherwise would have paid for the technologies. The complaint also alleges that consumers would be harmed because of N-Data’s conduct for a number of reasons, including that firms would be less likely to assist in the development of industry standards, and that many firms would be unwilling to rely on such standards even if they were developed. In addition, the complaint alleges that consumers would be forced to pay higher prices because of N-Data’s conduct.

N-Data has settled the charges and will be placed under an order prohibiting it from enforcing the patents unless it has first offered the patent license attached to the order, which is based on the terms offered in 1994, before the patented technology was incorporated into the Ethernet standard.

The Commission vote to issue the complaint and accept the consent order and to place a copy on the public record was 3-2, with Commissioners Harbour, Leibowitz, and Rosch voting yes and issuing a majority statement, and Chairman Majoras and Commissioner Kovacic voting no and issuing separate dissenting statements. The order will be subject to public comment for 30 days, until February 22, 2008, after which the Commission will decide whether to make it final. Comments should be sent to: FTC, Office of the Secretary, 600 Pennsylvania Ave., N.W., Washington, DC 20580.

NOTE: The Commission issues a complaint when it has “reason to believe” that the law has been or is being violated, and it appears to the Commission that a proceeding is in the public interest. The complaint is not a finding or ruling that the defendant has actually violated the law. The stipulated order is for settlement purposes only and does not constitute an admission by the defendant of a law violation. A consent agreement is for settlement purposes only and does not constitute an admission of a law violation. When the Commission issues a consent order on
a final basis, it carries the force of law with respect to future actions. Each violation of such an order may result in a civil penalty of $11,000.

Copies of the complaint, consent agreement, and an analysis of the agreement to aid in public comment are available from the FTC’s Web site at http://www.ftc.gov and also from the FTC’s Consumer Response Center, Room 130, 600 Pennsylvania Avenue, N.W.,
Washington, D.C. 20580. The FTC’s Bureau of Competition works with the Bureau of Economics to investigate alleged anticompetitive business practices and, when appropriate, recommends that the Commission take law enforcement action. To inform the Bureau about particular business practices, call 202-326-3300, send an e-mail to antitrust@ftc.gov, or write to the Office of Policy and Coordination, Room 394, Bureau of Competition, Federal Trade Commission, 600 Pennsylvania Ave, N.W., Washington, DC 20580. To learn more about the Bureau of Competition, read “Competition Counts” at http://www.ftc.gov/competitioncounts.

MEDIA CONTACT:

Frank Dorman
Office of Public Affairs
202-326-2674

STAFF CONTACT:

Kent E. Cox
Bureau of Competition
202-326-2058

 

The original FTC Complaint can be found here.