CPIP Supports Guidelines for the Protection of Fundamental IP Rights

Post author By Joshua Grove
Post date February 2, 2015

February 2, 2015

The Center for the Protection of Intellectual Property (CPIP) is proud to join today’s open letter to Congress providing a set of guidelines for considering laws and regulations governing intellectual property.

The letter outlines some of the fundamental economic and moral considerations that underscore the benefits of strong intellectual property rights. Framed by the following guidelines, the letter also highlights the need to respect and protect our intellectual property rights.

Intellectual Property Rights Are Grounded in the Constitution
Intellectual Property Rights Are a Fundamental Property Right Deserving the Same Respect as Physical Property
Intellectual Property Rights Promote Free Speech and Expression
Intellectual Property Rights Are Vital to Economic Competitiveness
Intellectual Property Rights Must Be Protected Internationally Through Effective IP Provisions in Trade Agreements
Intellectual Property Rights Are Integral to Consumer Protection and National Security
Intellectual Property Rights Must Be Respected and Protected on the Internet
Voluntary Initiatives to Address Intellectual Property Theft Are Positive

The letter, signed by 67 scholars, think tanks, advocacy groups, and other experts, concludes by noting that the “Founding Fathers understood that by protecting the proprietary rights of artists, authors, entrepreneurs, innovators, and inventors, they were promoting the greater public welfare. The continued protection of these fundamental rights is essential to American innovation and competitiveness.”

Read the letter in its entirety here

Antitrust Commercialization DOJ FTC High Tech Industry Injunctions Innovation Intellectual Property Theory International Law Patent Law Patent Licensing Patent Theory Reasonable Royalty Remedies Software Patent Uncategorized

Curbing the Abuses of China’s Anti-Monopoly Law: An Indictment and Reform Agenda

Post author By Joshua Grove
Post date December 1, 2014

The following is taken from a CPIP policy brief by Professor Richard A. Epstein. A PDF of the full policy brief is available here.

Curbing the Abuses of China’s Anti-Monopoly Law:
An Indictment and Reform Agenda

Executive Summary

There are increasing complaints in both the European Union and the United States about a systematic bias in China’s enforcement of its Anti-Monopoly Law (AML). In an extensive report on China’s abuse of its antitrust laws in advancing its own domestic economic policies, for instance, the U.S. Chamber of Commerce noted among many examples a recent action against Microsoft in which Chinese antitrust authorities used a “speculative possibility of licensor hold-up” following Microsoft’s acquisition of Nokia to justify a decree under the AML to “cap license fees for domestic licensees of mobile handset-related software.”

Although the biases in the enforcement of the AML against foreign companies are rooted in systemic problems in China’s political and legal institutions, the abuses are particularly evident in the patent space. FTC Commissioner Joshua Wright has recognized the “growing concern about some antitrust regimes around the world using antitrust laws to further nationalistic goals at the expense of [intellectual property rights] holders, among others.” He specifically mentioned China as one such antitrust regime that may be finding encouragement or at least rationalization in recent FTC and DOJ actions that presume that “special rules for IP are desirable . . . and that business arrangements involving IP rights may be safely presumed to be anticompetitive without rigorous economic analysis and proof of competitive harm.”

This same theme has been recently echoed by FTC Commissioner Maureen Ohlhausen, who explained that recent American decisions on standard essential patents (SEP), such as the FTC’s use of its merger review power to enforce settlement agreements on SEPs against Bosch and Google, have “created potentially confusing precedent for foreign enforcers.” This concern was brought home to her when she witnessed Chinese officials invoke these recent FTC actions against Bosch and Google to justify their per se claim under the AML that “an ‘unreasonable’ refusal to grant a license for a standard essential patent to a competitor should constitute monopolization under the essential facilities doctrine.”

Such broad propositions pave the way for Chinese officials to favor domestic, state-run companies who incorporate foreign patented innovation in their own domestic products and services. These unfettered notions of “unreasonable” conduct become weapons that let Chinese officials force down prices of foreign goods to promote their own nationalist economic policies. Unfortunately, as Commissioner Ohlhausen observed just this past September, recent U.S. antitrust enforcement actions are giving Chinese officials grist for their industrial policy mill.

It is critical that American legal authorities do not give aid and comfort to China’s discriminatory treatment of foreign companies under the AML by the way in which American regulators either speak about or take action on SEPs or other issues relating to patented innovation in this country. The antitrust laws should not be applied so as to single out patents or any other intellectual property rights for special treatment; all property deployed in the marketplace should be treated equally under the competition laws.

The unfortunate situation in China is one example of a dangerous set of practices which could spread to other countries, motivated either by imitating what China has done or retaliating against its abuses. The risk is that the disease can spread all too easily. Until reforms are implemented in both the substance of the AML and the enforcement practices of the Chinese authorities, American policymakers and enforcement authorities should do everything they can to avoid aiding this misuse of antitrust as a domestic economic policy cudgel.

Curbing the Abuses of China’s Anti-Monopoly Law:
An Indictment and Reform Agenda

Richard A. Epstein

I. Introduction

There is a loud chorus of complaints from both the European Union and the United States about a systematic bias in China’s enforcement of its Anti-Monopoly Law (AML). This bias is evident in a wide range of economic sectors and companies. The Economist reports that China has imposed extra-heavy antitrust penalties on foreign automobile manufacturers, such as Daimler, including a record $200 million penalty on a group of ten Japanese car-parts firms, and the New York Times reports that China has imposed another $109 million penalty on six companies selling infant milk formula. China has also initiated antitrust enforcement actions against American high-tech companies, such as Microsoft and Qualcomm, and there is an ongoing Chinese probe of Qualcomm (a firm for which I have consulted unrelated issues), which is said to be done with an effort to force a reduction in the prices that it charges for its advanced wireless technology, which China needs to implement a new 4G system for mobile phones. Similarly, in a wide-ranging report on China’s abuse of the AML to advance domestic industrial policy, the U.S. Chamber of Commerce noted many examples, including a recent action against Microsoft in which Chinese antitrust authorities used its acquisition of Nokia as a basis for a completely “speculative possibility of licensor hold-up” to justify a decree to “cap license fees for domestic licensees of mobile handset-related software.” It is no wonder that many commentators are repeatedly stressing the distinctive foreign focus of China’s recent antitrust activities.

Chinese public officials insist that their stepped-up enforcement of the AML is even-handed. “Everyone is equal before the law,” asserted Li Pumin, the head of the National Development and Reform Commission, which takes the lead in investigating foreign firms. But others in China disagree. More market-oriented Chinese writers have lamented how China’s commitment to market processes has reversed course since the adoption of the AML law, as China is now using this law as an industrial policy cudgel in promoting its own domestic firms at the expense of foreign ones. Its recent behavior, which provoked expressions of concern from American antitrust officials at both the Federal Trade Commission and the Department of Justice, suggests that this is indeed the case.

II. The Chinese Anti-Monopoly Law

The current situation is an unwelcome reversal of the initial optimism that surrounded the adoption of the AML in 2008, and so a quick overview of the AML’s provisions is necessary. Hailed at the time as “a tremendous leap forward for China,” the law adopts, at least in the abstract, many of the standard categories of antitrust analysis found in the United States and in the European Union. In Article 3, it contains the standard prohibitions against horizontal arrangements that raise prices, reduce output, or divide territories, subject to an exemption under Article 15 for agreements that improve technical standards or upgrade consumer products. The AML also bans “abuse of dominant market positions by business operators,” which under Article 17 includes setting prices in “selling commodities at unfairly high prices or buying commodities at unfairly low prices;” or in selling goods at below costs, refusals to deal, and tie-in arrangements, all “without any justifiable cause.”[i]

In many ways what is most notable about the AML is the extent to which it imitates the major features, both good and bad, of the more developed competition law applied in the United States and the European Union. But by the same token, it is quite clear that the Chinese law is embedded in a different set of institutional arrangements. Two elements stand out.

First, the AML reflects the unique Chinese approach to “market socialism” that was first implemented by Deng Xiaoping’s reform policies in the late 1970s as “socialism with Chinese characteristics.” Article 4 of the AML thus attempts to square the circle: “The State constitutes and carries out competition rules which accord with the socialist market economy, perfects macro-control, and advances a unified, open, competitive and orderly market system.”

Second, the socialist legacy reflected in Article 4 has resulted in an extensive system of state-owned industries in China, and Article 7 of the AML provides special controls, exemptions and protections for this sector of the Chinese economy:

Industries controlled by the State-owned economy and concerning the lifeline of national economy and national security or the industries implementing exclusive operation and sales according to law, the state protects the lawful business operations conducted by the business operators therein. The state also lawfully regulates and controls their business operations and the prices of their commodities and services so as to safeguard the interests of consumers and promote technical progresses.

The scope of Article 7 offers instructive clues toward understanding the current situation. Its text refers to entire “industries,” not just individual firms, that are given special treatment under the AML. It still speaks in terms of constraining the ability of “industries” to engage in any abusive practices, which at least in principle serve as the basis for competition-focused anti-monopoly law.

Unfortunately, the odds of it remaining focused in this constructive way are necessarily reduced because of its dual operation with respect to both state-owned enterprises (SOEs) and foreign corporations. The SOEs have a built-in preferential position that can manifest itself in two ways. Either they can get gentle slaps on the wrist for offenses that prompt far harsher sanctions against private companies, especially foreign companies who are either suppliers or competitors with SOEs, or the SOEs could prod Chinese anti-monopoly enforcement authorities to take action against their foreign competitors. The AML can all too easily function as a new form of protectionism by virtue of its differential application to foreign firms vis-à-vis SOEs doing business in China.

The difficulties here are increased, moreover, by the structural decision to parcel out enforcement of the AML to several agencies. The National Development and Reform Commission has the lead with respect to enforcement over monopoly agreements. The State Administration of Industry and Commerce deals with abuses of dominant position. The division of enforcement authority between these agencies makes it much harder to impose uniform standards on the overall operation of the system. This split in enforcement authority increases the risks of differential enforcement and, more worrisome, the misuse or discriminatory use of the AML.

Therefore, it is evident that no evaluation of the operation of the Chinese anti-monopoly system can be made solely on the basis of the statutory terms in the AML itself. So much depends on the oft-concealed enforcement practices of the relevant public authorities, who are given very broad powers of inspection and investigation under AML Article 39, which empowers the AML enforcers to run investigations “by getting into the business premises of business operators under investigation or by getting into any other relevant place,” or by forcing them to respond to interrogatories “to explain the relevant conditions” to the public authorities.” Chinese officials also have the power to examine or duplicate all business papers and to seize and retain relevant evidence, and to examine bank records and accounts. The only procedural protection contained in Article 39, if it can be called that, is that a “written report shall be submitted to the chief person(s)-in-charge of the anti-monopoly authority” before the investigation is approved. What kind of report and how it is to be reviewed are not stated, even though these substantive and procedural issues are subjects of volumes of statutory, regulatory and decisional law on administrative procedure in the United States and Europe. Even more significant, there is no mention anywhere in the AML of any probable cause or warrant requirement that must be demonstrated before any independent judicial body.

III. Rule of Law

At the root of the many complaints about the Chinese approach to competition law is the constant concern that its antitrust enforcement practices are inconsistent with the rule of law. Its legal system invites arbitrary and differential enforcement of anti-monopoly standards. In dealing with these rule of law issues, it is incumbent to note that they address a critical mix of concerns about both substantive standards and administrative enforcement.

As a general rule of thumb, the more precise the particular rules of conduct that receive government enforcement, the better the prospects to avoid both rule of law violations and the general perception of such government violations. In this regard, it is worth noting that the ordinary rules of property, contract and tort score very well under this general standard. As I have argued in my book Design For Liberty: Private Property, Public Administration and the Rule of Law, these common law rules have several key structural features that facilitate rule of law values.

First, the basic norm with respect to private property is that all other persons need only follow the basic norm “keep off” to comply with the system. The simplicity of this command means that anyone can follow it regardless of the size of the polity in which this rule operates. The same command works as well in China with 1.4 billion people as it does in New Zealand with a population just under 4.5 million people.

Second, the content of this simple rule is easily known and understood, so that no one need give special notice of what it requires to the many people who are bound by it. It is no small deal to have a rule that is not promulgated by statute, which is thereafter interpreted by dense pages of administrative text to which the public has only imperfect knowledge, and which both small and large businesses are able to interpret and apply only with the aid of professional intermediaries such as trade associations and law firms.

Third, the simple rule in question works as well in poor countries as in rich ones, so that there is no awkward transition in rules with increasing development over time. At this point, the property rules are complemented by the contract rules that allow people within broad limits to decide their own agreements for the provision of goods and services, so that in most cases the key function of the state is to enforce the agreement as designed, not to improve upon its terms with flights of legislative or judicial fancy.

The Chinese AML does not, and cannot, exhibit anything like the requisite level of overall clarity. In order to determine whether a horizontal arrangement violates the antitrust law, for example, it is necessary to have some sense as to the scope of the market, and the nature of the agreement, to see whether it is or is not in restraint of trade. It is also necessary to gather evidence about practices that can span both continents and years. The AML’s standards for dealing with abusive practices are even looser; for example, there is no clear metric by which to determine whether prices are unfairly high or unfairly low. Another nagging question is what it means under the AML for goods to be sold at below cost, because it is completely unclear if the metric is average or marginal cost. No matter which is chosen, the difficulties of estimation further the scope for abuse of administrative discretion.

This nagging uncertainty about the basic operating rules prompted the late Ronald H. Coase to quip to me long ago in a conversation only partly in jest: “If prices move up in any market, it is surely the result of monopolization. If they remain constant, it is surely the result of market stabilization arrangements. If they go down, it is surely the result of predation” (quoting from memory). Coase’s quip ruefully reflects the modus operandi of the Chinese AML. Since any and all price movements could be associated with some violation of the AML, it follows that in principle no party, and no group of firms, is immune from investigation and criminal prosecution, regardless of how it conducts its own business. And owing to the vastness of the multinational businesses who are targeted, these investigations can exert a large influence on the behavior of firms and on their key employees who bear the brunt of those investigations, where they are subject to the possibility of criminal sanctions in addition to emotional wear and tear.

IV. The Patent Dimension

The dangers of this system are apparent and easily understood. With respect to accusations of secret horizontal arrangements and price gouging arrangements, the risk comes in the form of extensive and exhaustive investigations that are intended to stifle and not promote competition in the marketplace. In dealing with these issues, it is critical that our American legal authorities do not give aid and comfort to China’s aggressive regulation of foreign businesses enterprise by the way in which American regulators address similar issues in this country. We live today in an intensely global environment, and any actions in the United States that overstate the role of the antitrust laws can easily be used as reasons to expand antitrust application overseas.

The point applies to all areas of law, but has especial importance in connection with patents, given that technology that is available in one country is instantly available in all. After the Supreme Court handed down eBay v. MercExchange in 2006, injunctive relief is no longer presumptively available for patent infringement in the United States. As Professor Scott Kieff, now of the International Trade Commission, and I have written, eBay eased the way for Thailand to impose its regime of compulsory licensing for pharmaceutical patents, at far below market rates.

Evidently, decisions like eBay do not go unnoticed by foreign nations, where they set up a climate in which the weak enforcement of patent rights becomes par for the course. That same development happens most emphatically in the crossover area between patent and antitrust law. In general, the proper application of the antitrust law does not single out patents for special treatment of the antitrust laws. A clear articulation of this principle was recently made by FTC Commissioner Joshua D. Wright in his 2014 Milton Handler Lecture: “Does the FTC Have a New IP Agenda,” which stressed the importance of the “parity principle” that states a central tenet in the Department of Justice/Federal Trade Commission 1995 Antitrust Guidelines for the Licensing of Intellectual Property: “Agencies apply the same general antitrust principles to conduct involving intellectual property that they apply to conduct involving any other form of tangible or intangible property.”

The parity principle is critical to successful antitrust enforcement because it places an important fetter on the arbitrary use of government power, which increases greatly if any government, China included, could use a wide catalogue of novel arguments to justify some deviation from the general rule. Indeed, this parity principle is an extension of what I have termed elsewhere as the “carry over” principle, which means that intellectual property rights in general should be based on the rules that are applicable to other forms of property, subject only to deviations required by the distinctive features of property rights in information, which chiefly relates to their finite duration to allow for the widespread dissemination of information. But once that key adjustment is made, the standard rules for property used elsewhere, including the rules for injunctive relief, should continue to apply.

Yet as Commissioner Wright mentioned, recent FTC and DOJ actions presume that “special rules for IP are desirable . . . and that business arrangements involving IP rights may be safely presumed to be anticompetitive without rigorous economic analysis and proof of competitive harm.” Commissioner Wright has also recognized the “growing concern about some antitrust regimes around the world using antitrust laws to further nationalistic goals at the expense of [intellectual property rights] holders, among others.” He specifically mentioned China as one such antitrust regime that may be finding encouragement or at least rationalization in these recent actions against IP owners by American antitrust agencies.

This same theme has been recently echoed by FTC Commissioner Maureen Ohlhausen, who noted how foreign nations invoke “‘competition fig leaves’ to address other domestic issues or concerns.” More specifically, Commissioner Ohlhausen explained how this tendency has manifested itself in the debate over standard essential patents (SEPS), that is those patents that are incorporated in setting key technical standards that allow for the interoperability of various technical devices. She also noted how recent American decisions on SEPs have “created potentially confusing precedent for foreign enforcers.” That concern was brought home when Chinese officials invoked recent FTC enforcement actions against Bosch and Google SEPs to justify a per se claim under the AML that “an ‘unreasonable’ refusal to grant a license for a standard essential patent to a competitor should constitute monopolization under the essential facilities doctrine.” Such broad propositions pave the way for Chinese officials to favor domestic, state-run companies who incorporate foreign patented innovation in their own domestic products and services. These unfettered notions of “unreasonable” conduct become weapons that let Chinese officials force down prices of foreign goods to promote their own nationalist economic policies. Unfortunately, as Commissioner Ohlhausen observed just this past September, recent U.S. antitrust enforcement actions are giving Chinese officials grist for their industrial policy mill, by insisting that their heavy-handed antitrust action against foreign patent owners “has support in U.S. precedent,” such as the Google and Bosh settlements.

V. Enforcement Abuses

The suppression of patent licensing rates charged to domestic Chinese firms is just one example of how the AML enforcers have a built-in invitation to run massively intrusive and expensive investigations into any firms. These investigations are unhampered by any clear legal definition of relevance and are undertaken without regard to the high costs incurred by firms seeking to comply with the officials’ edicts, both administrative and reputational. In some cases, the charge falls within the yawning gap in the AML concerning limits on its enforcement practices. For example, the European Union Chamber of Commerce has found that China engages in administrative intimidation, which is intended to short-circuit formal hearings, and forces parties charged to appear before tribunal hearings without the assistance of counsel and without involving their own governments or chambers of commerce in the process.

It is of course impossible for any academic sitting in the United States to make any estimation of the actual level of abuse in any one individual case. But the simple point here is that the Chinese authorities are already low on credibility because of the way in which they conduct themselves in so many other areas. It takes no great imagination to connect the dots between China’s anti-monopoly investigations of foreign companies doing business in China proper with the Chinese government’s hostile response to the Hong Kong protests against the high-handed way in which Chinese authorities are stifling homegrown democratic activities by insisting on government vetting of all candidates for public office to weed out those who might oppose China’s national agenda. And it takes no great leap in imagination to realize that the same aggressive attitude that China now takes on territorial issues with Vietnam and Japan can spill over to these investigations. It is also well known that China blocks (censors) service supplied by the mainstays of the internet and social media, including Google, Facebook, Wikipedia, and Twitter, which would provide ample opportunity for information about government (and private) abuses to be widely spread.

It also looks as though the lack of any formal protections in the AML investigative process opens up the entire system to these forms of abuse. The lack of any reliable reporting on these matters is consistent with wide-scale abuse because of this simple stylized threat: “Be silent and take your punishment and we shall reduce the penalties. Speak about the matter in public and the penalties will increase.” These threats are all too credible within a tightly run collectivist society. The legal system may give little or no relief, and even if the courts were somehow attuned to the civil liberties and procedural issues, the lack of any clear standards for what counts as either a violation or an appropriate penalty reduces the chances that judicial intervention could be used to slow down an official juggernaut.

VI. Reforms

China needs to do more than make bland and predictable protestations that the AML applies on even terms for all players. The question is how? At the most basic level, one way to get rid of this problem is to spin off all SOEs into private hands, preferably by bona fide auctions, so that there is less risk of political influence displacing the rule of law. That path is of course hampered by China’s explicit commitment to socialist principles in the AML and everywhere else.

There is, however, no reason why that has to create an insuperable barrier. Socialist principles are also inconsistent with private ownership of the means of production, and with the belief that open competition in the marketplace will assure the highest level of social output for any given set of resources. In a sense, the 2007 adoption of the AML itself should be regarded as an implicit rejection of the principles of the socialist economy found in Article 4, because it assumes private companies and a functioning free market. It should take only a little imagination to push the cycle one step further by privatizing key government industries with auctions or other schemes of devolution, and the Chinese government has already proven resourceful in finding ways to explain how such free market reforms are consistent with its preexisting socialist system.

Even if this approach is not undertaken, it should still be possible to make reforms internal to the AML itself that are not likely to reduce its economic benefits but could do much to control its adverse effects. Within the American system, a strong distinction is taken between the horizontal arrangements that are governed under Section 1 of the 1890 Sherman Act and the variety of vertical arrangements that are covered under the monopolization provisions of Section 2. The argument in favor of this distinction turns on the anticipated rate of social return from the enforcement of these two provisions.

With the Section 1 prohibition on contracts in restraint of trade, the nature of the societal loss is generally easy to figure out. The horizontal arrangements that restrict output, raise prices or divide territories do not result only in the transfer of wealth from consumers to producers, but also a reduction in overall social wealth by removing those transactions that could take place for mutual benefit at the competitive price, but which will be foreclosed when the cartel raises its price to the monopoly level. As noted earlier, the Chinese AML tracks that approach, at least on paper. The enforcement questions here are not easy, but since there is a clear sense of what the wrong is, it should be possible to obtain evidence from examining evidence of cooperation, including from disgruntled employees of the given firms. And the matter can be helped along immeasurably by rules that waive treble damages to the first cartel member that reports the cartel practices. These rules apply with great force in the current American enforcement efforts, much of which has been directed toward international cartels.

The dynamics under Section 2 of the Sherman Act are quite different. In these instances, it is hard to develop a simple explanation as to why various kinds of vertical arrangements are harmful to consumer welfare. In many cases, the practices that are undertaken by the dominant firm are also undertaken by their smaller rivals that have no element of market power. The clear implication of this simple point is that the practices that are routinely attacked as restrictive are also practices that have efficiency benefits. Any effort to ban or punish these factors could both stifle useful innovations and distort the competitive balance between firms of different size.

The situation gets even worse when the only charge leveled under the AML is that prices are “unfairly high” or “unfairly low,” which is just asking for trouble. At one level the impetus behind this claim is that certain products are sold at higher (or lower) prices in China than in the United States or the European Union. But these simple price comparisons miss so many of the relevant marketplace complications. Higher prices could stem from higher costs in distribution or in compliance with local laws. Lower prices could result from the simple fact that the fixed costs of producing these goods are allocated to the home market where demand is higher, such that the foreign sales at a lower price improve the welfare of both the firm (which gets a chance to expand markets and recover an additional fraction of its fixed costs) and its Chinese customers, who get the benefit of low prices that forces local firms to reduce their costs. It follows therefore that the Chinese antitrust system could do well to narrow the class of offenses that are said to be practiced by dominant firms, avoiding confusing and unclear terms such as “unfair” prices.

Once a sharper definition of monopolization activities is adopted, it reduces the pressure on the enforcement system to engage in overbroad and unfettered investigations or prosecutions, and thus the risks of massive abuse. Nonetheless, it is a grim fact of life that the investigation of cartel-like behavior is always intrusive, precisely because these arrangements are always carried out in secret, which requires extensive government efforts to ferret them out. But in this regard, it is imperative that China reform its antitrust system for the benefit of both its own citizens and foreign companies investing in China. It should adopt procedural protections that impose some definitive and clear checks on how investigators can behave in ways that avoid both massive human rights violations on the one hand and routine investigative abuses on the other.

At this point, it is necessary to add into Chinese law the same kinds of safeguards that are commonplace in most countries with respect to other forms of criminal investigation, whether crimes of violence or drug offenses, or simple cases of fraud and nondisclosure in financial circles and elsewhere. The point here is that the most dangerous sentence in the English language—“trust me I am from the government”—translates perfectly into Chinese. It is not enough that the abuse stops. It is absolutely imperative that the appearance of abuse ceases as well. Those reforms are not beyond the power of the Chinese legal system to implement, but it will take a long overdue switch from the inquisitorial types of system that socialist countries have found all too congenial in the political and economic sphere.

In urging these major antitrust reforms, it is imperative to put the Chinese position into global perspective. The Chinese government is not the only government that uses its anti-monopoly laws as a cudgel to achieve other political or economic objectives. It has lots of company worldwide. There are, more specifically, other illustrations of abuse in the United States and the European Union. The American system is overly exuberant in its discovery processes, especially with respect to international operations under the 1995 guidelines of the United States Department of Justice and the Federal Trade Commission. It offers shameless protection to American export cartels under the Webb-Pomerene Act, passed in 1918 at the end of World War I, when the need for free trade could hardly have been greater. The European Union thrives on broad definitions of “abuse of dominant position” under Article 102 of its 2009 Treaty on the Functioning of the European Union. The enforcement in many other nations, such as India, with its endless protectionist practices, is also in need of major reform.

In dealing with all these multi-national issues, the fundamental insight is that free trade across international borders offers the best hope for the amelioration of the human condition, especially in developing or underdeveloped countries. It is widely understood that tariffs and other restrictions impede the flow of goods across international borders, which is why the World Trade Organization maintains global free trade as its primary objective. The general attack on explicit entry restrictions by foreign firms and goods has borne much fruit in recent years, although there is still work to be done. But it is precisely because tariffs and other barriers to entry are public and thus verifiable that it is (relatively) easy to control their abuse.

The success of the WTO in controlling these practices does not put to rest the protectionist impulses that have generated too many obstacles to free trade. The differential enforcement of the anti-monopoly laws poses major dangers in this regard, for the same laws that protect against anticompetitive practices are all too often used to achieve the very abuse that they are intended to guard against. Commissioner Ohlhausen bluntly puts the point: “Critics claim that China is using its antitrust law to promote industrial policy.” The unfortunate situation in China is but one example of that dangerous set of practices, which unchecked could spread to other countries, motivated either by imitating what China has done or retaliating against its abuses. The risk is that the disease can spread all too easily. Other nations can protest against these practices. But ultimately it is for China itself to throw aside the shackles that disadvantage foreign firms and the Chinese people alike.

Endnotes:

[i] The AML also contains a prohibition against mergers that lead to “concentration of business operators that eliminates or restricts competition or might be eliminating or restricting competition,” but this is not addressed in this brief essay. These prohibitions cover only a few large transactions, none of which involve ordinary commercial practices that are the subject of the anti-monopoly and abuse of practice provisions at issue in the current applications of the AML.

Commercialization Economic Study High Tech Industry Innovation Law and Economics Legislation Patent Law Patent Licensing Patent Litigation Software Patent Uncategorized

Cohen et al. “Patent Trolls” Study Uses Incomplete Data, Performs Flawed Empirical Tests, and Makes Unsupportable Findings

Post author By Joshua Grove
Post date November 12, 2014

PDF summary available here

I. Introduction

A recent draft study about patent licensing companies entitled “Patent Trolls: Evidence from Targeted Firms” is making the rounds on Capitol Hill and receiving press coverage. This attention is unfortunate, because the study is deeply flawed and its conclusions cannot and should not be relied upon. If the draft paper is ever published in a peer reviewed journal, it will certainly need to be greatly revised first, with its most notable results likely changing or disappearing. In sum, the study should receive no credit in policy debates.

The study, by Lauren Cohen, Umit G. Gurun, and Scott Duke Kominers, finds that non-practicing entities (NPEs) are “opportunistic” because they target defendants that (1) are cash-rich (particularly compared to practicing entity patentees), (2) operate in industries that “have nothing to do with the patent” in suit, (3) are staffed by small legal teams, and (4) are busy with numerous non-IP cases. Additionally, the authors conclude that defendants that lose in patent litigation with NPEs on average have marked declines in subsequent R&D expenditures, on the order of $200 million per year. On this basis, the authors suggest “the marginal policy response should be to more carefully limit the power of NPEs.” One of the authors has been circulating this unpublished study to congressional staffers to make the case that NPEs have a large negative effect on US innovation.

II. Critique of the Study

Professor Ted Sichelman, University of San Diego School of Law, and an expert in empirical studies of patent litigation, critiques the most recent, publicly available version of the Cohen et al. study in detail in his response paper, “Are Patent Trolls ‘Opportunistic?”.[1] He finds that the study’s dataset is incomplete and unrepresentative, its theoretical model is flawed, and its empirical models are unsound. Professor Sichelman concludes that neither their findings nor policy prescriptions are justified. Major weaknesses in the study are as follows:

The study’s public firm defendant dataset in current version of paper is incomplete and unrepresentative
The study relies on proprietary, unverified coding from PatentFreedom that groups together numerous NPE types (including individuals, R&D shops, and IP holding companies of operating companies), but in making its policy recommendations, the study assumes all NPEs are patent aggregators
The study’s finding that NPEs sue cash-rich defendants may simply be driven by the fact that NPEs tend to target software, Internet, and finance-related companies for reasons unrelated to cash holdings, but these companies simply happen to have larger cash-holdings than the average publicly traded company
When comparing NPE behavior to that of operating companies, the study improperly includes operating company suits in which the patentees primarily seek injunctions, which are not cash-driven suits
- Our belief is that NPEs and operating companies alike that primarily seek royalties are likely to seek defendants with enough cash to pay likely damage awards and—like a seller of goods ensuring that a buyer has sufficient cash to pay for those goods—there is nothing “opportunistic” in this behavior
NPEs asserting patented technology that is different from the primary industry of the accused infringer are typically not going “after profits unrelated to the patents”
- For instance, the use of patented computer hardware, software, or technical equipment may occur in any industry and provide a competitive advantage relative to others using non-patented technology
The study’s datasets and variables to determine the size of law firm and the number of pending cases are incomplete and flawed
The authors’ finding that R&D of accused infringers is differentially affected by a “loss” is based on a very small dataset of “wins” (n=35)

In sum, there is no support for the study’s policy recommendation “to more carefully limit the power of NPEs.” In this regard, we reiterate our view that any plaintiff targeting defendants with enough cash to satisfy a damages judgment is simply ordinary litigation behavior. According to Professor Sichelman, there is “massive risk aversion by many small NPEs” and “large uncertainty in [patent] cases” that may cause any patentee primarily seeking money damages to assert its patents against defendants who can pay their bills.

Finally, in making their policy proposals to restrict NPEs, Cohen et al. rely on the discredited study of Bessen and Meurer (2014) to argue that NPEs do not channel a large percentage of funds received back to inventors. As Schwartz and Kesan (2014) have shown, Bessen and Meurer’s study is inapplicable to most NPEs, because only 12 publicly traded aggregators were examined, and even for those 12 aggregators, Schwartz and Kesan persuasively argue that Bessen and Meurer’s findings are wrong. Indeed, there is ample evidence that many patent aggregators return 50% of net recoveries in litigation or licensing (i.e., after paying for attorneys’ fees and related costs) and that many NPEs are individuals, R&D shops, and other entities that effectively keep 100% of the net returns from recoveries.

As such, the Cohen et al. (2014) study should receive no credit in congressional policy debates. Indeed, another leading academic at a recent conference expressed surprise and dismay that this early-stage study was being circulated by its authors throughout Congress.

Notes:

[1] The authors presented new material in response to Sichelman’s critique at a recent conference, but as far as we know, they have not made any of it available to the general public. As such, we focus on Sichelman’s critique of the most recent, publicly available version of the study.

Conferences Copyright Copyright Theory History of Intellectual Property Injunctions Innovation Intellectual Property Theory Internet Inventors Patent Law Patent Theory Remedies Uncategorized

IP Promotes Progress by Securing the Individual Liberty of Inventors and Creators

Post author By Joshua Grove
Post date October 20, 2014

This is the third in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014. Videos of the conference panels and keynote will be available soon.

The second panel of CPIP’s 2014 Fall Conference analyzed the common moral case for copyrights and patents. The panel was moderated by Professor Chris Newman (George Mason University School of Law). Two of the panelists, Professor Mark Schultz (CPIP, and Southern Illinois University School of Law) and Professor Eric Claeys (George Mason University School of Law) explained the theoretical and normative principles underlying the moral case for intellectual property. The other two panelists, Dr. Ken Anderson (Thermaquatica) and David Lowery (musician, producer, and lecturer at the University of Georgia), then showed how those principles play out in practice.

Professor Schultz noted that the moral case for intellectual property is often overshadowed by (or outright ignored in favor of) the economic case. But in addition to being economically valuable, intellectual property serves important moral functions by enabling artists and inventors to live free and flourishing lives. Intellectual property fosters economic independence, enables the creation of a private sector, and supports political freedom. Patents and copyrights give an important set of choices to creators and inventors, enabling them not only to survive, but also to thrive. As such, intellectual property is a moral right that facilitates individual liberty. While the economic justifications for copyrights and patents remain important, it is equally important not to lose sight of their strong moral underpinnings.

Professor Claeys discussed the moral case for injunctive relief against IP infringement. Starting from a traditional property law perspective, he explained that remedies (such as injunctive relief) are essential in reinforcing and vindicating property rights. Just as with traditional property, copyrights and patents confer exclusive control to their owners to secure to them the value of their productive labors. By protecting copyright and patent owners’ discretion over the deployment of their property, injunctions protect their moral rights in the fruits of their labors. Claeys further noted that this labor-based understanding of intellectual property could inform the balance of equities discussed in eBay v. MercExchange, filing significant gaps in the Supreme Court’s reasoning and likely leading to a different conclusion regarding licensing companies’ ability to obtain injunctions.

Anderson and Lowery addressed the role of IP in their respective fields. Dr. Anderson discussed how patents were crucial to his ability to obtain investors for his green tech company. He invented a new, environmentally-friendly technology to convert “coal, biomass and other organic solids into low molecular weight products.” Being able to protect the value of his work through patent protection (he filed multiple rounds of patents all over the world) has been essential to his company’s success and his ability to commercialize his invention.

Lowery discussed how the lack of copyright enforcement in the digital era has affected the music industry, leading to an environment where internet platforms thrive, but the artists and creators who fuel the value of those platforms struggle mightily to make ends meet. In many ways, musicians are worse off now than they were in the 1950s (an era that s well-known for the exploitation of musicians). Nonetheless, he expressed hope that the third decade of the Internet could embrace legal and technological innovations that make it a better place for artists.

In sum, the panelists illustrated the fundamental moral importance of intellectual property, which applies equally to inventors’ patent rights as it does to artists’ copyrights. Intellectual property isn’t just about economic incentives. IP also promotes progress by securing the individual liberty of inventors and creators.

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The Common Economic Case for Patents and Copyrights

Post author By Joshua Grove
Post date October 19, 2014

This is the second in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014. Videos of the conference panels and keynote will be available soon.

The opening panel of CPIP’s 2014 Fall Conference examined the common economic case for patents and copyrights. Unfortunately, IP policy discussions often include a false narrative that intellectual property produces monopolies that harm innovation and economic growth. The panelists, Troy Dow (Disney), Professor Stan Leibowitz (University of Texas at Dallas), Jon Santamauro (Abbvie), and Professor Jay Kesan (University of Illinois College of Law), highlighted how this narrative, in fact, ignores the essential role that intellectual property serves in enabling the creation, development, and commercialization of both inventions and creative works.

Kesan explained how patents provide economic benefits from both an ex-ante and ex-post perspective. Ex-ante, a strong patent system provides incentives to create, invest in R&D, and finance further innovation. While there are other ex-ante motivations to invent (such as a first mover advantage, the ability to secure trade secrets, and reputational advantages), Kesan argued that innovation is best facilitated ex-ante by a combination of all of these incentives plus the incentives created by patents. The ideal system incorporates a heterogeneous mix of these incentives to invent—in the absence of patents the level of disclosure decreases and innovation slows down.

Patents also provide numerous ex-post benefits. Patents facilitate coordination with producers and perform important signaling functions. They additionally allow for important private ordering by giving inventors increased control over who uses their invention and under what circumstances. In many industries, this is essential to collaboration, interoperability of products, and the aggregation of complementary benefits.

Jon Santamauro discussed the role of patents in the pharmaceutical industry. The exclusive property rights created by patents encourage R&D and serve as a crucial catalyst for new discoveries and businesses. Patent protection is particularly important in the pharmaceutical industry due to the high-risk, lengthy, and costly process necessary to develop new, safe, and effective drugs.

Pharmaceutical companies developing new drugs screen thousands of potential compounds over 6-7 years of testing to gain FDA approval, at an average cost of about $1.2 billion per drug. The reasons for the high R&D costs? Out of 10,000 initial molecules tested, only 6 go to clinical trials, and of these, only 1 is approved by the FDA for use in the healthcare market. Of the 1 out of 10,000 drugs that make it to market, only 2 out of every 10 medicines produce enough revenues to recoup the initial high costs of R&D and also provide revenue to invest in more R&D. In short, pharmaceutical and biotech firms face very high risk—high R&D expenditures and very few market successes. Strong IP protection helps offset this risk and encourages further investment and research.

Leibowitz explained that one of the primary criticisms of copyright—that it grants a monopoly, and that monopolies are intrinsically bad for society—is utterly thoughtless. A property right is, by definition, a monopoly of sorts. This criticism is an indictment of property rights on the whole, including real property rights. This is even more inapt to copyright, as copyright does not restrict entry and does not provide an economic monopoly.

Leibowitz also addressed the common argument that IP isn’t necessary because inventors and creators would continue inventing and creating even if they didn’t get to own the fruits of their productive labors. While some innovative and creative activity would undoubtedly continue, many innovators and creators do not simply create for creations sake. They need salaries (like everyone else), and strong IP rights allow them to capture the value of what they produce.

Finally, Troy Dow highlighted the benefits of strong copyright protection in the movie industry. Bringing a film to market involves substantial risks that many people do not appreciate. He explained that studios perform the same market function as venture capitalists: they invest in films at the birth of the original idea and then provide financing all the way through the final showing in movie theaters. This financing comes from banks, other investors, or other studios in order to spread the risk. Dow analogized a new film project to a new startup company, as each new film has its equivalent of a CEO (producer), COO (director), and thousands of employees and independent contractors. And just as with startup companies, everyone must be paid before the film makes a single cent in revenue.

A single film can cost over $200 million to produce. While a particularly big hit can gross over $350 million after long-term distribution (including on-demand and DVD sales), only 4 out of every 10 movies recoup their investment at the box office. Copyright thus serves the vital function of making it possible for studios to make substantial, upfront investments with the hope of a return on this investment and a sufficient profit to reinvest in further film projects.

Disney’s IP is enormously valuable and is the dominant driver of their business. Even though only $6 billion of Disney’s $45 billion in revenues last year came directly from movie revenue, the movies, including the stories they tell, are at the heart of the Disney experience. The movies form the basis for other products, media networks, theme parks, and licensing. A strong copyright regime allows studios like Disney to keep producing both creative works and the myriad other products and experiences that so many of us enjoy.

Together, the four panelists illustrated that the economic foundations of IP are equally applicable to the creative industries as they are to the innovation industries. By securing for inventors and creators the value of their productive labors, IP provides the economic bedrock of our creative and innovative economy.

Tags Abbvie, copyright, creative industries, Disney, drugs, Illinois, innovation industries, investment, Jay Kesan, Jon Santamauro, movie, patent, pharma, risk, Stan Leibowitz, studio, Troy Dow, UT-Dallas, venture capital

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Intellectual Property Unites Creators and Innovators

Post author By Joshua Grove
Post date October 17, 2014

This is the first in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014. Videos of the conference panels and remarks, as well as panel summaries, will be available soon.

Introduction by Professors Adam Mossoff and Mark Schultz

Common Ground: How Intellectual Property Unites Creators and Innovators

The creative industries and innovation industries have much in common, but too often this is overlooked. Both industries engage in brilliant intellectual work to bring new products and services into the world, both take great risks to commercialize this work, and both depend on intellectual property – copyrights (for the creative industries) and patents (for the innovation industries). Unfortunately, most accounts of these two industries emphasize their differences and frequently portray them in conflict.

This conference will explore the common ground shared by these two dynamic industries, focusing on the similar values secured by their patents and copyrights and thus their common policy goals and commercial developments.

It should be unsurprising that these two industries share much in common. The work of inventors and artists is much the same. We see hints of this in their respective aspirations. Engineers, for example, often talk of seeking “elegant” or “beautiful” solutions to the technological problems they face. Artists also strive to innovate technically in how they create their works, as demonstrated with much panache in the recent documentary, Tim’s Vermeer. Many creators apply their prodigious talents to both art and invention.

One may think of a Steve Jobs today as exemplifying this truth, but history is replete with examples. Leonardo da Vinci also comes to mind, the quintessential Renaissance Man. In the 19th century, Samuel Morse invented the telegraph, but he was also a successful artist and in fact he developed the telegraph while working as a well-known Professor of Art at New York University.

In modern America, Walt Disney has defined much of our culture not just with his artistic creations, but also with his innovative technological creations in movies, theme parks and products. More recently, filmmakers George Lucas and James Cameron have cast large shadows in popular culture, but their contributions to filmmaking technology may prove even more enduring and pervasive.

These and many other examples are unsurprising when one considers that art and technology both result from the same source: productive intellectual labor.

As the work of artists and inventors is at heart the same, so is the moral and economic case for securing property rights to them. Artists and inventors deserve to own the fruits of their productive labors. In protecting these labors, intellectual property rights secure to them their liberty and their careers. These rights thus fuel the vast economic activity that drives the innovation economy – bringing to market the products and services that ensure full and flourishing lives for them and for the rest of us as well.

Too often, though, the creative and innovation industries are portrayed as being at odds. One popular narrative today – in both scholarly and popular accounts – is that technology disrupts the creative industries, forcing copyright owners to adapt. This is a myopic account of their relationship that ultimately creates a false picture. In truth, creativity and innovation – secured by copyrights and patents – constantly spur each other to greater heights.

The true story of creativity and innovation is more properly viewed as a virtuous circle.

Recording and broadcast technology, for instance, gave musicians and other performers their first worldwide audiences, whose demand for ever-more entertainment and information spurred further improvement and expansion of technology. The invention of the electric guitar, spurred by a series of patented improvements, enabled blues and rock ‘n’ roll, which in turn pushed further developments in music and recording technology.

The Internet certainly created much disruption, but it also has been a fountainhead of creativity. To take just one example, streaming of original, creative content enables television viewers to enjoy storytelling as never before, bringing about what some are now calling a Second Golden Age of Television.

Our technological devices, such as smartphones and iPads, would not be so well loved and so ubiquitous without the games, music, and video content they deliver to hundreds of millions of people the world over.

The common ground and shared aspirations of creators and innovators is clear, but rarely appreciated in the din of today’s policy debates.

Thus, our Annual Conference this year considers afresh the common goals, challenges and needs of the creative and innovation industries. Many distinguished speakers with extensive knowledge and experience in both fields will address how intellectual property rights represent the bedrock of this common ground. We hope that you will enjoy what promises to be enlightening discussion.

**Panel summaries coming soon**

Administrative Agency Antitrust Commercialization Damages DOJ Economic Study FTC Injunctions Innovation Law and Economics Patent Law Patent Licensing Patent Litigation Reasonable Royalty Remedies Uncategorized

Patent Policy Debates Characterized by "Intolerably High Ratio of Theory to Evidence"

Post author By Joshua Grove
Post date September 11, 2014

In an interview with Law360 last week, FTC Commissioner Joshua Wright spoke about the FTC’s upcoming study on PAEs and the state of today’s patent policy debates. The interview is well-worth reading in it’s entirety, and we’ve also highlighted a couple key quotes below.

“One of the most fascinating things about the the policy debates in and around patents and by extension the intersection of patent law and antitrust law, is that most of the debate is chock full of theory and supposition but completely devoid of empirical evidence…It is very difficult to move forward sensibly in debates with those characteristics”

“Wright said that without evidence of ‘pervasive market failure’ in the standard setting space, the FTC and the U.S. Department of Justice should avoid the temptation to serve as ‘management consultant’ to standard setting groups and their members.”

Copyright Copyright Theory History of Intellectual Property Innovation Intellectual Property Theory Law and Economics Patent Law Patent Litigation Patent Theory Statistics Uncategorized

Intellectual Property, Innovation and Economic Growth: Mercatus Gets it Wrong

Post author By Joshua Grove
Post date August 28, 2014

By Mark Schultz & Adam Mossoff

A handful of increasingly noisy critics of intellectual property (IP) have emerged within free market organizations. Both the emergence and vehemence of this group has surprised most observers, since free market advocates generally support property rights. It’s true that there has long been a strain of IP skepticism among some libertarian intellectuals. However, the surprised observer would be correct to think that the latest critique is something new. In our experience, most free market advocates see the benefit and importance of protecting the property rights of all who perform productive labor – whether the results are tangible or intangible.

How do the claims of this emerging critique stand up? We have had occasion to examine the arguments of free market IP skeptics before. (For example, see here, here, here.) So far, we have largely found their claims wanting.

We have yet another occasion to examine their arguments, and once again we are underwhelmed and disappointed. We recently posted an essay at AEI’s Tech Policy Daily prompted by an odd report recently released by the Mercatus Center, a free-market think tank. The Mercatus report attacks recent research that supposedly asserts, in the words of the authors of the Mercatus report, that “the existence of intellectual property in an industry creates the jobs in that industry.” They contend that this research “provide[s] no theoretical or empirical evidence to support” its claims of the importance of intellectual property to the U.S. economy.

Our AEI essay responds to these claims by explaining how these IP skeptics both mischaracterize the studies that they are attacking and fail to acknowledge the actual historical and economic evidence on the connections between IP, innovation, and economic prosperity. We recommend that anyone who may be confused by the assertions of any IP skeptics waving the banner of property rights and the free market read our essay at AEI, as well as our previous essays in which we have called out similarly odd statements from Mercatus about IP rights.

The Mercatus report, though, exemplifies many of the concerns we raise about these IP skeptics, and so it deserves to be considered at greater length.

For instance, something we touched on briefly in our AEI essay is the fact that the authors of this Mercatus report offer no empirical evidence of their own within their lengthy critique of several empirical studies, and at best they invoke thin theoretical support for their contentions.

This is odd if only because they are critiquing several empirical studies that develop careful, balanced and rigorous models for testing one of the biggest economic questions in innovation policy: What is the relationship between intellectual property and jobs and economic growth?

Apparently, the authors of the Mercatus report presume that the burden of proof is entirely on the proponents of IP, and that a bit of hand waving using abstract economic concepts and generalized theory is enough to defeat arguments supported by empirical data and plausible methodology.

This move raises a foundational question that frames all debates about IP rights today: On whom should the burden rest? On those who claim that IP has beneficial economic effects? Or on those who claim otherwise, such as the authors of the Mercatus report?

The burden of proof here is an important issue. Too often, recent debates about IP rights have started from an assumption that the entire burden of proof rests on those investigating or defending IP rights. Quite often, IP skeptics appear to believe that their criticism of IP rights needs little empirical or theoretical validation, beyond talismanic invocations of “monopoly” and anachronistic assertions that the Framers of the US Constitution were utilitarians.

As we detail in our AEI essay, though, the problem with arguments like those made in the Mercatus report is that they contradict history and empirics. For the evidence that supports this claim, including citations to the many studies that are ignored by the IP skeptics at Mercatus and elsewhere, check out the essay.

Despite these historical and economic facts, one may still believe that the US would enjoy even greater prosperity without IP. But IP skeptics who believe in this counterfactual world face a challenge. As a preliminary matter, they ought to acknowledge that they are the ones swimming against the tide of history and prevailing belief. More important, the burden of proof is on them – the IP skeptics – to explain why the U.S. has long prospered under an IP system they find so odious and destructive of property rights and economic progress, while countries that largely eschew IP have languished. This obligation is especially heavy for one who seeks to undermine empirical work such as the USPTO Report and other studies.

In sum, you can’t beat something with nothing. For IP skeptics to contest this evidence, they should offer more than polemical and theoretical broadsides. They ought to stop making faux originalist arguments that misstate basic legal facts about property and IP, and instead offer their own empirical evidence. The Mercatus report, however, is content to confine its empirics to critiques of others’ methodology – including claims their targets did not make.

For example, in addition to the several strawman attacks identified in our AEI essay, the Mercatus report constructs another strawman in its discussion of studies of copyright piracy done by Stephen Siwek for the Institute for Policy Innovation (IPI). Mercatus inaccurately and unfairly implies that Siwek’s studies on the impact of piracy in film and music assumed that every copy pirated was a sale lost – this is known as “the substitution rate problem.” In fact, Siwek’s methodology tackled that exact problem.

IPI and Siwek never seem to get credit for this, but Siwek was careful to avoid the one-to-one substitution rate estimate that Mercatus and others foist on him and then critique as empirically unsound. If one actually reads his report, it is clear that Siwek assumes that bootleg physical copies resulted in a 65.7% substitution rate, while illegal downloads resulted in a 20% substitution rate. Siwek’s methodology anticipates and renders moot the critique that Mercatus makes anyway.

After mischaracterizing these studies and their claims, the Mercatus report goes further in attacking them as supporting advocacy on behalf of IP rights. Yes, the empirical results have been used by think tanks, trade associations and others to support advocacy on behalf of IP rights. But does that advocacy make the questions asked and resulting research invalid? IP skeptics would have trumpeted results showing that IP-intensive industries had a minimal economic impact, just as Mercatus policy analysts have done with alleged empirical claims about IP in other contexts. In fact, IP skeptics at free-market institutions repeatedly invoke studies in policy advocacy that allegedly show harm from patent litigation, despite these studies suffering from far worse problems than anything alleged in their critiques of the USPTO and other studies.

Finally, we noted in our AEI essay how it was odd to hear a well-known libertarian think tank like Mercatus advocate for more government-funded programs, such as direct grants or prizes, as viable alternatives to individual property rights secured to inventors and creators. There is even more economic work being done beyond the empirical studies we cited in our AEI essay on the critical role that property rights in innovation serve in a flourishing free market, as well as work on the economic benefits of IP rights over other governmental programs like prizes.

Today, we are in the midst of a full-blown moral panic about the alleged evils of IP. It’s alarming that libertarians – the very people who should be defending all property rights – have jumped on this populist bandwagon. Imagine if free market advocates at the turn of the Twentieth Century had asserted that there was no evidence that property rights had contributed to the Industrial Revolution. Imagine them joining in common cause with the populist Progressives to suppress the enforcement of private rights and the enjoyment of economic liberty. It’s a bizarre image, but we are seeing its modern-day equivalent, as these libertarians join the chorus of voices arguing against property and private ordering in markets for innovation and creativity.

It’s also disconcerting that Mercatus appears to abandon its exceptionally high standards for scholarly work-product when it comes to IP rights. Its economic analyses and policy briefs on such subjects as telecommunications regulation, financial and healthcare markets, and the regulatory state have rightly made Mercatus a respected free-market institution. It’s unfortunate that it has lent this justly earned prestige and legitimacy to stale and derivative arguments against property and private ordering in the innovation and creative industries. It’s time to embrace the sound evidence and back off the rhetoric.

Tags AEI, Chamber of Commerce, copyright, creativity, economic prosperity, economics, eli dourado, empirical study, ian robinson, innovation, Institute for Policy Innovation, intellectual property, IP, jobs, Mercatus Center, patents, prizes, Stephen Siwek, USPTO

Biotech Commercialization Gene Patents Innovation Patent Law Patentability Requirements Uncategorized

The Critical Role of Patents in the Development, Commercialization, and Utilization of Innovative Genetic Diagnostic Tests

Post author By Joshua Grove
Post date July 14, 2014

Last week, CPIP released an important new policy brief, The Critical Role of Patents in the Development, Commercialization, and Utilization of Innovative Genetic Diagnostic Tests, by Professor Chris Holman. Professor Holman explains the important role that patents play not only in attracting the capital investment needed to bring genetic tests to market, but also in incentivizing companies to invest in educating patients and their doctors about new tests and in facilitating insurance reimbursements for new tests. Professor Holman addresses the common mistaken assumption that patents negatively impact patient access to genetic diagnostic testing, concluding instead that patent protection is a critical spur for the innovation and commercialization of next-generation genetic diagnostic tests.

The full document (including endnotes) is available here, and we’ve also included the text (without endnotes) below.

The Critical Role of Patents in the Development, Commercialization, and Utilization of Innovative Genetic Diagnostic Tests

Christopher M. Holman

Genetic diagnostic testing is an increasingly high-profile subject in the minds of the public, academia, and policymakers. This increased attention was prompted in part by highly publicized events such as Angelina Jolie’s decision to undergo a preemptive double mastectomy based on the results of a genetic diagnostic test, followed shortly thereafter by a U.S. Supreme Court decision invalidating patent claims held by the company (Myriad Genetics) that developed the test used by Ms. Jolie. Although traditionally viewed as a relatively unglamorous sector of the healthcare market (accounting for less than 2% of total health care spending), genetic analysis and other innovative molecular diagnostics seem poised to become “a powerful element of the healthcare value chain,” playing an increasingly important role in the prediction, detection, and treatment of disease. “Personalized medicine,” a new term that refers to the pairing of a molecular diagnostic test with a patient-specific course of pharmaceutical treatment, represents a particularly promising avenue through which molecular diagnostics might improve therapeutic outcomes while containing healthcare costs.

Those involved in the development and commercialization of innovative molecular diagnostics stress the important role of effective intellectual property rights in attracting the substantial capital investment required to bring these products to market. Influential voices outside the innovation community, however, have argued strongly against patent protection for molecular diagnostics, claiming that such patents are overly broad, reduce patient access, and inhibit research that might otherwise lead to new and improved diagnostic tests. Most of these critics would acknowledge that strong patent protection is appropriate, and indeed critical, for the development of innovative drugs, in view of the huge cost of developing drugs and securing FDA marketing approval. They argue, however, that the same considerations do not apply to diagnostic tests. Unfortunately, their argument is based largely on the outdated and now-incorrect belief that diagnostic tests are developed by publicly-funded academics who are primarily motivated by non-patent incentives, and that commercialization of these tests is cheap and easy.

The critics have been heard and are finding resonance in the legislative, judicial, and executive branches. Legislation to limit the patentability of genetic inventions and the enforceability of genetic patents has been introduced in Congress, although not yet enacted. Omnibus patent reform legislation enacted in 2011 does contain a section requiring the U.S. Patent and Trademark Office (“PTO”) to conduct a study examining the “impact that current exclusive licensing and patents on genetic testing activity has on the practice of medicine, including but not limited to the interpretation of testing results and performance of testing procedures,” and to report back to Congress with recommendations as to how to deal with presumed problems with respect to the ability of health care providers “to provide the highest level of medical care to patients” and of innovators to improve upon existing tests. In the courts, the alleged impact of genetic diagnostic patents on genetic research and the availability of diagnostic testing played an important role in litigation brought by the ACLU against the genetic testing company Myriad Genetics, challenging the validity of Myriad’s so-called “gene patents.” The ACLU won before the Supreme Court. The Obama administration filed amicus briefs in the Myriad litigation arguing against patent eligibility for patent claims allegedly relating to genetic testing, and National Institutes of Health (NIH) Director Francis Collins has been an outspoken critic of patents on genetic tests.

The plaintiff’s victory in Myriad has not lessened the call for more severe restrictions on the availability of effective patent protection for innovative molecular diagnostics. When the Supreme Court invalidated some of Myriad’s patent claims relating to the BRCA breast cancer genes, a number of Myriad’s competitors were emboldened to enter the BRCA testing market, and Myriad responded by filing lawsuits alleging infringement of some of its remaining patent claims (patent claims that were not at issue in the previous litigation). In response, Sen. Patrick Leahy (D-Vt.) sent a letter to Francis Collins asking NIH to “use its march-in rights under the Bayh-Dole Act to force Myriad Genetics Inc. to license its patents related to testing for genetic mutations associated with breast and ovarian cancer.”

This essay addresses some of the criticisms that have been leveled against genetic diagnostic testing patents. It identifies the critical role that patents play not only in the discovery and development of new molecular diagnostic tests, but also in making these tests more accessible to the patients who can benefit from them. When we move beyond the improperly restricted and crabbed view of patents as incentivizing only discovery of new medical drugs or tests, we recognize that patents also have a fundamental role in incentivizing companies like Myriad to create markets for these new discoveries by investing in educating patients and their doctors and in facilitating the reimbursement of patients for the cost of the test via their insurance plans.

Molecular Diagnostic Tests and Personalized Medicine

To understand the important role of patents in molecular diagnostic testing, it is important to have a basic understanding of what these tests are and where they come from. This is important if only because there is substantial misinformation in the public policy debates about these innovative medical discoveries. Thus, a brief primer on the topic is in order.

Molecular diagnostic tests involve the detection and/or analysis of a molecular biomarker in a patient in order to discern clinically relevant information about that patient. Molecular biomarkers come in many forms – prostate-specific antigen (PSA), for example, is a protein biomarker used to diagnose prostate cancer, while high levels of glucose in the blood can serve as a biomarker for diabetes. Today some of the most promising biomarkers are genetic variations, which are detected by analyzing an individual’s genomic DNA. Some genetic variations in the human breast cancer genes BRCA1 and BRCA2, for example, can be used to predict the likelihood that an individual harboring that variation will develop breast or ovarian cancer. Although significant progress already has been made, scientists are just beginning to scratch the surface of the potential of molecular diagnostic testing. Research continues in the quest to identify and validate new biomarkers correlated with a host of diseases and disease outcomes.

Testing for molecular biomarkers is not only useful in the diagnosis and prognosis of disease; it can also be used to guide doctors in the best course of treatment tailored to the needs of an individual patient. Personalized medicine, for example, encompasses the use of molecular diagnostic testing to identify the best course of drug therapy for an individual patient by (1) identifying the best drug for that individual, or (2) predicting the optimal drug dosage for that particular patient in terms of safety and efficacy. In a case involving determining personalized levels of drug dosage, Mayo v. Prometheus, the Supreme Court recently invalidated patent claims covering a non-genetic molecular diagnostic test that enables doctors treating patients for Crohn’s disease to prescribe a drug dosage at a level that maximizes efficacy while minimizing the horrible side effects too often endured by patients before the test became available. In doing so, the Court overturned a decision by the Court of Appeals for the Federal Circuit which upheld the validity of the claims – the Federal Circuit’s decision explicitly acknowledged that the claims relate to methods of medical diagnosis and treatment which have until recently been assumed to constitute patentable subject matter.

The fundamental challenge in developing molecular diagnostic tests is identifying and validating clinically significant molecular biomarkers. The magnitude of this challenge is vastly underappreciated by those who argue against patent protection for these tests. It is true that some relatively rare genetic diseases such as sickle cell anemia, cystic fibrosis and Tay-Sachs are associated with specific genetic variations (sometimes referred to as mutations), and once those variations have been identified it is relatively straightforward for any competent clinical laboratory to test for the presence of a mutation that has been unambiguously associated with the disease. But these are the low hanging fruit. For the vast majority of human diseases which have a genetic component, the correlation between biomarker and clinically relevant information is much less straightforward, and substantial investment is necessary to support the lengthy and labor-intensive research efforts required to discern and validate the clinical significance of novel biomarkers.

With respect to any two individual humans there typically exists about 6 million genetic variations (referred to as polymorphisms) spread across the genome. Most comprise single nucleotide variations that occur on average about once in every 1000 nucleotides. Significantly, almost all of these polymorphisms are believed to be clinically irrelevant. Thus, the challenge is to identify that small cohort of human genetic variations that can function as useful biomarkers, and to assign and validate their clinical significance.

Compounding the difficulty is the fact that the clinical significance of most genetic variations is substantially affected by the influence of other genetic variations residing throughout the rest of the genome, oftentimes in a manner that is not additive, and by interactions with non-genetic environmental factors. For example, there is often an observed synergistic amplification of susceptibility to disease caused by the interaction of variations at multiple locations in the genome, or, conversely, a dampening of the effect of one variation caused by variations at other locations. It can be extremely difficult to identify and validate correlations for multifactorial genetic diseases of this type, which in large part explains the relatively modest progress that has been made in molecular diagnostic testing in the decade subsequent to the initial sequencing of the human genome.

For example, some genetic variations in the BRCA1 and BRCA2 breast cancer genes have been shown to be associated with an extremely high likelihood of developing cancer, while others are associated with a likelihood of developing cancer only somewhat higher than the general population. Many of the observed variations in the BRCA genes are believed to be neutral, having no cancer-related implications. In fact, even after years of research and millions of dollars in investments, we are still finding patients with variations in the BRCA genes for which the significance is currently unknown. These “variations of uncertain significance,” or VUSs, constitute a major limitation on the clinical usefulness of molecular diagnostic tests. Patents provide the incentive for the substantial up-front investment in gathering and analyzing the clinical data necessary to assign a predictive value to a VUS.

Shrinking Patent Protection for Molecular Diagnostics and Personalized Medicine

For years, innovative scientists and physicians working in diagnostics and personalized medicine have sought and obtained patent protection for diagnostic tests that are based on the detection and/or analysis of molecular biomarkers. While patent claims covering isolated and synthetic DNA molecules can play some role in this regard, the most direct and effective means of patenting a diagnostic test is by claiming the method itself. Unfortunately, the Supreme Court’s recent decisions in Mayo and Myriad have substantially impaired the ability of innovators to obtain effective patent protection for DNA molecules used in diagnostic testing and for diagnostic testing methods per se. Although Myriad has garnered more public attention, Mayo is likely a much more significant decision with respect to the patentability of diagnostic tests, since it most directly implicates the method claims which are so important for effective patent protection in this area of technology.

Three aspects of Mayo could prove extremely problematic for future patenting of molecular diagnostics in general. First, the Court adopted a very broad definition of the term “natural phenomena” as it is applied in the context of patent eligibility for discoveries in medical treatments. The Mayo Court’s definition of this term, which refers to facts of nature that are unpatentable, appears to encompass the discovery of clinically significant biomarkers that is the essence of innovation in diagnostics and personalized medicine. Second, the Court held that in order to be patent eligible, a method claim must include some “inventive concept” above and beyond the discovery of a natural phenomenon. And third, the Court declared that a method claim is patent ineligible if it “preempts” all practical applications of a natural phenomenon.

A recent district court decision, Ariosa Diagnostics v. Sequenom, illustrates the profoundly troubling implications of Mayo for patents on molecular diagnostic methods. On a motion for summary judgment, the judge invalidated all of the genetic diagnostic testing method claims at issue in the case for failure to satisfy the requirements of patent eligibility as set forth in Mayo. In particular, the judge held that the claims failed the “inventive concept” test because they encompassed conventional methods of DNA analysis, and failed the “preemption” test based on a determination that the claims would cover all “commercially viable” methods of performing the test as of the filing date of the patent.

If this is indeed the standard by which the validity of molecular diagnostic claims will be assessed, the prospect for effective patent protection appears bleak. Innovation in molecular diagnostics resides primarily in the identification and characterization of biomarkers of clinical significance, e.g., genetic variations useful in the diagnosis and prognosis of disease. Once the biomarker and its clinically significant correlation has been identified, conventional forms of DNA analysis involving techniques such as PCR amplification and/or labeled hybridization probes are employed for diagnostic testing. A patent eligibility test that bars the inventor from claiming the use of conventional DNA analysis techniques will render the patent ineffective in blocking competitors from entering the market and thereby free-riding on the initial inventor’s substantial investments in the discovery of this molecular biomarker.

This troubling concern is not mere prophecy. In Ariosa Diagnostics,the judge held that Mayo prohibits any patent claim that encompasses all “commercially viable” means of testing for a biomarker. This decision renders any protection afforded by a valid diagnostic patent illusory. After all, how many venture capitalists are interested in investing hundreds of millions of dollars in a start-up diagnostic company whose patents are unable to preclude competition by free-riders using alternate, unpatented (but still commercially viable) methods for detecting the same biomarkers that the start-up invested in identifying?

Furthermore, in Myriad, the Supreme Court held that isolated DNA molecules corresponding to naturally occurring DNA are patent ineligible, absent some significant structural difference compared to the naturally occurring molecule. This holding is problematic for innovators in genetic testing because the DNA molecules used in the course of genetic diagnostic testing, such as DNA primers for PCR and hybridization probes, are inherently highly similar in chemical structure to naturally occurring DNA molecules, and thus apparently patent ineligible under Myriad. A district court recently adopted this view in a decision denying the patentee’s motion for preliminary injunction against an alleged infringer in a lawsuit commenced post-Myriad, finding that product claims directed towards DNA primers useful in BRCA genetic testing are likely invalid under Myriad. The PTO recently issued guidance adopting the same restrictive interpretation of Myriad with respect to DNA primer claims.

The Role of Patents in Molecular Diagnostic R&D

The Unfounded Assumption that Patents Inhibit Research

The plaintiffs in Myriad argued that Myriad’s patents inhibit research that might otherwise lead to improvements in BRCA testing. Unfortunately, many share this pessimistic view of the role of patents in the research and development of molecular diagnostic tests, and this deeply mistaken notion found support in a number of amicus briefs filed with the Supreme Court in support of the Myriad plaintiffs. A typical example was an amicus brief filed by the American Medical Association, which argued that patents are not only unnecessary to incentivize the optimal level of innovation in genetic diagnostic tests, but that genetic diagnostic patents allegedly inhibit research that could develop improved tests.

The argument that patents inhibit research in genetic diagnostics is based largely on an unfounded assumption that the existence of a patent necessarily precludes research on the patented subject matter. In fact, empirical studies have shown that basic researchers follow a norm of ignoring patent infringement, and that patent owners do not enforce their patents against basic researchers, resulting in a de facto research exemption from liability. Patent owners have little if any incentive to enforce patents against basic researchers – to the contrary, patent owners often welcome third-party basic research on patented subject matter, since it tends to promote and enhance the value of the patented subject matter.

Myriad’s policy toward basic research on the BRCA genes is a good case in point. During the time in which Myriad’s BRCA patents have been in force, basic research on the BRCA genes has flourished in both the US and abroad. While patent-skeptics assume that Myriad’s patents preclude research on the genes, in fact thousands of research articles relating to the genes have been published, many by researchers at leading US academic institutions such as the University of Pennsylvania, the University of Chicago, Emory University, and the University of Rochester. While it has been widely publicized that Myriad has on occasion threatened lawsuits against academic institutions that engaged in genetic diagnostic testing, it is important to bear in mind that these academic institutions were invariably engaged in commercial genetic testing, not basic research – i.e., they were charging patients for the testing services and thus competed with Myriad.

In attempting to support their assertion that patents harm research and development of diagnostic tests, patent-skeptics often point to the “SACGHS Report,” a 2010 report on the impact of patents on patient access to genetic tests that was prepared by the Secretary of Health and Human Services’ Advisory Committee on Genetics, Health, and Society. Despite these citations to the SACGHS Report, the case studies presented in the SACGHS Report for the most part show exactly the opposite. For example, the Report’s case study on the impact of patents and patent licensing practices on access to genetic testing for hereditary hemochromatosis concluded not only that “concerns regarding inhibition of research due to the HFE gene patents do not seem to be supported,” but that substantial basic research aimed at identifying new genes and genetic variations associated with hemochromatosis, along with new methods of testing for these biomarkers, were proceeding in spite of third-party patents. Similar findings were reported with respect to genetic tests investigated in other case studies, including the tests for cystic fibrosis, hearing loss, and Alzheimer’s disease.

The Important Role of Patents in the Development and Commercialization of Diagnostic Tests

While patents do not inhibit basic research, they do play a critical role in incentivizing the substantial investment required to translate the results of basic research into high-quality, commercially available diagnostic tests that meaningfully impact people’s lives. In a recent report, the President’s Council of Advisors on Science and Technology found that the “ability to obtain strong intellectual property protection through patents has been, and will continue to be, essential for pharmaceutical and biotechnology companies to make the large, high-risk R&D investments required to develop novel medical products, including genomics-based molecular diagnostics.” Similarly, commentators familiar with the challenges associated with the development and commercialization of diagnostics have concluded that patents are vital “to incentivize the significant investment required” for clinical research in personalized medicine. And while the AMA came out against genetic diagnostic testing patents in Myriad, the Association of American Physicians and Surgeons (“AAPS,” a national nonprofit association representing thousands of physicians) filed an amicus brief in support of Myriad’s patents, explaining that “advancing patients interests means supporting and defending incentives for medical innovations.”

Innovators in molecular diagnostics rely heavily on venture capital to fund the years of research, development, and validation necessary to bring a novel diagnostic product to market, and the decision of whether to invest is heavily dependent upon the availability of effective patent protection. Weakening of patent protection for molecular diagnostics will inevitably cause venture capitalists to shift their investments to other sectors of the economy. Not surprisingly, the National Venture Capital Association filed an amicus brief with the Supreme Court in support of Myriad.

One of the most compelling amicus briefs submitted to the Supreme Court insupport of Myriad was filed by Lynch Syndrome International (“LSI”), an all-volunteer organization founded and governed by Lynch syndrome survivors, their families, and health care professionals who treat Lynch syndrome. Lynch syndrome is a genetic condition caused by genetic variations in certain genes that result in a greatly increased risk of developing colon cancer. Lynch syndrome and BRCA mutations are highly analogous, with one important difference – patents in the area of Lynch syndrome have been nonexclusively licensed, so there has been no single provider to invest in developing and improving genetic tests for Lynch syndrome, nor in making the test widely available to the patients who could benefit from it. In its brief, LSI argues passionately for greater patent protection in the area of genetic diagnostic testing, in the hope that patent exclusivity might incentivize a patent owner to invest in Lynch syndrome in a manner comparable to Myriad’s investment in BRCA testing.

LSI explains that:

The development and commercialization of genetic tests require significant amounts of capital, but capital sources will not provide the necessary funding unless the newly developed tests will have patent protection. Only patent protection will assure the capital sources of sufficient investment return to make the provision of funding worthwhile.

LSI’s brief goes on to urge the Supreme Court to maintain patent eligibility for genetic tests in the hope that patents might provide incentives for the development of high-quality tests comparable to those available for BRCA thanks to the investments made by Myriad. LSI points to the long odds against success facing start-up companies like Myriad, noting that most start-up companies fail, particularly in the area of diagnostics. In the words of LSI:

Myriad’s survival, due largely to patent eligibility for genetic tests, has been a miracle for BRCA1 and BRCA2 patients: without Myriad, it is possible that only fragmented and potentially unregulated testing would be available. Lynch syndrome patients desperately need access to the quality testing that Myriad has been able to provide to BRCA1 and BRCA2 patients.

While the SACGHS Report found little evidence that patents impede basic research, it also found (incorrectly) that patents are largely unnecessary for genetic research, based largely on an assumption that genetic research is primarily conducted by academics who are not particularly interested in obtaining patents. The Report opines that while patents incentivize some private investment in genetic research, this private funding is “supplemental to the significant federal government funding in this area.” In conclusion, the Report states that “patent-derived exclusive rights are neither necessary nor sufficient conditions for the development of genetic test kits and laboratory-develop tests.” But these conclusions are seriously flawed, as explained below.

When the Report assumes that most genetic research is conducted by academic researchers, it is specifically referring to the identification of genes associated with genetic disease. While finding a gene associated with genetic disease is an important first step, the Report fails to take into account the much more difficult and costly research required to discern and validate the clinical significance of genetic variations. The Report’s conclusions, based on an analysis of the relatively straightforward genetic diseases that have been the basis for the first round of genetic diagnostic tests, are largely inapplicable to the next generation of diagnostic tests, where the correlation between genetic variation and clinical significance will be much more attenuated and difficult to establish.

The BRCA genes provide a good example of this. While the discovery of the genes in the 1990s was an important first step, the real work began after the genes were identified, as Myriad and others sought to distinguish the clinically significant variations in the BRCA genes from the clinically insignificant, and to quantify and validate the likelihood of cancer for patients having clinically significant variations. Some variations have been shown to correspond with only a marginal likelihood of cancer, others with a very high likelihood. Myriad reports that even today 3% of the variations it finds when it tests patients are still of unknown significance, and this is after performing thousands of tests and compiling enormous amounts of data. In Europe, where for years Myriad has as a practical matter not enforced its patents, many independent laboratories perform BRCA tests. The number of variations of uncertain significance in Europe is much higher than in the US, not surprising since without an exclusive provider there is less incentive and ability to gather and analyze the data necessary to assign significance to ambiguous variations.

Celera Diagnostics, a private-sector developer of advanced diagnostic tests, made this point in a comment submitted in connection with the SACGHS Report:

Even though the Draft Report suggests that scientists who search for gene-disease associations may not be motivated by the prospect of receiving a patent, they cannot conduct this type of research without considerable capital and resources. In our experience, meaningful gene-disease associations are confirmed only if the initial discoveries are followed by large scale replication and validation studies using multiple sample sets, the costs of which are prohibitive for many research groups. Private investors who provide funding for such research invariably look to patents that result from such work as a way of protecting their investment.

The SACGHS Report concluded that patents are unnecessary for the development and commercialization of diagnostic test, but that conclusion was based on an unrealistic assumption that the cost of developing a sequencing-based diagnostic test is in the range of $8,000-$10,000. While this paltry sum might have been sufficient for the development and commercialization of the simple diagnostic tests considered by SACGHS in preparing its Report, it is orders of magnitude short of the investment required for the critical next generation of diagnostic tests being developed by companies such as Myriad, Celera, and Genomic Health.

Furthermore, patents also promote innovation by facilitating collaboration and coordination between firms, which will be particularly important in the development of personalized medicine. For example, the pairing of the cancer drug Herceptin with a companion genetic diagnostic test that identifies patients likely to benefit from treatment with Herceptin represents one of the first successful implementations of personalized medicine. Herceptin, a biotechnology drug developed by Genentech, is only effective for a subpopulation representing about 30% of breast cancer patients, but for those for which it is effective it can reduce the recurrence of a tumor by 52%. Another pharmaceutical company, Abbott, developed the companion genetic diagnostic test used to distinguish between patients who will benefit from Herceptin and those who will not. The distinction is important because it allows doctors to rapidly begin Herceptin treatment for patients who will benefit from it, while avoiding the high cost and delay that result from trying Herceptin on a patient that, for genetic reasons, will not respond to the treatment. Patents play an important role in incentivizing companies like Abbott to develop a companion diagnostic, as well as facilitating the collaboration necessary to effectively pair one company’s diagnostic with another company’s drug.

Now that Myriad’s patent protection has been weakened, some argue that the company should make its proprietary data freely available in order to allow competitors to improve their tests. At one time Myriad did share this data, but in recent years it has adopted a policy of maintaining much of it as a trade secret. Of course, this is exactly the response one would predict in the face of weakened patent protection. No company is likely to invest in the creation of a valuable database if competitors are free to appropriate the value of the data. An important attribute of patents is that they encourage the disclosure of information that in the absence of the patent would likely be kept as a trade secret. Indeed, the SACGHS Report explicitly recognized that an absence of patent protection promotes secrecy, and that such “secrecy is undesirable because the public is denied new knowledge.”

The Important Role of Patents in Promoting Access

One of the main complaints leveled against patents on genetic diagnostic tests is that a patent owner like Myriad is able to charge a higher price as the exclusive test provider, which limits access for patients who cannot afford the test. A study included in the SACGHS Report attempted to assess this allegation by comparing the cost for Myriad’s BRCA test with the genetic test for Lynch syndrome. When normalized for the relative sizes of the genes, the Report found that Myriad charges “little if any price premium” for its exclusively controlled BRCA testing relative to the price charged for nonexclusively licensed testing of the Lynch genes. The Report concluded that this “surprising” finding “suggests that the main market impact of the BRCA patents is not on price but rather on volume, by directing BRCA full-sequence testing in the United States to Myriad, the sole provider.”

While the prices of BRCA and Lynch syndrome testing are comparable, many more BRCA tests are performed in the US compared to Lynch syndrome testing, suggesting that, at least with respect to these two tests, patent exclusivity actually serves to enhance patient access. Epidemiologically the two syndromes are quite similar – both have a similar prevalence in the overall population and in cancer populations, both can result in drastic increases in the risk of developing cancer, and breast and colon cancer are two of the leading causes of cancer death in the country. Prior to the Myriad decision there were 15 providers of full sequence Lynch syndrome testing in the US, and only one authorized provider of full sequence BRCA testing (Myriad). However, in the period from June 2010 through March 2013 nearly 5 times as many patients in the US received BRCA testing than testing for Lynch syndrome (339,294 vs. 70,294).

One explanation for the discrepancy could lie in the relative quality of the tests. The turnaround time for Lynch syndrome testing results is reportedly longer than that of Myriad’s BRCA tests, and the VUS rate is much higher for Lynch syndrome (15-30% for non-Myriad Lynch testing vs. 3% for Myriad BRCA testing). The amicus brief filed by LSI specifically noted the superiority of Myriad’s BRCA test, which LSI attributed to the patent exclusivity enjoyed by Myriad with respect to the BRCA genes.

Increased public awareness of BRCA testing relative to Lynch syndrome testing is likely to account for much of the discrepancy in usage of the tests. The SACGHS Report specifically found that the “incentive to advertise the service and broaden the market is stronger for a monopoly provider than in a shared market because a monopolist will gain the full benefit of market expansion.” According to the Report, one of the social benefits of patents is that they incentivize an exclusive test provider like Myriad to invest in creating more public knowledge of the availability of genetic tests. The Report acknowledges a clear “link between [Myriad’s] status as a single provider and incentives for direct-to-consumer advertising, with single provider status in this case associated with exclusive patent rights for BRCA testing.”

A Center for Disease Control (CDC) survey found an increase in BRCA test requests and questions about testing among women, and an increase in test-ordering among physicians and providers, in cities where Myriad invested in direct-to-consumer “public awareness campaigns.” The SACGHS Report noted that “[t]he overall impact of a DTC advertising campaign on the Kaiser Permanente health system in Denver was a more than two-fold increase in number of women in the high risk category getting tested, a more than three-fold surge in contacts about testing.” Another study showed that high-risk women—those eligible for BRCA testing based on family history—were three times as likely to get tested following a physician recommendation as those who did not get such a recommendation.

Ironically, while Myriad fought to inform patients and healthcare providers about the availability of BRCA testing, many policymakers argued in favor of restricting patient access to the results of these tests. For example, the Working Group of Stanford’s Program in Genomics, Ethics and Society recommended that ‘for most people, testing for BRCA1 and BRCA2 mutations is not appropriate.’ Similarly, NIH director Francis Collins testified before Congress that the results of genetic testing for BRCA mutations should generally not be made available to patients. With respect to BRCA testing, patents have played an important role in empowering patients to take control of their own their own genetic information, in the face of a medical establishment that sought to limit patient access to this information.

One of the most formidable obstacles facing patients in need of genetic diagnostic testing services is insurance reimbursement. Patents play an important role in overcoming this obstacle, by providing an incentive for patent owners to work with insurance companies to ensure that a maximum number of patients will be able to get insurance reimbursement for testing. For example, in 1995 only 4% of insurance providers allowed reimbursement for BRCA genetic testing. By 2008 Myriad was able to report that it had established contracts or payment agreements with over 300 carriers and has received reimbursement from over 2500 health plans, reducing the number of self-pay patients to single-digit percentages of its clientele. By 2010 BRCA genetic testing in the U.S. was covered for roughly 95% of those requesting tests, and reimbursed to cover 90% of their charges. In contrast, non-profit diagnostic testing services in many cases charge patients upfront for genetic testing, and require patients to seek their own reimbursement from their insurance company, which can be slow in coming, assuming it comes at all.

Conclusion

Arguments in favor of reining in the availability of effective patent protection in the area of genetic diagnostic testing are based largely on two fundamental misconceptions regarding the role of patents in this important area of technological innovation. The first is the mistaken assumption that patents negatively impact patient access to genetic diagnostic testing by preventing research that might lead to new or improved versions of a genetic test and by increasing the cost of testing services. The second is the failure to appreciate the substantial positive role patents play in in the development and utilization of genetic diagnostic tests. In fact, patents have little if any negative impact on basic research, and have been proven to significantly improve patient access to advanced diagnostic testing services by incentivizing the substantial investment that is necessary not only to bring these tests to market, but also to educate patients and their doctors with respect to the availability of the tests, and to work with third-party payers to expand patients’ eligibly for reimbursement. Next-generation technologies are poised to dramatically improve healthcare and patient outcomes, but this will only occur if effective and enforceable patent protection is available as the necessary spur for innovation and commercialization.

Supreme Court Says Aereo has to Play by the Rules

Post author By Joshua Grove
Post date June 25, 2014

Today in American Broadcasting Companies, Inc. v. Aereo, Inc. the Court held that Aereo’s television service, which re-transmits over-the-air TV signals to subscribers does indeed transmit performances to the public within the meaning of the Copyright Act.

Aereo tried to engineer its system around the law by using individual micro-antennas assigned to each subscriber. An appellate judge below described this system as a “Rube Goldberg-like contrivance.” Aereo’s system was a case of legal engineering rather than technical innovation, as it was hard to see any purpose for its design beyond exploiting perceived loopholes in the law.

The Court today chose to look to the clear result and commercial purpose of Aereo’s system, rather than the superficial appearances created by Aereo’s technical design. In doing so, it returns to Congress’s intent under the 1976 Copyright Act to define the rights of copyright owners in a technologically neutral way.

Contrary to critics, it is important to note that this decision does not make Aereo or its technology, illegal. Instead, it simply confirms that copyright owners and broadcasters continue to have the right to decide how their property is used and sold by commercial resellers. In other words. Aereo must play by the rules just like everybody else does — cable systems, Netflix, and broadcasters themselves. Among other things, they need to pay in the first place for what they are re-selling to consumers.

Despite what some are saying, this decision is a boon, not a threat, to innovation. Studios and TV networks are investing hundreds of millions of dollars into new business models and are licensing their creative works to dozens of new entrants. They can now continue to make these innovative investments with greater certainty that they wont be undermined by overly-technical interpretations of their rights.

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