mofo digital content: who owns the consumer? trade...

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INFORMATION, TREND-SPOTTING, AND ANALYSIS FOR SCIENCE AND TECH-BASED COMPANIES FROM MORRISON & FOERSTER LLP

SPRING /SUM

MER 2012

Patent PendingShifts in patent law—and their impact—extend beyond the new America Invents Act

HOW THE

ITC WORKS

SPECIALREPORTINSIDE!

DIGITAL CONTENT: Who owns the

consumer?

TRADE SECRETS: Catching thieves

LIABILITY: Is being a corporate

officer a crime?

SOCIAL GOALS: Do good with

less risk

Our clients are innovators, scientists, and business leaders like you. Today, more than ever,

technology companies need the best legal advice and strategic counseling to drive their

ideas to success in the global marketplace. That’s why tech leaders turn to us for business-

minded solutions to their most complex legal issues, and that’s why we were honored to be

selected as “Law Firm of the Year” in Technology Law.*

Morrison & Foerster tops in tech

* Based on a U.S.News - Best Lawyers® 2011 survey. Rankings are based on client and peer feedback regarding expertise, responsiveness, understanding a business and its needs, cost-effectiveness, civility, referral likelihood and integrity. © 2012 Morrison & Foerster LLP | mofo.com

U.S.News - Best Lawyers ® Names MoFoTechnology “Law Firm of the Year”

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MoFoTech

It’s tempting when legal news tops the headlines to assume that the stories grabbing both column inches and airtime are the most important stories of the day. The truth is, there’s always more news than fits in print (or on the screen). There’s the back story. But there are also all the related stories, many of which are truly more compelling and wide ranging in their impact. So it was, a few months back, with two key stories of critical interest to the readers

of MoFo Tech: the passage of patent reform through the America Invents Act and the rejection of two bills focused on Internet piracy—SOPA and PIPA. As we explain in this issue, the good news surrounding AIA only hints at a host of positive changes that are likely to benefit everyone (page 12). And the dustup over piracy (page 10) obscures some of the deeper issues that are now roiling the U.S. movie industry.

INFORMATION, TREND-SPOTTING, AND ANALYSIS FOR SCIENCE

AND TECH-BASED COMPANIES FROM MORRISON & FOERSTER LLP

SPRING/SUMMER 2012

12 Cover Story

The Quiet RevolutionWith the passage of the America Invents Act, is the patent system becoming fairer and more rational? 4Plus! How the ITC works

Feature

Digital Entertainment:Rolling in the DeepIndustry problems run deeper than piracy.

Equity without liquidity is not an incentive. —Jeff Thomas, senior vice president, SecondMarket, page 19

DatagramRisk & Responsibility:Pursuing sustainability with less backlash.

First Mover Show Them the Money: New liquidity options for startup investors and employees.

RebootTo Catch a Thief: Trade secrets: Now more enforceable—and more important.

Printed on recycled paper

TM

Log In 4 Fraud allegations make life uneasy

for Chinese issuers. 4 Proposed guidelines for biosimilars.

Focus 4 Saving energy by sharing information.

Aggregator 4 Good governance and outsourcing. 4 China: Innovation for sale.

Support 4 Executives unwittingly

facing liability. 4 Should you choose a generic domain?

Critical Mass 4 Paving the path from startup to IPO. 4 New limits on the discovery process.

Follow-Up 4 California goes nontoxic. 4 Public input on online privacy.

3 Visit the enhanced electronic version of MoFo Tech by scanning this QR code.

SPECIAL REPORT!

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On a Different Path Brand-new FDA guidelines have created a long-awaited shortcut for bringing biosimilars—cheaper versions of biologically derived pharmaceuticals—to the U.S. market. But the pathway won’t be nearly as straightforward as the one for generic versions of less complex, chemically based drugs that was created under the Hatch-Waxman Act in 1984.

Unlike the Hatch-Waxman route, the biosimilar guidelines is-sued in February call for drug mak-ers to be in regular contact with the FDA during virtually every step of the development process, explains Morrison & Foerster attorney Cary Miller. Many decisions will be made on a case-by-case basis. “I think the approval process will evolve as companies develop their products,” she says.

“The uncertainties associated with the new process could spur companies to forgo it in favor of the traditional licensing process,” adds Stephanie Hsieh, Of Counsel at Morrison & Foerster. Some have also raised concerns about the amount of confidential information an applicant might have to disclose through the new process.

Despite the difficulties, it ap-pears that many companies will press on with biosimilars efforts. One research firm has estimated that U.S. sales of biosimilars could reach $8 billion by 2020.

—Jennifer Pilla Taylor

t wasn’t anything like Madoff, but it was still pretty juicy: Some 50 pri-vate foreign companies—especially from China—had achieved listings on U.S. exchanges via reverse merger or reverse takeover (RTO) with dormant publicly traded U.S. shells. The tactic is neither new nor illegal and garnered only passing attention—until several of these companies collapsed, exposing an allegedly long-running fraud by stock promoters and others.

The alleged fraud resulted in staggering investor losses in these companies, vaporized market caps, and a rash of securities fraud class-action lawsuits. The SEC has prom-ised vigorous scrutiny and oversight. Meanwhile, all the negative attention is making life difficult for legitimate Chinese issuers.

“Along with Chinese RTO firms, Chinese companies that went public through traditional IPOs are also being targeted with investor lawsuits,” says Timothy Blakely, a

litigation partner in Morrison & Foerster’s Hong Kong office and a member of the firm’s Securities Lit-igation, Enforcement, and White-Collar Defense practice. “Plaintiffs’ law firms are closely monitoring Chinese stocks, which could pro-duce a continuing flow of lawsuits against Chinese companies.”

Fraudulent and conspirato-rial activity aside, short-sellers are actively stirring the pot. “We have seen a predictable pattern develop with respect to Chinese companies,” he continues, “where a ‘research’ firm, typically a short-seller, raises questions about the company’s public disclosures, often resulting in a dramatic stock price drop.” Once the company has responded to the allegations, plaintiffs’ law firms announce an “investigation” of the company and then file a class-action suit.

“This has turned into a business for plaintiffs’ lawyers,” notes New York-based Morrison & Foerster

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[ LOG IN ] By Jeff Heilman

Guilt by Association

Fraud allegations make life uneasy for Chinese issuers

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securities litigation partner Joel Haims. “Yes, some Chinese RTO firms have real problems, but many lack the resources or even the interest to defend these lawsuits, so the attention has shifted to le-gitimate issuers where there is real money and a real desire to main-tain a U.S. listing.” The spectacle of short-position holders profiting from stock drops they helped cre-ate has sparked tension between the U.S. and China, as the RTO-spun controversy has triggered a new phase of regulatory oversight and enforcement activity.

“U.S. politicians and regulators are skeptical about China, as are U.S. exchanges, which now seem less willing to grant the benefit of the doubt to companies trying to respond to allegations, short-term difficulties, or less-than-ideal governance practices,” adds Blakely. For their part, some aggrieved Chi-nese firms have stated intentions to sue the short-sellers, while others have threatened to abandon the U.S. capital markets altogether.

Haims sees “no real chance” of the latter happening in any sig-nificant way: “The U.S. is still the go-to market for capital raising.” As Blakely notes, short-sellers are also agitating in other markets. “This is not just a U.S. phenomenon, and retreating from U.S. capital markets will not completely insulate Chinese companies from these forces,” he explains. “Going public in the U.S. is still the right decision for certain companies, and decisions over list-ing or remaining listed in the U.S. should not be driven by short-seller reports, investigations, and lawsuits.”

The smarter route for U.S.-listed Chinese companies, say Haims and Blakely, is to adopt strong corporate governance policies, retain strong independent directors and U.S. ad-visors, get adequate D&O insurance coverage, and stay compliant with financial regulations—including the whistleblower provisions of Dodd-Frank as they relate to the Foreign Corrupt Practices Act.

[ FOCUS ] By Scott Burlingame

Power to the PeopleSAVING ENERGY BY SHARING INFORMATION

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Social media adoption is increasing rapidly. So why not leverage this trend to realize a desired social

outcome, like energy savings? That’s the inspiration behind a joint effort between San Francisco-based startup Opower, Facebook, and the National Resources Defense Council to release an app that empowers people to reduce their use of energy. The app currently allows consum-ers to compare their energy use to similar homes, to friends, and with any group that wants to connect and pursue energy sav-ings. Future features will allow competi-tions between groups, with rewards and incentives provided by participating utili-ties. “Behavior change is a critical element of energy efficiency because it creates

lasting demand for products and services,” observes Theresa Cho, Of Counsel in the Energy and Environment Group in Morri-son & Foerster’s San Francisco office. “The use of peer-to-peer networking such as the joint Facebook project can generate behavior change at an unprecedented level.”

The app is well timed, adds Gabe Meister, a partner in the Technology Transactions Group in the Tokyo office of Morrison & Foerster and co-editor of the firm’s Socially Aware newsletter. “Consumers are ready for this. Social media has empowered users to share information collaboratively, and those same users are acutely aware of the need to save energy. So there is fertile ground for an app like this to take root.” M

“It is telling that the SEC’s initial report about whistleblower tips received since the passage of Dodd-Frank reveals more tips received about China—including U.S.-listed Chinese companies and U.S. com-panies doing business in China—than any other foreign country,” Blakely adds. “The differences in

Chinese business and governance culture, the latter of which is still catching up to U.S. standards, is perhaps most evident in the FCPA context. It’s therefore wise to revisit FCPA compliance policies and practices to ensure that they adequately address legal concerns and business needs.” M


China: Innovation for SaleThe Chinese government has been encouraging overseas pharmaceu-tical companies to outsource R&D to Chinese firms—part of an effort to move into more high-value work. The draw: a growing, cost-effective bioscience talent pool made up of both local graduates and “sea turtles” who went to U.S. universities and returned, accord-ing to Morrison & Foerster partner Gordon Milner.

Global pharmaceutical compa-nies find access to that workforce appealing, but some caution is in order when dealing with R&D. Con-trary to what many people think, Milner says, China now does have fairly comprehensive IP laws in place. However, they are designed to help Chinese companies retain rights to innovations they produce for an outsourcing partner, and in general, “make the IP stick in China.” That makes IP protection more complex, but not an insur-mountable issue. Contracts need to be written with those Chinese laws in mind. But protection also needs to include practices such as enhanced data security, ensuring that facilities have the physical security to keep research safe, and compartmentalizing data, so that a given partner does not have a full enough picture of an innovation to be able to lay claim to the work.

More companies are implementing cloud-computing solutions, lured by the promise of lower costs and

the ability to adjust capacity as needed. While many companies have focused on cost, flexibil-ity, and security when choosing their vendors, they shouldn’t overlook governance, or the de-gree of control the company can exert over its own data. Good governance is key for reducing the legal and regulatory risks a company might face by storing its data in the cloud.

Before adopting a cloud-computing solu-tion, a company should identify the gover-nance tools and procedures it will need and then determine whether and at what cost its cloud-computing vendor of choice can offer them, says Russell Weiss, chair of the Los Angeles office Technology Transaction Group at Morrison & Foerster. “For example, a hospital that stores medical records in a cloud environment needs to ensure that its cloud-computing vendor offers data verifica-tion and search tools needed by the U.S. Department of Health and Human Services to conduct periodic audits to ensure compli-ance with the HIPAA Privacy and Security Rules,” Weiss says. “If a hospital fails to iden-tify its need for these tools before entering

into the services agreement with a cloud-computing vendor, the hospital is at risk of being in violation of its HIPAA obligations, or at risk of being overcharged by the vendor for access to these tools after signing the agreement.”

Another oft-overlooked governance tool is the ability to create customizable searches of email messages and other documents stored in the cloud. “When a company is served with a subpoena, it needs to be able to search and identify those documents stored in the cloud that may be responsive to the subpoena,” Weiss notes. “A company must produce these documents on the same basis and timeline as physical copies of documents stored in the company headquarters.” If the company does not have the necessary tools to identify and search these documents, it might be found to be in contempt of court.

It might not seem obvious, but legal considerations should play a role in choosing a cloud vendor and negotiating the contract, Weiss says. “By conducting the necessary due diligence before entering into a cloud-com-puting services agreement, a company can greatly increase the likelihood that its foray into cloud computing will be successful.” M

Keep Control in the Cloud

[ AGGREGATOR ] By Peter Haapaniemi

Good governance practices in the cloud reduce future risks and costs

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Access to the Chinese workforce is appealing, but caution is still in order.

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[ SUPPORT ] By Eric Schoeniger

As a semiconductor manufacturer, how would you—or your competitor—like the exclusive right to the Web domain suffix “.chip”? The Internet Corporation for Assigned Names and Numbers is accepting applications for new generic top-level domains that can be comprised of virtually any name or number string. Top trademarks and brands have taken notice. “Some trademark owners worry this will create problems, for example if an entity applies for their trademark as a top-level domain,” observes Rosemary Tarlton, a partner in Morrison & Foerster’s trademark practice. While some companies might consider applying for defensive purposes, Tarlton sug-gests it may only be worth the effort “if the company also has business strategies that make it worth doing—like enhancing brand image, building secure communities for customers and trading partners, or improving

segmentation and targeting.” Apply-ing is expensive (it costs $185,000, plus $25,000 per year), and chal-lenging (there are stringent business and technical requirements). “It’s probably a better idea, in general, to continue to handle domain-name cybersquatter threats through the traditional means of cease-and-desist letters, UDRP arbitration actions, and lawsuits under the ACPA or other equivalent statutes,” Tarlton says. —Scott Burlingame M

From .com to .younameit

L egal principles traditionally shield corporate officers and employees from criminal liability for violations by their

companies in which they did not take part. An exception is the Responsible Corporate Officer Doctrine, or RCOD, which holds executives criminally liable for corporate activities that occur on their watch—even if those executives had no knowledge of the wrongdoing.

Over the past 60 years the RCOD has sel-dom been applied. But now the FDA and other agencies are increasingly citing the doctrine. “The targets increasingly are health care and life sciences companies,” points out Morrison & Foerster associate Demme Doufekias, whose practice focuses on federal investigations.

“Some in government believe that even fines in the billion-dollar range aren’t a big enough deterrent to alleged violations,” says Morrison & Foerster partner Bob Salerno, who focuses on white-collar criminal litigation. “So now they’re focusing on individuals.”

They’re also seeking jail time and adminis-trative sanctions that would effectively prevent convicted individuals from working in the health-care industry. One recent case involved U.S.-based KV Pharmaceutical, which pro-duced and distributed mislabeled morphine tablets. The company’s CEO was ordered to pay a $1 million fine, forfeit $900,000 in gains, and serve 30 days in jail.

To protect yourself and your company, take steps to minimize potential risks. Doufekias and Salerno offer some recommendations:

n Work top-down: Set a clear tone of com-pliance and transparency at the top of the organization, and make sure you communi-cate that throughout the organization, with specific training for appropriate roles.n Assess your risks: Focus on areas most likely to be high-risk factors in your compa-ny. For example, if you do business interna-tionally, your biggest risks might involve the Foreign Corrupt Practices Act.n Ensure quality assurance: A history of quality-assurance problems will weigh against you.n Enforce compliance: You should be able to demonstrate to regulators that you have a robust compliance program and that you can quickly uncover, report, and resolve problems.n Audit and remediate: Conduct periodic audits of high-risk business activities. If you lack the expertise or resources for an internal audit function, seek the help of a reputable, experienced vendor. “That’s especially impor-tant for smaller companies, which sometimes grow faster than their regulatory expertise can keep pace with,” Salerno notes.

“The Responsible Corporate Officer doctrine provides prosecutors with tremen-dous leverage against corporations to extract criminal pleas, settlements, and higher fines,” concludes Adam Hoffinger, a Morrison & Foerster partner whose practice focuses on white-collar criminal matters. “Taking sensible, proactive steps can help mitigate the associated risks.” M

Who’s in Charge Here?Executives face liability for crimes they don’t know about

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Go Public, Young Co.nitial public offerings attract capital that drives business growth, job creation, and even industry expan-sion. But if startups are unable to raise capital efficiently, they may never make it to an IPO stage, and all that promise may become missed opportunity.

That’s one of the concerns behind the bipartisan Jumpstart Our Business Startups (JOBS)Act, which has broad support from President Obama and Congress.

New legislation aims to pave the path from startup to IPO

“There are costly administra-tive and regulatory requirements that often cause companies to avoid IPOs and to seek out other liquidity opportunities,” says Mike Rosenberg, an associate in Morri-son & Foerster’s Capital Markets Group. “This bill would reduce those hurdles by phasing in many of the costliest disclosure and re-porting obligations, while retain-ing key investor protections.”

The bill would create a new category of issuer, an “emerging growth company,” for companies that have annual gross revenues under $1 billion. Qualifying companies would benefit from phased-in regulatory require-ments. This means that a compa-ny that completes an IPO would ease into compliance with many of the most burdensome and costly regulatory requirements over time, as it grows and has the revenue and infrastructure to address them.

The legislation could be a particular boon to tech startups, many of which are hatched by young entrepreneurs blessed with a wealth of ideas but little cash.

In a rare act of bipartisanship, both the U.S. House and Senate passed the Act (H.R. 3606) by large margins. As MoFo Tech went to press in March, the bill was headed to President Obama’s desk for signature into law. M

[ CRITICAL MASS ] By Eric Schoeniger

For companies daunted by the high cost of intellectual property litigation, some relief may be at hand in the form of proposed limits on the discovery process.

A council that advises the U.S. Court of Appeals for the Federal Circuit last year decried the use of discovery as a “tactical weapon.” It pinpointed the increasing size of requests for electronic documents, noting “disproportionate, over-broad email production requests” that “have a debilitating effect on

litigation.” Less than 1 in 10,000 electronic documents produced in discovery ends up on the exhibit list, the council estimated.

The council issued a new Model Order, which specifies that each party may request email retained by only five people—known as cus-todians—and five search terms per

custodian. If one side wants more emails, it must pay for the cost of production.

The U.S. Court of Appeals for the Federal Circuit is the appeals court for patent cases. Judges for the U.S. District Court—where patent cases are heard first—are not required to adopt the new order. But it was adopted recently by a magistrate in a case in the Northern District of California, and Morrison & Foerster partner Brian Kramer says he expects more

judges to do the same. “This is going to save litigants

a lot of money by forcing people to think about what discovery they really want earlier, rather than just asking for everything,” Kramer says.

He adds that this fee-shifting provision is one of the most intriguing aspects of the model order. “Any time you have an op-portunity to send your opponent a bill, it makes things interesting.”

– Jennifer Pilla Taylor

The End of Fishing Season

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The JOBS Act incorporates a num-ber of measures that are designed to promote capital formation, including an “on ramp” for compa-nies that choose to go public.

The primary goal is to cre-ate jobs, as studies suggest that 90 percent of job growth occurs after a company goes public. And the average time to go public has stretched from 4.8 years in the 1980s to 9.4 years today, according to Thomson Reuters.

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C ontinuing its tradition of cutting-edge environmental reform (see “Clean-tech’s Hothouse,” MoFo Tech, Fall/

Winter 2011, page 2), California is close to releasing a series of regulations for the use of toxic chemicals in everyday consumer products. The state has chosen to build an ambitious new system from the ground up that will call on manufacturers, importers, retailers, and others to limit or even ban certain chemicals.

The Green Chemistry regulations promise to shake up the entire value chain of producers of com-mon household products like toys, cleaning items, and personal care products. “The regulation of toxic chemi-cals in consumer products is probably the most important environmental regulation that will come out in the U.S. this year,” says Peter Hsiao, head of Morrison & Foerster’s Envi-ronment and Energy Group in Los Angeles. “This will affect a manufacturer’s global supply chain, who they procure from, how they do quality control, everything.”

California is expected to arrive at final regulations and release a list of about 3,000 “chemicals of concern” this year. The state will study an initial group of priority chemicals in common products. Each review will consider potential exposure effects, how products containing the chemical are disposed of, and whether a less toxic substitute can be found.

William Tarantino, a Morrison & Foerster partner who focuses on environmental and consumer protection law, warns that Califor-nia’s Department of Toxic Substances Control, charged with cleaning up hazardous waste,

is taking on a vast and potentially expensive responsibility just as California faces declining resources. The state has also chosen to build a program from scratch and, from industry’s perspective, has not adequately studied how it can take advantage of work that has already been done in the EU and elsewhere. Tarantino says the EU has reached out to California because of concern that California regulations could impact global trade. “California has an

opportunity to be the first state in the U.S. to develop

a science-based sustainable

chemistry program, and it is critical that Califor-nia coordinate that effort with coun-tries that are

farther along than we are. Nobody wants this program to be an only-in-California phenom-enon,” Tarantino says.

The U.S. currently has an outdated federal statute regulating toxic chemicals in consumer goods. Both the federal government and many states are watching California’s initiative, and the U.S. EPA has entered into a memorandum of support. “Let California blaze the trail and they will follow,” Hsiao says.

Before long, California could ban certain chemicals, limit their use, or require their substitution when possible. Violators may be fined or added to a failure-to-comply list.

It is not too soon for California compa-nies to begin auditing their products that include chemicals likely to be targeted by the state, Hsiao adds. They should also prepare to negotiate with regulators about require-ments and possible exemptions. “Companies should be asking themselves, ‘If this chemical gets regulated, what will I do?’” M

California Goes NontoxicThe state passes an unprecedented green initiative

[ FOLLOW UP ] By Gary Stern

Re Advertising: Public Input on Online PrivacyIn late February the Obama administration unveiled a “Consumer Privacy Bill of Rights,” drawn up by a U.S. Department of Commerce task force, based on principles including individual control, transparency, respect for context, and security. Over the coming months, the Department of Commerce will bring together companies, privacy advocates, academics, and other stakehold-ers to develop a code of conduct aligned with the Bill of Rights. Adoption of the code would be voluntary, but companies that claim to be in compliance of any code of conduct are subject to Federal Trade Commission enforcement if that representa-tion turns out not to be accurate, notes D. Reed Freeman Jr., a Mor-rison & Foerster partner focused on consumer protection law.

Any company that advertises or delivers advertising on the Internet will want to be involved in this discussion, Freeman says, whether directly or through their trade association. The process will be managed by Commerce’s National Telecommunications and Informa-tion Administration; the full report on the Bill of Rights is at Ntia.doc.gov. “Through a stakeholder-yield-ed code of conduct, the adminis-tration wants to allow for privacy protection for customers, but have it in a way that is flexible enough to respond to changing technologies and business practices,” Freeman says. —Richard Sine

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Short-term financialpressures/recession

Lack of recognition fromfinancial markets

Uncertain or insu�cientpolicy frameworks

Uncertain return oninvestment

Lack of models or bestpractice case studies

Lack of senior executivesupport

Complexity ofimplementation

Competing strategicpriorities

Lack of internal expertise

Barriers to Addressing Climate Change

In January, the California legislature created a new kind of com-pany: the Flexible Purpose Corporation. This is the latest effort to create a corporation targeting social purposes alongside sharehold-er value. The traditional corporate form does not prevent compa-nies from pursuing social goals; the corporate “business judgment rule” allows boards and managers to weigh environmental and social factors when considering shareholder interests. In practice, however, those factors are often put on the back burner due to concerns about short-term results and shareholder lawsuits.

“Most of the incentives run counter to looking ahead to the long term or doing anything that could jeopardize today’s bottom line,” says Morrison & Foerster partner Susan Mac Cormac, who co-chaired the group that formulated the new legislation. Typical-

ly, too much emphasis on social issues that does not translate into improved financial performance is seen as risky—and avoided.

FPCs are required to identify social and/or environmental pur-poses in their charters, pursue them, and report annually on prog-ress. “The premise is that management agrees with shareholders on one or more social purposes. They have a fiduciary duty to them,” she explains. As a result, directors and management are largely protected from liability when they make these decisions.

Existing corporations can merge into or convert into an FPC with approval of at least two-thirds of shareholders. “It takes time for corporations to change, but we may not have a lot of time left to meet our social and environment challenges,” says Mac Cormac. “The hope is that this will help speed things up.”

[ DATAGRAM ] By Peter Haapaniemi Charts by Alex Reardon

Risk & Responsibility

New corporate form lets companies pursue sustainability with less chance of backlash

New Forms for New Challenges

Business is playing a growing role in addressing issues like the environment, social problems, and resource usage. Some companies have “bent” the traditional corporate form to include sustainability as a goal. But that approach often has limited success, and it can create legal risks for management and board members. Thus, over the past decade, new types of corporate forms have emerged aimed at balancing the traditional focus on profits and shareholders with the new mandates for social and environmental action.

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FLEXIBLE PURPOSE CORPORATIONThe idea: Company must focus on at least one spe-cial purpose beyond profits, such as sustainability.What it means: n Directors’profit/special purpose trade-off deci-

sions are legally protected. n Requires annual reporting on special purpose.n Retains legal robustness of traditional corpora-

tion; suitable for large and small companies. Where it’s in effect: In CA since January 2012.

BENEFIT CORPORATIONThe idea: Company is required to create a gen-eral benefit for society and shareholders. What it means: n Primarily for private,

sustainability-focused companies looking for so-cially responsible capital.

n Requires annual report describing social/environ-mental efforts.

n Significant variation in laws across states.

n Directors must consider a complex range of factors.

Where it’s in effect:In six states, starting with MD in 2010. More states pending.

LOW PROFIT LIMITED LIABILITY COMPANY (“L3C”) The idea: For-profit company that engages in socially beneficial activities.What it means: n Designed to facilitate investments by foundations in

socially beneficial, for-profit ventures.n Offers flexibility/familiarity of LLC partnership form.n May lack protections for management.Where it’s in effect: In nine states, starting with VT in 2008. Active efforts underway in additional states.

Silent SpringRachel Carson’s book on toxic

chemicals and the environment brings environmental issues to

mainstream audiences

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Rethinking Responsibilities

Over several decades, corporate responsibility has moved from theories and manifestos to government policies, global conferences, and a plethora of efforts by corporations focused on embedding it into business. “There has been a clear trend in corporate governance toward increased attention to the environmental and social impacts of business operations and toward bringing sustainability into the business main-stream,” says Mac Cormac. For companies, practicality is key. The new Flexible Purpose Corporation lets companies pursue social goals while receiving protection from liability and availing themselves of mainstream capital.

Long-term Vision, Short-term Pressures

Executives are increasingly aware of the busi-ness value of sustainability. In a recent survey from the corporate responsibility group BSR, 84 percent said that they are optimistic that global business will embrace sustainability in the next five years. “A lot of large companies really get it, because they know that this is coming and they see the potential for com-petitive advantage in making the shift,” Mac Cormac says. But obstacles remain. For example, when asked about barriers to addressing climate change, respondents in the BSR survey cited “short-term financial pres-sures” and “competing strategic priorities.” Those barriers are especially difficult to over-come under the traditional corporate form.

Percentage who selected “a very significant barrier” (5) plus (4) on a 5-point scale, where 1 is “not at a barrier,” and 5 is “a very significant barrier.” See bsr.org/reports/BSR_Globescan_State_of_Sustainable_Business_Poll_2011_Report_Final.pdf

First Earth DayNationwide teach-ins and demonstrations help build

momentum for environmental legislation in U.S.

Limits to GrowthControversial Club of Rome report foresees

resource depletion and extensive pollution.

Energy CrisisArab oil embargo drives up

price of oil, underscoring developed world’s dependence

on finite resources.

Climate ChangeDebate about long-term effects of greenhouse

gases begins, prompted by EPA/National Academy of Sciences report; becomes main-stream political and business issue in 1990s.

Constituency StatutesU.S. states begin passing laws that allow corporate officials to consider the interests of a

variety of stakeholders, not just shareholders, in carrying out duties.

Earth SummitThe Rio Declaration on

Environment and Development outlines 27 key principles for

sustainable development.

Global Reporting InitiativeNonprofit organization pro-vides businesses with glob-

ally applicable sustainability reporting framework.

Dow Jones Sustainability Indexes

Tool helps investors identify companies that

follow principles of sustainable development.

U.N. Global CompactU.N. initiative launched

to encourage businesses worldwide to adopt

sustainable and socially responsible policies and

report on their efforts.

Carbon Emissions TradingEurope adopts the

first emission-trading law, setting a market

value for carbon dioxide.

Kyoto ProtocolFirst agreed to in 1997,

greenhouse gas reduction protocols take full legal effect.

CEOs Weigh InChief executives of GE and

Wal-mart deliver high-profile speeches supporting green

business and sustainability.

G8 Cuts EmissionsThe group of industrialized

nations agrees to cut greenhouse gas emissions

in half by 2050.

Benefit CorporationsFirst U.S. state passes law creating

a corporate form designed to benefit society and shareholders.

ISO 26000 StandardVoluntary corporate

responsibility standard established for areas such as the environment, community

involvement, and development.

Sustainability ROIHarvard Business School paper reports that the stock of companies with a sustainability focus outper-formed those without such a focus.

Flexible Purpose CorporationFirst U.S. state passes law creating a corporate form that that supports the convergence of business profitability and sustainability.

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SThe U.S. movie industry is scrambling to avoid a similar fate. While it lost the recent high-profile dustup over proposed legislation—the Stop Online Piracy Act (SOPA) and the Protect Intellectual Property Act (PIPA)—aimed at enlisting the U.S. government in cracking down on rogue foreign sites offering down-loadable movies, that defeat also obscured the industry’s myriad forays into devising market-based solutions. These are less about thwarting pirates than about meet-ing customers’ demand for convenience and affordabil-ity, the absence of which is the pirates’ real opening.

The industry’s new Holy Grail is the ability to offer premium digital content that can be purchased once and is viewable at any time on any screen, notes Paul Jahn, a partner in the Licensing and Technology Transactions practice in Morrison & Foerster’s San Francisco office. Consumers would, in effect, be buying a digital license to stream content for viewing on a wide range of registered devices—similar to iTunes’ arrangement. The library of digital content owned by the consumer would reside in the cloud, in a “digital locker” to which consumers could get near-immediate access. For consumers, streaming gets around the problem of limited disk space and pro-tects against digital obsolescence when devices change; providers like streaming content because it is significant-ly harder to pirate compared to downloads.

Rolling in the Deep

hortly after the rude arrival of Napster, the pioneering peer-to-peer file-sharing site, in 1999, this uninvited guest was eating the music industry’s lunch and eyeing its supper too. Within a year, Napster could offer Madonna’s single, “Music,” even before its commercial release, and by 2001 it had more than 26 million users worldwide. Adverse court rulings forced Napster’s bankruptcy that same year, but the sophisticated piracy it heralded would take a huge bite from the music industry, which now takes in less than half of its 1999 revenues and supports about half as many direct employees—currently less than 10,000.

[ FEATURE ] Digital Entertainment

Piracy might get the headlines, but industry problems—and solutions—run much deeperBy Ken Stier • Illustration by Matt Herring

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“ The idea is to enable the consumer to make a digital purchase with the same confidence as a physical purchase.” —John Batter, M-GO

Numerous industry initiatives are aiming for this goal. One of the most popular is UltraViolet, which is backed by the roughly 70 consumer electronics manufacturers, technology providers, and studios of the Digital Entertainment Content Ecosystem (or DECE). “The idea is to enable the consumer to make a digital purchase with the same level of confidence as a physical purchase. It will be there when they want, it will be there for many years, it will be available across myriad devices,” explains John Batter, CEO of M-GO, the consumer-facing brand of MediaNavi, the digital distribution joint venture formed by Technicolor and DreamWorks Animation. As part of UltraViolet, M-GO has its own digital locker system—as do Disney, Amazon, and many others—and its own library of content that will not be offered via UltraViolet. (Apple, naturally, has its own ecosystem.)

Delineating lines of cooperation and competition among a complex constellation of players—hardware, software, content, and cloud services providers—is far

more about deal structuring than about copyright issues, explains Jahn, who helped DreamWorks structure the deal that created M-GO. “There are a lot of questions about how you structure the economics of the distribu-tion—how do you incentivize the studios to participate, to make it studio friendly, who gets what margins—so that it is a win-win for everyone to participate,” Jahn says.

The new platforms have triggered a complex dance within the industry, with players striving to forge crucial partnerships without ceding too much revenue potential. The problem for studios is that the purchase models (both physical and electronic) garner far more revenue per view than do rentals or subscription services, but increasingly, consumers prefer the latter. The UltraViolet platform, which is essentially a digital rights management authentication system, is some-thing of a hybrid, giving users unlimited online access to movies once they’ve purchased a DVD.

Retailers also face compressed margins, and to date few retailers have signed on to UltraViolet. Even the UK retailer Tesco, a DECE consortium member, has not yet supported the platform, instead throwing its lot in with a digital locker devised by its subsidiary Blinkbox. Ama-zon, the largest retailer yet, joined in January, about the same time that Netflix pulled out. At the annual Con-sumer Electronics Show, the DECE said it has 750,000 UltraViolet accounts in U.S. households since launching in October and anticipated “exponential” growth even though only 100 titles are expected to be released in this year, adding to the 19 that became available in 2011.

That low number illustrates the challenge in find-ing mutually felicitous business arrangements. Digital distribution has disrupted traditional models in a number of ways, says Russell Weiss, chair of Morrison & Foerster’s Entertainment and Media Group. “There are a lot of moving parts, and you have to be able to think through them and understand how one part is going to interact with the others.” Technology has empowered consumers, who are ever more demanding (witness how quickly illegal streaming services sprang up to serve fans of basketball’s New York Knicks in the monthlong standoff between Time Warner Cable and Madison Square Garden). And the proliferation of devices has blurred the lines of distribution. Soft-ware companies are moving into manufacturing, and consumer electronics makers will also become content providers. Both Apple and Google will soon offer smart TV sets that search the Web for content. Then there is Verizon—primarily a phone company—which is team-ing up with Redbox, the DVD rental kiosk operator (owned by Coinstar Inc.), to offer Web streaming. Like cable companies with their triple plays, more compa-nies will try to offer multiple and bundled services.

“Distributors must secure broad rights that permit the digital distribution of content across a wide array of devices,” says Weiss. “The negotiations between distributors and content providers always involve a fight over defining the scope of the specific digital distribu-tion rights being granted.”

The survival struggle comes amidst a markedly shrinking market. From a peak of $14.1 billion in 2004, U.S. consumer purchasing of video content—both physical and digital—has dropped nearly 30 percent to less than $10 billion last year. The IHS Screen Digest projects this could drop another $2 billion by 2015. The entertainment industry has not always known how to play nice in the sandbox. Now that box is shrinking, just as cooperation is more necessary than ever. M

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Once upon a time, patents were supposed to reward—and protect—innovation. That was before the U.S. Patent and Trademark Office (or PTO) got snowed under with applications, slowing the patent process to a crawl. Before the PTO started issuing streams of patents that many viewed as vague and overly broad. And before so-called nonpractic-ing entities, or NPEs, began snapping up hordes of patents themselves. Many of these NPEs don’t focus on research or on making products; instead, they’ve used patents as weapons to extract money from organiza-tions that do. Their aims are backed by the threat of highly expensive and drawn-out litigation. As a result, it has sometimes been impossible for companies to know the real costs of marketing a given technology.

For executives in the tech and life sciences indus-tries, it may seem like there has been no improve-ment in this status quo. Business headlines about patents have focused not on reforms but on the global wars between wireless handset makers and the enor-mous prices paid for patent portfolios. Passage of the America Invents Act last fall—the first major reform of the patent laws in nearly 60 years—got compara-tively little attention, and the attention it got focused mostly on alleged shortcomings.

The truth is, not only the AIA but also a series of other developments have shaken up the entire patent system in ways that may well make it fairer and more rational, predictable, and efficient over time. The AIA will have a profound effect, but just as importantly—and even more quietly—the federal courts have moved to defang the NPEs and reduce the sting of litigation in terms of cost and time. These changes won’t be immediate or even very smooth, but then, sea changes rarely are.

THE COURTS SPEAKThe first big spotlight on problems in the patent system was shined by the National Academy of Sci-ences with its 2004 book envisioning A Patent System for the 21st Century. Congress followed the lead of that study with its first crack at major patent reform in 2005. But as that legislation foundered, the federal courts charged ahead with rulings that had a reform-ing impact.

What inspired the courts to make these rulings? For companies in the IT realm, patent litigation has become especially thorny because their complex products often

Patent Reform [ COVER STORY ]

REVOLUTIONTHE QUIET

Look past the headlines about patent wars and policy clashes. Is the patent system really becoming fairer and more rational?

By Richard Sine • Illustrations by Walter Vasconcelos


Though you might not guess it from the name, the International Trade Commission has become an increasingly popular forum for intellectual property disputes. It typically issues rulings much faster than the district courts—the traditional venue—and that’s crucial, given the short lifecycle of many tech products. And while the ITC does not award damages, it is considerably easier to get an injunction banning sale of a product in the ITC than in a district court.

The ITC looks likely to grow even more popular over the next few years. The new America Invents Act severely restricts patent plaintiffs’ ability to name multiple defendants in district court, while the ITC allows plaintiffs to name anyone involved in the manufacture or distribution of a product. And last fall, a federal judge ruled that the ITC could block imports of products made with misappro-priated trade secrets of a U.S. company, even when the theft occurs abroad. (See “Reboot,” page 22, for more details.)

Order at the PortA trade court pulls up the drawbridge for tech that violates patents

depend on dozens of patents. These companies face the threat of huge damages or even an injunction against marketing the product if they are found to infringe even a single (and potentially questionable) patent. Injunc-tions are particularly terrifying as they can grind busi-ness to a halt.

But in a 2006 ruling over eBay’s “Buy It Now” function, the Supreme Court unanimously ruled that a finding of patent infringement should not automati-cally lead to an injunction. In a concurring opinion, Justice Anthony Kennedy grappled with the question of NPEs: “An industry has developed in which firms use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees.... For these firms, an injunction, and the potentially serious sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent.... When the patented invention is but a small component of the product the companies seek to produce and the threat of an injunction is employed simply for undue leverage in negotiations, legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest.”

Since the ruling, it has become quite rare for NPEs to win an injunction, notes Morrison & Foerster partner Jason Crotty, who specializes in complex patent litiga-tion. But injunctions remain very powerful tools for companies suing genuine competitors because they can argue that they’ve suffered serious harm due to the infringement.

More recently, judges have moved to moderate the

damages resulting from patent infringement suits. In a series of verdicts, the U.S. Court of Appeals for the Fed-eral Circuit—which specializes in intellectual property-related appeals from the federal district courts—has rejected or disputed some of the most common theories used to calculate damages.

Last year, the court rejected a jury’s $388 million award—one of the largest patent verdicts on record—to security software maker Uniloc USA after Microsoft was found to infringe a patent to deter unauthorized copying. The award was based on a theory that an infringer should pay 25 percent of expected profits on the product using the patent. The appeals court wants to force plaintiffs to more accurately gauge the impact of the particular patented technology on the customer demand for the product, Crotty says.

Besides being important in their own right, these rulings on damages and injunctions also helped pave the way for passage of the America Invents Act, notes Colette Verkuil, a Morrison & Foerster IP litigator based in Palo Alto. Previous versions of the act had stumbled on disagreements between the IT and life sciences sectors. The IT firms worried that legal enforcement of (sometimes questionable) patents had gone too far. But life sciences firms—with products that often rely on a single powerful patent and which do not face issues with NPEs—favored more vigorous enforcement. By settling issues in the case law rather than via “one-size-fits-all” legislation, judges are making enforcement decisions that are appropriate for each sector, Verkuil says. Mean-while, controversial provisions on enforcement were largely stricken from the AIA.

SPECIAL REPORT

SPECIAL REPORT

DIFFERENT, BUT FAMILIARITC hearings proceed much like court cases, with witness testimony, presentation of evidence, motions, and arguments. Witnesses are examined by both sides, just like in a typical court hearing.

HIGH-TECH CASES, HIGH-TECH DISPLAYSMany of these cases involve complicated technology, which means detailed presentations with flashy graphics and animation. The tutorial of the day might be about the patents covering a feature of semiconductor chips or buttons on a smartphone, for example. They’re high-tech presentations for high-tech cases.

ALL YOU NEED: A U.S. PATENTYou don’t have to be American to demand an “investigation” by this trade court. Complainants (the equivalent of plaintiffs) need only be owners of U.S. patents attempting to block the importation of violating goods. And the complainant does not need to establish that the respondent has a presence in the U.S., unlike in district court. Busey has represented complainants from Japan as well as the U.S.

BUT YOU NEED TO PRACTICE— DOMESTICALLYThe ITC is intended to protect “domestic industry.” So to bring a patent action regarding a technology, the complainant must prove that companies are already “exploiting” the technology domestically, Busey says. That can involve not only manufacturing but also engineering or R&D, and possibly even product servicing or customer service. (So-called non-practicing entities find it difficult to use the ITC because they don’t practice their patents.)

KEEPING THE ORDER IN ORDERThe Customs offices are charged with enforcing the ITC’s orders. But experience shows that enforcement doesn’t always go smoothly, says Busey, as orders are interpreted more or less broadly than parties would like. Parties on all sides should consider meeting with Customs’ Intellectual Property Rights Branch to clarify the scope of the order, Busey recommends. Some companies monitor import data and even hire private eyes to lurk at the ports to ensure that the order is being followed properly.

GLOBAL MARKET, LOCAL DEPOSITIONMany depositions are taken wherever the products are being designed and built. Unlike district courts, there is no limit on the number of depositions that may be filed; the number can exceed 100, boosting the cost of ITC cases.

G. BRIAN BUSEY, A MORRISON & FOERSTER PARTNER WHO SPECIALIZES IN ITC CASES, SPOKE WITH MOFO TECH ABOUT HOW THE ITC WORKS:

ILLUSTRATION BY STEVE STANKIEWICZ

CLOSING THE DOORThe ITC can do more than just block imports of a banned product; it can also issue a cease-and-desist order to prevent the sale of goods already in U.S. warehouses. The provision makes ITC rulings a very powerful tool for stopping a competitor.

JUSTICE IS SWIFTThe ITC has 30 days after a complaint is filed to declare whether an investigation is warranted and to assign it to a judge. The judge sets a target date to complete the investigation—usually about 16 months. The judge’s initial ruling is usually issued within 12 months, and a final decision is made by the ITC. District court cases often require two years or more.

ADDING ANOTHER LAYERMost ITC cases include a staff attorney from the Office of Unfair Import Investigation. These attorneys advise the judge on aspects of the case from the “public interest” perspective. They can file briefs, cross-examine witnesses, and speak with parties privately; lawyers from both sides do their best to influence them.

50’S A CROWDThe respondent’s side can get crowded with manufacturers and distributors; one recent case involved 50 respondents.

BUSIER EVERY DAYAmerican, Asian, and European companies have been keeping the ITC busy with patent disputes over wireless and other technologies even as they also sue in district court. The ITC commenced 69 investigations in 2011, up from 56 in 2010 and only 31 in 2009.

THE ITC EDGEThe ITC’s six administrative law judges are typically well briefed in both patent law and complex technology, which can give them an edge over district judges who are expected to hear a wide variety of civil and criminal cases. ITC cases also lack a jury, which tends to make outcomes more predictable.

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A FAIR SHAKEOther quiet reforms have focused on the courts themselves. The complex legal and technical issues involved in patent cases have led some executives to advocate for more specialization in the district courts, which hear all kinds of criminal and civil cases. In Congress one of the most fervent advocates for patent reform has been Darrell Issa, a California Republican who displays on his office wall 16 patents under his name from his time as a car-alarm manu-facturer. “Prior to coming to Congress, I was part of a number of patent suits,” Issa has said. “I was often struck by the fact that many district court judges either knew little of the applicable law or did not understand the technology involved.”

Issa was co-sponsor of a law that has created a pilot program to enhance the patent expertise of dis-trict court judges. Under the program, a select group of jurists will volunteer to hear a larger percentage of patent cases in their districts and receive special training. The aim is to speed up the disposition of these cases and reduce the rate of reversal on appeal, reducing the cost and uncertainty of litigation.

At the same time, defendants have become

increasingly concerned about the tendency of plain-tiffs to “shop” for district courts that tend to favor them. For example, plaintiffs prefer the Eastern Dis-trict of Texas and the District of Delaware—where plaintiff win rates are just below 50 percent—to the Eastern District of Wisconsin and the Northern District of Georgia, where plaintiff success rates are 10 to 15 percent.

But since the end of 2008, the Federal Circuit has repeatedly ordered judges from the Eastern District of Texas to transfer cases from their district. They’ve directed judges to base venue decisions on factors such as where the parties’ headquarters are located, where witnesses reside, and where employees work.

RADER TAKES THE REINSThe appeals court’s chief judge, Randall R. Rader, has been a major force behind these reforms. The world of intellectual property took notice in 2010 when Judge Rader traveled from Washington to the pine woods of East Texas to try several cases. And last September he returned to the Eastern District to deliver a major speech calling for several reforms:

FAQs: The America Invents ActCould the America Invents Act help reduce the backlog of patents pending before the U.S. Patent and Trademark Office?The PTO has long suffered from budgetary shortfalls, resulting in a backlog of some 670,000 applica-tions. The AIA gives the PTO the right to boost its fees and keep at least some of its own funding. But fees collected above the PTO’s annual appropriation will go into a “reserve fund,” which Congress will still control. And the AIA includes several new procedures that should add to the PTO’s workload. But the PTO director says he’s already started hiring more examiners and upgrading the office’s IT to take advantage of the funding increase.

What does the AIA do to stop frivolous patent suits?The AIA will put an end to a pernicious boon in so-called “false marking” suits. Previously, anyone could sue a company if a product carried a label saying that it was covered by a patent that had expired. The law provided for fines of up to $500 “per offense,” which could add up to hundreds of millions of dollars for popular consumer products. The AIA effectively outlaws these suits. In other provisions, the law restricts a widespread practice by NPEs of filing one suit against a wide swath of defendants. It also inaugurates a handful of new PTO-based procedures that are intended to head off court disputes.

Why did some small inventors and venture capitalists oppose the AIA?The AIA switches the U.S. to a system where the patent goes to the first inventor to file for it, rather than the first person to invent it. Small inventors worry they will lack the legal and eco-nomic firepower to rapidly draw up and file patent applications. But when the National Academy of Sciences studied this issue a few years ago, they found it to be overblown. Big companies often face bureaucratic hurdles to filing that small inventors do not, notes Morrison & Foerster’s Otis Littlefield. And the first-to-file system eliminates the possibility that inventors will have to defend their filings in expensive “interference proceedings.” Finally, the PTO offers special assistance—and discounts on application fees of up to 75 percent—for small inventors.

Small inventors are also concerned that first-to-file will restrict their ability to discuss an invention with potential investors and business partners to gain funding and support prior to a patent filing. While the AIA will affect disclosure policies, it also includes a unique “grace period” that will allow inventors (or others who obtained information from them) to make disclosures as long as the pat-ent is filed within one year of the first disclosure. Like many provisions in the law, this one is a bit vague; the details will likely be worked out in the courts.

Patent Reform [ COVER STORY ]


n Judge Rader noted that IP cases were nearly two-thirds more expensive than others and said the “driving cost” was the discovery process, which dates back to the 19th century. With less than 1 in 10,000 of all documents found in discovery ending up in a trial exhibit, Rader offered the district courts a model order aimed at vastly downsizing the elec-tronic discovery process. (See Critical Mass, page 6, in this issue for more details.)n The judge called summary judgments practice—motions that ask the court to settle issues or wrap up cases prior to trial—“the key to efficient resolution of disputes.” He urged attorneys and judges to present motions for summary judgments whenever possible to end the litigation, or reduce the scope of the case in a way that could lead to settlement.n Judge Rader urged district court judges to make a litigant liable for attorney fees and costs if it can be identified as a “troll,” which he defined as a party that tries to enforce a patent far beyond its actual value. A litigant should also pay up, Judge Rader said, if it is a “grasshopper”—his term for a party that unreasonably refuses to pay a license fee on a strong patent.

The proactive approach by Judge Rader and his Federal Circuit colleagues “show that the Federal Circuit has listened to the bar and to litigants, and is reaching out and trying to remedy perceived prob-lems in real time,” says Mark Danis, a Morrison & Foerster partner with 20 years of IP trial experience.

A HISTORIC MOMENT?Six years in the making, the America Invents Act was finally signed into law last September. The act was applauded by major tech and life sciences industry groups such as the Biotechnology Industry Organization, which proclaimed the bill would “ben-efit all sectors of the national economy by enhancing patent quality and the efficiency, objectivity, predict-ability, and transparency of the U.S. patent system.” But the law has actually spawned considerable controversy in the IP and venture capital communi-ties (see sidebar, page 17).

After the law passed, the PTO launched a “Track One” program in which patentees who pay a higher application fee are guaranteed a decision within 12 months. (The current average wait time is 34 months.) “I think Track One will be beneficial to patentees and should run like a well-oiled machine,” says Otis Littlefield, a Morrison & Foerster partner who has shepherded patents under an earlier ver-sion of the fast-track program.

The AIA declares that patents should be awarded to the first inventor to file for a patent (dubbed “first-to-file”), rather than the first person to have invented the technology (“first-to-invent”). The aim is to avoid costly legal arguments over who was the first to come up with the idea. The change also brings the U.S. into harmony with the rest of the world’s patent systems, which are all based on first-to-file. “This should improve business cer-tainty,” says Littlefield. “It will hopefully be easier to predict—even before the patent is issued—who will have the patent rights here in the U.S. and who will have them in the rest of the world.”

The bill also ushers in a handful of new PTO-based procedures that allow parties to challenge or attempt to strengthen a patent after it has been issued. The goal is to have potential disputes handled more cheaply and quickly than if they had been handled in a courtroom. And the patents that can survive this new gauntlet of challenges will presumably be stronger. “Once these provisions are adopted, going to court may not be as attractive,” points out James Mullen, a Morrison & Foerster partner focused on life sciences IP.

The new procedures have attracted some criti-cism, however. Retired U.S. Court of Appeals for the Federal Circuit Chief Judge Paul Michel worries they may result in some patents facing “back-to-back challenges lasting five years or more,” discouraging investment decisions. But if the law results in pat-ents facing greater scrutiny from the outset, then it should help improve the ability of companies to es-timate those patents’ true value, notes Rufus Pichler, Of Counsel at Morrison & Foerster and a specialist in technology transactions. That’s a key consider-ation in a variety of transactions such as M&A, patent portfolio purchases, or patent licensing.

With 37 sections, the AIA will transform every company’s competitive strategy (including whether a company decides to keep its invention a trade secret, see page 22). But it’s too early to gauge the full impact of the law, notes Mullen. Some of the new procedures will not take effect for a year or more, and some provisions will only affect new pat-ents. Vagaries in the law’s wording will have to be resolved in the courts over the next several years.

But in the long run, the AIA promises greater transparency, objectivity, efficiency, and certainty in the patent system. Meanwhile, the federal courts are taking actions that might not get much notice outside the law journals and blogs, but that are changing the rules of business nonetheless. M

[ COVER STORY ] Patent Reform

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he listless IPO and M&A markets have not been friends to young companies this past decade. “The median time from a company’s initial funding to either an IPO or an M&A exit has nearly doubled since 2000, with IPO exits now taking around nine years,” says Palo Alto-based Morrison & Foerster partner Paul “Chip” Lion, citing Dow Jones VentureSource. “One consequence is illiquidity, which locks up founders, early-stage inves-tors, and employees while hindering growth.”

One creative solution is a private secondary market for hard-to-trade assets, one bright example of which is the aptly named New York-based SecondMarket.

Barry Silbert, formerly an investment banker specializing in corporate restructuring and the sale of distressed, illiquid assets, founded the firm in 2004 initially as an online exchange for restricted stock in public companies. Registered with the SEC and also as a broker-dealer belonging to FINRA, MSRB, and SIPC, SecondMarket has since expanded into other

asset classes including auction-rate securities, bank-ruptcy claims, fixed-income products, and its signature discipline, private company equity. In early 2010, the firm introduced capabilities on its platform that allow investors to “watch” thousands of private companies and receive publicly available information in the form of a newsfeed on their SecondMarket dashboard.

Based in the firm’s San Francisco office, Senior Vice President Jeff Thomas leads business development for SecondMarket’s Private Company Market division. As he explains, the firm remains focused on bring-ing structure and order to a prohibitively inefficient marketplace. “Historically, small growth companies have had unfettered access to the traditional capital markets,” explains Thomas, who worked with private equity and venture capital firms on deal sourcing and structuring at global consultancy Gerson Lehrman Group before join-ing SecondMarket in 2010. “From the mid-’90s forward, however, structural changes, from SOX to high-fre-

[ FIRST MOVER ] By Jeff Heilman

Show Them the Money SecondMarket provides new liquidity options for startup investors and employees

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quency trading to the narrowing of spreads, have effectively closed the door to small- and micro-cap firms.”

In fact, according to a 2010 report from Grant Thornton LLP, the U.S. IPO market is “closed to 80 percent of the companies that need it.” Without research and brokerage cov-erage—the economics aren’t there anymore, says Thomas—and with the market cap for ad-mission to the public equity markets inhospi-tably set at $1 billion, venture-backed startups are stuck in an unnaturally protracted wait for the exit door. “Especially given the state of the economy, it’s impractical to handicap growth by sticking investors and employees with shadowy liquidity prospects,” he says. “Equity without liquidity is not an incentive.”

Not all companies want their employees cashing out equity before an IPO, however. Some fear early cash-outs could threaten relationships with key employees or dilute their control over the company. “While private market trading can be a great vehicle for the orderly sale of securities by employees, some CEOs and boards view it as a negative,” says Lion, who works closely with SecondMarket. “It’s important to manage the process carefully.” Forming close relationships with management teams and educating them on the benefits of the private market are integral to the game plan.

“Our approach is based on making the market work for the company, not the other way around,” says Thomas. “When you go public, the market controls you, through daily stock churn, quarterly earnings pres-sure, and other factors. First, we learn the type of investors a company wants on its cap table. Then, by facilitating trading windows, which essentially set liquidity schedules for their stock, we help to control and optimize

the buying and selling process.” Adhering to strict SEC rules, SecondMar-

ket has created an automated system for pre-qualifying investors, who must meet the “ac-creditation” standard of possessing $200,000 or more in salary over the past three years, or a net worth of $1 million or more (excluding primary residence), and an assumed level of investment acumen and sophistication. Heav-ily concentrated on the institutional side, the firm’s investor base can make informed invest-ment decisions via the “watching” platform, where sellers can disclose select financial and other sensitive data in a controlled environ-ment. With the SEC now closely “watching” the private secondary market, SecondMarket’s diligence is paying dividends: two competitors were recently fined for allegedly misleading and overcharging investors.

Reporting over $1 billion in private com-pany stock transactions since forming its pri-vate company division in 2008, SecondMarket is hitting milestones while also finding itself at an intriguing crossroads. In early February, Facebook, launched the same year as Second-Market, had just announced its monster IPO. Transacting pre-public Facebook shares in 2007 propelled SecondMarket’s private com-pany business into life and has formed the bulk of its trading activity since—but with Face-book now following fellow social media giants Zynga, Groupon, and LinkedIn off the table, some have asked if the model can survive.

“We are maturing into a viable alternative for the many companies still unable to access the capital markets,” says Thomas. “Even if the IPO market starts to turn around and more companies get funded earlier, this will let us work with an even broader range of compa-nies, further enhancing our business.” M

[ FIRST MOVER ] SecondMarket

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“ Our approach is based on making the market work for the company, not the other way around.”

BREATHING ROOM FOR YOUNGCOMPANIES

In a time when young compa-nies, as sparks of renewal for a weakened U.S. economy, need help in forming capital and going public, an inflexible old SEC rule seen as a hindrance to growth is currently under review by Congress. Enacted in 1964—long before startups started routinely handing out stock options to compensate new employees—the “500 Shareholder Rule” requires private companies to publicly disclose financial information once they exceed 499 shareholders and have more than $10 million in assets.

Among several measures introduced in Congress last year aimed at helping small issuers, the Private Company Flexibility and Growth Act sought to raise the 500-shareholder threshold to above 1,000 (in the House version) or 2,000 (in the Senate version). SecondMarket CEO Barry Silbert was among a group of tech community signatories to a December 2011 letter sent to congressional leaders in support of the bills, saying in part that the current rule is “outdated, overly restrictive, and limits U.S. job creation and American global competitiveness.”

According to SecondMarket’s Jeff Thomas, the rule forces entrepreneurs to go public with their financial information before they are ready, limit-ing growth opportunities while proving burdensome on the financial and regulatory fronts. “By modernizing this outdated legislation, private companies will be granted the ability to readily raise capital and hire new employees until it makes strate-gic sense for them to enter the public markets,” he says. n

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MOFO TECH is a custom publication produced for Morrison & Foerster LLP by Leverage Media LLC, Dobbs Ferry, NY. Editorial Director: Michael Winkleman // Editor: Richard Sine // Art Director: James Van Fleteren // Production Director: Rosemary P. Sullivan Copy Editor: Sue Khodarahmi // Cover Illustration: Walter Vasconcelos // Morrison & Foerster: Dave Harvey, Lauren Max ©2012 by Morrison & Foerster LLP. All Rights Reserved. Morrison & Foerster and MoFo Tech are trademarks of Morrison & Foerster LLP. Morrison & Foerster (UK) LLP is regulated by the Solicitors Regulation Authority. A list of Partners of Morrison & Foerster (UK) LLP, a Delaware Limited Liability Partnership, is available at our offices. Leverage Media LLC is a member of the Custom Content Council.

DAVID VORDTRIEDE FOR

MO

FO TECH

By Jennifer Pilla Taylor

hen Bloomberg released its list of the 10 biggest intellectual property verdicts of 2011, the most notewor-thy thing about it may have been that the jury award total was twice that of 2010. The second-most noteworthy: the two largest verdicts weren’t for patent infringement but trade secret misappropriation.

Trade secrets’ spot atop the 2011 list highlights its growing im-portance in businesses’ intellectual property portfolios. Companies are increasingly aware of the value of their trade secrets and are will-ing to sue to protect them, says Eric Akira Tate, co-chair of Morri-son & Foerster’s Employment and

Labor Practice Group. And as trade secret law develops,

the remedies for trade secret theft are becoming more robust, adds Daniel Westman, managing partner for Morrison & Foerster’s Northern Virginia office. Westman says both the top suits from 2011 follow a familiar pattern: American manu-facturers accused ex-employees of stealing trade secrets for use by their foreign competitors. Tate notes that the scenario has become more com-mon because employees are more mobile and technology has made it easier to steal company secrets.

But that same technology has also made it easier to catch thieves,

says Tate. Trade secret thieves may leave behind evidence in text mes-sages or in an online chat. Or they may make the mistake of hooking their smartphone to their work computer and inadvertently down-loading identifiable information.

“There’s always a gotcha,” says Tate. “A company is going to be more likely to sue because they can prove pretty definitively that the ex-employee committed the theft.”

The surge in trade secret litiga-tion is expected to continue. In fact, American trade secret protection appears to be growing teeth. In Oc-tober, the federal circuit ruled that the International Trade Commission could block imports of products made using the misappropriated trade secrets of a U.S. company. The decision gives U.S. companies a way to enforce their trade secret rights against foreign manufacturers that try to sell their goods in the U.S., says Westman (see page 14).

Also last fall, U.S. Senators Herb Kohl and Christopher Coons introduced legislation that would amend the 1996 Economic Espio-nage Act—a criminal statute—to give companies the ability to go to federal court to stop trade secret misappropriation and collect dam-ages. Unlike patent infringement suits, private claims of trade secret misappropriation have to be filed in state courts—where outcomes are less predictable. The legisla-tion wasn’t passed last year, but it has sparked significant discussion about the need for a federal trade secret law.

Trade secrets even got a bit of a boost in last year’s America Invents Act, which allows companies ac-cused of patent infringement to, un-der limited circumstances, claim as a defense that they were practicing the invention as a trade secret. M

Trade secrets: now more enforceable— and more important

To Catch a Thief

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For more information on our M+A and Private Equity Practice, please visitwww.mofo.com/mergers--acquisitions-services.

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$1 BillionAcquisition of

Wind River Systems Counsel to Intel

$125 MillionAcquisition of the

InfiniBand Business of QLogic Corp. Counsel to Intel

$7.7 Billion

Acquisition of McAfee Counsel to Intel

$1.4 BillionAcquisition of the Wireless

Solutions Business of Infineon Technologies AG

Counsel to Intel

$720 MillionAcquisition by Rovi

Counsel to Sonic Solutions

$600 Million Acquisition of Sanyo

Semiconductor Counsel to

ON Semiconductor

$10.2 Billion Acquisition of Autonomy plc

by Hewlett Packard Counsel to Qatalyst Partners,

financial advisor to Autonomy plc

$2.25 Billion Acquisition of Isilon Systems

by EMC Corporation Counsel to Qatalyst Partners,

financial advisor to Isilon Systems

$2.3 BillionAcquisition of

Landis+Gyr AG Counsel to Toshiba

$2 BillionJoint Venture with SanDisk

to Expand NAND Flash Manufacturing Capabilities

Counsel to Toshiba

$1.2 BillionAcquisition of

Keane International, Inc. Counsel to NTT Data

$943 MillionAcquisition by 3M Counsel to Cogent

$5 Billion Acquisition of

Hitachi Storage by Western Digital

Counsel to Hitachi

$3.3 Billion Acquisition of

Lam Research Corp. Counsel to

Novellus Systems

$2.6 Billion Acquisition of CaridianBCT

Counsel to Terumo

$333 Billion Acquisition of

Tiny Prints Counsel to Shutterfly

Terms Not Disclosed Acquisition of Infor

Counsel to ENXSuite

Terms Not Disclosed

Acquisition of NitroSecurity Inc.

Counsel to McAfee

$104 Million Acquisition of OpenFeint Inc.

Counsel to GREE

$90 Million Acquisition of

Worldwide Information Network Systems, Inc. Counsel to ManTech

International Corporation

Coming Soon: A Special Survey on M+A Trends

Morrison & Foerster is teaming up with 451 Research, a leading global analyst and data company, to create a bi-annual Tech M+A Survey. The survey is geared toward technology acquirers and dealmakers to assess trends and issues in technology M+A transactions. Publication of survey results and analysis will be shared in future issues of MoFo Tech.

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