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Seeking Alpha SCOTUS Decision analysis

http://seekingalpha.com/article/2279953-alice-corp-vs-cls-bank-are-software-patents-dead

By Markman Advisors


Jun. 20, 2014 9:27 PM ET | 3 comments | Includes: AAPL, COPY, DSS, FNJN, GOOG, GOOGL, IBM, WDDD



Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)






Summary
•The Supreme Court did not invalidate all software patents. The impact of the decision will be felt on a patent-to-patent basis.
•Automating an abstract idea on a generic computer is not enough to make the idea eligible for a patent.
•Patent assertion entities march on.

The Supreme Court of the United States has issued its long-awaited opinion in Alice Corp. v. CLS Bank Int'l (No. 13-298). This case was highly-anticipated by investors in high-tech companies, holders of stock of patent assertion entities, and the patent bar. It was expected to answer the highly contentious question of whether software can be patented. The decision was anticipated to have a significant impact on software tech giants such as Google (GOOG) (GOOGL), IBM (IBM) and Apple (AAPL), who are among the largest patent-filers.

In addition to the prospective impact on tech giants, the decision was expected to impact numerous patent assertion entities whose share prices are predicated upon expected revenue from pending or anticipated patent litigations. These include Document Security Systems (DSS), Finjan Holdings (OTCQB:FNJN), CopyTele (OTCQB:COPY) and Worlds (OTCQB:WDDD), among others. Some of these companies have asserted software patents. For instance, in the case of DSS, Facebook (FB) and LinkedIn (LNKD) managed to have DSS' cases stayed on the grounds that the Supreme Court's Alice decision could make the case go away overnight. Did that happen? It doesn't look like it, and we can expect DSS to continue to try its case forward. Has the Alice decision eviscerated scores of software patents? As with many things in life, the answer is it's complicated. The impact of the Supreme Court's decision will be felt on a patent-to-patent basis.

What do investors need to know? For investors in patent stocks, and particularly stocks whose valuation is predicated on assertion of software patents, this article provides an overview of this highly-anticipated patent law decision from the Supreme Court.

What was the case about?

Alice Corp. is an Australian corporation with a portfolio of patents. The patents are directed to a computerized trading platform for settling trades to avoid "counterparty" or "settlement" risk. This is a long way of saying an escrow arrangement. And therein lies the dispute - Alice's patents arguably are nothing more than taking an age-old practice (using an escrow to settle a transaction) and automating that process with a computer.

Should those types of ideas be patentable? Should they warrant the monopolization protection afforded by the United States Patent and Trademark Office for protecting and rewarding novel, non-obvious inventions? Shouldn't patents require something more than just applying an old, abstract idea on a computer? These were the questions at the heart of this case.

Why is this case important?

The Supreme Court's opinion does not actually include the word "software," but this case was widely anticipated among patent practitioners as having potentially devastating impact on software patents. Why? Because software patents do not typically recite source code. Rather, they recite something much more general, such as the steps of a process to be achieved by code. They recite stages of an algorithm for accomplishing what the underlying software is supposed to do. Software patents are typically more akin to a flow-chart mapping out the overview of a piece of code rather than the detailed lines of code itself. They claim steps such as "determining X based upon Y", or "calculating Q based on Z", and so forth. They use gerund terms, such as "obtaining", "transmitting", "determining", "sending", "storing". This is what makes software patents so powerful - by covering a handful of generalized steps for a claimed algorithm, endless implementations of that algorithm in source code can infringe a software patent.

The patents at issue in the Alice case were themselves software patents. They described the steps of using an escrow to settle a financial transaction, but claimed those generalized steps through automation on a computer. If these patents are invalid, this may render scores of other software patents susceptible to the same fate as those belonging to Alice Corp.

And this is why this case is important. Software patents have been behind the proliferation of patent lawsuits suits by non-practicing entities (NPEs). The 1990s yielded a plethora of internet- and networking-based inventions that are being litigated today. The forces that brought Alice Corp. v. CLS Bank to the Supreme Court include, among others, high-tech companies seeking a cure to what they view as a proliferation of unfounded lawsuits. With this case, they attempted to invalidate, in one fell swoop, the bulk of the patents that they claim are at the heart of the "patent troll" problem allegedly plaguing high-tech businesses. One of the Federal Circuit Judges (Judge Moore) estimated that the validity of more than 320,800 patents granted between 1998 and 2011 could be eviscerated through this case. At the same time, many of those same companies themselves have significant patent portfolios that promised to be impacted by the Supreme Court decision.

So, did the Supreme Court eviscerate all software patents or not?

No. The Supreme Court's decision will no doubt have an impact on patent litigation in the U.S., but it is hardly the death-blow to software patents hoped for by high-tech companies and feared by patent-holders.

To be sure, the Supreme Court invalidated Alice Corp.'s patents. The Court applied a very simple test to do so, one that will now be applied to all software patents to determine whether they cover patent-eligible subject matter: First, the Court asked whether the patents embody an "abstract idea." The Court found that they did because they essentially cover the practice of using an escrow to settle trades. Second, the Court asked whether the patents add "something more", i.e., an "inventive concept," to make them more than just the recitation of an age-old, abstract idea. In this case, the "something more" was simply automating the escrow through a computer. The Supreme Court held that automating an abstract idea on a computer is not enough of "something more" to make an idea eligible for a patent.

How will this affect cases currently pending?

The Supreme Court endorsed the prevailing test for determining whether a software patent is valid or not. But that does not mean that scores of software patents that were valid on June 18 are suddenly invalid today. Instead, each patent will have to be challenged individually for whether it falls under the Supreme Court's test. That test asks, does the claim embody an abstract idea, and if so, is there something more making the claim eligible?

What does that mean? Right now, we don't really know. It will be up to the district courts and the Federal Circuit to add more gloss, color, dimension and parameters to which patents fall into that trap and which do not. That will take years. To the extent that patents claim specific types of hardware, are directed to computer-specific functions, and do more than simply claim an abstract idea such as using an escrow to avoid counter-party risk, then they stand a good chance of passing the test. And many software patents do so. Most software patents are more specific than commonly perceived. If anything, the Alice decision will only carve out a narrow band of patents that claim a very general, old idea, but apply it on a computer in a generic way.

In the meantime, the cases pending that are asserting software patents will march on. Some may be dismissed, but others will push through. At Markman Advisors, we disagree with commentators pointing to specific stocks and claiming that the Alice decision has eviscerated their market capitalization. Such ad-hoc predictions are premature, and inconsistent with the level of diligence that we think is necessary on a case-by-case basis. In the end, the biggest take-away from this decision is that the Supreme Court did not set forth any black-letter, hard guidelines that make it impossible for software patents to be asserted. In a lot of ways, for good or for ill, the world is the same today as it was the day before the decision.

I keep hearing that this case is about eligibility - what does that mean?

The Alice case was about what ideas are eligible for patent protection, not whether an idea is novel enough for patent protection.

The Patent Statute (35 U.S.C. § 101) provides that eligible subject matter includes "any new and useful process, machine, manufacture or composition of matter, or any new and useful improvement thereon..." Exceptions to this provision include laws of nature, natural phenomenon and abstract ideas. These things are not patentable no matter how innovative, novel or genius they are.

The Alice case was not about novelty or non-obviousness. To be awarded a patent, an inventor must file an application with the United States Patent and Trademark Office. What most people do not know is that 99 percent of patent applications, even if drafted correctly, are initially rejected. At that point, it is necessary for the inventor to demonstrate - through argument - that his or her invention is patentable. The majority of patent applications are rejected for not being novel - i.e., the invention is anticipated or obvious in light of prior art. Indeed, when challenging the validity of a patent in a district court litigation, most challengers opt to argue the patented invention is not novel.

The Alice case is about something entirely different. Rather than being about whether Alice's patents were novel, it was about whether they claim subject matter that is even eligible to be patented. Not all great ideas are eligible for a patent, regardless of whether they are novel or not. Einstein had a number of truly innovative ideas, one of which embodied discovery that energy equals mass times the speed of light squared (E = mc2). Under the patent statute, however, Einstein's brilliant idea would not be eligible for a patent because it is a law of nature, and laws of nature, no matter how much genius was required to discover them, are not patentable. Otherwise, allowing someone to patent a law of nature would absurdly grant one person the right to stop other people from using that law of nature without taking a license. That would hold up science and technological innovation, rather than fostering it, which is the underlying policy behind the Patent Statute.

Anything else to take from this case?

A rather technical point, but one that investors should be mindful of: The Court held that both the method and system claims in Alice's patents were ineligible. Some patent practitioners, as well as Federal Circuit Judges, have viewed systems claims (i.e., a computer configured to perform a specifically recited software routine) as more worthy of patent protection, even if they embodied an age-old, abstract idea. Their reasoning was that, by being directed to a piece of hardware (a computer programmed to do something specific), that was enough of "something more" to elevate a run-of-the-mill patent covering an abstract idea into something patent-worthy. The Supreme Court has rejected this approach. Simply reciting an old idea along with the requirement to "apply it" on a computer (along with other typically hardware, such as a controller and a server) is not enough. This is important because clever drafting of patents by patent attorneys is unlikely to escape any of the pitfalls to patentability established by the Alice decision.

Ultimately, the Alice decision highlights the importance for investors to conduct ongoing due diligence with respect to any of their holdings that can be impacted by patent law changes or decisions. Whenever the Supreme Court speaks, another opportunity to reevaluate patent-impacted investments presents itself. And that analysis is still carried out by human beings, not computers. At least for now.


Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.