Issue 1 • September 2011 IT Byte

IT companies are frequently involved in mergers. On July 7, 2011, the Federal Trade Commission (FTC) announced important amendments to the Premerger Notification Rules (the Rules), which implement the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act). The HSR Act is the federal premerger notification program that allows the FTC and Department of Justice Antitrust Division (DOJ) time to consider the competitive effects of proposed mergers and acquisitions and, if appropriate, to challenge and enjoin transactions under the antitrust laws before they are completed.

The amendments affect the information and documents that parties are required to provide to the agencies as part of their HSR notification forms. Most significant are the amendments requiring new information be submitted:

• A broader set of documents analyzing or evaluating the acquisition target than those already required by Item 4(c) of the form

• Information regarding holdings of “associates” of the filing parties

• Revenues derived in the US from foreign manufacturing operations

Amendments to the Hart-Scott-Rodino Notification RequirementsBy Michael Bodosky and Sydney Smith

IT ByteIssue 1 • September 2011

Welcome to the premiere edition of the IT Byte, a publication of the Information Technology Industry Group of Latham & Watkins. The IT Byte will feature timely articles and updates on various topics of interest to our clients in the Information Technology industry. This first edition includes updates from the firm’s tax specialists, and from the intellectual property, antitrust and white collar litigation attorneys. We hope you find them to be useful, and look forward to your comments and readership.

Karen SilvermanPartnerLitigation Department

Ulrich WuermelingPartnerCorporate Department

Mark FlagelPartnerLitigation Department

Inside This Issue:

Amendments to the Hart-Scott- Rodino Notification Requirements . . . . . . . . . . . . .1

Supreme Court Holds That the Patent Act Requires Invalidity Defense to be Proved by Clear and Convincing Evidence . . . . . . .4

Say on Pay and Related Advisory Vote Proposals . . . . . . . . . . . .7

IRS Allows Taxpayers to Treat 70 Percent of Success-based Fees in Certain M&ATransactions as Deductible . . . . . . . . . . . . .9

An End to the Rule of Thumb: Uniloc USA, Inc. v. Microsoft Corp. . . . . . . . . .10

New SEC FCPA Unit in San Francisco Signals Increased Scrutiny for Silicon Valley, Asia . . . . . . . .13

™

Latham & Watkins • IT Byte, Issue 1 • September 20112

Michael BodoskyCounsel

Litigation Department

• Information regarding investors in and holdings of non-corporate entities

Although the amendments reduce information requirements in some respects, these new obligations have the potential to impose significant additional burdens on notifying parties. For these reasons, earlier versions of the amendments that were circulated within the HSR community and later published for public comment drew intense and broad-based criticism. Although somewhat modified from earlier versions, the net effect of the final amendments is to increase notification burdens. The amendments are effective as of August 18, 2011. The amended Rules do not change the substantive standard of review for proposed transactions.

Documents Prepared for the Purpose of Evaluating or Analyzing the Acquisition Target or the TransactionNew Item 4(d) expands upon the familiar Item 4(c) in several significant ways. While Item 4(c) of the HSR form requires documents (i) prepared by or for an officer or director (ii) for the purpose of evaluating or analyzing the acquisition (iii) with respect to “market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets,” Item 4(d) requires more, particularly in calling for information related to prior contemplated deals or other analyses of the affected assets:

• Item 4(d)(i) requires production of all Confidential Information Memoranda (or, if there are none, documents serving such function) prepared within one year prior to submission of the HSR notification by or for an officer or director of the acquiring person, target and ultimate parent entities, that specifically relate to the sale of the acquired entity or assets. Ordinary course documents and financial data are not responsive unless such documents served the purpose of a Confidential Information Memorandum in the absence of such a document.

• Item 4(d)(ii) requires production of all documents prepared within one year prior to submission of the HSR notification for an officer or director of the acquiring person, target and ultimate parent entities, by investment bankers, consultants or other third party advisors during the course of an engagement or for the purpose of seeking an engagement, provided such documents contain “4(c) content” and specifically relate to the sale of the acquired entity or assets.

• Item 4(d)(iii) requires production of all documents evaluating synergies or efficiencies prepared by or for any officer or director for the purpose of evaluating or analyzing the acquisition.

AssociatesUnder the prior rules, the information required from the acquiring person in its notification was limited to the ultimate parent entity of the acquiring entity (the control person as defined in the rules) and entities that the ultimate parent controls. “Control” for HSR purposes is defined as: (i) for a corporation, holding 50 percent or more of the outstanding voting securities, or, having the contractual power presently to designate 50 percent or more of the directors; or (ii) for an unincorporated entity, having the right to 50 percent or more of the profits, or the right to 50 percent or more of the assets upon dissolution. For HSR purposes, a general partner is typically deemed to not control a limited partnership. For this reason, investment funds and Master Limited Partnerships have not typically had to report information regarding related funds and partnerships.

The new rules require the acquiring person also to provide certain limited information regarding “associates.” Associates include any entity that (i) has the right to manage the operations or investments of the acquiring person, (ii) has its operations or investments managed by the acquiring person or (iii) has its operations or investments under common management with the acquiring person. Examples include general partners of a limited partnership, other partnerships with

Sydney SmithCounsel


Latham & Watkins • IT Byte, Issue 1 • September 2011 3

the same general partner, other investment funds whose investments are managed by a common entity or under a common investment agreement, and investment advisors of a fund. Under the new rules, acquiring persons will need to provide the following information regarding associates and their investments:

• Minority Holdings of Associates: If an associate has a minority investment (5 percent to less than 50 percent) in a company that derives revenues from a NAICS code that to the person filing’s knowledge or belief overlaps with the target’s codes the filing must include the name of the “top level” associate and the investee entity and percentage interest held.

• Subsidiaries of Associates: To the extent a subsidiary of an associate derives revenues from a NAICS code that to the person filing’s knowledge or belief overlaps with the target’s codes the filing must include the name of the associate and its subsidiary and a list of states in which the subsidiary derives revenues from the overlapping code.

Revenue Reporting and Foreign Manufactured ProductsItem 5 previously required filing parties to provide dollar revenues by 6-digit NAICS industry code with respect to operations conducted in the United States during the most recent year as well as the base year. Prior to implementation of the new rules, the base year was 2002. To the extent dollar revenues were derived from US manufacturing operations, revenues were required to be reported by 7-digit NAICS product class for the most recent year and by 10-digit product code for the base year. Amended Item 5 eliminates entirely the base year reporting requirements. To the extent dollar revenues are derived from US manufacturing operations, amended Item 5 requires most recent year revenues by more

precise 10-digit NAICS product code, in place of 7-digit NAICS product class. Amended Item 5 also requires filing parties to report most recent year revenues for each product manufactured outside of the US and sold into the US.

Non-Corporate EntitiesThe amended rules further expand upon the 2005 amendments with respect to aligning the treatment of unincorporated entities with the treatment of corporations. Under the prior rules filing parties were required to identify each holder of 5 percent or greater minority interests in corporate entities controlled by the person filing notification. The new rules require filing parties to also identify each holder of 5 percent or greater minority interests in unincorporated entities controlled by the person filing notification. For limited partnerships, only the general partner should be listed, but all general partners must be listed, regardless of their percentage interest in the partnership. The new rules also eliminate the US$10 million asset threshold which permitted omission of holders of entities having less than US$10 million in assets.

In addition, the prior rules required filing parties to report their holdings of 5 percent or greater, but less than 50 percent, of the voting securities of corporate issuers. The new rules require filing parties also to report 5 percent or greater minority interests in noncorporate entities. The acquiring person’s response is limited to entities that derive revenues in the same six-digit NAICS industry code as the target. The acquired entity’s response is limited to entities that derive revenues in the same six-digit NAICS industry code as the acquiring person.

There are many other technical changes, including ministerial revisions to implement the amended Rules and minor changes to the notification form. The full text of the amendments is available on the FTC website at www.ftc.gov. n


Microsoft Corp. v. i4i Limited Partnership, 564 U.S. (June 9, 2011).

Many IT companies own and assert patents, and defend against allegations of infringement of others’ patents. On June 9, 2011, the US Supreme Court issued a unanimous opinion (8-0, with the Chief Justice recused), holding that 35 U.S.C. § 282 establishes a presumption of patent validity that an alleged patent infringer must overcome by clear and convincing evidence in all circumstances. The decision affirmed the “clear and convincing” evidentiary standard long applied by the Federal Circuit and leaves the law largely where it has been for more than 50 years. The decision also provides guidance to patent litigants and lower courts as to the instructions that juries should be given concerning the relative weight of prior art evidence that was not before the Patent and Trademark Office examiner at the time the patent was granted.

The i4i Litigationi4i Limited Partnership sued Microsoft in the United States District Court for the Eastern District of Texas, alleging that certain functionality of Microsoft’s word processing software, Microsoft Word, infringed i4i’s patent. Among its defenses, Microsoft claimed that i4i’s patent was invalid because the patented invention had allegedly been embodied in a software product called S4, an earlier product also created by i4i that was sold in the United States more than a year before the patent application was filed. Thus, Microsoft argued, i4i’s invention was not patentable because of the “on-sale” bar in 35 U.S.C. §102(b). The PTO had not considered this prior art software during its examination of i4i’s patent application. Because i4i had long since discarded the source code for this early software, i4i argued that Microsoft could not prove by clear and convincing evidence that the early software anticipated the patent.

Microsoft responded by requesting a jury instruction that would have set the evidentiary standard instead at a “preponderance of the evidence” for defenses based on prior art not reviewed by the PTO examiner. Microsoft argued that the statute is silent on the question, and that many lower court cases leading up to the enactment of the Patent Act had applied a lower burden in circumstances where the PTO examiner had not considered prior art. The district court refused to give the requested charge, and the jury returned a US$290 million verdict against Microsoft.

The Federal Circuit affirmed, based on its long-standing precedent that patent invalidity must be proved by clear and convincing evidence. The Supreme Court granted Microsoft’s petition for certiorari to consider whether that standard was proper when a PTO examiner had not considered the prior art that is before the factfinder at trial.

The Supreme Court’s DecisionThe Supreme Court affirmed in an opinion by Justice Sotomayor, holding that Congress adopted the “clear and convincing” standard when it enacted § 282. Although § 282 does not expressly articulate the standard of proof, “by stating that a patent is ‘presumed valid,’ Congress used a term with a settled meaning in the common law.”1 Citing its decision in Radio Corp. of America v. Radio Engineering Laboratories, Inc., the Court found that by the time Congress enacted § 282 the presumption of patent validity was understood “not to be overthrown except by clear and cogent evidence.”2 Based on this settled understanding, a defendant asserting an invalidity defense bears “a ‘heavy burden of persuasion,’ requiring proof of the defense by clear and convincing evidence. That is, the presumption encompassed not only an allocation of the burden of proof but also an imposition of a heightened standard of proof.”3

Supreme Court Holds That the Patent Act Requires Invalidity Defense to be Proved by Clear and Convincing EvidenceBy Greg Garre, Max Grant and Inge Osman

Greg GarrePartner


Maximilian GrantPartner


Inge OsmanAssociate



Microsoft argued that Radio Corp. was not controlling, and that the law in the lower courts was very unsettled at the time Congress enacted § 282. It further argued that the preponderance of the evidence standard should be applied to invalidity challenges generally because reading the phrase “[a] patent shall be presumed valid” as embodying a clear-and-convincing burden of proof renders superfluous the statute’s statement that “[t]he burden of establishing invalidity of a patent … shall rest on the party asserting such invalidity.” The Court conceded that the latter phrase is superfluous, but held that the canon against superfluity does not apply because neither of Microsoft’s alternative interpretations of the statute would give effect “to every clause and word of a statute.”4

The Court similarly rejected Microsoft’s more limited argument that a preponderance of the evidence standard should, at a minimum, apply where the evidence before the factfinder was not before the PTO. The Court agreed that “the rationale underlying the presumption [of validity] — that the PTO, in its expertise, has approved the claim — seems much diminished.”5 Nonetheless, the Court explained that other rationales may animate the presumption in these circumstances. For instance, that the patent holder was the first to publish his invention and thus doubts as to the inventor should be resolved in his favor, and that the heightened standard protects the patent holder’s reliance interests in the disclosure of his invention to the public. Moreover, the Court reiterated that Congress specified the applicable standard of proof that must be applied in § 282. Nothing in § 282 indicates an intent to depart from the common law to enact a hybrid standard of proof that would vary based on the facts of a particular case, the Court reasoned. Rather, if Congress had intended such a departure, “it would have said so expressly.”6

Still, the Court noted that where evidence was never considered by the PTO, a “challenger’s burden to persuade the jury of its invalidity defense by clear and convincing evidence may be easier to sustain” because that evidence may carry more weight.7 Under those circumstances, a jury instruction on the effect of new evidence not previously

considered by the PTO “can, and when requested, most often should be given.”8 Microsoft, it noted, had not requested such a charge below.

The Court disclaimed reliance on policy considerations, though both Microsoft and i4i (supported by the United States as amicus curiae) had presented the Court with numerous policy-based arguments as to the wisdom of the clear-and-convincing standard. Microsoft argued that the heightened standard of proof dampens innovation by “insulating ‘bad’ patents from invalidity challenges.”9 i4i contended that the patent issuance rate is not above the optimal level, and that the heightened standard of proof reflects proper deference to the judgment of an expert agency.

Justice Breyer, joined by Justices Scalia and Alito, issued a separate concurrence (though he also joined the Court’s opinion in full). That opinion simply notes that the evidentiary standard of proof at issue applies to questions of fact, and not to questions of law. Those Justices urged the courts properly to limit the application of the “clear and convincing” standard to factual issues by using instructions or special interrogatories to help make clear which factual findings underlie the jury’s conclusions.

Justice Thomas issued a separate opinion concurring only in the judgment. He would have held Radio Corp. controlling as a matter of common law, rather than finding congressional ratification of its holding, as the Court’s opinion does.

ImplicationsThis decision had the potential to effect a significant change in the law by making it easier to prove patent invalidity. Indeed, many Court observers expected the Court to make some change in existing law, once it granted certiorari in the case. Instead, the decision largely maintains the status quo. By affirming the status quo, the Court left intact a complex body of law that balances many competing interests. Any fundamental change in this area of the law would have impacted competitive incentives and may well have resulted in a number of unintended consequences.


Continued from Page 5

The decision does have implications for those asserting invalidity defenses. The Court stated that an instruction explaining to the jury that it should evaluate whether the evidence before it is materially new, and if so, consider that fact when determining whether an invalidity defense has been proved by clear and convincing evidence, is generally appropriate. This is consistent with the Federal Circuit’s jurisprudence, including its decision in American Hoist Derrick Co. v. Sowa & Sons, Inc., which held that where a defendant attacking patent validity “produces prior art or other evidence not considered in the PTO, there is … no reason to defer to the PTO so far as its effect on validity is concerned. Indeed, new prior art not before the PTO may so clearly invalidate a patent that the burden is fully sustained merely by proving its existence and applying the proper law.”10

Patent defendants would be wise to request such an “Am. Hoist” instruction, as some have, in cases where the defense is based on prior art that had not been considered by the PTO. The decision may also encourage defendants to request interrogatories along the lines suggested by Justice Breyer’s concurring opinion, which were endorsed by Justices Scalia and Alito. As those Justices explained, “[b]y isolating the facts … courts can thereby assure the proper interpretation or application of the correct legal standard (without use of the ‘clear and convincing’ standard). By preventing the ‘clear and convincing’ standard from roaming outside its fact-related reservation, courts can increase the likelihood that discoveries or inventions will not receive legal protection where none is due.”11 n

Endnotes

1 Slip op . at 7 (internal citation omitted) . 2 293 U .S . 1, 2 (1934) . 3 Slip op . at 8 .4 Slip op . at 12 (quoting Duncan v. Walker, 533 U .S . 167,

174 (2001)) .5 Slip op . at 14 (quoting KSR Int’l Co. v. Teleflex Inc ., 550

U .S . 398, 426 (2007)) .6 Slip op . at 16 .7 Slip op . at 17 . 8 Slip op . at 17 . 9 Slip op . at 18 . 10 American Hoist Derrick Co. v. Sowa & Sons, Inc ., 725 F .2d

1350, 1359-60 (Fed . Cir . 1984) .11 Breyer op . at 2 .


Earlier this year, the Securities Exchange Commission (SEC) issued final rules (Final Rules) implementing Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act), which generally provides shareholders of US public companies with the right to cast three types of pay votes: (i) an advisory vote to approve the compensation of the named executive officers (say on pay vote); (ii) an advisory vote on the frequency with which shareholders should be entitled to cast votes on the company’s executive compensation (frequency vote) and (iii) an advisory vote to approve certain payments made in connection with an acquisition, merger or other specified corporate transaction (golden parachute vote).

Public companies in the information technology sector may be affected by the Final Rules and the required advisory votes pursuant to such Final Rules because the rules apply to all US public companies, with specific temporary exemptions for smaller reporting companies (i.e., generally, public companies with less than US$75 million in public equity float). Other than as specifically exempted by the Final Rules, all US public companies are required to hold a say on pay vote and frequency vote at their first shareholder meeting held on or after January 21, 2011 and a golden parachute vote for deal proxies filed on or after April 25, 2011. To view our previous Corporate Governance Update regarding the advisory vote requirements pursuant to the Final Rules, click here.

The frequency vote, and the issue of whether board of directors should recommend annual, biennial or triennial say on pay advisory votes, which arguably garnered the most attention early in the proxy season, are generally settled now. Company recommendations have trended toward annual say on pay advisory votes and such recommendations have overtaken triennial recommendations, due to the voting results of the proxy season which, in approximately

82 percent of reported meeting results, have favored annual say on pay votes.1 Public information technology companies that have not yet filed their proxies should still consider their compensation policies and plans and determine which frequency recommendation is in the best interest of the company. The Final Rules require disclosure of the final decision on how often it would hold a say on pay vote on a Form 8-K. Such filing may be made no later than the earlier of 150 calendar days after the date of the shareholder meeting or 60 calendar days prior to the deadline for the submission of shareholder proposals for the subsequent annual meeting.

The golden parachute advisory vote rules are also now in effect. The Final Rules require golden parachute compensation arrangement disclosures and a golden parachute advisory vote in connection with shareholder meetings to vote on certain change of control transactions. Such advisory vote is not required if the golden parachutes have been subject to a prior say on pay vote. However, if a company modified its golden parachute arrangements after the prior vote, the new arrangements and revised terms must be put up for a new golden parachute vote. To view our previous Corporate Governance Alert regarding the golden parachute requirements pursuant to the Final Rules, click here.

Collective attention has now turned to the say on pay advisory vote results. The Final Rules require companies to discuss in the Compensation Discussion and Analysis (CD&A) of subsequent proxy statements whether they considered the results of the most recent vote and if so, how such consideration affected the companies’ executive compensation decisions and policies. Therefore, the result of the say on pay advisory vote is of particular importance. As of July 21, 2011, of the 2,293 Russell 3000 companies that have reported meeting results, say on pay advisory votes failed to receive at least majority approval at 37 companies, five of which are in the information technology sector. Of the

Say on Pay and Related Advisory Vote ProposalsBy James D.C. Barrall and Alice M. Chung

James BarrallPartner

Tax Department

Alice ChungAssociate

Tax Department


approximately 315 information technology companies that have reported say on pay advisory vote results, the average approval rate is 91 percent.

Of particular note, as of July 21, 2011, Institutional Shareholder Services (ISS), a proxy advisory service, had issued against recommendations for say on pay proposals in approximately 13 percent of Russell 3000 companies that it had assessed. On average, shareholder support for say on pay proposals is 25 percent lower at companies that received an adverse recommendation from ISS. A majority of adverse ISS recommendations with regard to the say on pay proposal is due to pay for performance disconnects.

Accordingly, public information technology companies not only need to make sure that they are complying with the Final Rules, they must also carefully analyze their compensation policies in the face of the say on pay advisory votes and proxy advisory service scrutiny. Such companies should consider including an executive summary at the beginning of the CD&A and list their good corporate governance compensation features toward the beginning of the CD&A. Further, such companies should

use the executive summaries to disclose how their executive pay aligns with the companies’ financial performance and how such pay and performance compare to such figures from the companies’ peers. In the event that companies receive adverse recommendations from proxy advisory services, companies should carefully analyze the recommendations and consider responding to the advisers and possibly discussing the recommendations with shareholders. As of July 21, 2011, at least 107 companies have filed public disclosures with the SEC in response to proxy advisers’ adverse recommendations on a variety of issues, including say on pay proposals due to pay for performance disconnects. Pay for performance issues may be even more important next proxy season with the SEC contemplating adoption of final regulations relating to the Act’s “pay-versus-performance”disclosure requirements as early as January 2012.n

____________________

Endnote1 All statistics are according to the Semler Brossy

Consulting Group, LLC report entitled, “2011 Say on Pay Results: Russell 3000 .” The report may be accessed here .



On April 8, 2011, the Internal Revenue Service (the IRS) issued Revenue Procedure 2011-29, which provides taxpayers with a safe harbor pursuant to which they may deduct 70 percent of success-based fees paid in connection with certain business acquisitions and reorganizations. As the volume of M&A activity in the information technology (IT) industry continues to increase, IT companies would be well advised to understand this taxpayer-favorable guidance and position themselves to take advantage of it.

Current Treatment of Facilitative CostsTaxpayers are generally required to capitalize, rather than deduct, fees paid to “facilitate” a wide range of business acquisitions and reorganizations.1 Amounts are considered to “facilitate” a transaction where, based on all of the facts and circumstances, they are paid in the process of investigating or otherwise pursuing such transaction. If a fee is not paid to facilitate a transaction, then such fee is generally deductible. Existing Treasury Regulations provide a number of factors to be considered and presumptions to be made in determining whether and how much of a given fee was paid to facilitate a transaction. One such presumption treats a fee that is contingent on the closing of a transaction (a “success-based fee”) as facilitating the transaction (and therefore required to be capitalized), unless the taxpayer maintains detailed documentation, including supporting records, that establishes a portion of the success-based fee is allocable to activities other than facilitating the transaction.

Revenue Procedure 2011-29Noting that the properly deductible portion of success-based fees paid in the context of “covered transactions” has been a source of controversy between taxpayers and the IRS, the IRS issued Revenue Procedure 2011-29.

“Covered transactions” generally include the taxable acquisition of assets constituting a trade or business, the taxable acquisition of ownership interests in an entity where the taxpayer and entity are considered related after the transaction and certain tax-free reorganizations.2 The safe harbor contained in Revenue Procedure 2011-29 allows taxpayers to treat 70 percent of a success-based fee incurred in connection with a covered transaction as deductible as long as the remaining 30 percent of the fee is treated as facilitative of the transaction and capitalized. Compliance with the safe harbor provided in Revenue Procedure 2011-29 offers taxpayers the assurance that their deductions of success-based fees paid in connection with a covered transaction will be respected and relieves taxpayers of the burdensome documentation requirements otherwise required to establish the deductibility of success-based fees.

In order to elect the safe harbor, taxpayers must attach an identifying statement to their federal income tax return for the year in which the success-based fee is paid or incurred. The safe harbor has to be elected for each covered transaction entered into by a taxpayer and, once elected, is irrevocable and applies to all success-based fees paid with respect to a given covered transaction. Accordingly, IT companies contemplating an acquisition should carefully review this guidance.

Revenue Procedure 2011-29 is effective for all success-based fees paid or incurred in taxable years ending on or after April 8, 2011. n

____________________

Endnotes1 Treasury Regulation Section 1 .263(a)-5(a) .2 Treasury Regulation Section 1 .263(a)-5(e)(3) .

IRS Allows Taxpayers to Treat 70 Percent of Success-based Fees in Certain M&A Transactions as DeductibleBy David S. Raab, Lisa G. Watts and Kevin J. Brogan

David RaabPartner

Tax Department

Lisa WattsPartner

Tax Department

Kevin BroganAssociate

Tax Department


IT companies continue to be involved in high stakes patent litigation. Before the Federal Circuit’s recent decision in Uniloc USA, Inc. v. Microsoft Corp., patentees often used the so-called 25 percent rule to approximate a reasonable royalty rate — i.e., the royalty rate that an accused infringer would have paid to the patentee during a hypothetical negotiation at the time infringement began. That rule presumptively allocates 25 percent of the profit associated with a product to the licensor of a relevant patent. The Uniloc decision unambiguously prohibits reliance on this rule moving forward: “Evidence relying on the 25 percent rule of thumb is . . . inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.”1 This article discusses background of the Uniloc case, highlights the damages portion of the Federal Circuit’s decision, which significantly impacts the law relating to the 25 percent rule and entire market value rule (the EMVR), and concludes with observations for practitioners. The parties’ petitions for the rehearing were denied in May.

BackgroundUniloc owns US Patent No. 5,490,216 (the ’216 patent), which is directed to a software registration system to deter copying of software. Uniloc accused Microsoft’s Product Activation feature for Word XP, Word 2003 and Windows XP of infringing independent claim 19 of the ’216 patent.

On remand from a prior Federal Circuit appeal (which reversed and remanded summary judgment of noninfringement), the district court denied several motions limine before holding a jury trial. Specifically, the trial court denied Microsoft’s motion to exclude testimony by Uniloc’s damages expert under Daubert and Rule 702 of the Federal Rules of Evidence because, among other things, the expert used the 25 percent rule.

The jury returned a verdict of willful infringement and no invalidity of the asserted claim, and awarded US$388 million in damages to Uniloc. Microsoft moved for judgment as a matter of law (JMOL) on a number of issues. The district court (1) denied JMOL of invalidity, (2) granted JMOL of noninfringement, (3) granted JMOL of no willfulness, (4) granted a new trial on damages based on Uniloc’s improper use of the entire market value rule and (5) granted in the alternative a new trial on infringement and willfulness. Uniloc appealed the grants of JMOL and new trial on damages, and Microsoft cross-appealed denial of JMOL on invalidity.

The AppealThe Federal Circuit issued a comprehensive decision touching on various aspects of infringement, willfulness, invalidity and damages. This article, however, focuses on the damages portion concerning the application of the 25 percent rule and the entire market value rule.

There, the Federal Circuit affirmed the district court’s grant of a new trial on damages based on improper use of the 25 percent rule and the EMVR by Uniloc’s expert. Under 35 U.S.C. § 284, damages shall be “adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer.” The reasonable royalty is commonly calculated based on a hypothetical negotiation between the parties at the time infringement began.

Uniloc’s damages expert opined on a reasonable royalty rate purportedly based on such a hypothetical negotiation. His analysis started with an internal Microsoft document stating that “a Product Key is worth anywhere between US$10 and US$10,000 depending on usage.”2 The expert then applied the “25 percent rule of thumb” to US$10, notably for no reason specific to the facts of this

An End to the Rule of Thumb: Uniloc USA, Inc. v. Microsoft Corp.By Bob Steinberg, Mark A. Flagel, Maximilian A. Grant, Matthew J. Moore and Adam M. Greenfield

Bob SteinbergPartner


Mark FlagelPartner


Maximilian GrantPartner


Matthew MoorePartner


Adam GreenfieldAssociate



case, and arrived at a baseline royalty rate of US$2.50 per license issued. He also considered several Georgia Pacific factors with a view toward adjusting the baseline royalty rate up or down, albeit ultimately concluding that no adjustment was needed. Uniloc’s expert then calculated a reasonable royalty by multiplying US$2.50 by the number of new licenses to Office and Windows products, ultimately concluding that a reasonable royalty is almost US$565 million. He also “checked” this reasonable royalty amount by applying the EMVR. In other words, he applied the EMVR (though its application here was questionable under Lucent Technologies, Inc. v. Gateway, Inc.)3 to determine if it gave a damages amount that was similar to the damages calculated by applying the 25 percent rule, which he opined confirmed the validity of that rule and its application in this case.

The 25 Percent Rule

The 25 percent rule is a tool “used to approximate the reasonable royalty rate that the manufacturer of a patented product would be willing to offer to pay to the patentee during a hypothetical negotiation.”4 Specifically, the rule suggests that a licensee would pay 25 percent of its expected profits for the product that incorporates the patented technology. This rule has long been used by economists and other damages experts as a basis for their damages opinions in patent cases.5

The Uniloc case questioned the admissibility of the 25 percent rule, and the Federal Circuit viewed the issue as one of first impression.6 The Federal Circuit acknowledged “passively tolerat[ing]” use of the rule in previous cases and noted that district courts “invariably admitted evidence based on the 25 percent rule, largely in reliance on its widespread acceptance or because its admissibility was uncontested.”7

But deciding the issue in this case, the Federal Circuit unequivocally held that “[e]vidence relying on the 25 percent rule of thumb is . . . inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.”8 In finding testimony based on the rule inadmissible, the Court explained that “the 25 percent rule of thumb

is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.”9

The Court further explained that critical to assessing the admissibility of expert testimony is whether the expert “has justified the application of a general theory to the facts of the case.”10 In the context of patent damages, “there must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case.”11 By contrast, “[t]he 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.”12 Moreover, “[i]t is of no moment that the 25 percent rule of thumb is offered merely as a starting point to which the Georgia-Pacific factors are then applied to bring the rate up or down.”13

The Federal Circuit did reaffirm that use of the Georgia Pacific factors to frame the reasonable royalty inquiry is proper.14 Nevertheless, “evidence purporting to apply [these factors] must be tied to the relevant facts and circumstances of the particular case at issue and the hypothetical negotiations that would have taken place in light of those facts and circumstances at the relevant time.”15

The Entire Market Value (EMVR)

The Federal Circuit rejected the expert’s use of the EMVR as a “check” because Uniloc failed to prove that the patented feature is the basis for customer demand of the infringing product. “The entire market value rule allows a patentee to assess damages based on the entire market value of the accused product only where the patented feature creates the ‘basis for customer demand’ or ‘substantially create[s] the value of the component parts.’”16 Here, the Court rejected Uniloc’s argument that application of the EMVR is appropriate if the royalty rate is sufficiently low.17 The Federal Circuit also explained that “[e]ven if the jury’s damages calculation was not based wholly on the entire market value check, the award was supported in part by the faulty foundation of the entire market value” — i.e., “that the entire market value rule was brought in as only a ‘check’ is of no moment.”18


Observations for Practitioners The Uniloc decision, which continues a recent line of Federal Circuit decisions heightening scrutiny applied to significant damages awards, will influence how practitioners prepare the damages portion of a case for trial. In short, the oft-relied on 25 percent rule of thumb is probably no more, and the application of the EMVR (even as a check) may likely require a showing that the patented feature is the basis for customer demand of the infringing product. The following are some exemplary observations for practitioners, who should begin developing their damages theory as part of early case assessment.

First, the Federal Circuit has made clear that the damages analysis, including the expert testimony, must be closely tied to the particular patents, technologies, industries and products at issue in the case at hand. Going forward, patentees will not be permitted to present damages numbers that lack any basis in the particular facts of the case, such as those derived from the 25 percent rule. Instead, patentees must find or develop case-specific factual evidence to support their damages numbers. This makes it important to figure out what those damages-related facts are early in the case. In the past, these facts may have gotten short shrift, by patentees who preferred to present damages theories that may not have been tied to the particular patents, technologies and products at issue in the case and by defendants who wanted to focus the jury on noninfringement and invalidity arguments, rather on how much they may have to pay for any infringement. That appears likely to change, and damages-related evidence should be part of early case assessment. Considerable uncertainly will still remain, however, as key facts will often not be known until well into the process of discovery.

Second, recent Federal Circuit damages case law has made it harder for plaintiffs to obtain damages that are out of proportion with the importance of the claimed functionality to the infringing product. it is important for damages experts to evaluate the contribution of each claimed invention to the overall damages claim. Uniloc suggests that patentees are likely not permitted to use the price of downstream products incorporating the accused

functionality in any way (even as a “check”) unless they are able to prove up the elements of the EMVR, including that the patented feature is the basis for customer demand of the product. As a result, it is probably more important than ever for patentees and accused infringers to consider the pros and cons of conducting consumer surveys to assess whether the accused functionality is the basis for customer demand of downstream products. license agreements, especially those resulting from settlement of litigation, may have diminished relevance. Parties might also consider involving a damages expert early in the discovery process and asking the expert what other evidence she needs to evaluate whether the patented feature is the basis for customer demand of the infringing product. Lastly, accused infringers in particular should review their document production and discovery responses with an eye toward whether any document or information would support or refute application of the EMVR. n

____________________

Endnotes1 No . 2010-1035, 2011 WL 9738, at *19 (Fed . Cir . Jan . 4,

2011) .2 Uniloc, 2011 WL 9738 at *15 .3 580 F .3d 1301 (Fed . Cir . 2009) .4 Id . at *16 (citing Robert Goldscheider, et al ., Use Of The

25 Per Cent Rule in Valuing IP, 37 les Nouvelles 123, 123 (Dec . 2002) (Valuing IP)) .

5 Id . at *18 (collecting several district court decisions, including Procter & Gamble Co. v. Paragon Trade Brands, Inc., 989 F . Supp . 547, 612 (D . Del . 1997)) .

6 Id .7 Id.8 Id . at *19 . 9 Id .10 Id . at *19-20 (discussing General Electric Co. v. Joiner, 522

US 136 (1997), and Kumho Tire Co. v. Carmichael, 526 US 137 (1999)) .

11 Id . at *20-21 (discussing Lucent Techs., Inc. v. Gateway, Inc ., 580 F .3d 1301 (Fed . Cir . 2009), ResQNet.com, Inc. v. Lansa, Inc ., 594 F .3d 860 (Fed . Cir . 2010), and Wordtech Sys. Inc. v. Integrated Networks Solutions, Inc., 609 F .3d 1308 (Fed . Cir . 2010)) .

12 Id . at *21 . 13 Id .14 Id .15 Id .16 Id . at *22 (alteration in original) (citations omitted) . 17 Id . at *24 .18 Id . at *25 .



IT companies have increasingly global operations. As such, they are aware that the investigation and prosecution of Foreign Corrupt Practices Act (FCPA) violations are drawing increased attention. A well-publicized 2010 undercover sting operation resulted in the indictment of 22 individuals across the country on FCPA charges. Big-ticket agreements in the past year by Daimler AG (US$185 million), Snamprogett/ENI (US$365 million), and Technip (US$340 million) to resolve criminal and civil FCPA charges are only the latest in a recent string of nine-figure prosecutions. And in a 2010 speech to the Organisation for Economic Co-Operation and Development (OECD), US Attorney General Eric Holder called combating corruption one of the Department of Justice’s (DOJ) “highest priorities” and noted that the pace of criminal prosecutions “is accelerating.” Notably, the US government’s scrutiny is focused on individuals as well as corporate entities. As the Attorney General remarked:

Let me be clear, prosecuting individuals is a cornerstone of our enforcement strategy because, as long as it remains a tactic, paying large monetary penalties cannot be viewed by the business community as merely “the cost of doing business.” The risk of heading to prison for bribery is real, from the boardroom to the warehouse.

Indeed, charging and seeking tough sentences for individuals is now part of a deliberate DOJ strategy to enforce the FCPA.

The government is putting its money where its mouth is. As Assistant Attorney General Lanny Breuer has emphasized, the government devoted the significant additional funding for economic fraud enforcement in the administration’s 2010 budget and a further 23 percent increase in 2011. The DOJ’s Criminal Division is also adding a number of attorneys to the Fraud Section, “lawyers who will be deployed immediately to prosecute crimes like . . . foreign bribery under the [FCPA].” The legislative branch

is on board as well. Recent financial reform legislation includes provisions awarding bounties to whistleblowers who report violations.

The SEC Bulks Up in San FranciscoLike the DOJ, the US Securities Exchange Commission (SEC) has made the FCPA a centerpiece of its enforcement efforts. Last year, the SEC’s Enforcement Division created national specialized units in five priority areas, one devoted entirely to the FCPA. As the Associate Director in the Division of Enforcement remarked, the “primary mission” of this unit is to become more proactive in its enforcement of the FCPA, including by gaining “in-depth knowledge of industries and regional practices” and conducting “more targeted sweeps and sector-wide investigations.”

FCPA criminal investigations are handled primarily by the DOJ’s Fraud Section in Washington, D.C., and until recently the SEC’s FCPA investigations also have largely been run from the East Coast. By doing so, the SEC has effectively limited the number of cases it had the ability to investigate. But that has changed. On the heels of its national reorganization, the SEC announced in 2010 that it had opened a specialized FCPA unit in its San Francisco Regional Office, the first of its kind among the SEC’s 12 regional offices. In doing so, the SEC sent a clear message that it views Silicon Valley as a target-rich environment. As the Assistant Regional Director in charge of the unit stated, “The fact that we have a significant presence of companies in Silicon Valley who do business internationally, specifically in Asia, makes us well-suited for addressing these kinds of issues.”

Targeting Silicon Valley, AsiaThe FCPA prohibits certain direct or indirect payments to foreign officials, candidates for

New SEC FCPA Unit in San Francisco Signals Increased Scrutiny for Silicon Valley, AsiaBy Timothy P. Crudo

Timothy CrudoPartner




foreign political position and foreign political parties. The global reach of many Silicon Valley companies, whether privately held or publicly traded, whether operating directly or though foreign subsidiaries, makes the FCPA a real concern. Doing business with any foreign governmental entity, whether as a customer, vendor, contractor, financier or partner, poses a potential for FCPA violations. Less directly, any business that involves government regulators, such as customs officials, also faces potential FCPA issues.

The most obvious situations involve what are clearly foreign entities and clearly problematic payments. Hewlett-Packard, for example, was the subject of an SEC probe concerning alleged bribes made by a foreign subsidiary to secure the sale of computer equipment to the office of the prosecutor general of the Russian Federation. But the governmental connection is not necessarily so obvious. Universities, hospitals, banks and telecommunications companies are just some of the entities that may be sufficiently nationalized or government-controlled to fall within the FCPA.

Regulators in the US have been aggressive in alleging that employees of state-owned or state-controlled enterprises fall within the FCPA’s prohibitions. This stance can pose problems especially in China, where the line between public and private is not always so clear. The bureaucratic hurdles involved in conducting business in China and the widespread Chinese cultural practice, often entirely legitimate, of exchanging gifts to strengthen personal and business relationships—guanxi—compound the opportunities to run afoul of the FCPA.

Nor are the problematic benefits at issue as obvious as a suitcase stuffed with hundred-dollar bills. One Bay Area tech company, for example, recently agreed to pay a US$1.5 million civil penalty and an additional US$1.5 million criminal fine as part of a joint SEC/DOJ FCPA investigation. Among other allegations, the SEC charged that the company’s wholly-owned Chinese subsidiary paid nearly US$7 million for hundreds of overseas trips by employees of Chinese government-controlled telecommunications companies. While the company claimed that

the trips were to provide customer training, the US government asserted that they were really sightseeing junkets.

As the SEC noted, its San Francisco FCPA outpost is particularly well-positioned to pursue Asia-related matters. Many Asian countries did not fare well in Transparency International’s 2010 Corruption Perceptions Index: China (79th out of 180 countries), Thailand (84th), Indonesia (111th), Vietnam (120th), Philippines (139th), Cambodia and Laos (tied for 158th). Given stepped-up cross-border enforcement cooperation and the increasing emphasis on battling corruption, as recently was on display in last year’s G-20 summit, the SEC expects to be busy.

The Increasing Costs of Penalties and Other ConsequencesThe current political climate means not only increased attention on enforcement, but also a more aggressive application of the FCPA and its penalties. Big corporate pay-outs have generated the most attention, but individuals are also seeing stiffer penalties. In 2010, a federal judge sentenced Charles Jumet, who, in a DOJ-led prosecution, was convicted of involvement in US $212,000 in bribes to Panamanian officials, to 87 months imprisonment, the longest sentence ever given under the FCPA.

In the year since opening its doors, the SEC’s San Francisco FCPA unit has been quiet — at least publicly. No FCPA charges or settlements have been reported from the San Francisco Regional Office in over a year. However, the word on the street is that the office has a number of active FCPA investigations (some in conjunction with the United States Attorney’s Office), so future announcements may be forthcoming.

More broadly, there are some noteworthy FCPA developments in the past 12 months. Since historically most FCPA cases have settled — many contemporaneous with the filing of the complaint — there has been little opportunity for courts to weigh in on some of the undeveloped aspects of the FCPA. It appears that more defendants,


however, are litigating FCPA charges. One district court recently addressed the extent to which an officer of a government-owned entity may be considered a “government official” under the FCPA. In United States v. Aguilar,1 the court ruled that employees of a electric utility company wholly owned by the Mexican government could be considered “government officials” under the FCPA.2

Other defendants have lost at trial or pled guilty, but several courts have rejected the government’s request for stiff sentences, indicating that the courts may not readily accept the government’s contentions of the seriousness of some FCPA offenses.3

What to Do?In a world where both global business and FCPA enforcement are continuing to expand, there are some things that you can do to minimize your exposure:

Compliance Program Vigilance

An ounce of FCPA prevention is worth a pound of government cure. Of course, a compliance program that prevents an FCPA violation from occurring in the first place will eliminate the extensive costs required to manage — even successfully — an FCPA claim. But while even the best compliance programs cannot guarantee that some employee somewhere won’t violate the FCPA, an effective program can go a long way to minimizing the costs of such violations.

Critically review your compliance program to make sure that it is designed for optimal effectiveness, that it is enforced and supported by all levels of management, that employees are property trained and incentivized to comply with it, and that it has sufficient resources to make it work. Special attention should be paid to issues specific to your industry and the parts of the world in which you operate.

Know Your Constituents

Know your partners and customers. Understand their ownership structure, particularly the extent to which they may be owned or controlled by a foreign government or by persons or entities acting on its behalf. Be familiar with the type and amount

of government funding they receive. In dealing with customers, vendors, agents or consultants, secure written representations that they are familiar with the proscriptions of the FCPA, that they are in compliance with the FCPA, and that they will continue to comply. Include meaningful sanctions for the failure to do so.

Where you are acquiring a company or new personnel, do your homework in advance. Improper practices can be an unintended part of a foreign acquisition. Many overseas managers and employees come from different national and corporate cultures, with different languages and experiences. Aggressively educate and train personnel so that they know your company’s values and procedures, especially where they may be at odds with their prior experience.

Disclose Where Necessary

Consider whether you need to disclose the FCPA as a risk factor for your business. These risks may be more prominent in developing countries, where business growth can be most promising, as well as in certain larger markets, such as Russia or China, with a history of such problems. In addition, certain business lines, including certain technologies involving heightened export restrictions, may be more susceptible to the exchange of improper benefits. n

____________________

Endnotes1 2011 WL 1792564 (C .D . Cal . Apr . 20, 2011) .2 See also United States v. Carson, Case No . 09-00077

(C .D . Cal . May 18, 2011) (whether government-owned entity is government instrumentality is question of fact) .

3 See e.g., United States v. Smith, Case No . CR 07-69-AG (C .D . Cal . Dec . 2, 2010) (6 months imprisonment, 6 months home confinement; government requested 37 months imprisonment); United States v. Elkin, Case No . 4:10-CR-15-JLK (W .D . Va . Oct . 21, 2010) (3 years probation; government requested 38 months imprisonment); United States v. Nguyen, Case No . 08-CR-522 (E .D . Pa . Sept . 15, 2010) (defendants sentenced to 9 and 16 months; government requested 87-108 months imprisonment); United States v. Green, Case No . CR 08-59-GW (C .D . Cal . Aug . 12, 2010) (6-month sentence; government requested 10 years imprisonment) .

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