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Setting The Stage

The VirnetX (NYSEMKT:VHC) short side has opened its toolbox unveiling a simple and manipulative tool idea. It has been suggested that the United States Patent and Trademark Office ("USPTO") has a limitless amount of control over Federal Court decisions. Although the USPTO does have a bearing in the validity of patents, they in no way can nullify the decision of a Federal Court judge. New Bay Capital LLC ("New Bay") is utilizing inter partes reviews through the USTPO, although a Federal Court judge is not bound by the USTPO's findings.

VirnetX has been the target of an inter partes review by Apple (NASDAQ:AAPL) and New Bay. VirnetX has responded to Apple's IPR request on September 17, 2013 and New Bay's request on September 27, 2013. This is not the first time that VirnetX has faced inter partes reviews of their patents asserted against companies in federal court litigation. In 2007 a jury against Microsoft found the asserted claims of the '135 patents not invalid and infringed by Microsoft. The company then requested an IPR of the same patent in 2009. The USTPO confirmed all claims in question and issued a Re-examination Certificate.


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Accounting for the short-term, VirnetX's shares are down 20% since New Bay's IPR petitions were filed. Although the company's share price can move down due to macroeconomic events or reverse conversions, these filings could very well be the reason for the short term decline. Although the impetus for a move up will be from the judgment of other court orders and not by a conclusion of these IPR events, since actual meaningful events will happen sooner. These can include the judge's decision on the Cisco retrial or the Apple royalty rate. Although many short term stock traders or option holders may be angered by the decline, the excessive retreat offers VirnetX's shares at a bargain - contingent on an understanding of how the events do not warrant a 20% decline at this time.

New Bay Capital LLC - A Shell Company's Actions

VirnetX filed subpoenas in three states to uncover the real party of interest behind New Bay's IPR requests. It seemed questionable that a company created just 46 days prior to filing could have:

  • A business model that is infringed upon by VirnetX's patents.
  • The financial resources to file these costly requests.
  • The technical knowledge to file these requests.
  • A business interest that in 46 days had run into problems due to VirnetX's technology and required an IPR to be filed.

It appears obvious that New Bay did not have any business or interests that were being intruded upon by VirnetX's technology. So, what was the real motive behind the requests? New Bay had approached VirnetX and offered to drop the IPRs in exchange for ten percent (10%) of the final judgment against Apple, approximately $40 million.

This may seem random, although it is not illegal. Let's keep in mind the problems with New Bay's position:

  • One of the three cases stemming from VirnetX's subpoena to unveil the real party of interest against New Bay has been recommended to be transferred from Florida to Texas. The same Judge is overseeing the all of the company's pending litigation.
  • Collateral estoppel applies to New Bay's request. New Bay is challenging only the patent claims that Apple faced at trial. If New Bay is ruled against, collateral estoppel would prevent these issues from being re-tried, specifically IPRs of these patents claims.
  • Judge Davis will now be able to look into the motives behind New Bay's requests, and see that their motives that are solely financially based.

Apple Filed These Requests As well

You may be wondering the same thing that many other investors are. Is there any way Apple can be the force behind New Bay's requests since Apple has filed their own IPR of the '135 patents? Apple's requests fall outside the timeframe that allows them to file such requests (over one year since the complaint was filed). It seems odd then that Apple would request to join New Bay's IPR requests of the same patent.

Although we have no solid proof that Apple is behind New Bay's requests, the stars do align quite nicely in my personal opinion:

  • New Bay files IPRs (not illegal) against VirnetX's patents even though New Bay does not have any businesses being infringed upon by VirnetX's technology. Note also that New Bay does not have the financial means to file the IPRs.
  • New Bay's merits ($40 million) are indeed very strange, yet this has no bearing on Apple's decision to join New Bay in their proceedings.
  • Apple's timeframe has fallen out of range to file IPRs so they attempt to join New Bay's proceedings.

What Are These IPRs Predicated On?

It is apparent that the market, as well as many people who have contacted me, are under the impression that New Bay is holding a gun to VirnetX's head. More importantly, it is also the mood that Apple has a grasp on weapon and will pull the trigger as well. Should VirnetX decline to pay New Bay the IPRs will invalidate their patents. Yet, if they do pay, then Apple will continue their newly-allowed IPR requests in their litigation in the Eastern District of Texas. These are some very big "what if" questions that need to be put into some perspective.

  • If New Bay or Apple are successful in their IPR requests, Federal Court judges do not have to take this into account.
  • As outlined in my other article, the IPR process will not be completed by the time Apple's appeal is completed. Apple filed their appeal on July 3, 2013 and this is a process that typically takes 12 to 14 months. An IPR takes 12 -18 months from the date it is accepted. Adding the two months' difference between July (Apple's appeal) and September (IPR requests), the IPR would not conclude for 14-20 months in total. At the low end there is a great chance that the IPRs will be concluded post Apple's appeal.
  • New Bay's IPRs do not have a chance of succeeding. VirnetX outlines in its response that New Bay's petition "…proposes several defective claim constructions that do not represent the broadest reasonable interpretation of the claims in light of the specification". Also, New Bay bases their argument on grounds numbered 5-8 "… on a largely fictional description of Kiuchi (proposed prior art) that finds almost no support in Kiuchi Itself". New Bay included a diagram "… containing these fictitious functions and modules" and "None of these component is actually disclosed in Kiuchi." VirnetX proves that these grounds do not support the basis to institute an IPR because they are based on a fake description of Kiuchi and cites only Mr. Housley's declaration that also does not cite Kiuchi to support Mr. Housley's findings.

The Baxter Case: Federal Court vs. USTPO

Most likely to come up is the discussion regarding how the USTPO has overturned a patent in re-examination even after the Court found the patent valid - as specifically demonstrated in the Baxter case. I have referenced this case to cement the fact that the USTPO's decisions do not impact judgments. The Court of Appeals of the Federal Circuit ("CAFC") stated that "… if a Federal Court awards relief to a patent holder against an infringer, a subsequent re-examination decision that the patent is invalid does not disturb the judgment of the Court or alter its binding effect on the parties."

Keep in mind that the Judge has already upheld the jury verdict against Apple and that the Judge does not have to follow any decisions or opinions of the USTPO.

Pending Judgments - It's Darkest Before Dawn

As to the company itself, VirnetX is still waiting to hear from the judge regarding their request for a new trial or judgment as a matter of law on the '759 patent and the royalty rate that will be applied to device sales of Apple's older model devices. This royalty rate will set the cornerstone of licensing decisions moving forward and will also play a huge role in litigation with Apple regarding their newer devices that infringe upon on the same technology. I wrote about VirnetX's request with regard to Cisco here and about the Apple royalty rate here.

This may be the last chance to obtain shares at these levels with intent to hold for the long-term. The two pending Court decisions regarding Cisco (NASDAQ:CSCO), and more importantly Apple, are of paramount importance to the future of the Company. Those decisions will be defining events in the Company's history that will likely move shares to higher levels, taking the current share price off of the table. Although still subject to macroeconomic events and reverse conversions, volatility will decrease as these Court orders remove uncertainty as to the future of the Company. Therefore, shares of VirnetX are a bargain at $18.

Not only is an arbitrary opportunity available if you invest before the Court decisions, but even better for VirnetX is the future of the Company after these defining court decisions. Should you instead decide to trade VirnetX after their future is defined, and their opportunity established, you would be up against Wall Street's algorithms. An investor of VirnetX prior to these defining events is afforded more opportunity than an investor of VirnetX would have after the fact. Investors are also subject to lower taxes as well if they hold long enough.

Take Your Eyes Off The Clock: Tick Tock

It has been over two months since the last hearing regarding Cisco and in my opinion the judge would not be taking this long simply to deny VirnetX's motion. It has been around the same time since Apple's last hearing on the royalty rate. Some have concluded that the judge is waiting until after October 17, 2013 to rule on his royalty rate decision. This date is Apple's last day to file their Appeal brief. The judge is likely waiting for Apple to file their Appeal brief due October 17, 2013 before ruling on the royalty rate. This would prevent the previous two severed cases from being joined into one Appeal.

No news is good news and there is no rush to push out decisions that will be defining cornerstones for VirnetX moving forward. I previously wrote about the Judge's brilliant decision to sever the case and Apple's appeal here.

Conclusion:

The above scenarios are of subject to the Courts' decisions. Apple has not been granted their motion to join New Bay and New Bay's IPR requests are not rock solid and have not been decided upon by the USPTO. More interestingly, if it is found that Apple conspired with New Bay in their IPRs then collateral estoppel will attach, thwarting Apple’s IPRs.

Disclosure: I am long VHC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. All of the information included in this article is my own personal opinion. Always research your investments and contact a financial professional regarding any investments or trades prior to executing them.

Source: VirnetX: New Bay Capital LLC's And Apple's Contrived IPRs - Why?