Much has been written about Document Security Systems, Inc. (NYSEMKT:DSS), as well as the potential upside that the company's pending patent litigations against Facebook (NASDAQ:FB), LinkedIn (LNKD), and more recently, Apple (NASDAQ:AAPL) can provide to investors. We do not endeavor to re-hash what has already been said, and this article is not intended to be an overview of DSS as an investment. Rather, this article will focus on critical issues that investors need to understand in connection with the pending patent cases against Facebook and LinkedIn.
These cases have moved rather slowly over the past year. Even though there has been much speculation over the strength of DSS's cases against Facebook and LinkedIn, not much has happened.
That is about to change. The claim construction hearing (also known as the Markman hearing) has been scheduled for March 2014. Briefing in advance of that hearing is about to start. In short, the parties are about to start putting some cards on the table, and investors will soon have the opportunity to assess whether Facebook or LinkedIn have some meat behind their defenses. We intend to report on the claim construction briefing and the Markman hearing as it occurs. Having informed assistance to assess the claim construction briefs and attend the hearing will be imperative for investors in DSS to stay ahead of any movement in this stock.
The Cases Against Facebook and LinkedIn
DSS's patent cases against tech-giants Facebook and LinkedIn may augur well for substantial damages, well in excess of DSS's current market cap (currently ~ $100M). (We will have more visibility into the strength of DSS's damages arguments - remember that the burden of proof in a patent case is on the patentee with respect to damages - once the damages expert reports are filed, and in particular after Facebook and LinkedIn challenge those reports via Daubert or other motion practice.) DSS has already settled with all of the other accused infringers, which in theory speaks highly for the strength of its patents. Of course, the settlement numbers are kept confidential, but most likely in the low six figures. That's not bad, considering the size of the settled out defendants and the effective royalty rate of 3-5%.
As a result of the merger between DSS and Lexington, DSS owns a subsidiary named Bascom Research, LLC, which is the nominal plaintiff in its cases against Facebook and LinkedIn. Four patents are being asserted. Thomas Bascom is the named inventor for three of the asserted patents (U.S. Patent Nos. 7,111,232 ("the '232 Patent"), 7,158,971 ("the '971 Patent") and 7,389,241 ("the '241 Patent"), and he is a co-inventor for the fourth patent (U.S. Patent No. 7,139,974 ("the '974 Patent")). These patents will be referred to generally as the "Bascom Patents."
The Bascom Patents are directed to methods and systems for organizing and structuring information in computer systems. DSS is claiming that this technology enables Facebook's and LinkedIn's social media services so as to make them scalable to accommodate millions of users.
Bascom applied for his patents in 2001. At the time, the Internet was up and running, yet not anchored by many of the online institutions that have come to dictate our browsing - Wikipedia, Facebook, LinkedIn, to name a few. Bascom identified a need to make searching the Internet more meaningful, rather than dependent upon search queries that often netted pages and pages of unhelpful links. At the heart of his inventions was the idea to create linked relationships between different pages. These linked relationships will include associated attributes and will be stored in databases. This way, users searching on a network and finding one published page would be directed to finding another, related page based on associated attributes. In this way, the "linked relationships" and the corresponding attributes of the linked pages make searching the Internet more meaningful and useful. If these published pages correspond to user profiles on a social-media page, where one user profile indicates all the linked relationships, and the associated attributes correspond to how two users know each other (co-workers, family, etc.), then it quickly becomes apparent how the core of Facebook's and LinkedIn's product may be utilizing Bascom's technology in a manner that warrants substantial damages for infringement.
There are additional facts supporting the validity case for the patents asserted against Facebook and LinkedIn. Notably, the patents claim early priority dates, going back to 2001. Importantly, this date precedes the launch of other recognized social media institutions, including Facebook (founded in 2004), Myspace (founded in 2003) and even Friendster (founded in 2002). This bodes well for DSS to overcome expected challenges to the validity of the Bascom Patents by Facebook and LinkedIn.
Another notable fact of the Bascom Patents is the term Mr. Bascom used to describe his inventions. He called it "Linkspace." This was in 2001, before the advent of Myspace or LinkedIn or other social media giants. This rather prescient coincidence could go a long way with a jury. From the perspective of a Judge assessing whether or not Facebook or LinkedIn are infringing the Bascom Patents, use of the term "Linkspace" likely carries little weight. However, patents that survive summary judgment go to trial. And trials are decided by jurors, not judges. It is not unimaginable that jurors will buy into a trial story touting Bascom's inventiveness as self-evident from the face that he prophetically coined his invention with a name curiously similar to the social media giants that followed him.
On the other hand, Facebook and LinkedIn have already scored what could prove to be a game-changing win in an early skirmish against Bascom. Initially, Bascom sued Facebook and LinkedIn in the federal court located in the Eastern District of Virginia. That district is widely viewed as friendly to patent-holders due to its "rocket-docket" and jurors who statistically sympathize with inventors over deep-pocketed large companies. However, Facebook and LinkedIn succeeded in moving the cases to the federal court in the Northern District of California. The Northern District of California is located within San Francisco and its surrounding cities-in other words, right in Silicon Valley. As a result, the jury could be stacked with people who know people who work for Facebook or LinkedIn or companies like them. They may be engineers or employed by start-ups themselves, who view patents unfavorably and may find it difficult to believe that someone "invented" Facebook or LinkedIn before the champions of those companies did themselves. This could make it hard for DSS to succeed at trial having just a good jury story. There is a reason that the defendants fought hard to get the cases moved.
Either way, litigation on the merits of these cases is about to get underway. Markman decisions are typically important trading catalysts for patent stocks, and in this case, the upcoming Markman hearing in DSS's cases against Facebook and LinkedIn is no exception. A technology tutorial is scheduled for March 5, 2014, and the Markman hearing is scheduled for late March 12, 2014. Briefing in advance of that hearing will occur over the next two months. It will be imperative for investors to have informed assistance to assess those briefs and attend those hearings in order to determine how to build up or wind down a position in DSS's stock before the decision on the Markman hearing is issued.
The NPE Question
Analysts of DSS frequently tout that it is an operating entity, selling actual product, and therefore it is exempt from charges typically waged against other patent-assertion companies for being a non-practicing entity (NPE). In this section, we provide some insight into this question because, for the reasons discussed below, it is likely to affect the scope of potential damages collected by DSS in its patent cases against Facebook and LinkedIn.
The tide of the public's opinion about patents is shifting. The media is rife with indictments describing patent-assertion entities as "trolls," and the House of Representatives recently endorsed legislation claiming to solve the country's patent problem. Part of this criticism stems from the public's perception that NPEs are damaging our economy. By merely suing on patents, rather than commercializing or "practicing" the inventions themselves, NPEs are holding back the true engines of our economy.
There is both truth and falsehood to these allegations, which we have previously discussed at greater length here, and about which we will have much more to say later down the road. Nevertheless, many patent-assertion entities are on the defensive to demonstrate that they are not just another NPE. DSS is no different.
DSS appears to have countered this charge by arguing that it is, in fact, a practicing entity. DSS is not a purely licensing entity, but it does manufacture and sell products. Among other things, it manufactures paper and plastic products to protect information from unauthorized scanning, copying, and digital imaging in the United States and internationally, including RFID products. In Q3 of 2013, DSS contracted with MedTech Wristbands, a provider of ID and access control solutions, for a three-year contract to employ the DSS AuthentiSuite Technologies. Accordingly, it cannot be denied that DSS has an operations arm through which it manufactures and sells product.
The actual entity suing Facebook and LinkedIn, however, is a DSS subsidiary, Bascom Research LLC. This entity has also claimed to be a practicing entity. For instance, the inventor of the Bascom portfolio, Thomas Bascom, launched a company called "LinkSpace" in 2001, which according to Bascom, developed enterprise and personal knowledge management software solutions. Bascom Research claims to be developing a line of products that will be offered for sale, and has at least eight independent contractor / consultants in its employ. In particular, Bascom Research is currently developing a line of products that leverage the inventions of LinkSpace for sale in the medical technology field. In particular, the products will comprise software systems capable of linking distributed medical information resources, including patients' electronic health records. The aim, among other things, is to allow the tracking of labeled medical products in connection with clinical trials. Nevertheless, despite these auspicious developments, Bascom has acknowledged that these products and its business are in their "infancy." It is clear, therefore, that Bascom is not likely a legitimate commercial competitor to either Facebook or LinkedIn.
Whether or not DSS is a "practicing entity" depends on what patent we are talking about. It is undeniable that DSS manufactures and sells product. However, that alone will not exempt it from accurately being described as an NPE. If a company manufactures and sells chairs, but has a patent directed to televisions, it cannot claim that it is a "practicing entity" of its television patents. Here, DSS, or more particularly, Bascom Research, has sued Facebook and LinkedIn on patents directed to linked relationships over a network. Whether or not Bascom Research is a "practicing entity" depends on whether it is practicing-i.e., manufacturing, selling and so forth-embodiments of the very patents it is accusing Facebook and LinkedIn of infringing. Based upon publicly available knowledge, we cannot yet make that determination. However, it is important to understand that that is, in essence, the question that needs to be answered, not simply whether or not DSS is manufacturing something.
Are there any material consequences as to whether Bascom Research is an NPE? The answer is absolutely. In the context of DSS's patent lawsuits against Facebook and LinkedIn, the consequences could be enormous. A finding that Bascom Research is a practicing entity could entitle it to an injunction and/or lost profits. In 2006, the United States Supreme Court held that a finding of patent infringement does not automatically warrant an injunction. Since that time, federal courts have consistently held that non-practicing entities are not entitled to an injunction. Accordingly, whether or not Bascom Research is entitled to an injunction will turn heavily on whether or not it is an NPE.
Unfortunately, there is no hard-and-fast rule pertaining to whether a company is or is not an NPE. In other words, the level of commercialization required to amount to a practicing entity is not black and white. Indeed, based on our experience litigating patents, a finding of whether or not company is practicing an asserted patent will be subject, at least in part, to the Judge's discretion. For Bascom Research to be entitled to an injunction, it will likely have to demonstrate that it is selling product covered by the asserted patents. And it will also likely have to demonstrate that those sales are somewhat substantial.
In our experience, selling one or two products does not make a practicing entity. Rather, some sort of meaningful revenue must be generated from a commercialized embodiment to warrant enjoining an accused infringer from continuing to sell its products. This is why injunctions are typically awarded in patent cases between competitors. Here, Bascom Research has acknowledged that its commercialization efforts are still in their "infancy." That will likely be a factor in this determination.
To boil this down, we trust the Honorable Susan Illston, who is currently presiding over these cases, will give considerable thought to the question of whether Bascom Research is a practicing entity before deciding that DSS is entitled to an injunction. The reason being, deciding that DSS is entitled to an injunction will effectively mean that Judge Illston will order Facebook and LinkedIn to shut down and cease operations. The disruption and outcry from doing so, without proper justification, cannot be discounted. Given the dearth of commercial activity to date, we believe it is unlikely that Bascom Research will be entitled to an injunction, even if it does prove that it is selling a small amount of product covered by the asserted Bascom Patents. In fact, if Facebook and LinkedIn perceived an actual threat of an injunction, which would effectively shut down their businesses, then these cases would already have been settled long ago.
The CLS Question
On December 13, 2013, Facebook and LinkedIn moved to stay DSS's patent cases pending an anticipated decision from the United States Supreme Court. If granted, a stay would temporarily postpone the cases, during which time nothing would happen. That would prolong any collection of damages by DSS.
The basis of the requested stay is that on December 6, 2013, the Supreme Court granted certiorari in the case, Alice Corp. v. CLS Bank Int'l. In other words, the Supreme Court, which is at liberty to choose which appellate decisions it wishes to review, has chosen to review the decision issued by the Federal Circuit in the CLS Bank case. That decision reflects a hotly-contested issue in patent-law pertaining to whether software inventions should be eligible for patentability. Accordingly, the consequences of the Supreme Court's decision on the patent-sector may be far-reaching, well beyond Bascom's allegations against Facebook and LinkedIn. For this reason, Facebook and LinkedIn have argued, not without merit, that the Supreme Court's decision in CLS Bank could potentially deflate the merits of Bascom's cases overnight, and therefore, rather than moving ahead with the cases at this time, it would be prudent for the court to stay them pending the Supreme Court's anticipated decision in CLS Bank.
So what is the CLS Bank case all about? It is about patent-eligibility. Contrary to popular thinking, not all great ideas are eligible for patent protection. Einstein's genius behind discovering General Relativity doubtlessly involved innovative and inventive thinking. Nevertheless, those ideas could not have been patented. Rather, a patent is typically directed to a method or system for doing something. This is why most patents are directed to technological innovations, not just insightful ideas. What is and is not eligible for patent protection is codified by section 101 of the Patent Statute. Pursuant to that section, the rule-of-thumb is that abstract ideas (such as E = mc2) cannot be patented.
The advent of computer technology spawned a whole new generation of patents. Those patents cover the implementation of tasks that were previously performed by humans on a computer. The brilliance of these inventions, as often touted within their corresponding patents, is the efficiency and scale achieved by implementing tasks on a computer that were previously performed laboriously by humans.
Let's look at an example. In the CLS Bank case, the patents are directed to computerized trading platforms for exchanging obligations in which a trusted third party settles obligations between a first and second party so as to eliminate "settlement risk." That's a complicated way of describing an escrow arrangement. Nobody doubts that payments have been made using escrows for possibly hundreds of years. However, the patents involved in the CLS Bank case were presumably the first to automate such escrow arrangements on a computer. Should that type of invention be entitled to a patent? Today, almost all inter-bank financial payments occur over computer networks, which might mean that these patents could make any bank using an escrow an infringer of those patents. Is that fair? On the other hand, implementing such things as escrows on a computer achieves efficiencies and scales that were previously unachievable by hand. If the inventors behind the patents at stake in the CLS Bank case were truly the first persons with the idea to do that, why shouldn't they be entitled to a patent covering that idea? Encouraging innovation that achieves speed and efficiency behind any process is surely one of the underlying goals of any patent system.
These are the types of questions at stake in the Supreme Court's upcoming decision in the CLS Bank case. Should pre-existing ideas, such as an escrow, implemented on a computer be eligible for a patent? If not, is something more required than just taking an old idea and putting it on a computer? If so, what is that something more?
Based on how the Supreme Court answers these questions, the consequences could be far-reaching. Hundreds of thousands of unexpired patents cover software that implements processes and systems on a computer. If the Supreme Court decides these patents are ineligible for patent protection that could invalidate all of these patents overnight. As far as investors are concerned, that could seriously undercut the viability of patent-assertion entities as lucrative investments. Many of the patents being bought, licensed and litigated today cover, to some extent, the computer-implementation of an idea. Companies that could be affected, just to name a few, include Vringo (VRNG), DSS, Acacia (NASDAQ:ACTG), Marathon Patent Group (NASDAQ:MARA), Spherix (NASDAQ:SPEX), Internet Patents (PTNT), Worlds (OTCQB:WDDD), MGT Capital (NYSEMKT:MGT) among others. In fact, the Supreme Court's CLS Bank decision could more decisively impact the perceived "patent troll" issues than the pending patent legislation recently passed by the House. (This is one reason that we, at Markman Advisors, have decided to address this issue in slightly more depth within this article.) Ultimately, the public needs to see what the Supreme Court does with this important case, as it clearly could have ramifications such as stifling innovation in the entire software industry.
Turning back to DSS's cases against Facebook and LinkedIn, we do not anticipate that the cases will be stayed, but consider the prospect an important one to monitor. Facebook's and LinkedIn's litigation counsel will be particularly busy over the next six months conducting discovery and preparing for the Markman hearing. Rather than conduct all of that work, they are attempting to leverage a pending decision from the Supreme Court, one that could potentially short-circuit these cases overnight, as an excuse not to do all of this work. This argument has merit, and it should be viewed by investors as both, reasonable and expected. While we do believe that Judge Illston will give defendants' request for a stay due consideration, there are many facts weighing against granting of the stay.
Principal among them is that Supreme Court has not been asked to decide a yes-or-no binary question, which depending on the answer, will dispositively decide the validity of Bascom's asserted patents. On the contrary, the Supreme Court could resolve the questions at stake in the CLS Bank case in a number of different ways. It could choose to provide only general guidance, leaving it to the district courts to work out the details over what that something more is that entitles some software ideas to patent protection, while barring others. Indeed, this is how the Supreme Court proceeded in another hotly-contested case addressing business-method patents a few years ago (see Bilsky v. Kappos (2010)). If that happens, Judge Illston will nevertheless have to revisit the patents and determine whether or not they are patent-eligible. That will likely require a claim construction hearing either way. This is because the Federal Circuit has previously indicated that claim construction is often a necessary pre-requisite to deciding a motion for invalidity for lack of patent eligibility under section 101. (See e.g., Ultramercial, Inc. v. Hulu, LLC, 722 F.3d 1335, 1342 (Fed. Cir. 2013). Therefore, Judge Illston may decide that if a Markman hearing is required one way or another, it would be more efficient to proceed with the hearing now, rather than postpone the inevitable.
In addition, both Facebook and LinkedIn have indicated that they only intend to invalidate one of the four asserted patents on the grounds of patent ineligibility. That means, even if the CLS Bank decision resolves in their favor, presumably only one of the patents will be affected, and the cases will nevertheless need to continue. This also counsels against a stay.
Whether or not the case is stayed, however, is not the most critical issue. The Supreme Court is expected to issue its decision in the CLS Bank case by June 2014, which means that any stay should only last six months, at the most. What is more critical, as we have attempted to highlight in this article, are the ramifications of the Supreme Court's decision on the validity of software patents, and their continuing potential to extract damages due to infringement. That decision could have consequences for all participants within the entire patent sector, DSS among them, stay or no stay.
DSS has enormous potential. The defendants, Facebook and LinkedIn, if proven to be infringers, could be forced to satisfy high damages that could drastically up the market cap for DSS. The next big catalyst will be the Markman hearing. This will likely be a critical turning point in these cases, providing deeper insight into the strengths and weaknesses of Bascom's infringement contentions and Facebook's and LinkedIn's defenses. We intend to report on the briefing, and if possible, attend the Markman hearing, which will be imperative for investors in DSS to adequately assess its long-term potential.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.