Broken Symmetry

George Soros Explains His Worldview

And it is surprisingly fascinating:

While I was reading Popper I was also studying economic theory and I was struck by the contradiction between Popper’s emphasis on imperfect understanding and the theory of perfect competition in economics which postulated perfect knowledge. This led me to start questioning the assumptions of economic theory. These were the two major theoretical inspirations of my philosophy. It is also deeply rooted in my personal history.

The FT has a whole website up with transcripts from each of his lectures, which are ongoing this week. It's little things like this that make my day.

Transcripts of first three lectures are here, here, and here.

For an earlier post on epistemlogical and ontological questions that offers one version of reflexivity, see here.

In reponse to Soros's proposal that we dichotomize the natural and social sciences, I have this to say: His misinterpretation of Heisenberg's uncertainty principle kills his proposal. In fact it is true of both natural and social scientific theories that our theories influence how reality evolves. It is true too that bad natural science may not have as catastrophic or immediate consequences for us as bad social science. But what we perceive depends in part on our theory of what exists, and those theories are not social. Soros's dichotomy is in fact a continuum.

To wit, from whence did Soros derive his understanding of positive and negative feedback loops? By analogy to the natural sciences. Our exploration of nature is the ultimate origin of all of our theories, bot natural and social.

Mandelbrot and the Glassy State of the Economy

From Fractals and Scaling in Finance, page 367:

Everyone agrees that the distribution of firm sizes is far from Gaussian, hence the proper metaphor is not a "soft," but a "hard" object. This leaves open the question of whether it is a real solid or a glass. Physics describes glasses as being extremely viscous liquids that mimic solids and happen to be particularly difficult to study. In the same way, the lognormal distribution averages mildly in the very long run, but in the short run it mimics the wild randomness of the scaling in a very treacherous fashion. One can call it a sheep in wolf's clothing.

Why is Mandelbrot skeptical of lognnormal distributions of firm size? Because market concentration appears to be a scale invariant quantity -- i.e., the amount of concentration appears not to vary as much with the number of firms in the market as one would expect from distributions with finite variance.

Truth on the Market Merger Guidelines Symposium

Check it out. The symposium offers a preview of the arguments and evidence to be presented at FTC/DOJ hearings on the guidelines scheduled through the winter.

The big shift that could occur as a result of these hearings is a move away from market definition to more direct measurement of the effect of mergers on consumers. The legal formalists of antitrust law tend to go into fits at the suggestion, but is there an area of law more appropriate for legal realism than antitrust? Even legal formalists have to admit that there are rule of law virtues in issuing opinions on decisions that cite the actual grounds on which the decision turned, rather than a reframing of those grounds in terms of market definition rules that turn judges into home plate umpires.

W. Brian Arthur on How Science and Technology Evolve

From the NYT:

“What I began to realize as I got into the project is that everything emerges out of technology,” Dr. Arthur said in a recent interview. “It’s technology that gives rise to both modern science and the economy, and we tend to think of it in reverse — that science gives rise to technology and the economy gives rise to technology. But technology is more fundamental than either one.”

Think about what this means for how we view the relationship between industry and universities.

Distinguishing Exogenous from Endogenous Market Crashes

Simoleon Sense links to what could be a useful bit of anlaysis from Sornette et al.:

[W]e have provided an objective test of the hypothesis that the largest negative markets moves are special and form two distinct populations. The exogenous crashes can be attributed to extraordinary important external perturbations and/or news impacting the market. The endogenous crashes can be seen as the natural deaths of self-organized self-reinforcing speculative bubbles giving rise to specific precursory signatures in the form of log-periodic power laws accelerating super-exponentially.

Sornette applied a similar approach to analyzing YouTube video traffic here.

I'm slowly warming up to Sornette's idea of log-periodic scaling. The mathematical part of this model, at bottom, arises from a treatment of fractional dimensions as complex rather than real-valued quantities.

Feedback Loops in Education

From the Frontal Cortex blog:

Kids learn material much faster when they screw-up first. In other words, getting the wrong answer helps us remember the right one.

Not only kids, I might add. The information content of negative feedback is greater than that of positive feedback. The trick is creating an environment in which it is both encouraged and welcomed.

The work of Carol Dweck has been covered in earlier posts here and here. When I heard her speak to an audience of parents in Palo Alto about a year ago (all there to figure out how to get their kids into Stanford, natch), I asked her whether anybody had looked to see whether the growth mindset was correlated with higher levels of flow experiences. She said that a study had been done of race car drivers, which found some correlation between the two. I haven't been able to find a link on the web.

The Wire and Csikszentmihalyi's Theory of Flow

Last night I finished the last episode of Season 1 of The Wire. If you haven't seen any of this, check it out. The show compares favorably with any film or lit I've consumed in many years.

The show, in fact, provides a good fictional depiction of a complex system, of the kind discussed repeatedly on Broken Symmetry. Of particular note in this regard is the term chosen by characters in the show to describe the complex system of which they are a part -- "the game."

The term naturally calls to mind Csikszentmihalyi's theory of flow, which was discussed in an earlier post, which included this excerpt C.'s book Flow: The Psychology of Optimal Experience at 81:

Cultures are defensive constructions against chaos, designed to reduce the impact of randomness on experience. They are adaptive responses, just as feathers are for birds and fur is for mammals. Cultures prescribe norms, evolve goals, build beliefs that help us tackle the challenges of existence. In so doing they must rule out many alternative goals and beliefs, and thereby limit possibilities; but this channeling of attention to a limited set of goals and means is what allows effortless action within self-created boundaries [i.e., flow]."

It is in this respect that games provide a compelling analogy to cultures. Both consist of more or less arbitrary goals and rules that allow people to become involved in a process and act with a minimum of doubts and distractions. The difference is mainly one of scale. Cultures are all embracing: they specify how a person should be born, how she should grow up, marry, have children, and die. Games fill out the interludes of the cultural script. They enhance action and concentration during "free time," when cultural instructions offer little guidance, and a person's attention threatens to wander into the uncharted realms of chaos.

When a culture succeeds in evolving a set of goals and rules so compelling and so well matched to the skills of the population that its members are able to experience flow with unusual frequency and intensity, the analogy between games and culture is even closer. In such a case we can say that the culture as a whole becomes a "great game." Some of the classical civilizations may have succeeded in reaching this state. Athenian citizens, Romans who shaped their actions by virtus, Chinese intellectuals, or Indian Brahmins moved through life with intricate grace, and derived perhaps the same enjoyment from the challenging harmony of their actions as they would have from an extended dance. The Athenian polis, Roman law, the divinely grounded bureaucratcy of China, and the all-encompassing spiritual order of India were successful and lasting examples of how culture can enhance flow -- at least for those who were lucky enough to be among the principal players.

On my view, this is the most compelling explanation for why the characters are at once enthralled and entrapped by the institution of which they are a part.

Um. How is this different from any other kind of secured credit?

Financial engineering "news" from Tech Transfer Tactics:

An emerging paradigm called royalty-based financing — applied to early-stage start-ups — may be another, according to Gregory T. Huang of Xconomy Seattle. The concept is simple. Instead of buying equity in a young company, an investor agrees to receive a percentage of the company’s monthly revenues - but the upside is capped at a limit of, say, three to five times his or her investment.

It's a bond, folks. And people have been making venture loans in Silicon Valley for a long time.

How Things Break

From Michael Marder and Jay Fineberg:

Galileo was seventy-two years old, his life nearly shattered by a trial for heresy before the Inquisition, when he retired in 1635 to Florence to construct the Dialogues Concerning Two New Sciences. His first science is the study of the forces that hold objects together, and the conditions that cause them to fall apart, the dialogue taking place in a shipyard, triggered by observations of craftsmen building the Venetian fleet. The second science concerns ``local motions:'' laws governing the movement of projectiles. The two subjects Galileo founded have fared differently. One is a respectable branch of mechanical engineering, while the other is a core subject that physicists learn at the beginning of their education. Although now, as in Galileo's time, ship-builders need good answers to questions about the strength of materials, the subject has never yielded easily to basic analysis. Galileo identified the main difficulty: ``one cannot reason from the small to the large, because many mechanical devices succeed on a small scale that cannot exist in great size.[1]'' Nearly three hundred years elapsed after Galileo wrote these lines before science reached the atomic scale and began to answer the questions he had posed on the origins of strength, and the relation between large and small.

...

An engineer and a physicist compete to find the best material to build a house. The engineer chooses brick because she knows it is what everyone else uses. The physicist decides to conduct some basic research. Turning to the periodic table, he finds the element with the highest bonding strength and melting point, and first proposes diamond. Trying to find something cheaper, he next proposes a vitreous mixture of silicon and oxygen, since the raw materials are abundant and safe and form strong bonds. All is well until someone throws the first stone. In fact, the relation between bonding energies and strength of materials is far from direct; physicists had best respect the practical experience of engineers until they can really explain why one should not build glass houses.

...

Take a slab of material, make a saw cut in it, and pull. In a brittle material, the tip of the saw cut spontaneously sharpens down to atomic dimensions, and like a knife blade one atom wide slices its way forward[3]. In a ductile material the tip of the saw cut blunts, broadens and flows, so that great effort is required to make it progress.

See earlier post: An Economy Made of Glass

More on the Long Tail

As Michael Nielsen explains, the value of the exponent in your power law matters a great deal:

If you’re developing a long tail business or collaboration, you need to make sure the exponent in the power law is less than one. The smaller the exponent, the better off you’ll be.

How can you make the exponent as small as possible? In particular, how can you make sure it’s smaller than the magic value of one? To understand the answer to this question, we need to understand what actually determines the value of the exponent. There’s some nice simple mathematical models explaining how power laws emerge, and in particular how the power law exponent emerges. At some point in the future I’d like to come back and discuss those in detail, and what implications they have for site architecture. This post is already long enough, though, so let me make just make three simple comments.

First, focus on developing recommendation and search systems which spread attention out, rather than concentrating it in the short head of what’s already popular. This is difficult to do without sacrificing quality, but there’s some interesting academic work now being done on such recommendation systems – see, for example, some of the work described in this recent blog post by Daniel Lemire.

Second, in collaborative projects, ensure a low barrier to entry for newcomers. One problem Wikipedia faces is a small minority of established Wikipedians who are hostile to new editors. It’s not common, but it is there. This drives newcomers away, and so concentrates edits within the group of established editors, effectively increasing the exponent in the power law.

Third, the essence of these and other similar recommendations is that they are systematic efforts to spread attention and contribution out, not one-off efforts toward developing a long tail of sales or contributions. The problem with one-off efforts is that they do nothing to change the systematic architectural factors which actually determine the exponent in the power law, and it is that exponent which is the critical factor.

If the power law is a description of network clustering, then you could say that the power law is likely to shift from less than 1 to greater than 1 as the strength of preferential attachment increases.

What about the third hand?

Why not do an academic study on data provided by the FTC/DOJ?

Antitrust lawyers know the goal in a merger case is to preserve -- or restore -- competition, but the competitive concerns must be balanced against the economic realities, Wales says. But officials at the DOJ have argued the agency lacks the research capabilities of the FTC, which would be necessary to do a thorough assessment of the efficacy of various types of divestitures. And at a recent American Bar Association event, Bureau of Economics Director Joe Farrell said a divestiture study would strain scant resources at the agency. Instead, Farrell suggested, a divestiture study might best be done by academics with an interest in antitrust regulation, ignoring that such a data-intensive project would be ineffective without access to sensitive corporate information of the type the FTC easily collects.

What makes a market concentrated?

Does this qualify?

These days, bulge-bracket banks -- notably Goldman, Sachs & Co. and Morgan Stanley -- pretty much have a lock on underwriting new issues. (Goldman Sachs, for example, was co-lead manager on five of the seven IPOs that late-September week, and only Vitacost.com turned to bookrunners who weren't bulge-bracket banks.)

Not only does their "brand" dominate, but they've done a good job of convincing pre-IPO companies of their worth. "The common joke is that no CEO gets fired for hiring Goldman Sachs," says Cowen's Biele.

Domination means that these larger banks can pretty much dictate IPO terms. With very few exceptions, they demand IPOs of $100 million or more "to make it worth their while," one venture capitalist says.

That translates into a minimum valuation of $400 million to $500 million, which excludes a whole universe of high-growth, middle-market concerns.

But the FTC and DOJ by themselves cannot solve this problem. They need to work with SEC to clear the hurdles to smaller companies making offerings. Without an IPO option, these companies have to negotiate with potential acquirers with zero leverage.

Call for IP Hall of Fame Nominations

I have been told that nominations are now open for 2010 inductions to the IP Hall of Fame. The IP Hall of Fame is an institution sponsored by the IP Media Group, who also publish the excellent Intellectual Asset Management magazine.

Given the announcement of new FTC rules on sponsored posting, in the interests of full disclosure, I have... NOT received any consideration whatsoever for this announcement. I am an enthusiastic supporter of what the IP Media Group and IAM are doing to bring more attention to this industry, which is so vital to the future growth of our economies.

Previous inductees set a high bar for nominations, nonetheless there are many who are worthy of such an honor. Maybe you know who. Go submit your nominations!

What's Wrong with HHI? Or: What Kind of Competition is Bad for Consumers?

The DOJ/FTC have announced upcoming workshops to review the Merger Guidelines, which are now (depending on whether you count the 1997 revision) either about to start or about to end their teenage years -- i.e., in an awkward stage.

Recently the paper by Shapiro and Farrell on upward price pressure came to my attention:

We propose a simple, new test for making an initial determination of whether a proposed merger between rivals is likely to reduce competition and thus lead to higher prices. Under current antitrust policy, the government can establish a presumption that a proposed horizontal merger will harm competition by defining the relevant market and showing that the merger will lead to a substantial increase in concentration in that market. However, this approach can perform poorly in markets for differentiated products, where market boundaries are unclear and the proximity of the products sold by the merging firms is a key determinant of the merger's effect on competition. Our test looks for upward pricing pressure (UPP) resulting from the merger. We develop a simple diagnostic for UPP based on the price/cost margins of the products sold by the merging firms and the magnitude of direct substitution between the two firm's products. We argue that our approach is well grounded in economics, workable in practice, and superior to existing methods in a substantial class of mergers.

In general, I am enthusiastic about this paper and what it signifies about how this administration will approach these complex problems. In short, UPP avoids the rather artificial analysis of market share using HHI by substituting a direct measure of relative cross-elasticity (or, more precisely, the diversion rato) adjusted by profit margins. In other words, within the UPP framework, the higher the profit margins and the lower the cross-elasticity, the more likely the merger will be bad for consumers. Both economists and lawyers should appreciate how this is a vast improvement over the entirely static calculation of HHI for the market pre- and post-merger.

But for me the problems with HHI suggest a different angle of attack. More specifically, if we agree that one of the core problems with HHI is that it provides too static a picture of competition, then one can justly ask whether UPP really solves the core problem rather than substituting a different (albeit better) measure of the prospective effect of the merger.

What is HHI? For the uninitiated, HHI is an index calculated by adding in quadrature the market share (usually in percentage units) of various companies pre- and post-merger. One of the consequences of adding in quadrature, of course, is that the square of the post-merger market share will always be less than the sum of the two pre-merger companies' market shares squared. Why is that?

I do not know what H and H or others have to say. At first, I was putting off this post until I could find out. Today I realized that that could be a long while. So I will offer my own thoughts.

In probability theory, we add the error of normal variables in quadrature. In other words, if a calculation depends on two measurements, each of which has a certain tolerance for error (e.g., 10 meters plus or minus 2 meters and 4 meters plus or minus 1 meter), then the result of the calculation will be the sum of the measurements, but the error will be the sum of the squares of the errors (i.e., here, 2^2 + 1^2 = 5), not merely the sum of the errors (i.e., 2 + 1 = 3).

The reason errors are added in quadrature is because an error in one direction can cancel an error in the other. That is, if the two measurements are made along the same dimension of units, a statistical fluctuation in the positive direction for one can cancel a statistical fluctuation in the negative direction for the other.

This all carries over very naturally to our analysis of HHI. At bottom, what HHI invites us to imagine is that our market share percentages are actually the variance (or, if the distribution is gaussian, the "standard deviation") of some distribution of possible market share. Hence, to determine market share after combining two distributions associated with two companies, we add in quadrature.

Notice that if we think about market share in these terms, then there is an implicit role for time in the picture. Namely, the distributions are produced by "measurements" in the form of dealflow that result in a distribution with particular variance over some period of time. If the distributions are not stationary (and why would they be?), then that variance should fluctuate. But only when two distributions are combined in the sense that they stop competing for the same dealflow will their variance change discontinuously. That fits nicely with the HHI picture.

But what does it leave out? How about how the variance is changing over time? Wouldn't you like to know whether the distributions are getting fatter are narrower over time?

On my view, the key parameter for defining competition is change in distribution width per unit time. In practice, this would produce a dimensionless number, the internal rate of return, or IRR. If, even adjusting for mergers, a company has posted an IRR over a certain percentage, then there is a reasonable chance that their growth has been built through the use of unsustainable modes of operating, such as fraud.

UPP is an improvement, but doesn't really get to the core problem, which is dynamic.

UPDATE: Investigation of Herfindahl's early papers shows an infatuation with the chi-squared distribution. There are serious fundamental problems with relying upon a chi-squared distribution to fit market concentration, perhaps the most important of which is that market shares cannot and should not be assumed to be independent. Another is that any actual distribution of market shares will probably not be stationary, either over same-width intervals or at different length intervals. We should have cast this kind of theory to the flames a long time ago.

The entropy concentration index is an interesting slice at the problem of characterizing concentration, and brings out the fact that it is the correlation of market shares rather than their statistical independence per se that makes HHI unrealistic. But the entropy index fails for the same reason -- i.e., that market share measurements are not uncorrelated, as they must be for entropy to be an extensive quantity (i.e., for S of 1 and 2 combined to equal S1 + S2). In this regard, a generalization to nonextensive entropy metrics might be considered useful. But there are conceptually and practically simpler ways to get at the degree of correlation in market share, such as cross-correlations in the time-series of cash-flows of different firms.

Time to Update the Ethical Rules on the Practice of Law

Larry Ribstein makes the case:

Law firms’ problems go even deeper than just retaining lawyers and require even more basic changes in ethical and licensing rules. First, unlike most other large firms, law firms must be worker cooperatives because ethical rules allow only lawyers to own firms that provide legal services. This rule raises firms’ cost of capital and further constrains their ability to build durable businesses.

Second, legal advice has strong synergies with other types of advice, such as finance and accounting. Yet the restriction on non-lawyer owners inhibits the formation of multidisciplinary firms.

Third, much legal advice potentially could be packaged and sold like other intellectual property rather than dribbled out by the hour to individual clients. Yet professional regulation keeps law practice in its traditional mold by requiring legal information to be dispensed by licensed lawyers who work for firms that comply with the rules discussed above.

For more on the dubious history of our "ethical" rules, see here.

Thouhts on Nick Paumgarten's "The Secret Cycle"

Nick Paumgarten's piece, "The Secret Cycle" in the 12 October 2009 New Yorker is probably worth a read for some readers of Broken Symmetry. The article, which is unfortunately gated, retells some of the history of technical forecasting based on observed periodicities in a variety of independent variables, including (naturally) market prices.

Armstrong sounds like an idiot savant to me. He probably is quite good at the technical analysis, but is full of @#$# when it comes to his speculations about what mechanisms might account for observed periodicities. So are most people who claim to see signal in the noise of market prices. For the record, your author endeavors to invest only with a margin of safety calculated Graham-and-Dodd-style (or, better, Buffett and Munger-style) from fundamentals.

But long-time readers of Broken Symmetry may recall earlier posts on a "fundamental hypothesis of periodicity." Also for the record, I will say that I believe there are probably collective modes of oscillation produced by organizations of individuals that arise from weak nonlinear couplings of human behavior. That belief is not pure speculation, as the papers from Malmgren and Watts and on synchronized clusters demonstrate.

I am profoundly skeptical -- in fact, I believe it's impossible -- for us to accurately forecast market price cycles out for years into the future with day-level precision as people like Martin Armstrong claim to be able to do. Yet I believe it's not impossible that much more of our social and economic lives are governed by low frequency, but large-scale and low-magnitude "forces" than most economists would admit. It's just that the higher energy noise of everyday life makes the influence of these weak forces much harder to discern. It's only in moments of profound social uncertainty -- such as the present crisis -- that people begin to wonder how much of their individual destiny is truly independent of their neighbors'.

Robert Musil says somewhere that we are as connected to each other as two drops in a river. That has always sounded about right to me. And if you're thinking, "That's not too connected!" then I refer you to consider the chemistry of water more carefully (and particularly the hydrogen bond), and remind you that Musil was trained in that chemistry.

From a Comment on PatentlyO on the Stanford v. Roche opinion

See original here.

Initial title rests with the inventors, and nothing in Bayh-Dole contradicts that fundamental principle, ie, Bayh-Dole does not transfer title of invention from the inventors to anyone else by operation of law alone. It is the University's obligation under Bayh-Dole to control its employees in accordance with the funding agreement at issue, ie, to force them to assign. If the University does not do that, the problem is between the University and the funding agency.

Commentary Worth Reading in view of Stanford v. Roche

From an interview of Dr. Gerald Barnett at the excellent ip-advocate.org, which I just discovered:

Bayh-Dole focused on harmonizing agency patent policies and distributing opportunities to promote inventions to universities across the country. It wasn't directly concerned with innovation, but with using the patent system to promote use of inventions, development of collaborative relations with industry, and support for U.S. small business and U.S. labor.

The law itself hasn't constrained innovation - but the way in which universities have implemented practice under it has had mixed outcomes. In response to the law, many universities established Technology Transfer Offices (TTOs) to act as a central reporting agency and to facilitate the selection of inventions that will benefit from use of the patent system. This mixed a regulatory function (reporting) with an invention management function (patents). The result was pressure to monetize patent rights rather than to create an environment that promoted innovation.

The TTO works great for paperwork reporting, but not so well when you have a diversity of inventions, from biotechnology and nanotechnology and software and composters, moving through a single office. Even if the TTO is well-funded and staffed, you still only have a one in a hundred chance of a monetary success worth talking about.

What universities haven't done well is the use of the patent system to build working relationships with industry, support the development of research and early adopting practice communities, or support inventor-based insights into commercialization directions. For this last bit, TTOs find themselves cornered between processes designed to identify inventions with great "commercial potential" and a demand that everyone get equal treatment. As a result, it's difficult, especially in public research universities, to mobilize resources in support of any particular invention - beyond filing a patent application.

Second, and just as important, many universities also established employment policies that compel inventors to agree to assign their inventions to the TTO. This is a subtle but huge transformation in how invention is managed within the context of university research. A hundred years ago, when Cottrell invented the electrostatic precipitator, he was working with a company, at the University of California. He used the patents to found Research Corporation, which then supported research throughout the country and served as an agent for other faculty who had inventions they felt could benefit from Research Corporation's expertise. The system was voluntary, not compulsory. And it gave rise to the idea of the research foundation, as later established as university affiliated at Wisconsin, Kansas, Washington State and elsewhere.

Bayh-Dole gave universities an incentive to wrap voluntary inventor interests with a process-based policy, anchored in contracting regulations. These were then extended for consistency, if not convenience, to cover all instances of invention, not just those made with federal support. As you know, this move to compulsory claims based on employment, rather than voluntary offer based on recognition of resources, has created tremendous issues.

When you think about it, Bayh-Dole set up a classic struggle between bureaucracy and innovation. After all, innovation threatens institutional norms that bureaucracy seeks to codify. Given the opportunity to do so, institutions - agencies and companies included - inadvertently bottleneck and suffocate bright ideas with process. It turns out that consistency, compliance, efficiency and avoidance of risk are the dominant virtues of a process approach to research innovation. Mobilization for a purpose, risk-taking to achieve an outlier advantage, and preparedness for rare events don't count for much.

A very Drucker-esque view of innovation. Here's an important question for tech transfer offices to consider: given the bandwidth issues they face in addressing the many demands on their time, wouldn't now be a good time to consider working with a private intermediary like the Research Corporation?

In economic terms, the Research Corporation acted as a market-maker in those early days of university patenting. The Bayh-Dole Act seemed to have disrupted that model when a handful of universities were successfully able to patent and license innovations without the help of such an intermediary. But what the last decade has shown, I believe, is that entities like the Research Corporation performed an even more important economic function than the provision of professional (even legal) services. Intermediaries like Research Corporation help close feedback loops between universities and industry that are difficult because of the Prisoners's Dilemma of incentives and the asynchronous time horizons of universities and for-profit industry. Without such intermediaries, the tech transfer market is going to become more and more like the patent secondary market, with its litigation-driven norms and valuations. We need more experienced and culturally sensitive intermediaries to foster transactional norms.

Patents and Non-Compete Agreements

Another key portion of the Stanford v. Roche decision from the Federal Circuit relates to California's restriction on the enforceability of non-competes:

Under California law, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Prof. Code § 16600 (2009). Stanford argues that section 16600 voids the VCA because Holodniy conceived the patented invention after departing Cetus, and the VCA violates public policy if it encompasses inventions conceived after employment terminates. Stanford also contends that once Holodniy’s research was published, it became public information, and that Roche’s interpretation of the VCA would prevent Holodniy from using this information in his later clinical studies.

We find no merit in Stanford’s arguments. By the plain language of section 16600, only those contracts that prevent “engaging in a lawful profession, trade or business of any kind” are void. Stanford provides no evidence that the VCA restrained Holodniy from engaging in any profession. Indeed, the record shows that Holodniy freely continued his HIV research at Stanford, publishing articles and using the knowledge he obtained from Cetus to further the science behind the patents-in-suit. Nor does Stanford explain how Holodniy’s assignment of his rights to Cetus prohibited Holodniy from using any public information in his later research. Moreover, California courts apply section 16600 to employment restrictions on departing employees, not to patent assignments.

This illustrates one of the most important sources of social value that patents offer. At least since Lincoln, owning human capital directly has been illegal in this country. But corporations and inventors need some way to credibly commit to each other. (Banks and poor students who want to go to expensive universities have a similar problem, which is solved by making student loans non-dischargable in bankruptcy.) Patents facilitate that bargain -- inventors option off the right to ideas they come up within in a certain period with patent rights, guaranteeing employers that their ideas won't leave with them (as they would if only trade secrets and non-competes were available) when they go to a competitor or retire.

An Inventor's Declaration of Independence?

From the Stanford v. Roche case, decided today:

We have held that the contract language “agree to assign” reflects a mere promise to assign rights in the future, not an immediate transfer of expectant interests. [citations omitted] Therefore, in the [IP agreement with Stanford], Holodniy agreed only to assign his invention rights to Stanford at an undetermined time. Additionally, Stanford’s contemporary Administrative Guide to “Inventions, Patents, and Licensing” states: “Unlike industry and many other universities, Stanford’s invention rights policy allows all rights to remain with the inventor if possible.” J.A. 743. While Stanford might have gained certain equitable rights against Holodniy, see Arachnid, 939 F.3d at 1581 (“[A]n agreement to assign . . . may vest the promisee with equitable rights.”), Stanford did not immediately gain title to Holodniy’s inventions as a result of the CPA, nor at the time the inventions were created.

Note that this result came about under a Stanford policy no longer in effect. Stanford changed its policy so that ownership would go automatically to the university in 1995. Was the change a step forward or a step back for inventors inside Stanford? Is it easier or harder now for groups like Holodniy's to enter into joint research efforts with companies like Cetus?

When organizations increase in complexity, one reaction by management is often to put stricter constraints on the organization. This doesn't work. Both the people trying to achieve the organization's goals and the people who don't care about the organization's goals will simply find ways to work around the constraints. The underlying cause of the problem is that the constraints are too static -- managers have less information than the employees managed about what's happening. That's why other organizations delegate and decentralize authority to the lowest level at which problems can be solved. Within universities, that may be the level of principal investigator.

Another passage from the case could be more cause for contention in the future:

Just as we explained that Bayh-Dole does not automatically void ab initio the inventors’ rights in government-funded inventions, Cent. Admixture, 482 F.3d at 1352-53, we see no reason why the Act voids prior contractual transfers of rights.

This sentence is footnoted: "We express no opinion as to whether Holodniy's execution of [the agreement with Cetus] violated any provisions of the Bayh-Dole Act, or whether the act provides the Government or Stanford some other legal recourse to recover Holodniy's rights. Cent. Admixture, 482 F.3d at 1353."

Under the Bayh-Dole Act, the government does retain so-called "march-in rights." But to date, these rights have yet to be exercised by any federal funding agency, at least to my knowledge. And in any case, the requests for march-in rights to be exercised have not been made to shift funding from one private party (like Cetus) to another (like Stanford), but rather to make a drug for some virulent disease available on cheaper terms than the patent owner wants to make it available.

If there are other private rights of action under the Bayh-Dole Act, then I don't know what they are. Even inventors' rights to reasonable royalty have not been recognized as the basis for a private right of action.

This is an interesting area of law, which is vital to the future health of our economy.