Broken Symmetry

Balance-Sheet Networks

From Robert M. May, Simon A. Levin and George Sugihara:

although the study of payment flows is of immediate interest to central bankers, it may miss an essential aspect of systemic risk, namely the ‘contagion dynamics’ of public perceptions and asset valuation associated with the interaction of balance-sheets (the mutual financial obligations and exposures that link companies). For example, how contagious are inflated valuations of Internet stocks? Are there hidden, mutually dependent risks associated with such high valuations? It could be useful to examine the dynamic network of balance-sheets, and if possible to quantify the inter active effects of valuations, credit policies, hedging and so on among financial institutions, especially investment banks. Such balance-sheet networks could be helpful in studying the effects of asset- pricing bubbles, credit crises and the poorly understood but potentially worrying effects of the current widespread use of derivatives (futures and options) and dynamic hedging by investment banks to manage risk on the fly.

Just discovered Sugihara through a link in an interesting post on O'Reilly Radar.

Paul Samuelson the Investor

From Economic Principals:

It turns out that the great MIT economist was influential in the creation of one of the earliest and most influential hedge funds. Launched in 1970, Commodities Corp. blazed a trail of extremely high returns throughout the 1970s and early ’80s, before disappearing in various pieces into Bermuda mailboxes and Goldman Sachs. Many of its star traders – Bruce Kovner of Caxton and Paul Tudor Jones, chief among them—formed successful hedge funds of their own. Samuelson thus had a ringside seat at the birth of an influential industry that is still only poorly understood.

About the same time, he invested a substantial amount in shares of Warren Buffet’s Berkshire Hathaway Inc. It was in 1970, too, that he won the Nobel prize in economics, the second to be awarded. Long famous for the fortune that his pioneering textbook earned him after 1948, it turns out that Samuelson may have made more money as an investor than as an author. He was both smarter and richer than is generally understood: as an investor, a bigger winner, perhaps, than the more volatile John Maynard Keynes.

Via Tyler Cowen at MR. More evidence for the Paul-Samuelson-as-Isaac-Newton theory?

Does patenting strategy improve after a buyout?

According to a careful empirical study by Lerner, Sorenson, and Stromberg, the answer is yes:

Our main finding is that firms pursue more influential innovations, as measured by patent citations, in the years following private equity investments. Firms display no deterioration in their research, as measured either by patent “originality” and “generality,” and the level of patenting does not appear to change after these transactions. We find some evidence that the patent portfolios become more focused in the years after private equity investments. The increase in patent quality is greatest in the patent classes where the firm has been focused historically and in the classes where the firm increases its patenting activity after the transaction. The patterns are robust to a variety of specifications and controls. Collectively, these findings are largely inconsistent with the hypothesis that private equity-backed firms sacrifice long-run investments. Rather, private equity investments appear to be associated with a beneficial refocusing of firms’ innovative portfolios.

Via the Harvard Law School Corporate Governance and Financial Regulation blog (actually "forum"). (Am I wrong or does their name keep getting longer-winded?)

PTO Commissioner David Kappos on University Tech Transfer

Available here:

The methodologies universities use to facilitate IP transfer are currently in flux, as traditional models evolve and new best practices emerge.

Universities on the cutting edge of this field realize that the long accepted choice between maximum diffusion of innovation and maximum revenue capture is a false choice. Put simply, universities need not sacrifice their societal obligation to disseminate knowledge in exchange for research funding. In fact, when executed well, diffusion-focused technology transfer generates more net aggregate funding, not less.

Now, royalty generation from university innovation will continue to play a role in the commercialization life cycle. But it will synergize with diffusion-focused tech transfer. And we will see less conflict between the models, because astute university innovators realize that when royalty generation comes into conflict with diffusion, it inhibits the fundamental mission of educating researchers and conducting research to produce breakthroughs that create American jobs and economic opportunity. Astute university innovators are already working to a better end.

Via Tech Transfer Tactics. I couldn't agree more at this level of generality. Now let's see whether the theory gets put into practice with more inventor and industry-friendly institutions.

Renaissance Returns

From the WSJ:

Mr. Simons made his reputation on his signature fund, called Medallion, which has posted average returns of about 45% a year, after fees, since its inception in 1988. Since 1995, it has had only one money-losing quarter, slipping 0.5% in the first quarter of 1999, according to documents reviewed by The Wall Street Journal.

Wow. That's quite a benchmark.

For those readers wondering what speech recognition might have to do with market prices, click on the "Fourier Analysis" category link at right.

The Good, the Bad, and the Ugly

From Dan Primack at peHUB:

The secondary market’s stickiest wicket continues to be the gap between buyside and sellside pricing expectations. Rather than trying to bridge the divide, it would appear that both sides are calcifying – believing that the other will cave.

For buyers, that means banking on a theory that increased capital call volume will push some LPs over the line from liquidity-parched to liquidity-desperate. Sellers, on the other hand, counter that an increase in capital calls is likely to be coupled with an increase in distributions, which could help them maintain an even keel.

The detente among LPs, buy-side GPs, and sell-side GPs recalls a classic spaghetti western:

One cannot help observing that the same groups that before the crisis were actively engaged in buying and selling have undergone a sort of phase transition to passive standoffs in which the biggest concern is with being the last man standing.

What will break up this "calicified" state, and get the volume of transactions flowing again? Government interventions seem not to be enough. Only restored trust and confidence will do the job. And these take time.

Geanakoplos and Farmer on the Nonequilibrium Statistical Mechanics of Markets

The WSJ leads with Geanakoplos today and Marginal Revolution picks the story up. Skimming through SSRN publications by Geanakoplos, I find this chestnut:

An alternative point of view is that, due to a lack of a perfect rational ity, the market is not in perfect equilibrium and thus prices do not simply passively reflect new information. Under this view the market acts as a non-linear dynamical system: agents process information via decision-making rules that respond to prices and other inputs, and prices are formed as a result of agent decisions. Since this information processing is imperfect, the resulting feedback loop amplies noise. As a result a signicant component of volatility is generated by the market itself.

From a paper co-authored with J. Doyne Farmer.

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.

Patent Auctions, Patent Artifice, and Patent Artistry

From today's NYT:

“Yes, you can move in the direction of trading markets for patents, but these are complicated assets that are individualized and hard to value,” said Josh Lerner, an economist at the Harvard business school. “They are more like works of art than stocks.”

Couldn't have said it better myself. As somebody who has attended a couple of patent auctions, and even helped sell a lot at one, it is surprising to see the market presented as growing. The auction market is winding down, as Ocean Tomo's recent cancellation of its event in Paris demonstrates. There will always be an auction market at the low-end, but the larger portfolios are going to be bundled and exchanged more privately.

That's not to say that there isn't going to be some growth in the IP market. It's just that it will be growth that accommodates the artisanal qualities of IP that Prof. Lerner notes.

Carol Mimura on the Nuances of Managing IP Rights

Since I recently complained about the culture in technology transfer offices, I thought it only fair to point out that there are indeed a few universities that have developed or are developing a healthier approach to university-industry relations. Carol Mimura at UC Berkeley recently posted a draft book chapter on SSRN:

[Tech transfer] is an ongoing relationship continuum, not just a single transaction. A relationship continuum spans many years. It results from many points of contact, and many engagement types. It is akin to building a pyramid or climbing a staircase, or contributing different sectors of a pie to create a whole. Our networks are essential. We cannot accelerate innovation on our own; rather, our public-private partnerships and product development partnerships demonstrate that we can expedite translational research and bridge funding gaps through creative partnering and flexible contracting.

Success under the relationship model consists of rights transfer and knowledge transfer in both directions (into and out of the university) to enable innovation acceleration, deployment, uptake, and translation. By many measures, the relationship model has borne fruit. By valuing corporate relationships more than any single transaction, utilizing our networks to advantage, and valuing research support as highly (if not more highly) than license revenue, the overall industry dynamic has changed. Cultural and negotiation biases have been reduced, industry and foundation funding have risen dramatically, collaboration types and numbers have increased, barriers to gifting into the university have been lowered, and greater numbers and types of contracts and strategic alliances have been formed. We have also enjoyed reputational gains as a campus that has improved its corporate relations and contracting units.

The high-bandwidth feedback loops established through what Mimura calls a "relationship-based" approach to tech transfer are an example of the integrated complex systems that are a theme for this blog. Like the neural networks of its individual members, the social networks established can learn over time, gradually building up tacit knowledge of the science and engineering problems that pose challenges both to public and private organizations.

A key cultural difference between UC Berkeley's IPIRA and other university tech transfer offices is that Mimura and her team first took the time to learn about the needs of every stakeholder involved in these complex, multilateral agreements. As a result, the deals she has closed -- including the pathbreaking BP-Berkeley deal and the Socially Responsible Licensing Program (SRLP) -- are nothing less than the future of the IP market. Although it might be inconvenient for some market participants to acknowledge, ultimately the highest value of IP rights is realized through the increased collaboration (and hence learning) that they promote.

What is Wrong With Technology Transfer Office Culture?

Jon Sandelin from Stanford University's Office of Technology Licensing published an article in the Summer 2009 issue of an AUTM journal called University-Industry Relationships: Potential Risks. Perhaps unsurprisingly, the article is gated and available only to members. Already in the title you can see where Sandelin comes out on the idea of having more commercial ties with universities. One of the messages repeated on this blog over the past year has been that feedback loops promote innovation. The feedback loops between universities and industry are perhaps the most difficult to forge and maintain of any in our innovation pipeline. We should be promoting these feedback loops aggressively. Unfortunately, the tentative, preening, and antiseptic tone of this article is all too characteristic of tech transfer culture inside top-tier research universities.

Sandelin does a good job listing some of the benefits of tech transfer. But consider the "summary of risks" he comes up with:

1. That patenting and licensing by universities may inhibit rather than promote the progress of science and production of innovation
2. Of a loss of public trust in the university and/or its employees
3. Of unfulfilled commitments to research sponsors, students, or the university
4. Of bias when reporting research results or not reporting research findings that would be adverse to the interests of an industry patron
5. Of exploiting the work of students to benefit personal interests of their supervising professor
6. Of adverse and embarrassing reports in the media, whether actual or perceived, that affect the reputation of the university
7. That new discoveries made by university employees are not reported to the university or to a federal funding agency as invention disclosures, but are instead diverted to a company in which the employee has a financial interest

That's it. Wait. That's it?! Of these, only 4 is what I would consider an actual risk to the university. Look at the other six items on this list more carefully. What is really there?

First off, what on earth can he mean by one? If one is true, then why are we even bothering? The tech transfer experiment has been a wild success. As economist Kenneth Arrow noted recently, some of the best work results when academics are asked to work on a problem they've never thought about before. Tech transfer relationships work because universities get data from industry that is as valuable to academics as the theory that industry gets from universities.

Two just shows how little conviction Mr. Sandelin has in the fact that he is doing something important and beneficial for the university and its employees. Why would these people not trust the university if it is doing things that benefit society at large by cooperating and collaborating with private companies? Does he believe making money is inherently evil? If so, why not come right out and say that instead?

Three strikes me as very strange. Isn't the possibility of unfulfilled commitments to research sponsors a risk for the research sponsors? How is that a risk for the university? Similarly, why would students see more industry relationships as a risk? Students need jobs after they graduate, and somebody has to provide work.

Five would be hilarious if it weren't sad because it demonstrates how big a problem negotiating ownership rights is when it isn't done properly upfront. Universities love to ask graduate students to sign a thick contract when they start that gives away all of their rights. Most grad students, of course, never read the fine print and only find out how badly they've been taken advantage of later when somebody makes millions on their blood, sweat, and tears.

Six also makes me wonder. That's not a risk of relationships with industry. That's a risk of dysfunctional relationships with industry. Why would that be a problem for a university like Stanford, I wonder?

So of these seven risks, it is only four, the risk of bias caused by taking money from a particular group, that strikes me as very serious. But that risk is a risk for any institution, public or private, for-profit or not-for-profit. There's nothing really more difficult or challenging about solving that problem at a university. In fact, it's probably easier to solve that problem at universities, where most academics prize their professional reputations far above any particular grant money. Let the researchers themselves be the ones to decide whether it's worth risking their reputation on taking funding from some large corporation. Then just make sure that everybody can lookup and find out from whom researchers are getting their support. That's how we do things in this country.

It's very frustrating to see how backwards the thinking is at what is considered one of the best technology transfer offices in the world.

Excellent Sentences from Joff Wild at IAM

However, how do you measure value when IP can be so frustratingly intangible - what price that collaborative relationship with a competitor that a piece of IP may enable, for example? One at least partial solution to this conundrum may be to make royalty rates far more transparent. One suggestion was that all licensing deals agreed in the US should be publicly recorded at the USPTO so that people could see the sums involved. This would have to be compulsory as no-one would do it voluntarily.

From the IAM Blog.

Highlights from the 2009 IP Business Congress

Monday and Tuesday of this week I attended the second annual IP Business Congress, which this year was venued at the Four Seasons Hotel in Chicago. There were almost 400 attendees at the event, which was a good turnout given the economic climate. Attendees represented stakeholders in nearly every part of the IP Market, both primary and secondary. As expected, the panels organized by IAM magazine were excellent and informative, especially the question and answer sessions afterward. This is an event that I expect to put on my calendar annually.

Highlights for me as an attendee to this event included (1) the first panel on Monday on the state of IP rights in China, India, Japan, Europe, and the United States; (2) the panel on patent pools on Monday afternoon; (3) the panel on open innovation on Monday afternoon; and (4) the Gala dinner on Monday night. Tuesday's panels were also excellent, but of less interest to me because of my more direct involvement with many of the issues addressed on Tuesday.

State of IP Rights Internationally

Harvey (expert on China) kicked things off by noting how IP rights had been a strong influence on the development of rule of law more generally in China: IP was the first private property right to be recognized by the Chinese government after the cultural revolution. Harvey also explained that in number of lawsuits, there is more IP litigation in China than in any other nation. The picture he painted was of a thriving IP system in China that was operating decoupled from the rest of the IP world. The coupling of China's IP system into the rest of the world's will produce winners and losers of epic proportion, and now is the time for us to think strategically about how to prepare our clients and customers for this inevitable merge of the Chinese system into the rest of the world.

McGinley (EPO Officer) followed Harvey with sobering statistics on the patent application bubble that is growing inside the US, EPO, and Japanese patent offices: 2 million applications althogether are now pending inside these offices. Given how the rate of examination has not kept up with the rate of growth in filing, McGinley suggested that the system was beginning to resemble a pyramid scheme! This was a brave position for a government official to take, but everybody in the system should appreciate what McGinley is trying to do. Where might we have been had more financial regulatory authorities here in the U.S. pointed out the pyramid-scheme-like growth of the subprime mortgage market? McGinley was short on answers as to how to solve the problem, but he did suggest that Chinese officials were probably at the top in terms of training practices and the reduction of systematic errors in examination. This seemed unsurprising to this listener given the on-the-ground experience of many Chinese with more complex manufacturing workflows!

The presenter from Japan had little of interest to say, and presented some confusing interpretations of statistics on patenting in Japan. For example, he pointed out that the largest number of patents issued in Japan were to computer companies rather than pharma companies. Pharma companies need only one well-drafted and prosecuted patent to protect their products. This is not very surprising, and is true everywhere in the world.

Basheer from India gave in many ways the most interesting presentation. His was mostly a diplomatic presentation of facts about the IP market in India, where the political agenda is driven by the success of generic drug manufacturers. As a few BS readers may know, Basheer is also one of the authors of the consistently excellent (but very detailed!) Spicy IP blog. From listening to Basheer, one could piece together a picture of India in a critical state, in which more or less IP protection could result from a sharp push in either direction. Too difficult to call for the time being. On my view, it seems that Indian biotech and pharma researchers have a regulatory arbitrage over their U.S. counterparts, who have many years of redtape to cut through before carrying out even relatively safe clinical trials! Note that beating heart transplants are now being carried out in Indian hospitals. There are many high-risk, high-reward medical treatments now avaiable in India that may never be available in the United States. Another trend to watch carefully.

The first question/comment for this panel was also notable. It came from Sherry Knowles of GSK, who noted that Chinese generic manufacturers were getting drugs to market before US manufacturers by simply scraping clinical data off the clinicaltrials.gov website on which U.S. manufacturers, such as GSK, have to post their data by law! There's one for the USTR to call to Chinese government attention.

Patent Pooling

The Monday afternoon panel on patent pools included Sisvel founder Dini, Hinman from Verizon, and Michel from the FTC. Dini gave a great pitch for hiring independent administrators (such as Sisvel) for allocating profits among patent pool participants, and for getting such admins involved at as early a stage as possible. Michel gave a presentation of the recent history of FTC regulation of patent pools, including a summary of the federal court holdings relating to Rambus's participation in JEDEC. Hinman talked about the perils of patent pool participation, and noted that even opt-out could be anti-competitive. Referring to one patent pool in particular, he pointed out that all but two industry participants had entered. I saw Michel scribbling notes!

The upshot is that if your company is involved with patent pools, you need to hire experienced outside counsel with knowledge at the interface of IP and Antitrust law to help ensure your business strategy reduces the risk of antitrust liability. Your author knows and works with a few such experts, and is happy to make an intro. Note that most corporate lawyers or IP lawyers will not be aware of the perils of competition law because the Bush and Clinton administrations were relatively lax on this front. All indications are that the Obama administration will be more active in enforcing competition law.

Open Innovation

By now the term "open innovation" has become relatively well-known within the business community. Some IP owners may believe that open innovation represents a form of socialism -- an alternative to a system of property rights. Attendance to this panel would have been the antidote to such misunderstandings of this theory. Panelists Weedman from P&G, Simonton from Exelixis, and Bergelt from the Open Innovation Network (and formerly of Paradox) talked about the dynamic growth that the feedback loops established by open innovation networks facilitate for the companies that take open innovation seriously.

Because the theory of open innovation is a paradigm shift from traditional neoclassical economic theories, only a handful of businesses (including P&G and Exelixis) have been fortunate enough to find leaders willing to foster the organizational commitments necessary to make open innovation work. This business model is the future of every large public corporation in the world. Watching these businesses continue to outgrow their competitors, others will eventually follow.

Gala Dinner

One of the best parts of the event was meeting the attendees. Over drinks before the Gala dinner, I had the chance to catch up with Niels Reimers, who later that evening was inducted into the IP Hall of Fame for his path-breaking work in technology transfer. In this rare moment of opportunity, I had the chance to ask Niels about how he worked at Stanford. By Niels's description, he was practicing the same technique followed by the best founders and managers in Silicon Valley both then and now -- "management by walking around." Dave Packard and Bill Hewlett, Bill Perry at ESL, and Nils at Stanford were all doing management by walking around. Niels's personal accounts of his work connecting Stanford music department (!) professor John Chowning with Hamamatsu corporation engineers were a highlight among highlights for this event.

Later, when Niels cited the Teece Model of innovation in his acceptance speech, I nearly fell out of my chair. The same model was cited by FTC Commissioner Tom Rosch in his speech about new theories in competition law on June 1, 2009. Note that Teece was also cited in the explanation of systems theory provided in your author's letter comment to the FTC on the Evolving IP Marketplace.

Final Thoughts

Another highlight made possible by my attendance to the event, but not directly related thereto, was an invitation to a breakfast with Congressman Bill Foster on Tuesday morning. I am already a fan. Foster is an entrepreneur and physicist who decided (after 22 years of building superconducting magnets to detect subatomic particles) to roll up his sleeves and try to help fix government. I'm pretty sure there's nobody else in Congress who would know what the title of this blog refers to. The discussion of the patent system and innovation at this breakfast was the best I've heard ever anywhere, but it also revealed to me the underlying problem facing patent reform: nobody has a complete view of the whole system. Almost everybody (at least) focuses on the broken incentives and procedures facing them in their subsystem, without stepping back to see how all of the subsystems coalesce into an competitive and innovative ecosystem. Nonetheless, the kinds of questions asked and answers given at this breakfast suggest that already the level of discourse has progressed far beyond the pat answers that were served up last year when patent reform was before Congress. There is more widespread awareness at least of how the public has been manipulated to some extent by the more technologically sophisticated and media-connected subset of stakeholders in the system. Perhaps we will have sensible patent reform after all. Here's to that hope.

Judge Posner on the Systems Theory of the Financial Crisis

Yet even if all firms that create systemic risk decided to shrink, or to reduce their interactions with other financial firms, systemic risk would not be eliminated. For such risk is a property of the financial system rather than of individual firms. That is, systemic risk is correlated risk. If the entire banking industry were heavily invested in home mortgages, and a housing bubble caused a drastic fall in the value of those mortgages, it wouldn't matter if the industry consisted of 10,000 banks of equal (and therefore equally small) size that had no dealings with other financial firms. The whole industry would be brought down.

Read the whole post here.

Financing with Future Royalties

Nice summary of the market from The Deal:

The investor's motivation for making a royalty financing investment is the expectation of receiving a private equity level return (e.g., modeled internal rates of return often exceed 20%) in an asset class (directly or indirectly consisting of intellectual property interests in pharma and biotech assets) that is relatively non-correlated with broader market indices. The investor's return expectations are predicated on its assumption of the risks of the sustainability of future cash flows (for royalty interest transactions) and of the commercialization of assets that have not yet generated meaningful cash flows or made substantial commercial penetration (most frequently in synthetic royalty transactions.) The investor's ability to take on these risks intelligently is predicated on the synthesis of highly specialized capabilities in analyzing the commercial and regulatory landscape for the relevant assets, including assessments on the strength of the underlying intellectual property in the relevant markets, the likelihood of competing or cannibalizing products and the likelihood of market acceptance for the underlying products.

A Systems Theory of Financial Regulation

From Geithner and Summers:

First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole. As a result, institutions were not required to maintain sufficient capital or liquidity to keep them safe in times of system-wide stress. In a world in which the troubles of a few large firms can put the entire system at risk, that approach is insufficient.

Perfectly consistent with Summers's column on "Regulatory Systems Design" almost a year ago today.

For a systems theory of patent law, see Question 9 here.

More on the UC Berkeley, Livermore, UIUC, and British Petroleum Bio-Energy Institute

Available here:

According to Carol Mimura, assistant vice chancellor for intellectual property and industry research alliances at UC-Berkeley, the EBI decided on the unusual lab space structure in order to prevent bottlenecks that typically occur in sponsored research agreements.

“Real-time feedback from industry in this one field in particular is deemed to be very valuable input for us,” Mimura said, noting that the agreement includes a “typical publication preview clause” that allows BP to check manuscripts prior to publication “to make sure we haven’t inadvertently included any confidential information.”

BP will also be able to discuss options for filing patents before publication — a process that is often long and arduous in university-industry collaborations.

“In this case that process is going to be even faster than usual, because the person doing that vetting will be right here,” Mimura said. “So it’s possible that there won’t even be the publication delay that could be possible under these types of agreements.”

How to Get Toxic Assets Moving Like Hotcakes?

One of the problems with pricing the derivatives books at banks is that nobody wants to go first and then lose their shirt if it turns out they got their valuation wrong. And these suckers are nearly impossible to value now that we know that our theory of valuation was catastrophically wrong. So what do you do?

Well one idea is to recognfigure credit-default swaps into providing negative feedback rather than positive feedback to prices:

This analogy can help us figure out how much capital large financial institutions should be required to keep on hand. The answer: an LFI will have to post enough collateral (equity) to insure that its liabilities are always paid in full. When the fluctuation in the value of the underlying assets puts creditors at risk, the LFI's equity holders will be faced with a margin call: They will either have to inject new capital or lose their equity. In both cases the creditors will be protected.

The main difference between margin calls and our new capital requirement system is the trigger mechanism. In a margin account, the broker looks at the value of the investments (which is easily determined since all assets are traded) and compares the value of the collateral posted with the possible losses the position might have in the following days. Creditors of LFIs, however, are often dispersed and so unable to coordinate to make a margin call. And since most LFI assets, such as commercial loans and home equity lines, are non-standardized and not frequently traded, their value is hard to assess. Another mechanism will be needed to determine when the margin is too thin.

One possibility is to leave the decision of when to make a margin call in the hands of a regulator. However, the risk here is twofold. Either the regulator is powerful, leaving financial institutions exposed to the risk of abuse, or the regulator is weak and will be unduly influenced by failing institutions and intervene too late.

Regulators should therefore rely on a market-based trigger: a credit default swap (CDS). Despite being viewed by many as a "financial weapon of mass destruction," CDSs are like any tool that can be used wisely or foolishly. In this context, they are potentially some of the best regulatory instruments available. A credit default swap on an LFI is an insurance claim that pays off if that institution fails and creditors are not paid in full. Since the CDS is a "bet" on the institution's strength (or weakness), its price reflects the probability that the LFI debt will not be repaid. Such CDSs, in essence, indicate the risk that a large financial institution will fail.

In our mechanism, when the CDS price rises above a critical value (indicating that the institution has reached an unacceptable threshold of weakness), the regulator would force the LFI to issue equity until the CDS price and risk of failure back down. If the LFI fails to do this within a predetermined period of time, the regulator will take over.

This regulatory takeover would not be dissimilar to a milder form of bankruptcy, and it achieves all the other goals of bankruptcy -- discipline on management and shareholders -- without imposing any of the systemic costs.

Larry Summers should like this idea. It fits very well with his principles of regulatory systems design.

The proposal is from Oliver Hart and Luigi Zingales. Good creative thinking.

Spring 2009 Ocean Tomo Auction: The Secondary Market Evolves

Although many of the attendees to the auction may have come away with the sense that the auction market is closed until the recession ends, a look at the numbers says otherwise. In particular, the total volume of sales at the auction was around $3 million -- considerably less than the immediately preceding auctions, but on par with the the first auctions held by Ocean Tomo about four years ago. For the auction market at least, it has been a lost half-decade rather than a lost decade as it has been for the equity markets.

I have some first-hand experience here. This was my second auction. The first I attended was in Chicago in October 2007. The impression I had there was the same that many who first attended yesterday probably came away with -- i.e., that this is a very thin market, with few bidders, and very specialized property for sale. For an investor, thin markets are a good thing, presenting the opportunity for arbitrage given the right connections and funding. From that perspective at least, things are looking better now than they did a few years ago. It was clear, for example, that some bidders who had been involved in 2007 were no longer around for this auction. There is no reason to believe, however, that there is less valuable IP available for sale.

On the other hand, it was obvious to me as somebody representing a seller that most sellers were ill-advised at this auction. Thanks to some careful pre-auction work, we (at Drinker Biddle & Reath) were able to close the sale for our client's lot. (Sorry, but due to client confidentiality rules I cannot say more.) Unfortunately, this was not the result for many of the sellers at the auction yesterday. In some of these cases, I could pick out from the description in the catalog some obvious problems that might have prevented bids from coming in. In others, it was clear to me as somebody who has worked at a VC fund that there was no market whatsoever (at least for now) for the technology claimed by the portfolio. In all of these cases, the sellers probably could have been better advised on how to value their IP and present it for sale at the auction.

Noteworthy also was the level of excellence demonstrated by Ocean Tomo in putting together these events. At both of the auctions I have attended, Ocean Tomo has assembled a first-class group of panelists to provide information and training for the inventors, business people, lawyers, and investors who attend. I might add too that they know how to pick their venues. No rubber chicken for lunch at these events. Ocean Tomo and its sponsors are providing a valuable public service to the market at the same time they are doing good business at these events.

Despite these successes, it is becoming clear by now that because of the transactions costs associated with the valuation and exchange of IP, auctions are usually the best option only for smaller, more isolated portfolios. Once the strategic value of a portfolio exceeds a certain threshold, IP owners will find it more worthwhile to hire lawyers or private brokers to package and market a portfolio to potential buyers.

Some people might think this spells doom for Ocean Tomo. Those people are sorely mistaken for the simple reason that the packaging and marketing of IP requires highly specialized training, along with access to a specialized network of professional buyers and sellers. Regardless of whether Ocean Tomo continues its auctions with the same frequency with which they have been held over the past few years, there is no doubt that it has accumulated an amazing group of professionals and perhaps the best social network of accountants, lawyers, brokers, buyers, and sellers that is available to non-repeat players in this market. This is only a guess, but an educated one: the IP market is evolving and Ocean Tomo is about to evolve with it.

Stephen Quake calls for Change in Technology Transfer

This op-ed by successful academic, inventor, and entrepreneur Stephen Quake is a landmark piece. The current system of technology transfer must evolve for the United States to maintain its competitive advantage as a producer of new technology:

Licensing is often a protracted process, and licensing officers so paralyzed with fear about making a mistake and not maximizing licensing revenues that they discourage all but the most persistent licensees. Because universities are non-profit institutions, the true measurement of technology transfer success should not be the total amount of licensing revenue, but rather the successes in helping faculty members patent inventions, in forming new ventures that create jobs, and in facilitating the commercialization of technologies that in many cases will help improve our society.

The best way for universities to achieve this would be to make the same decision the federal government did, and relinquish their control over licensing. Since in most cases faculty know the context of their invention and how it can be best commercialized, they should drive the licensing process, and the OTL should play a supporting role. The university deserves to receive some compensation, but this should be fixed by a simple formula and limited — bearing in mind that the vast majority of research funding that leads to inventions has been obtained by the faculty through grants, and that the university has already taxed a fair bit of that to support its facilities.

Please read the whole thing. There is almost nobody with more first-hand experience than Quake. He's telling us what's wrong with the system.

Commercial entities (from venture capital funds to public corporations) and universities face a prisoner's dilemma when it comes to IP rights. Cooperation offers benefits to both; but the incentive in individual transactions is to defect. Quake is calling for inventors to have more control over the process, and that will help. But even better would be for technology transfer offices to recognize a bigger role for private equity funds in assisting with the process. An intermediary with equity incentives will outperform even the best organized and well-meaning of in-house technology transfer offices.

Read the comments on the NYT page too. See how many in industry are frustrated with the technology transfer offices?

Innovation in Idaho

Tech Transfer Tactics reports:

Mahoney envisions multiple revenue sources for I-Cubed, including selling IP and taking a percentage, negotiating royalty agreements with public partners, buying ownership stakes in companies that receive funding, and charging a percentage for managing the investment fund. The clearinghouse would employ a sales and marketing team to market Idaho technology globally. Most licensing revenues would be returned to the source company or institution. Although all three state universities have tech transfer departments, they must “go back to the legislature every year for more [funding], which doesn’t breed consistency,” says Brian Dickens, administrator of the Idaho Department of Commerce’s Commercial Innovation Division. Universities have been thus far receptive to I-Cubed, whose business model “seems to supplement efforts that are already underway here and other places,” says Mary Givens, TTO director at Boise State University. “Once it is up and running, Boise State will look for ways we can work together.”

Sounds like a great idea to me. I'd say that even more established tech transfer offices would be interested in that sort of partnership if I didn't know better from personal experience. But the real story here is the innovative source of funding -- a great example of creative entrepreneurship:

I-Cubed is seeking foreign investment under the federal EB-5 immigration program, which grants visas to foreigners in exchange for committing at least $500,000 to rural or high-unemployment areas and $1 million to urban areas for at least two years.

This is a terrific way to foster the growth of human capital here in the U.S.

What Has Caused the Decline of University Patenting?

Intellectual Property Watch reports on a new academic study showing a decline in patenting at U.S. universities.

We have noted for some time that the Bayh-Dole effect in the USA itself has withered away, with a relative decline of university patenting since 2000. However, since our indicators were not sufficiently robust, we have not previously published these results. More recently, Wong &Singh (2007) published data about the numbers of US patents by leading universities as a percentage of all patents in the database of the US Patent and Trade Office (USPTO). This data, and the data made available by the Association of University Technology Managers (AUTM, 2007) in their yearly Surveys of US Licensing Activity, corresponded so well with our previous results that we investigated the noted decline of university patenting further.

...

At the global level university patenting is still gaining momentum, but in the most advanced economies the effects of the Bayh-Dole Act of 1980 seem to have faded away since the turn of the millennium. In our opinion, the reason for this is structural. More universities are nowadays increasingly ranked in terms of their knowledge output, and patents or spin-offs are usually not part of this ranking (e.g., THES, 2008). The nature of the competition among universities is changing, and the incentive to patent has thus withered. International collaborations and coauthorships, for example, have become more important in research assessment exercises than university-industry relations (Glänzel, 2001; Leydesdorff & Sun, 2009; Persson et al., 2004; Wagner, 2008).

Readers with a longer memory of the market may recall that the late '90s coincided with a burst of enthusiasm for IP as an asset. According to the timeline presented here, university investments in R&D patenting leveled off during the dot-com crash, and never picked up again with the rest of economic activity thereafter.

Although the authors seem to have a different "structural" reason in mind (U.S. News?), another conjecture as to why university patenting leveled off is that a good chunk of private investment shifted from technology to real estate, credit, and derivatives following the dot-com crash. Quite a bit of this funding comes from university endowments. None of these asset classes is closely linked to new technology, much less the early-stage kind that universities have a comparative advantage in producing post-Bayh-Dole. Thus an alternative explanation for the leveling off of investment in patents is that less private money was invested over that period of time. Also less public money was available for R&D at universities under the Bush administration than under Clinton administration. Finally, changes in the substantive rules of patent law and a general shift in public sentiment against the patent system over the same time period probably didn't help attract new investment either. It is possible that most university endowments maintained their pre-dot-com level of allocation to venture capital investment during this time period, but I doubt it. Only a handful invest with such long time horizons.

Putting aside the question of whether patenting R&D should be part of a university's mission (as regular readers know, I believe it should be), one can ask how the trend of private investment in university research and patenting could be rehabilitated given the recent history. The answer is that universities, like any institutions, will produce whatever they give their people incentives to produce. For there to be more industry joint ventures or other commercial development of IP, there have to be more and clearer incentives to researchers and tech transfer office employees to cooperate with private actors.

There are political reasons to be concerned about this decline in patenting. We in the U.S. like to congratulate ourselves for having the best universities and inventors in the world. But how are we going to pay for those universities and inventors in the future if we don't protect and promote their work?

There are always glimmers of hope. For example, I would doubt that patenting has stayed level at the University of Rochester since it's new subscription model was implemented.

How Rochester Solved a Prisoner's Dilemma

The Tech Transfer blog reports:

The program is the brainchild of university president Bill Destler, who implemented it shortly after taking office in 2007. Destler argued that corporations are often reluctant to enter into certain R&D agreements with universities because of the anticipated wrangling over IP rights. Under the new program, RIT relinquished all rights to future intellectual property generated in exchange for one-time, modest up-front payments. The work is carried out over the course of a year at a fixed price — typically under $100,000 — which the company pays in quarterly installments. The school also provides partnering companies with a grad student and a faculty adviser to work on specific research projects. RIT retains the right to publish scientific results after the sponsor has had a pre-negotiated amount of time to review the discoveries, and also gets the right to continue using the IP in future research.

The first research university to adopt this model for R&D with potential clinical relevance is going to see its endowment expand faster than it contracted in 2008.

Thank you to Michael A. Gollin

It's been a pleasure to have Michael A. Gollin as a guest here at Broken Symmetry, and I want thank him for sharing his thoughts with readers. Please do make sure to grab a copy of Driving Innovation so that you can benefit more from his insights.

I'm glad that Michael brought up Lincoln again, because I think we agree that his insights on the patent system, although nearly 150 years old to the day, remain a sound basis for our new President to rely upon in considering various patent reforms. In the lecture he gave on Inventions and Discoveries in Jacksonville, Illinois on February 11, 1859, Lincoln declared that:

All nature -- the whole world, material, moral, and intellectual -- is a mine; and, in Adam's day, it was a wholly unexplored mine. Now it is the destined work of Adam's race to develope, by discoveries, inventions, and improvements, the hidden treasures of this mine.

In Driving Innovation, in addition to the metaphor of an engine, you chose to describe the flow of innovation as an "innovation forest." The innovation forest is naturally closer to the ecosystem I had in mind in my reply to your first post. Innovation is not a sterile, individualistic enterprise. Ideas evolve healthiest and fastest in an organic, collaborative and competitive scramble in which new ideas are given resources and protection and older ideas are left alone to be used as a resource directly, or to provide indirectly through their decay into the commons a rich soil for new growth.

In fact, I believe your metaphor is an improvement on Lincoln's mine. From our perspective 150 years on, it is obvious that the natural world (including minerals), are not the bottomless pit that they might have seemed to us in the mid-19th Century. Indeed, there is now a broad consensus that our use of natural resources must be made with an eye toward their soon exhaustion.

How fortunate we are the ideas are more like trees than like minerals! When our minerals and fossil fuels are exhausted, there will be no way for us to replace them in our generation. But with an eye toward the future, and with careful planning, we could someday ensure that we do not use up our living resources before they can be replaced.

Beginning around the time of Lincoln, the incentives of the patent system helped to grow a redwood forest of ideas in the United States. On my view, we have been clearcutting from that forest for the last few years. There is nothing wrong with harvesting part of the bounty of what nature has provided us. But such harvesting should be done with an eye toward leaving enough for the forest to flourish on into the future, so that others may enjoy its benefits after us.

I like the idea that as a patent lawyer, I am a steward of that kind of national and natural treasure. I like your idea of a National Innovation Council, which could assist with determining what parts of the forest are in need of more fertilizer, and which need a brush fire to clear out the dead waste. Perhaps the innovation forest has grown too complex to be regulated under a single set of rules. We would not expect a redwood forest to grow well under the same conditions as a tropical jungle. So why should we expect innovation forests to be any different? I worry, however, that the best forestry experts will not be around to serve on such a council. Only time will tell.

Thanks again for sharing your thoughts.

RPX Closes Deal with Acacia

For "light valve" technology.  See press release here.

This must be one of the first deals closed by RPX since its launch late last year.

The deal is not unexpected given what has been publicly disclosed about RPX's business model. It will be interesting to see whether other intermediaries close deals for the same portfolio subsequently.