Patents vs. Trade Secrets: Which Promotes Innovation Better? November 7th, 2014MMM Tech Law Video Channel by John R. Harris, Morris, Manning & Martin, LLP The patent system has been criticized as not actually promoting innovation. Aside from the fact that the patent system is embedded in the U.S. Constitution (Article 1, Section 8) and cannot be readily eliminated, there is recent evidence that perhaps the Founding Fathers were on to something in creating a system to “promote the progress of science and useful arts” with a patent system. Patents and trade secrets are two very different forms of intellectual property (IP) protection. Patents (the word means, in Latin, “to be open”) are a temporary and limited monopoly on an inventive concept granted by the government in return for disclosure of how to make and use a claimed invention. Trade secrets, on the hand, are a different animal entirely – protection for an invention or other valuable information is provided by preventing disclosure of the information. For trade secret protection, the government allows for private lawsuits and criminal penalties to protect against wrongful disclosure. There has long been a loud debate whether patents promote or discourage innovation. See, for example, the paper by Andrew W. Torrance and Bill Tomlinson, “Patents and the Regress of Useful Arts”, Columbia Science and Technology Review, Vol. 10, 2009, found online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1411328. The recent phenomenon of “patent trolls” has spawned a flurry of articles about the alleged negative effects of patents on innovation. See, e.g., the paper by Lauren Cohen, Umit Gurun, and Scott Kominers, “Patent Trolls: Evidence from Targeted Firms,” found online at http://www.utdallas.edu/~ugg041000/Trolls.pdf. (Less pejorative terms for patent trolls include “non-practicing entities” (NPEs) and “patent monetization entities” (PMEs.) There is widespread belief that NPEs do not themselves do the innovating, they just buy up patents and try to extort money from people who might be found infringers. The behavior of some NPEs in their litigation tactics is considered bad, as well as the notion that the NPEs are often not the actual innovators. A recent U.S. Supreme Court decision, Alice Corp. v. CLS Bank, 573 U.S. ___ (2014), has caused a number of patent system stakeholders to consider whether it might now be advisable to avoid patenting and revert to trade secret protection for certain types of inventions. This consideration is most prominent for computer-implemented inventions, which can be found in so-called “software patents.” In the Alice decision, the Court held that patent claims directed to a scheme for mitigating financial transaction settlement risk using a computer system as a third-party intermediary were not considered to be patentable subject matter. Those claims were held invalid – not because of prior art, but because the claims were simply “too abstract” to be patented. The Court’s decision did not provide meaningful guidance on what kinds of inventions (and claims), especially those directed to computer-implemented technologies, are properly the subject of patent protection. The reasoning goes like this: “If I can’t get a patent on my technology, I don’t want to disclose anything about it if I can avoid it, since competitors will rip me off. So, I’ll just keep it a trade secret.” The case has created a real fear that the patent system, already under attack because of bad behavior of patent trolls and inadequate patent reform efforts, is experiencing a significant swing towards less effectiveness and power. Perhaps there are better alternatives than patenting to protect intellectual property, and the only real alternative is trade secrets. (Copyrights for software are still available, but have a different set of requirements and issues for protection.) A recent study by professors at the business schools at Georgia Tech and Rutgers suggests that IP protection, and patents in particular, play an important role in the financing of small firms and thus encourage innovation in that arena. See article by Dass, Nishant and Nanda, Vikram K. and Xiao, Steven Chong, “Intellectual Property Protection and Financial Markets: Patenting vs. Secrecy” (October 31, 2014). Available at SSRN: http://ssrn.com/abstract=2517838. The article asserts that stronger secrecy protection, as contrasted with patents and disclosure, encourages firms to adopt more secrecy, which increases “information asymmetry” and reduces stock liquidity. By contrast, better patent protection, they hypothesize, causes firms to disclose more information by patenting their inventions, resulting in (presumably) more information symmetry and higher stock liquidity. In other words, patents actually do encourage innovation if for no reason other than improving the ability of startups and small firms to raise capital and expand a business connected to the innovations disclosed in the patents. This study, if its methodology and conclusions are correct, suggests that startups and small firms should not necessarily give up on patents, even if the going has gotten tougher. The patent system is a complex set of compromises between the requirements for disclosure (the written description requirement, drawings, clear and unambiguous claims, discovery and avoidance of prior art, etc.) and the limitations of the grant of government rights. Movement between these compromises is like a pendulum that swings between the provision of weak and strong patent rights, as a function of the current political and economic climates. Although the pendulum may be swinging in the direction of weakened patent protection because of patent trolls and cases like Alice, it is could swing back in time. Trade secrets are simply too difficult for a small firm to monetize – and there is no established legal scheme of ownership and analysis to help in raising capital. Patents thus still can have significant value for small businesses and startups. Small firms and startups can still draw some comfort from the fact that their efforts to patent can be of major help in raising capital – by providing investors and prospective acquirers with knowledge and some degree of confidence in protection for the long run. Although the fight to obtain a meaningful patent may have gotten tougher, the end result may be worth the effort. John R. Harris is a partner at Morris, Manning and Martin, LLP. Copyright 2014 John R. Harris. All Rights Reserved. The information presented and contained within this article is provided as general information only, and does not, and is not intended to constitute legal, employment or tax advice. Any opinions expressed within this article are solely the opinion of the individual author(s). For more information, contact John Harris: firstname.lastname@example.org.