What Should Congress Do with Liars and Cheaters?

The U.S. legal system does not look favorably toward liars and cheaters. This is well known to the parade of executives sentenced to jail time over the last few years for securities fraud. But lawmakers need to take a closer look at how to treat fraud at the Patent and Trademark Office.

While most consumers may think of the PTO as a government office for the nerdy types seeking permits for new gizmos, the truth is that the rules governing the patent system stand to affect the prices paid on household products from the medicine cabinet to the desktop. And the ability to entice investors to back new science discoveries depends on a system that discourages scientists from being cheats.

Liars always face a cost-benefit trade-off. For securities fraud, lying may result in a short-run competitive edge, a boost in profits or market share, an uptick in stock value or a bigger year-end bonus. The costs can be large fines or--as in the case of Jeffery Skilling, Bernard Ebbers, Bernard Madoff and others--imprisonment.

In the case of intellectual property it is vital that patent holders not commit fraud.

These penalties reflect that markets cannot function well if investors worry about being stung by fraud. If investors cannot trust the information provided by the companies that they invest in, then financial markets cannot function efficiently and all investors will bear the greater risk. The public recognizes the importance of severe punishment as a deterrent against securities fraud, and there is little sympathy for these crooks.

In the case of intellectual property it is vital that patent holders not commit fraud. Patents obtained through deception can fundamentally weaken the entire patent system upon which our economy depends and depress incentives for investors to fund research and development for new products. In this sense, there are clear similarities in the consequences of cheating and lying to the PTO and the SEC: Investors will face higher costs.

Furthermore, ill-gotten patents are generally costly to our economy. As a consequence of the monopoly power entrusted to the innovator, consumers by and large pay higher prices. For a truly novel invention covered by a patent obtained in a fair and honest manner, the higher price is the reward to the inventor for undertaking the risks associated with innovation. But for a product protected by a patent obtained by fraud, the higher price isn't justified.

Current law states that intentionally lying to the PTO about information that is material to the application renders a patent unenforceable against competitors. Lawyers call this the "inequitable conduct" defense. But, unlike in the case of securities fraud, those that cheat at the PTO have not been subjected to criminal penalties, punitive damages or jail terms.

Congress, engaged in an ambitious process to reform the patent system in the U.S., is contemplating changing the rules with regard to inequitable conduct. Shockingly, however, they are being asked to weaken, not strengthen, the deterrent against fraud. Opponents of current law--companies holding complex but valuable patents--claim that inequitable conduct is asserted too freely and the cost of defending themselves against false claims of lying and cheating are too great. They also claim that rendering a patent unenforceable is too severe a punishment for firms found to have deceived the PTO.

But as is the case with executives who lie to the SEC, forceful punishment is the best deterrent against fraud at the PTO. A strong deterrent is necessary to produce confidence in the entire patent system so that investors are willing to risk their capital to develop new innovations. In fact, losing protection for one's patents may be an inadequate deterrent in many circumstances, such as when it occurs near the end of a patent's life.

Companies that feel overly burdened by current law should take solace in the fact that the government does not throw patent holders that lie and cheat behind bars. While an orange jumpsuit may be overkill when it comes to crimes at the PTO, let's hope Congress recognizes that there is no basis to defang the inequitable conduct defense and perhaps should consider putting some more teeth into it.

Alex Brill is a research fellow at AEI.

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