FTC decision favors standards over patent holder

In an historic decision that split the FTC almost down the middle, it has issued a complaint against a patent holding company allegedly that apparently sued computer and network manufacturers for having followed the Ethernet standard.

Where does a patented idea end and a standard begin? Judging from public forums alone, you'd think the two ideas would be polar opposites. But business deals between patent holders and standards groups tend to muddy the waters, and last week, one very important example of such an agreement came to a head before the US Federal Trade Commission.

Back in 1994, National Semiconductor had patented a technology called auto-negotiation, which was to be used between two computers in a gigabit Ethernet connection. Using a method which was fundamentally similar to the handshaking protocol developed by Microcom during the 9600-baud modem era, two network clients with AN could detect which was the best mode of communication by sending pulses into the signal, listening for responses, and adjusting accordingly. National gave the concept the brand name NWay.

"Auto-Negotiation is a mechanism that takes control of the cable when a connection is established to a network device," wrote legendary National engineers Bill Bunch and Donald Becker in 1995. "[It] detects the various modes that exist in the device on the other end of the wire, the Link Partner, and advertises it own abilities to automatically configure the highest performance mode of interoperation. As a standard technology, this allows simple, automatic connection of devices that support a variety of modes from a variety of manufacturers."

As National's engineers had learned at the time, the nature of the physical network medium is what had made the concept of auto-negotiation -- which had been tried on Ethernet before -- seemingly impossible. It was copper that had slowed things down, but gigabit Ethernet essentially demanded a move to fiberoptic. With that move, the essential impediment was completely lifted.

NWay way appeared to be the only way to make gigabit Ethernet work, so that year, the IEEE struck a bargain with National. If the Institute would agree to incorporate and adopt NWay into its Ethernet standards, it would accept a one-time licensing fee of $1,000 per licensee. Not that National really needed the $1,000 all that badly, but the move was important to help give the manufacturer the recognition it deserved.

Sadly, it wasn't enough, and later the company found itself having to sell this and other patents just to stay afloat. Eventually NWay was acquired by a company that later called itself Negotiated Data Solutions, or N-Data -- a name which came to refer to its litigation strategy as well as its technology.

While N-Data acquired National's patents, it did not feel it acquired its existing licensing agreements. What it did next is alleged in the FTC's statement on Wednesday: "The Complaint in this matter alleges that N-Data reneged on a prior licensing commitment to a standard-setting body and thereby was able to increase the price of an Ethernet technology used by almost every American consumer who owns a computer. Based on the facts developed by staff during the investigation, we find reason to believe that this conduct violated Section 5 of the FTC Act."

That section expressly prohibits "unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce."

What the FTC said next is indeed historic, and may have precedent that reaches far beyond this one case.

"We also have no doubt that the type of behavior engaged in by N-Data harms consumers," the majority wrote (PDF available here). "The process of establishing a standard displaces competition; therefore, bad faith or deceptive behavior that undermines the process may also undermine competition in an entire industry, raise prices to consumers, and reduce choices. We have previously noted that 'industry standards are widely acknowledged to be one of the engines driving the modern economy." Conduct like N-Data's -- which undermines standard-setting -- threatens to stall that engine to the detriment of all consumers."

The vote in favor of issuing the complaint was 3-2, with Chairwoman Deborah Platt Majoras voting in the minority.

One problem Chairwoman Majoras had was with the notion that N-Data's conduct was somehow exclusionary. For that to have happened, she contended, National's earlier conduct would have also had to have been exclusionary, perhaps in coercing the IEEE to adopt NWay as part of gigabit Ethernet...and nobody had made that allegation.

Second, National was far from the first company to have made such an agreement with the IEEE. Patent licensing agreements such as that one had been changed frequently, Majoras noted, without anyone else complaining about those doing the changing.

"From the time National submitted its letter of assurance in 1994 and at least until 2002," the Chairwoman wrote (PDF available here), "some patent holders changed or clarified the terms of their letters of assurance - even after the relevant standard was approved. And although a new IEEE bylaw, passed in January 2002, purported to make patent letters irrevocable, it did not address whether it was to apply retroactively."

Then there was a third problem worth at least a moment's worth of attention: Who is this N-Data really, Majoras' dissent put forth, in essence? If nobody's really heard of it, it can't be much of a market force, can it? And if that's the case, how can it be guilty of exclusionary conduct? The statistics showed that literally no one offered to pay National's one-time fee of $1,000 between 1994 and 2002.

"And despite ongoing licensing efforts by National's successors, Vertical [Networks, not named in the complaint] and N-Data," only one company paid materially more than the originally-quoted $1,000 for rights to the NWay technology. Most users evidently have preferred to infringe, running the risk of presumably minimal patent damages that they might face at the outcome of litigation...Thus, the facts do not support antitrust liability here."

The FTC's order last Wednesday prohibits N-Data from enforcing its NWay patent until it chooses to offer that patent for licensing under National's original terms.

Late last week, in a statement received by BetaNews, Linux Foundation attorney and board member Andrew Updegrove assessed the meaning of the FTC's order in the context of open source software, which plays into so many modern industry standards today.

"The reliance upon promises made with respect to patents is of concern not only in the standard setting context," wrote Updegrove, "but with respect to open source software as well. The details of the settlement will provide significant guidance as to how the regulators would view similar conduct in an open source setting. Moreover, in the case of N-Data, the FTC has acted aggressively while acknowledging that the actions at issue might not rise to the level of violating relevant antitrust laws. In doing so, the Commissioners provide strong assurance to participants in standard setting that the FTC recognizes the importance of standards in the modern world."