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Category: Legal


$120 Per Smartphone in Royalties – Outrageous!

An academic paper claims that the cost for royalties ($120 per phone) is about the same as the cost of the components in a smartphone.  This was accompanied by a number of articles suggesting this was outrageous and unsustainable.  For example see:

* High smartphone patent royalties undermine industry profitability: report 

* The $120 Smartphone Patent Tax: Patent Royalties Cost More Than The Actual Hardware In Your Phone:   This one from my favorite patent Luddite site, Techdirt.

* Smartphone royalties now equal manufacturing costs

The logical flaw underlying all these articles is that the value of products is determined by the amount of physical labor and/or the cost of the underlying materials.  On this basis, the actual material costs of a cell phone are probably less than $5 and the labor (unskilled labor in the US is worth perhaps $10/hr) involved in making the phone might be worth $5, let’s throw in $10 for distribution and the hard costs of a smartphone are about $20.[i]  The rest of the costs are the result of intellectual property, much of which is in the form of patents, but some is in the skilled labor, copyrights and trademarks.  The actual cost of the intellectual property in a smartphone is closer to $380.00.  Much of these costs are hidden.  For instance, when Intel sells a microprocessor they charge you $50, for example, but the labor cost and material cost of the microprocessor is pennies.  The reason they can charge $50 is because of the intellectual property, which means patents.  From an economic point of view you are paying a dollar or so for the manufacturing and $49 in patent royalties.

Another logical flaw in these articles is that this is an unsustainable business model.  First of all the underlying paper points out that sales of smartphones and tablets is now bigger than all the rest of the consumer electronics space, with over a billion smartphones sold in 2013.  Clearly the business model is not falling apart.  Second of all, the cost of Microsoft Office Home and Business 2013 is $219.00 and none of that is manufacturing cost.  The cost of Microsoft Office is essentially all IP (Patents, Copyrights, etc.).  Solidworks, which is 3D CAD software, cost $4000.00 and also has essentially no manufacturing costs, which means you are paying the equivalent of $4000 in royalties.  The argument that the model is unsustainable is absurd.

 

Actual Paper

The paper that started this economic stupidity is The Smartphone Royalty Stack: Surveying Royalty Demands for the Components Within Modern Smartphones.  The paper is clearly designed to sway public and Judicial opinion in a manner that will be beneficial for Intel.  Namely, Intel wants a patent system that emphasizes manufacturing, not inventing.  Another goal of the paper is to get courts to reduce the amount of royalties that inventors receive.

“In particular, there has been significant recent focus on “royalty stacking,” in which the cumulative demands of patent holders across the relevant technology or the device threaten to make it economically unviable to offer the product.”

This statement is absurd on its face, as the paper itself points out.

“The market for smartphones has exploded. Smartphones sales for 2013 topped one billion units globally for the first time ever.  In addition, global revenues for smartphone and tablet sales in 2013 are estimated to have surpassed for the first time revenues for the entire consumer electronics markets (e.g., televisions, audio equipment, cameras, and home appliances).”

Here is the real point that this paper is pushing:

“Further, the available data demonstrate a need for licensees to advocate and courts to rigorously apply methodologies for calculating royalties that focus on the actual value of a claimed invention put in context of the myriad other technologies in a smartphone and the components in which the technologies are implemented.”

I will admit that having courts set royalty rates is not ideal and the results can be squirrelly, which is why eBay  should be reversed.  The courts used to just prohibit the infringer from using the patented technology and then the parties had to work out a deal.  But the Supreme Court decided that enforcing the only right you get with your patent is an injunction – actually it is not an injunction it is an exclusion order requiring the infringer to not trespass on (use) the patent owner’s property.

The paper admits that its methodology is limited and the actual cash cost going to pay royalties could be higher or lower.  For instance, the paper does not track cross licensing, pass through, or patent exhaustion, all of which could significantly reduce the actual royalties paid.  They clearly made an error if they did not account for patent exhaustion.  If patent exhaustion was part of the royalty costs, then almost every high value component’s price is mainly due to patents.  Correctly accounting for patent exhaustion would show a royalty per smartphone closer to the $380.00 per phone as explained above.

The paper is just dishonest when discussing the growth in the number of patents issued and the number of patent lawsuits.  It shows in 20 years the number of patents issued in the US has increased from 100,000 per year to 250,000 per year.  The implication is that this is an absurd increase in the number of issued patents, but if you do the math this turns out to be a 4.75% annual increase, about the same as the increase in worldwide GDP over the same time period.  The paper also shows a graph depicting the number of patent lawsuits exploding around 2011.  This increase is due to the America Invents Act, which limited the joinder of defendants in patent lawsuits.  This has been well documented, as in the article  The America Invents Act at Work – The Major Cause for the Recent Rise in Patent Litigation.  The paper’s failure to point this out is just outright fraud.  The fraud is perpetrated again when the paper points to the increase in the number of NPE lawsuits.  These authors seem to have gotten their training from Al Gore and French economist Thomas Piketty.

 

 


[i] In fact you can buy cell phones for less $30.00 on the Internet.  The cost of materials in a smartphone and a $30 cell phone is essentially the same.  The material costs in a cell phone include the plastic which costs several cents, the metal for the conductors which might be worth a dollar, the silicon which in its raw form is worth almost nothing.

 
PATENT=MONOPOLY – A LEGAL FICTION

The authors (Sven Bostyn and Nicolas Petit) of this paper, PATENT=MONOPOLY – A LEGAL FICTION,  argue that patents are not a monopoly based on standard antitrust analysis.  It is very unusual for an academic paper to take such an unpopular position.  They must have not got the memo that the goal of all academics is to vilify inventors, patents, and property rights.  Below are some the lines I thought were interesting and my comments are below.

“No other IPR is so thoroughly examined and evaluated as a patent.”

No other property right is so expensive, time consuming and expensive to obtain title to.

“In 2011, approximately 1,000,000 patents were granted across the globe.  This would mean that 1,000,000 monopolies would have been created worldwide. This clearly, cannot be true.”

“Competition is very valuable, but innovation is probably equally, if not more, valuable.”

 

My main critique is that they did not explain how patents are a property right or the history of property rights and patents.  Under Locke’s theory of property rights, patents and copyrights are property rights – they are granted because of the creative effort (labor) of the inventor/author.  This was picked up by Sir William Blackstone in his Commentaries, where he affirms that patents and copyrights are property and therefore natural rights.  This was enshrined in the constitution as “securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”

 
Patents are Natural Rights

I have often pointed out that patents are a natural right under Locke’s theory of property rights.  Locke stated, in modern language, that you own yourself so you have the right to those things you create.  Many detractors have suggested that this absurd.  According to Locke the three chief natural rights are life, liberty, and property.  Locke states that protecting property rights is the main reason for forming governments.

Sec. 124. The great and chief end, therefore, of men’s uniting into commonwealths, and putting themselves under government, is the preservation of their property.[1]

Inventions are the result the inventor’s labor and therefore property under Locke.  Property is a natural right, so patents are natural rights.  Despite this logical connection, many people have continued to deny that patents (property rights in inventions) are a natural right.

Locke’s ideas were incorporated in the law of the United States by William Blackstone’s Commentaries on the Laws of England.  This treatise became the basis of common law in the US.  Here is what Blackstone said about patents and copyrights (intellectual property).  Note that he cites Locke’s ideas on property rights for his explanation for why intellectual property is Property.

There is still another species of property, which (if it subsists by the common law) being grounded on labour and invention is more properly reducible to the head of occupancy than any other; since the right of occupancy itself is supposed by Mr. Locke, and many others, to be founded on the personal labour of the occupant. And this is the right, which an author may be supposed to have in his own original literary compositions; so that no other person without his leave may publish or make profit of the copies. When a man by the exertion of his rational powers has produced an original work, he seems to have clearly a right to dispose of that identical work as he pleases, and any attempt to vary the disposition he has made of it, appears to be an invasion of that right.

Now the identity of a literary composition consists entirely in the sentiment and the language: the same conceptions, clothed in the same words, must necessarily be the same composition: and whatever method be taken of exhibiting that composition to the ear or the eye of another, by recital, by writing, or by printing, in any number of copies, or at any period of time, it is always the identical work of the author which is so exhibited; and no other man (it hath been thought) can have a right to exhibit it, especially for profit, without the author’s consent.

This consent may perhaps be tacitly given to all mankind, when, an author suffers his work to be published by another hand, without any claim or reserve of right, and without stamping on it any marks of ownership; it being then a present to the public, like building a church or bridge, or laying out a new highway: but, in case the author sells a single book, or totally grants the copyright, it hath been supposed, in the one case, that the buyer hath no more right to multiply copies of that book for sale, than he hath to imitate for the like purpose the ticket which is bought for admission to an opera or a concert, and that, in the other, the whole property, with all it’s exclusive rights, is perpetually transferred to the grantee.

On the other hand it is urged, that though the exclusive property of the manuscript, and all which it contains, undoubtedly belongs to the author, before it is printed or published; yet from the instant of publication, the exclusive right of an author or his assigns to the sole communication of his ideas immediately vanishes and evaporates; as being a right of too subtile and unsubstantial a nature to become the subject of property at the common law, and only capable of being guarded by positive statutes and special provisions of the magistrate.

The Roman law adjudged, that if one man wrote any thing on the paper or parchment of another, the writing should belong to the owner of the blank materials meaning thereby the mechanical operation of writing, for which it directed the scribe to receive a satisfaction; for in works of genius and invention, as in painting on another man’s canvas, the same law gave the canvas to the painter. As to any other property in the works of the understanding, the law is silent; though the sale of literary copies, for the purposes of recital or multiplication, is certainly as antient as the times of Terence, Martial, and Statius. Neither with us in England hath there been (till very lately) any final determination upon the right of authors at the common law.

But whatever inherent copyright might have been supposed to subsist by the common law, the statute 8 Ann. c. 19 hath now declared that the author and his assigns shall have the sole liberty of printing and reprinting his works for the term of fourteen years, and no longer; and hath also protected that property by additional penalties and forfeitures: directing farther, that if, at the end of that term, the author himself be living, the right shall then return to him for another term of the same duration: and a similar privilege is extended to the inventors of prints and engravings, for the term of eight and twenty years, by the statute 8 Geo. II. c. 13, and 7 Geo. III. c. 38, besides an action for damages, with double costs, by statute 17 Geo. III. c. 57. All which parliamentary protections appear to have been suggested by the exception in the statute of monopolies, 21 Jac., I. c. 3, which allows a royal patent of privilege to be granted for fourteen years to any inventor of a new manufacture, for the sole working or making of the same; by virtue whereof it is held, that a temporary property therein becomes vested in the king’s patentee. (emphasis added)

 

The idea that patents are a natural right is incorporated in early American law as the quote below shows.

“we protect intellectual property, the labors of the mind, productions and interests as much a man’s own, and as much the fruit of his honest industry, as the wheat he cultivates, or the flocks he rears.” (Davoll v. Brown, 7 F. Cas. 197, 199 [C.C.D. Mass. 1845].)

It is just obstinance or disingenuousness to suggest that patents are not part of natural rights.

 


[1] The Second Treatise of Civil Government; 1690; John Locke; CHAP. IX., Of the Ends of Political Society and Government.

 
CLS Bank v. Alice: 35 USC 101 Presumption of Validity

The en banc rehearing of this case is considering whether the presumption of validity applies to under 35 USC 101.  The statute involved in this question is 35 USC § 282 which states:

(a) In General.— A patent shall be presumed valid. Each claim of a patent (whether in independent, dependent, or multiple dependent form) shall be presumed valid independently of the validity of other claims; dependent or multiple dependent claims shall be presumed valid even though dependent upon an invalid claim. The burden of establishing invalidity of a patent or any claim thereof shall rest on the party asserting such invalidity. (Emphasis added)

CLS Bank argued in their brief that validity and eligibility are different and 35 USC 101 is directed to the latter.  Nothing in the statute suggestions that there is a distinction between eligibility and validity.  How can a patent be valid and not meet the requirements of 35 USC 101?  It can’t.  When you turn the question around you see the absurdity of this position.  In addition, the reason for a Patent Office is to review inventions to determine if they are eligible for a patent.  If the courts are going to ignore the determinations of the Patent Office, then we should just have a registration system.  In every other area of law the courts are extremely deferential to administrative agency decisions, but not with patents.  Ask yourself why this is.  I would suggest the reason is that every other administrative agency increases the power of government, but the Patent Office increases the power of the people.  It is patently unfair that an inventor has to defend their patent, two, three or more times and on multiple issues.  If the EPA or the FCC or the FTC, etc. had to survive this scrutiny or legislation in general, almost none of the laws or regulations passed in the last decade would stand.  It is time to end the double standard that gives a pass for every regulation that increases government power, while forcing private people to jump through hoops.  In fact it is time to reverse the process, as the Founders intended.

 

NO RATIONAL person would buy CLS argument that there is a difference between validity and eligibilityBut that does not mean the Judges on the CAFC or Supreme Court will not buy into CLS argument.

 

For more on the earlier decision CLICK HERE.

 
Everything Wrong With Patent Law Can Be Found in the Koontz Case

At first glance the Koontz v. St. Johns River Water Management District case does not appear relevant to patent law.  It is a Fifth Amendment regulatory takings case revolving around wetlands and private property.  But as I will explain in more detail below the underlying problem in both these cases is a lack of understanding of property rights.  The facts of the Koontz case according to Fox News are

 Coy Koontz in the 1970s bought a parcel of land, the majority of which later was classified a wetland. When he sought a permit to develop a portion of it in the 1990s, the Florida agency in charge of the area said Koontz would need to take steps to remediate the damage he would cause.

Koontz offered to give the agency 11 of the 15 acres, in exchange for a permit to develop the remaining land. In addition, the state government said he would need to undertake other improvements. Options ranged from numerous changes to the original plot to paying for enhancement of 50 government-owned acres miles away from the Koontz plot.

Though Koontz continued to offer the 11 acres, he refused to go along with the government’s other requirements and decided to sue.

Antonin Scalia’s comments at oral argument illustrate this lack of understanding of property rights.  “I can’t see where there’s a taking here,” Scalia said, adding, “Nothing’s been taken.”  Ronald Reagan must be rolling over in his grave – he appointed Scalia (For more of  Scalia’s outrageous thoughts see The Soviet Union’s Constitution Was ‘Much Better Than Ours’).  Scalia’s thought process, as best I can understand it, is that Koontz still has legal title to his land and his land is still there – it was not taken.  Judge Scalia seems to not understand the difference between property rights, possession, and the object.  (For more information click here)  Property rights define a relationship between a person and an object or thing.  When Mr. Koontz acquired title to the land, it did not have lien or an easement that required him to give up a part of land or pay for the enhancement of government land.  The government changed his rights in the land.  The Fifth Amendment states “nor shall private property be taken for public use, without just compensation.”  Mr. Koontz right to develop his property and his right to enjoyment of his property have clearly been altered without compensation.  The government has taken these rights in his land for public use, so it is clearly a taking.

Scalia has also shown an appalling lack of understanding of patent law and it is because he does not understand property rights.  Property rights derive from the fact that a person owns their self and therefore they own those things they create.  Patents are property rights that the inventor gets because they created a new invention.

Mr. Koontz attorneys work for the Pacific Legal Foundation.  This group does good work protecting economic freedom, but they also do not understand property rights either.  At least one of their lead attorneys believes intellectual property should not exist – see Another Confused Libertarian on Intellectual Property .  These people believe that property rights exist or should exist only because they result in more optimum economic outcomes.  Really, they should call they them ‘property privileges’ or ‘property expediencies.’  Their commitment to so-called property rights only lasts until they are convinced they know what better to do with your property.

So what we have is a case in which the supposed defenders of property rights do not understand them.  What do you think the likely outcome will be?

 

Patent and Property Rights

When the so-called defenders of property rights, believe they are just a political expediency that produces the best outcome for the collective, you can bet they will never support patents, which are property rights in an invention.  I have seen patent attorneys attempt to use this line of reasoning with patents.  They are happy to have people characterize patents as a monopoly, but think this is irrelevant because they can show patents are good for the economy.  These people do not understand the philosophical battle over patents or the definition of a monopoly.  They believe that because the anti-property rights crowd believe in monopolies for electrical and water systems, they will be in favor of monopolies for inventions.  However, they forget that in the electrical and water systems case the anti-property rights crowd supports this because it increases government power, not for the bogus efficiency argument.  But patents increase the power of the individual, not the state.  So it does not matter how well you can show that patents are important for economic growth and improve everyone’s life, they will not favor it because it increase the power of private citizens.

Property rights are derived from the right to own oneself.  If you do not own yourself, you are not free and do not live in a free society.  If you own yourself, then you own that which you produce, including inventions.  The patents are monopolies argument is without any merit from a historical, definitional, and empirical point of view.  Understanding that patents are property rights is the key to both solving the patent problem and the Koontz case.

 

For more on patents and monopolies see.

 

Monopoly/Rent Seeking vs. Property Rights/Intellectual Property .

This post explains the characeristics of a monopoly and a property right and poses three questions to show the difference.  Patents fit all the characteristics of a property right and none of a monopoly.  Note that professional license, such as a law license has some of the characteristics of a monopoly.

Patents: Monopoly or Property Right a Testable Hypothesis

If patents are a monopoly, as some suggest, then it should led to certain outcomes.  A close examination shows that none of the supposed monopoly effects result from granting patents.

More on the Myth that Patents are Monopolies.

This post contains a number of quotes from philosophers explaining that patents are not monopolies.

Property Rights, Possession and Objects

This post explains the difference in the concepts of property rights, possession, and objects.  Most economists and patent detractors confuse these concepts.  The origin, definition, and legal basis of property right are explained.

 The Myth That Patents are a Monopoly 

This post compares the definition of a monopoly to the rights obtained with a patent.  It shows that the rights obtained with a patent do not confer a monopoly.

 

 
Supreme Court Agrees to Hear so Called “Gene Patenting Case”: Myriad’s Stock Falls 9%

The Supreme Court agreed to review the case Association for Molecular Pathology (AMP) and ACLU v. USPTO and Myriad Genetics (Fed. Cir. 2012).  Myriad holds a patent for identifying certain mutations in the BRCA genes that correlate with an increased risk of breast and ovarian cancer.  Myriad’s stock dropped nine percent on the news.  This is the market’s way of saying they don’t believe the Supreme Court will uphold Myriad’s property rights.  The Supreme Court has displayed a shocking lack of understand of patents and property rights.  For instance, their decision in Mayo Collaborative Services v. Prometheus Labs., Inc. (Supreme Court 2012)  if followed logical would hold that only magic is patentable.  If I were handicapping this I would say there is a 75% chance that the Court will hold all the claims do not meet the requirements on 35 USC 101 (Patentable subject matter).  This will be devastating to the biotech industry, probably wiping out billions of dollars of value in a single day.

This case revolves around the myth that you can patent a person’s genes.  A number of books have been published on this theme and I have explained why this is nonsense in my post Patenting Life.  The CAFC’s most recent decision discussed below also explains why this is not true.

The only issue involved in the Myriad case is whether the claims are patent eligible under 35 USC 101.  In the Mayo case the Supreme Court mixed the concepts of 35 USC 101 (patent eligibility) with novelty (35 USC 102) and nonobviousness (35 USC 103).  No doubt we will see more of this confused statutory interpretation by the Court in this case.  The only minor justification for this confusion is that 35 USC 101 states the invention must be NEW and useful.  However, 35 USC 102 clearly defines novelty (new) in detail and any invention that meets the requirement of 35 USC 102 should be considered NEW under 35 USC 101.  This is something that should have been fixed in the America Invents Act that was just passed in 2011, but the drafters were too busy passing out goodies to Wall Street, pharmaceutical companies and large companies generally to actually worry about improving the clarity of statute.

 

CAFC ruling under reviewed

The ruling in the 2012 version of this case was very similar to the ruling in 2011 that I discussed in my post Association of Molecular Pathology v. USPTO.  Below I provide what I think are the most interesting excerpts from the opinion.

Composition claims are all eligible under 35 USC 101.

They (The isolated strands of DNA) are obtained in the laboratory and are man-made, the product of human ingenuity.  While they are prepared from products of nature, so is every other composition of matter.  All new chemical or biological molecules, whether made by synthesis or decomposition, are made from natural materials.  For example, virtually every medicine utilized by today’s medical practitioners, and every manufactured plastic product, is either synthesized from natural materials (most often petroleum fractions) or derived from natural plant materials.  But, as such, they are different from natural materials, even if they are ultimately derived from them.  The same is true of isolated DNA molecules.  PP. 38-39

The highlight portion points out a general rule of patent law (actually nature) – all inventions are combinations of existing elements, these elements are formed from natural materials.  You cannot create something from nothing – it’s called conservation of matter and energy.  Unfortunately, this simple rule of physics is often ignored by the courts – probably because most of them do not have a scientific background and are therefore unfit to rule in patent cases.

A composition of matter is not a law of nature.  P. 51

The anti-patent crowd has been trying to expand laws of nature to include anything that occurs naturally.  A law of nature is something that explains a host of data and can be used to accurately predict how things will behave in nature, such as gravity.  Using a counterbalance in an elevator uses gravity – a law of nature, but it is not a law of nature.

It is undisputed that Myriad’s claimed isolated DNAs exist in a distinctive chemical form—as distinctive chemical molecules—from DNAs in the human body, i.e., native DNA. P. 44

The critics of patenting human genes miss this point.  The claims do not cover native DNA, they cover DNA that does not exist but for the intervention and ingenuity of humans.

Claims 1 of the ’999, ’001, and ’441 patents, as well as method claims 1 and 2 of the ’857 patent—all of which consist of analyzing and comparing certain DNA sequences—not to be patent-eligible subject matter on the ground that they claim only abstract mental processes.  P. 55

I strongly disagree with this statement.  Myriad clearly showed that the analyzing step requires machines that are clearly described in the specification.  Even if a doctor had the print out of the results of analysis and then he compared the results without a machine, then this is contributory infringement.  The only justification for the CAFC’s decision is hyper technical analysis of the claim that requires a recited machine in the claims.  This sort of overly formal interpretation does nothing to protect the property rights of inventors, but does advance the interests of entities that want to steal other people’s inventions.

We once again, even in light of Mayo, arrive at the same conclusion of patent-eligibility because at the heart of claim 20 is a transformed cell, which is made by man, in contrast to a natural material.

By definition, however, performing operations, even known types of steps, on, or to create, novel,  i.e., transformed subject matter is the stuff of which most process or method invention consists.  All chemical processes, for example, consist of hydrolyzing, hydrogenating, reacting, etc.  In situations where the objects or results of such steps are novel and nonobvious, they should be patent-eligible.  P. 61

The idiots at the Supreme Court have attempted to break claims down and determine if each step is new.  You can’t create something from nothing and a step which is completely new does not meet the requirements of 35 USC 112.  This form of interpretation of the claims was specifically rejected by the 1952 Patent Act under 35 USC 103.  But the anti-patent Justices on the Supreme Court are not interested in logic, the Constitution, or the law.  They are only interested in forcing their policy visions on the American public.

We hold that claim 20 of the ’282 patent recites patent-eligible subject matter under § 101.

 

Conclusion

The Supreme Court is incompetent to hear patent cases and their jurisdiction over them should be removed by Congress.

 
Financial Regulation Does Not Work

In an article entitled “Sheila Bair: Two Years After Dodd-Frank, Why Isn’t Anything Fixed? , it points out that the LIBOR scandal, the MF Global’s bankruptcy, JP Morgan Chase’s “London Whale” and his trading losses, Barclays’ rate fixing, Peregrine Financial’s fraud have all happened despite the 2,319 page Dodd Frank Act has not stopped.  A decade earlier we passed Sarbanes Oxley, which according to its sponsors was going to stop financial fraud, increase investor confidence in the market and in the accounting statements of public companies, and lower the cost to raise capital.  But SOX did not accomplish any of this.  It did not stop Lehman Brothers, AIG or any of the other financial problems uncovered in the 2008 meltdown.  Even more ironic is that no one has gone to jail from these scandals, despite the CEO and others executive officers having to swear that their financial statements were accurate.  So what is Ms. Bair, the 19th Chairman of the FDIC, solution – MORE REGULATION.  Has Ms. Bair ever heard of the definition of insanity?

Ms. Bair argues that this proves that markets are not “self correcting.”  But she fails to note that the US Government always bails out big Banks and Wall Street.  Since the crisis of 2008, we have bailed on the banks with TARP, with zero interest rate loans from the Federal Reserve, and with QE1-3.  Pat Choate has shown that we bailed on banks and Wall Street at least eight times in the thirty years before that.  The markets are not self correcting because the Government does not allow them to work.  The Federal Reserve is nothing more than a Bank bailout protection mechanism.  Wall Street got special provisions in the America Invents Act to exempt them from competition from innovative startups.  Wall Street is acting rationally, because it knows there are no consequences to for failure, but huge upsides if they succeed.  That is not how the MARKET works Ms. BAIR – but it is how government works.

Every academic study has shown that Financial Regulation fails to achieve its goals and in fact hurts investors.  For instance, see Liu, Tung, Santoni, Gary J., Stone, Courtenay C., Federal Securities Regulations and Stock Market Returns. This paper surveys several papers that all show securities regulation has been a failure.  Here are some of the effects of SOX.  In 1996 60% of worldwide IPOs went public in theUS.  In 2005 only 20% of worldwide IPOs were in theUS.  TheUS is the only major country to have fewer public companies today than a decade ago.  There has been more than a 90% decline in the number of IPOs.  This particularly hurts the technology startup market.  It costs around $3 Million a year to comply with SOX as a publicly traded company.

What financial regulation does is increases the cost of obtaining funding for startup and eliminates competition among financial companies.

 
TECHCRUNCH’s Attack on Ron Paul Reveals it’s Collectivist Ideology

TechCrunch ran a story entitled Ron Paul’s Anti-Net Neutrality ‘Internet Freedom’ Campaign Distorts Liberty.  The article attempts to use John Locke to support their position for Net Neutrality.  It argues that the Internet is a Common Resource and therefore we need government to regulate it use.  The article distorts Locke’s teachings to reach the absurd conclusion that government coercion is freedom.  The way Locke and the free market manage a Common Resource is by provided property rights to those who improve the common resource.  The cable, telephone line, wireless connection that you use to connect to the Internet is not a Common Resource.  All connections to the Internet are improvements of a Common Resource and therefore the property of those who made the improvements.  There is no justification for government to steal the property of Internet providers – even for TechCrunch’s ‘GREATER GOOD’ schemes.

TechCrunch’s Orwellian argument that government coercion equals liberty is sadly consistent with its collectivist ideology.  TechCrunch has never met a property right it likes.  Usually its collectivist ideology is focused on stealing inventor’s property rights in their inventions – patents.  If you search for “TechCruch Patent Trolls” you will find numerous articles including “The Terrible Cost of Patents.”  Patents are a classic Lockean property right.  The inventor created something that did not exist before they created it, so they are the owner.  In the case of inventors, they created not an individual object (reproduction) but a new class of objects – an invention.

TechCrunch distorts the teachings of John Locke to support their collectivist ideology.  This is a common technique because the only way for statist to get people to support their collectivist goals is to hide them, which is exactly what Ron Paul said in his statement.  “They are masters at hijacking the language of freedom and liberty to disingenuously push for more centralized control.”

 

TechCrunch Ron Paul’s Anti-Net Neutrality ‘Internet Freedom’ Campaign Distorts Liberty  http://techcrunch.com/2012/07/06/ron-pauls-anti-net-neutrality-internet-freedom-campaign-distorts-liberty/

 
Book Review:  It Is Dangerous to Be Right When the Government Is Wrong: The Case for Personal Freedom

It Is Dangerous to Be Right When the Government Is Wrong: The Case for Personal Freedom, by Andrew P. Napolitano

Judge Napolitano has written an excellent book on Natural Law from the perspective of an attorney.  He attacks legal Positivists, who believe the law is whatever the government says it is.  He points out the moral bankruptcy of Positivists by pointing out that they have no logical basis to be against Hitler’s final solution of wiping out all Jews – since it was a validly passed law.  He also rejects the non-sense of “majority rule” or Democracy.

He explains that Natural Law is like science.  He states:

Only man-made theories for what those rules are and how the operate may change.

However, without an explanation or understanding, those rules remain just as “true”: Penicillin will combat certain infections, and gravity will always pull things toward the center of the Earth, regardless of whether or not we understand how.

He also states something that will not sit well with conservatives:

Truisms reject moral relativism, and American Exceptionalism.  They compel and understanding of the laws of nature that animate and regulate all human beings at all times, in all places, and under all circumstances.  And truisms equal freedom.

The book starts off with the Declaration of Independents.  It moves onto eminent domain issues where the judge has a number of illuminating points.  I particularly liked the freedom of association chapter.  Napolitano I think is one of the few people to write about this issue.  I also found the right to petition chapter illuminating.  I believe that only someone with Judge Napolitano’s legal background could have done this chapter justice.  His chapter on the growth of the Defense Industry was illuminating.  While I did not agree with all his points, he makes it clear that the Defense Industry has grown completely out of control.  According to the Judge the US military is in over 130 countries.  The quote from Fredrick the Great comes to mind “in trying to defend everything he defended nothing.”  The US military has become just another welfare/crony capitalism project.  The military will complain that defense spending as a percentage of GDP is less than it was during the Korean War.  However, we did not have the Department of Homeland Security, the Department of Energy, the Border Patrol, etc, which are all really part of our defense spending at the time of the Korean War.

Unfortunately, the book is marred by two problems.  I am in complete agreement with the Judge’s emphasis on Natural Law, but he defines it in terms of “essential yearnings.”  Someone might have an essential yearning to torture people or kill them.  That does not make it a natural right.  It is enough to state that people have ownership of their body.  The rest of Natural Law and Natural Rights flows from this simple concept.  Once I own myself, I clearly own the product of my labor which leads to all of property law, including patents.  Criminal law comes from violating my rights in my body or in my property.  The “essential yearnings” adds nothing to the concept of Natural Law and Natural Rights.

The second problem with the book is Judge Napolitano’s analysis of fractional reserve banking.  The Judge and some Austrian economists incorrectly state that fractional reserve banking allows banks to create money out of nothing.  A fractional reserve bank is a bank that lends out part of its depositors money.  Fractional reserve banking is how all modern banks (since at least 1750s) operate.  Wikipedia defines a Fractional-reserve banking as a type of banking whereby the bank does not retain all of a customer’s deposits within the bank. Funds received by the bank are generally on-loan to other customers. This means that available funds (called bank reserves) are only a fraction (called the reserve ratio) of the quantity of deposits at the bank. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money.

The history of fractional reserve banking starts with the concept of an exchange bank.  I explain in my book, The Decline and Fall of the America Entrepreneur: How Little Known Laws and Regulations are Killing Innovation:

Modern banking started in the early 1600s with the Bank of Amsterdam.  Merchants could deposit coins with the Bank of Amsterdam and use this account to pay for transactions.  Using checks, a merchant’s account was debited and another merchant’s account was credited.  This meant that coins did not have to be transported from one merchant to another with the attendant risk of theft and loss or the cost of transportation.  The Bank of Amsterdam was just an exchange bank that facilitated transactions between merchants.  Next came the Swedish Riksbank established in 1656.  The Riksbank was not only an exchange bank, it also lent money making it the first modern fractional reserve bank.  Fractional reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand.  Commonly, loans are made against collateral such as land or jewelry.  … Some people believe fractional reserve banking creates money out of thin air, but what really happens was the money for these loans were backed by some collateral other than coins or bullion.  The downside of other types of collateral is they are not as liquid as species (coins, bullion).  As a result, if large numbers of customers of a fractional reserve bank wanted species (currency) at the same time, the bank would not able to fulfill all its customer’s demands.  This is a classic run on a bank.  A run on a bank is a cash flow issue.  A sound bank may have plenty of collateral and performing loans, but if most of its customers demand species at the same time it will not be able to fulfill these requests.  Fractional reserve banks free up capital from low performing assets so that they can be invested in higher performing assets.  For example, if you owned a large tract of ranching land that was not highly profitable but represented a large amount of capital and you want to invest in an oil well, without fractional reserve banking you would have to sell some of the land in order to invest.  With fractional reserve banking you could convert your land into a generally accepted form of money, by pledging your land as collateral to a bank for a loan.  In the modern world, the loan to you is just a computer entry in your bank account.

It is clear from history that fractional reserve banks are not some sort of government institution, like the Federal Reserve.  Without fractional reserve banking it is would be very difficult to securitize (Collateralize) many assets, such as houses and land.  This would significantly impede the economic growth of a country.  Logically if you are against fractional reserve banking you should be against a stock market.  Both are just a way of securitizing assets.  The stock of paper money act as a claim against various assets and/or future earnings.

 

 
Repeal of Financial Reform?

Michele Bachmann has introduced a bill repeal the massive and widely criticized Dodd-Frank financial (see Newsmax story and Stillwater Gazette story).  This is a good first step, but she should have also included the repeal of Sarbanes Oxley.  Ms. Bachmann has correctly criticized SOX as ineffective and overly expensive.

When Sarbanes Oxley was passed, the SEC (Securities and Exchange Commission) estimated the cost of compliance would be $91,000.00 per year for each public company.  The most recent estimates for the cost of compliance are between $4.0 million and $5.0 million per year for publicly traded companies.  This clearly has an affect on the number of IPOs.

Is the cost of this law worth its incredible price? Has Sarbanes Oxley achieved its goal of protecting investors from fraud?  Sarbanes Oxley has cost the U.S. economy at least $400 billion since it passage.  This is just the direct costs and does not include the opportunity costs, which are most likely substantially higher.  The stock market has been flat or declining since its passage.  As a result, it is hard to argue that this legislation increased shareholder value.  The banking scandals of 2008 & 2009 that included Bear Sterns, Lehman Brothers, American International Group (AIG), Merrill Lynch, and the Bernie Madoff fraud make it impossible to suggest that Sarbanes Oxley has protected investors from fraud.

 

 
Net Neutrality: Requiem for the Internet

It is a sad day for innovation and freedom.  For more information on why see Does Net Neutrality Inhibit Innovation.  The FCC decided to enact a set of rules called Net Neutrality, which gives the FCC broad regulatory powers over the internet.  These rules are really an assault on property rights and a clear violation of the Fifth Amendment, which states “nor shall private property be taken for public use, without just compensation.”  Regulating the use of private property is a taking of some part of the owner’s property rights.  Property rights are a bundle of rights that define a relationship between something and the owner.  When the government takes, limits or modifies one of these rights it is a taking.

An ironic result about these rules is that the liberal left that pushed these socialist rules is unhappy with them.  They feel that the rules did not go far enough and that the regulatory process was captured by large companies.  Gee, that’s surprising.  Just look at how large Wall Street banks have used financial regulation to get rid of competition.  The large railroads did the same thing years ago.

Another ironic angle of these rules is that no consumer has come forward to complain about the way the internet works today.  A couple of very large technology companies have complained about issues of access.  They are part of the socialist groups that want to take someone else’s property without paying for it.  This is ultimately a fight between large companies that want to use the government to game the system in their favor.

A sad result of these rules is the useful idiots who believed that by supporting Net Neutrality they were supporting freedom and instead were supporting repression.  The FCC is out of control.  This is another assault by the FCC on free speech.  The FCC should be abolished.

 

 
Grant Thorton on the IPO Crisis

Grant Thornton has prepare a paper entitled Market Structure is Causing the IPO Crisis .  Here is my understanding oftheir position.  The IPO market, especially for small IPOs started to decline before Sarbanes Oxley.  The Manning Rule and Order Handling Rule and decimalization decreased the margin for handling illiquid securities by brokerage houses.  Finally, online brokerage accounts have killed quality research and encouraged speculation.

The things that effect the IPO market are the cost of going public, the return for going public, the alternatives to going public, and the willingness of an investment bank to take you public (might be part of the cost).  While not stated explicitly in the report, they seem to imply that there is little incentive for investment banks to take small companies public or to create a market in their securities after the fact.  If true, I think this would contribute to the IPO downturn, but I do not think they have stated their case very strongly.

 

According to the NYtimes the House Financial Services Committee approved an amendment to Sarbanes Oxley (Sarbox) that would allow some companies to be exempt from this legislation.  While the article implies that many companies would not be exempt under this amendment, the amendment only applies to companies worth less than $75 million and asks for a study of whether companies worth less than $250 million should be exempt.

Sarbanes Oxley has severely damaged the technology start-up market and the financial industry in the U.S.  Sarbox is very expensive: including enormous direct and indirect costs to our economy and to innovation.  It has not met its goals of improving the quality of auditing or preventing fraud.  The effects of this law include fewer public companies, fewer companies going public, more companies choosing to go public in foreign markets, absurdly high auditing expenses and a significant decrease in risk capital.

For More information see Sarbanes Oxley – Is the Medicine Worse Than the Disease – 1 and Sarbanes Oxley – Is the Medicine Worse Than the Disease – 2 .

 

Any government restriction on how the internet can operate will by definition limit innovation.  The FCC’s Net Neutrality proposal violates the “Rate Law of Innovation”, which states that rate of innovation is directly related to the number of elements that innovators have available to them.  The Net Neutrality rule limits how many variables or elements that innovators have to innovate.  See the Laws of Innovation  for more information.  All the major engineers who developed the internet are opposed to the FCC’s Net Neutrality rules.  According to Andrew Orlowski, “Engineers fear rash legislation would inhibit the ability of systems engineers to improve latency and jitter issues needed to move data at speed.”  See Mr. Orowski’s article for more information.

 

            Intellectual capital, financial capital and human capital were the three pillars of the incredible innovation of the 90s.  Human capital in the form of scientists, engineers, management, etc. was typically lured into a risky start-up company with stock options.  According to the online accounting dictionary an option is a right given the holder to buy a specified number of shares of stock at a certain price by a particular date.  Stock options were the prize if the venture worked out for talented individuals to forego better paying, less stressful positions with established organizations that often had better benefits.  The strike price of the stock option was always set at or below the fair market value of the stock at the time option was issued, meaning the option had no inherent value.  The promise was that if the venture succeeded the employees would be able to cash in their stock options and receive a large reward.  If the venture failed, these stock options would end up being worthless.  Some accountants believed that stock options should have an associated expense at the time of the option grant.  The Financial Standards Accounting Board (FASB) implemented a rule requiring expensing of options in December 2005. 

 

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