Patent Wars Cost Society $500 Billion (AAPL, GOOG, RIMM, SSNLF, SNE, ERIC, NOK, MMI, EK, RMBS, ACTG, IDCC, TSRA, WILN)

When news hits the street of another patent lawsuit, the characteristic reaction of some investors is to dump the defendant’s stock as quickly as possible. Those sales inevitably depress the company’s stock and typically don’t add anything to the plaintiff’s stock.

Recent patent litigation has been particularly heavy in the mobile phone industry, where Apple Inc. (NASDAQ: AAPL), Google Inc. (NASDAQ: GOOG), Research in Motion Ltd. (NASDAQ: RIMM), HTC Corp., Samsung Electronics Co. Ltd. (OTC: SSNLF), LG Electronics, Sony Corp. (NYSE: SNE), L.M. Ericsson Telephone Co. (NASDAQ: ERIC), and Nokia Corp. (NYSE: NOK) have filed and counter-filed a stack of lawsuits related to smartphone technology. Eventually the smartphone makers will come to some kind of cross-licensing agreement, but that day could still be a ways off.

A new study by three professors at the Boston University School of Law puts the cost of patent lawsuits at $500 billion in lost wealth to defendants during the 20-year period from 1990 to 2010.  The average lawsuit costs the defendant about $122 million, and the median loss is $20 million. According to the BU study, just 9% of the lost wealth goes to what are politely known as non-practicing entities, NPEs, and more commonly known as patent trolls — the rest simply evaporates as legal fees, costs of lost business, management distraction, and diversion of resources from product development.

The patent trolls often claim that they are providing a service to small inventors by making it possible for the inventors to share in the spoils of patent infringements. Yet the BU study concludes that small inventors typically receive just 2% of the money.

Google’s recent acquisition of Motorola Mobility Holdings Inc. (NYSE: MMI) added 24,500 patents to Google’s arsenal and created speculation that Eastman Kodak Co. (NYSE: EK) and its 1,100 digital imaging patents would be next on the block. Kodak’s portfolio has been valued as high as $3 billion, or nearly 5x the company’s current market cap. Google paid about $500,000 for each of Motorola’s patents, and the consortium of companies that bought Nortel’s 6,000 patents paid $65,000 for each of those.

Patent trolling got more difficult last week, though, with the enactment of the America Invents Act. While most of the attention on the passage of the new patent laws focused on the first inventor issue, the law also changed the way patent actions may be filed.

Under the old law, a plaintiff could round up as many defendants as possible and sue all in a single action. That will no longer be possible. The new law requires that a separate action must be filed against each accused infringer. The economics of filing patent infringement lawsuits has changed dramatically now that a single action cannot include a host of alleged infringers.

The study provides a list of publicly traded NPEs that includes Rambus Inc. (NASDAQ: RMBS), Acacia Research Corp. (NASDAQ: ACTG), Interdigital Inc. (NASDAQ: IDCC), Tessera Technologies Inc. (NASDAQ: TSRA), and Wi-Lan Inc. (NASDAQ: WILN). Of these stocks, Acacia’s shares have surged by 80% since January and Interdigital’s have risen by 40%.

The BU study’s most interesting conclusion is that there is no huge transfer of wealth from defendants to patent trolls. The bulk of the lost wealth is a cost borne by society at large. And the loss shows up in the lack of innovation and new product development.

There are some possible arguments against that conclusion, not the least of which is that there’s no guarantee that companies would spend the lost wealth on innovation instead of extravagant management perks. There’s ample evidence that company management does not always do the right thing.

Paul Ausick