3
Seven Criteria for Evaluating the Patent System

PATENTS AND INNOVATION

Ultimately, the test of a patent system is whether it enhances social welfare, not only by encouraging invention and the dissemination of useful technical information but also by providing incentives for investment in the commercialization of new technologies that promote economic growth, create jobs, promote health, and advance other social goals. Assessing the system’s overall economic impact is no simple task, perhaps an impossible one. For one thing, the dual functions of patents are in some degree at odds with each other. The exclusivity that a patent confers is undermined by its publication, which may help others circumvent the patent. Furthermore, patents entail a trade-off between the incentives provided for innovation and the costs resulting from a monopoly that may curtail competition and raise consumer prices or hinder further incentive efforts. Both sides of that ledger are exceedingly complex. Innovation in any technology area may benefit from the incentive created by a patent on a new product or process development, but it may suffer if patents discourage the combining and recombining of inventions that would have been made absent the patent or inhibit follow-on discovery. Competition may suffer when an inventor is granted a temporary monopoly right or a combination of patents is used to bar entry or to maintain a cartel in an industry. On the other hand, competition will benefit if this right facilitates investment by new, innovative firms lacking assets other than intellectual property. Patents can also foster the creation of markets for technology, enabling efficiencies in the research and development (R&D) process and promoting the transfer of discoveries from entities skilled at conducting R&D to firms potentially better suited to commercializing and marketing innovations.



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A Patent System for the 21st Century 3 Seven Criteria for Evaluating the Patent System PATENTS AND INNOVATION Ultimately, the test of a patent system is whether it enhances social welfare, not only by encouraging invention and the dissemination of useful technical information but also by providing incentives for investment in the commercialization of new technologies that promote economic growth, create jobs, promote health, and advance other social goals. Assessing the system’s overall economic impact is no simple task, perhaps an impossible one. For one thing, the dual functions of patents are in some degree at odds with each other. The exclusivity that a patent confers is undermined by its publication, which may help others circumvent the patent. Furthermore, patents entail a trade-off between the incentives provided for innovation and the costs resulting from a monopoly that may curtail competition and raise consumer prices or hinder further incentive efforts. Both sides of that ledger are exceedingly complex. Innovation in any technology area may benefit from the incentive created by a patent on a new product or process development, but it may suffer if patents discourage the combining and recombining of inventions that would have been made absent the patent or inhibit follow-on discovery. Competition may suffer when an inventor is granted a temporary monopoly right or a combination of patents is used to bar entry or to maintain a cartel in an industry. On the other hand, competition will benefit if this right facilitates investment by new, innovative firms lacking assets other than intellectual property. Patents can also foster the creation of markets for technology, enabling efficiencies in the research and development (R&D) process and promoting the transfer of discoveries from entities skilled at conducting R&D to firms potentially better suited to commercializing and marketing innovations.

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A Patent System for the 21st Century We have previously cited evidence that patents function differently in different industrial sectors. There is also a growing body of research on the relationship between patents and innovation across countries and time. Using mainly 19th-century data, Lerner (2002) and Moser (2003) find that instituting a patent system or strengthening an existing patent system does not produce more domestic innovation although the latter does induce inventors from other countries to patent more in the country making the change. It may also induce foreign multinationals to transfer more technology to affiliates in the country (Branstetter et al., 2003). Sakakibara and Branstetter (2001) studied the effects of a statutory change in Japan allowing multiple claims per patent, as has always been the case in the United States. They found that the effective broadening of patent scope had a very small positive effect on R&D activity by Japanese firms. Lanjouw and Cockburn (2000) found some limited evidence for attributing an increase in Indian research addressing developing country needs to patent reforms of the 1980s, which provided increased protection.1 The effect leveled off, however, in the following decade. Scherer and colleagues (1959) investigated the consequences of Italy’s moving from a no-patent to a patent regime in pharmaceuticals; they did not find a significant effect. Using firm-level survey data for Canada, Baldwin and colleagues (2000) found a much stronger relationship running from innovation to patenting than in the reverse direction. Firms that innovate take out patents, but firms and industries that make more intensive use of patents do not tend to produce more innovation. In the United States manufacturing sector, however, in a model that explicitly controls for mutual causation between patenting and R&D, Arora and colleagues (2002) find evidence that patenting is an important stimulus for R&D. Other positive results are those of Park and Ginarte (1997) using data across 60 countries for the period 1960-1990. They found that the strength of intellectual property (IP) protection (an index of pharmaceutical coverage, participation in international agreements, lack of compulsory licensing, strength of enforcement, and patent duration) was positively associated with R&D investment in the 30 countries with the highest median incomes. Elsewhere, the relationship was positive but not significant. These results, however, are cross-sectional and fail to account for the reverse causality between conducting R&D and having a robust patent system. The conclusions from this body of empirical research on the effects of patents are several but mostly tentative (Hall, 2003b). In developed countries, at least in manufacturing, patenting stimulates innovative activity broadly, but the stimulus varies among industries. Introducing or strengthening a patent system, however, unambiguously results in an increase in patenting and may encourage the strategic and tactical use of patents with attendant costs and possibly adverse 1   Although not a level of protection comparable to that in North America, Europe, or Japan.

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A Patent System for the 21st Century impacts on innovation and competition. One may legitimately question whether the impact of patenting on innovation and its consequences for social welfare are, on balance, positive outside of the handful of industries, such as pharmaceuticals, biotechnology, medical devices, and specialty chemicals where the benefits are well established, and possibly to a lesser extent, computers and auto parts. More subtle effects are suggested by recent economic studies and deserve more attention. Patents may enable the creation and affect the organization of knowledge-based industries by allowing trade in knowledge and facilitating the entry of firms with only intangible assets. As this abbreviated literature review suggests, the empirical economic research on the uses and impacts of patenting is more robust than it was nearly 20 years ago when George Priest (1986) complained about the dearth of useful economic evidence on the impact of intellectual property: “Economists know almost nothing about the effect on social welfare of the patent system or … other intellectual property.” Nevertheless, knowledge is still quite limited and the range of industries examined in any detail is quite narrow. EVALUATION CRITERIA In circumstances that at this stage defy a comprehensive evaluation, the committee posits a series of criteria for evaluating the patent system in terms of its impact on innovation rather than addressing its competitive or overall welfare effects. These criteria, although requiring judgments, can in varying degrees be assessed empirically and tracked over time to observe significant changes. In most cases they relate to factors widely thought to be important if not necessary and sufficient conditions for innovation. First criterion: The patent system should accommodate new technologies. A system granting even temporary monopoly rights to developers of one technology but providing no incentives to developers of other, including substitute, technologies obviously would be hostile to innovation over the long run. Second criterion: The system should reward only those inventions that meet the statutory tests of novelty and utility, that would not at the time they were made be obvious to people skilled in the respective technologies, and that are adequately disclosed. In the extreme case where an invention is already accessible to the public, or the full scope of what is patented cannot be carried out in practice, there is nothing to be gained and potentially a great deal to be lost by granting a monopoly. Third criterion: The patent system should serve its second function of disseminating technical information. That means that descriptions of patented inventions should be as complete, clear, and accessible as possible and disclosed in a reasonably timely manner, and there should not be deterrents to consulting the patent or any other technical literature.

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A Patent System for the 21st Century Fourth criterion: Administrative and judicial decisions entailed in the patent system should be timely, and the costs associated with them should be reasonable and proportionate. Protracted uncertainty about whether a patent on an application will issue or about whether a patent that is challenged in an infringement dispute will be upheld or found not infringed is not conducive to the investments necessary to innovate. In the same vein, high transaction costs entailed in obtaining or defending a patent are likely to discourage innovation. Such costs tend to escalate the longer the resolution of the issue, whether patentability or infringement, is delayed. Fifth criterion: In scientific research and in the development of complex or cumulative technologies, where one advance builds upon one or more previous discoveries or inventions and full exploitation of the technology is beyond the capacity of any single entity, reasonably broad access to patented inventions is important. Access depends upon at least three factors: (1) the scope of the patent claims, (2) the availability of licenses on reasonable terms, and (3) the complexity of the patent landscape. Of course, technology must first be created for access to be an issue. Thus, access must be balanced against the incentive to invent and disseminate technology. Sixth criterion: In an economy where a significant share of its technology-intensive products are bought and sold internationally, the compatibility of national patent systems can be a facilitator of trade and investment and therefore innovation. Indeed, there is an efficiency argument for the integration of the U.S., European, and Japanese patent systems to reduce public and private transaction costs. Seventh criterion: There should be a level field, with intellectual property rights holders who are similarly situated (e.g., state and private institutions performing research) enjoying the same benefits, while being subject to the same obligations. Accommodating New Technologies As the examples of the extensions of patenting in Chapter 2 illustrate, the patent system has proven highly adaptable to changes in technology. This includes not only emergent technologies in advance of or in tandem with their commercial application—for example, biotechnology and nanotechnology—but also technologies that at least in their early stages exhibited rapid progress and substantial commercial success without patents, such as software. The flexibility of the patent system is a function of at least three features. First, it is a unitary system with few a priori exclusions. Second, the initiative to extend patenting to a new area lies in the first instance with inventors and commercial developers, not with legislators, administrators, or judges. Third, some statutory features of the patent system, as well as administrative and court-

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A Patent System for the 21st Century interpreted case law, allow for somewhat specialized treatment in some fields of technology. The Patent Act of 1952 states that Whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefore, subject to the conditions and requirements of this title.2 The most expansive Supreme Court interpretation of this section was in Diamond v. Chakrabarty,3 the case that held a genetically modified microorganism to be patentable subject matter. In the course of its decision the Court stated that the Committee Reports accompanying the 1952 Act inform us that Congress intended statutory subject matter to “include anything under the sun that is made by man.” Sometimes these extensions occur readily. The first patent on a flying machine was issued to Orville and Wilbur Wright within 30 months of the flight at Kitty Hawk, North Carolina. In other cases the federal courts have played a prominent role. Particularly when the emergence of a new domain—for example, genetically modified life forms—is obvious and sensitive, the patent office has been hesitant to move in aggressively, and the courts have been asked to recognize patent eligibility. But even in these cases, the lag, if any, can be quite short. The Supreme Court’s Chakrabarty decision preceded by two years the introduction of the first commercial product, human insulin, made with recombinant DNA techniques. In other instances the judges have changed their minds over time. With respect to computer software and related inventions, the law changed radically during the latter decades of the 20th century. In the 1970s the Supreme Court held unanimously in Gottschalk v. Benson4 that a computer program was not patentable subject matter. Following two later Supreme Court decisions that suggested a shift in this position,5 the Court of Appeals for the Federal Circuit (“Federal Circuit”) felt comfortable in holding in 1994 that an abstract mathematical algorithm was not patentable, but a computer programmed to run such an algorithm was patentable.6 This may have been a nearly inevitable development, considering that innovations in the design of the software to run a computer and mechanical devices controlled by internal computer chips seem very close to traditional 2   35 U.S.C. Sec. § 101. 3   447 U.S. 303 (1980). 4   409 U.S. 63 (1972). 5   Parker v. Flook, 437 U.S. 584 (1978), and Diamond v. Diehr, 450 U.S. 175 (1981). 6   In re Alappat, 33 F.3d 1526, available at 1994 U.S. App. LEXIS 21129, 31 U.S.P.Q.2d (BNA) 1545 (Fed. Cir. 1994).

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A Patent System for the 21st Century inventions.7 But the courts have gone even further. The case that has received the most attention is State Street Bank & Trust v. Signature Financial Group,8 which contradicted the prevailing assumption that business methods were not patentable. State Street was followed by AT&T v. Excel Communications, Inc.,9 which, in essence, removed the requirement that software could be patented only as embodied in a computer program and therefore effectively permitted patents on algorithms themselves.10 Thus, the path toward incorporating new technologies in the patent system is not always rapid and seamless. Even less is it free of controversy. The wisdom of permitting the patenting of inventions involving genetic material, computer software, and especially methods of transacting business, where there is long history of innovations without patent protection, is still very much a matter of debate.11 Moreover, the courts have recognized limits to patenting. Historically, patent law has supported the public domain of fundamental scientific research results and other ineligible subject matter not expressed as a product or a method. In its decision in Chakrabarty the Supreme Court qualified its “anything under the sun by the hand of man” dictum as follows: This is not to suggest that [Section] 101 has no limits or that it embraces every discovery. The laws of nature, physical phenomena, and abstract ideas have been held not patentable. Thus, a new mineral discovered in the earth or a new plant found in the wild is not patentable subject matter. Likewise, Einstein could not patent his celebrated law that E=mc2; nor could Newton have patented the law of gravity. Such discoveries are manifestations of nature, free to all men and reserved exclusively to none. 7   Indeed, although the European Patent Convention explicitly excludes from patentability “programs for computers as such” (Art. 52(2) and 52(3)), the European Technical Board of Appeals has found it very difficult to keep the exception narrow and has upheld patents to several computer program innovations. For example, International Business Machines, Case No. T0935/97 (Feb. 4, 1999); and International Business Machines, Case No.T1173/97 (July 1, 1998). The European Parliament is currently considering a directive that directly embraces software patents. 8   State St. Bank & Trust Co. v. Signature Fin. Group, 149 F.3d 1368, available at 1998 U.S. App. LEXIS 16869, 47 U.S.P.Q,2d (BNA) 1596 (Fed. Cir. 1998). 9   AT&T Corp. v. Excel Communications,, Inc., 172 F.3d 1352, available at 1999 U.S. App. LEXIS 7221, 50 U.S.P.Q.2d (BNA) 1447 (Fed. Cir. 1999). 10   On remand, the patent involved in this case was held invalid for anticipation and obviousness. AT&T Corp. v. Excel Communications, Inc., available at 1999 U.S. Dist. LEXIS 17871, 52 U.S.P.Q.2d (BNA) 1865 (D. Del. Oct. 25, 1999). 11   Some members of the committee embarked on our study with great skepticism about the wisdom of patenting business methods in the absence of a convincing case for their protection and with some interest in a contemporary proposal to limit the term of business method patents to three or five years. A few members remain convinced that patents are not the most appropriate form of protection for software inventions. Nevertheless, we soon agreed to focus our efforts on means of ensuring better quality business method and software patents rather than on creating exceptions to the general system. The impact of business method patents merits rigorous study after longer experience.

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A Patent System for the 21st Century The recent extension of patenting has led to the granting of quite abstract patents, some of them representing intersections of biotechnology, software, and business methods. Examples include the use of a specific genetic characteristic to infer a specific phenotypic characteristic,12 a technique of statistical analysis on arrays13 and databases,14 and the use of specific protein coordinates in a computer program to search for protein complexes.15 It is of concern to some members of this committee but not clear to a majority that the line between practical invention and pure information is being breached. If it is being crossed in a few cases it is not clear that they represent precedents that the USPTO is continuing to follow, or if the patents were challenged, how the courts would construe these claims or whether the claims so construed would be held valid.16 That there is disagreement should not be surprising given that the line between ideas and inventions is indistinct. Notwithstanding its unitary character, the U.S. patent system is differentiated in transparent and subtle ways that accommodate differences in technologies or that affect technologies differently. An example of the former is the requirement for patent holders to pay maintenance fees periodically to take advantage of the full statutory patent term. As we discussed in Chapter 2, that means that many patents are allowed to lapse if the cost of keeping them in force exceeds their value. That is much more frequently the case in information technology, where the product cycle is as short as a few months, than in pharmaceuticals, where the returns to patents are concentrated in the last few years of their terms because the early years are consumed with clinical testing and achieving regulatory approval. The patent prosecution process also varies in duration and other characteristics from one major technology class to another (Allison and Lemley, 1998). Less obvious but important, the patentability rules applied to different technologies show some divergence. According to legal scholars Dan Burk and Mark Lemley (2003a), the ability to calibrate the patent system to industries and technologies derives from a large kit of policy levers available to the USPTO and the courts. These include or could include all of the following rules and patent doctrines—the rule against patenting abstract ideas, the standard of utility, the exception for experimental use, the test for obviousness of the “person having 12   U.S. Patent No. 5,998,145. 13   U.S. Patent No. 6,647,341. 14   U.S. Patent No. 6,023,659. 15   U.S. Patent No. 6,252,620. 16   For example, there are at least two patents with at least one claim to computer-readable material encoded with protein structure coordinates (U.S. Patent No. 6,546,074 and U.S. Patent No. 6,389,378) that could be at odds with USPTO examination guidelines. See I. Shimbo et al. (2004), which reports the results of a 2002 trilateral (USPTO, JPO, and EPO) review concluding that “information” such as protein three-dimensional structural coordinates is not patent-eligible subject matter in any of the three jurisdictions.

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A Patent System for the 21st Century ordinary skill in the art,” so-called secondary considerations of non-obviousness (for example, commercial success, long-felt need), the written description requirement, the doctrine of equivalents, the principle of pioneering patents, the presumption of validity, patent misuse, and injunctive relief.17 Often their application, not just the technology, is controversial, but they give the patent system a flexibility that would be lacking if it were necessary to amend the patent law every time a new technology presented itself. Ensuring High-Quality Patents In 1790 when Congress enacted the first patent statute it stipulated two substantive requirements—novelty and utility—for an invention or discovery to qualify for a patent. From the outset it was recognized that patents ought not to be granted for any trivial advance in an art, that some more substantial improvement should be shown. In 1851 the Supreme Court distinguished the “work of the skillful mechanic,” not justifying protection, from the “work of the inventor”; but for a century, courts struggled without statutory guidance to define an “invention.” Finally, in 1952, Congress adopted an alternative formulation, excluding from patentable subject matter what “would have been obvious at the time the invention was made to a person having ordinary skill in the art.” Thus, the third substantive requirement for patentability became known as the “non-obviousness” standard.18 The importance of these three conditions in the abstract is uncontested. Patents on known or only trivially modified inventions would confer potential market power to restrict access and raise prices and enable the patent holder to use litigation as a competitive weapon without providing incentives for making genuine advances or disclosing such advances to the public. They offer no public benefit in exchange for the benefit given to the patentee. Granting patents for inventions that are not new or useful or that are obvious unjustly rewards the patent holder at the expense of consumer welfare (Levin and Levin, 2003). A second theoretical argument against poor patents is that because of doubts about their validity they are likely to encourage more infringement and more litigation, raising the transaction costs of the system and discouraging some investment (Merges, 1999; Meurer, 1989). Poor patents may induce investment 17   Burk and Lemley go on to argue that some of the ways that the courts have applied the legal standards of obviousness, enablement, and written description are misguided—for example, producing more and narrower biotechnology patents and fewer broader software patents whereas innovation policy considerations suggest that the results should be the reverse. Burk and Lemley have been criticized (Wagner, 2003) for not distinguishing between their insightful descriptive “micro-exceptionalism” and their prescriptive “macro-exceptionalism,” calling on the courts to play a policy role for which, arguably, they are not suited. 18   The corresponding European requirement is that a patent application show an “inventive step.”

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A Patent System for the 21st Century in product development that is abandoned later when the patents are invalidated. Hunt (1999) and O’Donoghue and colleagues (1998) conclude from slightly different models of innovation that raising or lowering the standards of patenting could affect the character of R&D. If the standard is high, firms may be more likely to pursue larger innovations. Over the past decade the quality of issued patents has come under sharp attack.19 The conjecture that patent quality is declining or is simply too low has been characterized in two ways. First, some legal scholars have suggested that the standards of patentability—especially the non-obviousness standard—have been relaxed as a result of court decisions (Barton, 2000; Dreyfuss, 1989; Lunney, 2001). Other observers have suggested that the USPTO too frequently—or more frequently than in the past—issues patents for inventions that do not conform to generally accepted standards for patentability, especially in technology areas that are newly patentable, notably genomics, software, and business methods (Barton, 2000; Hall, 2003b).20 This alleged decline in USPTO performance is variously attributed to the quantity and quality of relevant resources, examiner qualifications, experience and incentives, the time devoted to searching and evaluating each application, and the information available to examiners (for example, access to automated data bases incorporating prior art). Although logically distinct, the notion that standards for patentability are slipping and the notion that USPTO examiners are failing to apply the legal standards appropriately are obviously difficult to distinguish in practice (Cohen et al., 2002). There is no lack of examples of issued patents that appear dubious on their face. One such list (Hall, 2003b) includes a patent on a computer algorithm for searching a mathematical textbook table to determine the sine or cosine of an angle,21 a patent for cutting or styling hair using scissors or combs in both hands,22 a patent on storing music on a server and letting users access it by clicking on a list of the music available,23 and a patent on initiating forward motion on a child’s swing by pulling on the ropes and swinging sideways (the last subsequently ordered to be re-examined by the director of the USPTO).24 Whether these are products of the office’s interpretation of court decisions or of internally generated guidance given to examiners or of less than thorough examination of applications 19   The complaint is not new, but previously it was associated with periods, such the 1970s, of generally low regard for the patent system, high rates of invalidity determinations by the courts, and low patenting activity. 20   Such criticisms have been leveled by the Supreme Court. For example in Graham v. John Deere Co., 383 U.S. 1 at 18 (1966), the Court referred to “a notorious difference between the standards applied by the Patent Office and by the courts.” 21   U.S. Patent No. 5,937,468. 22   U.S. Patent No. 6,257,248. 23   U.S. Patent No. 5,963,916. 24   U.S. Patent No. 6,368,227.

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A Patent System for the 21st Century or, indeed, whether some of them could withstand challenges in the courts is an open question. Further, whether the examples are aberrant or typical or, for that matter, increasing or declining in frequency is impossible to determine on the basis of a few handpicked examples of apparently bad results. But a nontrivial number of errors in judgment are inevitable in a system whose output by 3,000 individual examiners is 167,000 patents annually. In the late 1990s the U.S. Department of Commerce inspector general’s (IG) office investigated the growing backlog of applications awaiting decisions before the USPTO Board of Patent Appeals and Interferences (U.S. Department of Commerce, 1998). The IG reported that board personnel attributed declining production to the poor quality of cases being appealed. Board personnel whom we interviewed stated that cases they receive from the examining corps often contain administrative errors, inadequate support for the examiner’s final rejection, and other unanswered questions or omitted information about the patent’s claim that should have been addressed. As a result, APJs [administrative patent judges] are spending time searching prior art (technical literature including prior-issued patents and foreign patents, related documents, and non-patent literature such as journal articles and abstracts), a task which is normally examiner responsibility. Board workload data supports their assertions. Reversals of examiner decisions and remands for additional examiner review combined for 41 percent of the board’s total disposals in FY 1994, but 54 percent in FY 1997.25 Furthermore, rejections due to examiners having overlooked prior art have averaged 12 percent of the board’s decisions over the same period. In effect, overall production is cut because APJs are spending more time processing appeals in order to make these determinations. Nevertheless, the claim that quality has deteriorated in a broad and systematic way has not been empirically tested. Three seemingly direct measures of quality are (1) the ratio of invalid to valid patent determinations in infringement lawsuits, (2) the error rate in USPTO quality assurance reviews of allowed patent applications, and (3) the rate of claim cancellation or amendment or outright patent revocation in re-examination proceedings in the USPTO.26 These indicators show mixed results. The rate of invalidity findings in district (trial) court judgments has declined over time. P. J. Federico (1956), using data for 1925-1954, and Gloria Koenig (1980), using data for 1953-1978, found that before 1982 district courts and circuit courts upheld only about one-third of the patents litigated. At the appeals level the rate increased to about 55 percent with the advent of the Federal Circuit (Dunner et al., 1995), as did the validity rates in the district courts as a whole (Lemley, 2002, using data from 1994; and Allison and 25   The USPTO Annual Report stated the combined reversal/remand rate was slightly less in FY 1997—51 percent. 26   See Appendix A for a description of the re-examination procedure.

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A Patent System for the 21st Century Lemley, 1998, using data from 1989 through 1996).27 Although it may seem surprising that the probability that a patent will hold up under challenge is just over 50 percent, it should not be unexpected. Both parties exercise enormous care in deciding whether to run the risk of litigating a patent dispute rather than abandoning or settling it, the much more frequently exercised options. In most cases, not only is the commercial value high but also the validity issues are finely balanced. Consequently, one should be very cautious in interpreting the results of courts’ validity decisions. The error rate reported in USPTO quality assessment audits has fluctuated between 3.6 and 7 percent since 1980. There was a slight upward trend through the 1990s until 2000, but it has declined in recent years to around 4 percent. Only about 10 percent of patents subject to re-examination in the United States are completely revoked, although nearly two-thirds undergo some adjustment to their claims, often because the patent holders themselves sought re-examination to modify their claims in light of newly discovered prior art. All three indicators suffer from serious deficiencies, however. In addition to selection effects, the numbers of patents subject to any of these procedures are extremely small. The litigation rate of issued patents is just over 1 percent (Lanjouw and Schankermann, 2003); re-examined patents represent about 0.3 percent of the total (Graham et al., 2003); and about 2 to 3 percent of a year’s patents are reviewed by the USPTO for quality control purposes. Ostensibly, the USPTO’s audits come closest to producing a measure of quality and therefore deserve closer examination. The patents reviewed are not randomly chosen to assess overall system performance nor is the selection weighted toward technologies in which examination quality may be problematic. Currently, the protocol is designed to take a specific number of applications from each examiner depending upon examiner experience level and certification status.28 Because of the small percentage of allowed applications that are reviewed, the error rates are statistically significant only at the level of the seven technology centers, not the art units.29 27   The Federal Circuit is much more likely to affirm a district court’s finding of validity than invalidity. This is a reversal of the previous relationship between the district courts and circuit courts of appeals. 28   Under the USPTO’s 21st Century Strategic Plan, experienced examiners are recertified for competency every three years. Recertification is based in part on an expanded review of the examiner’s recent work by both the Technology Center Management and the Office of Patent Quality Assurance. 29   Curiously, error rates have tended to be higher in technologies where examination is most straightforward and least complicated. This may be because examiners in these technologies have less time allotted for examining each application or because reviewers find it easier to review and understand these applications and therefore more easily recognize errors. With respect to this latter possibility it should be noted that reviewers are drawn from the technology class they review (that is, chemical, electrical, mechanical), but they are required to review applications covering much broader subject matter than examiners are required to examine.

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A Patent System for the 21st Century TABLE 3-5 Estimated Median Litigation Costs for Each Party of Litigation (thousands of dollars)   2001 2003 Percent Change, 2001 to 2003 Less than $1 million at risk End of discovery $250 $290 16.0 Inclusive of discovery, motions, pretrial, trial, post-trial, and appeal $499 $500 0.2 $1-$25 million at risk End of discovery $797 $1,001 25.6 Inclusive of discovery, motions, pretrial, trial, post-trial, and appeal $1,499 $2,000 33.4 More than $25 million at risk End of discovery $1,508 $2,500 65.8 Inclusive of discovery, motions, pretrial, trial, post-trial, and appeal $2,992 $3,995 33.5   SOURCE: AIPLA (2003). effective in protecting the competitive advantage derived from their innovations than do small firms’ respondents; and outside the pharmaceutical industry, small firms disproportionately report that the expected cost of defending patents dissuade them from patenting altogether. Accessing Technologies for Research and Development In a variety of contexts the feasibility and terms of access to patented technology, usually by means of licenses, are crucial to further research, technology development, commercialization, and diffusion of new technologies, for example, cross-licenses on the myriad elements in semiconductor devices, without which multi-billion dollar investments in fabrication operations would not occur or could be held hostage; pooled licenses to technologies underlying technical standards permitting interoperability of electronic and communications equipment; licenses to multifunctional research tools that are crucial to progress in biomedical research. Concerns about access to patented technology, whether from the perspective of innovation or competition, tend to be quite specific to industries and firms. We

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A Patent System for the 21st Century would have a better general understanding of how markets for technology arise, how they work, under what circumstances impediments to innovation arise, and how they could be reduced if we had data on patent-related licenses, but so far, disclosure and data collection are very limited.59 Evidence has for the most part been limited to anecdotes, case studies, and occasional court cases. In all of the panel’s deliberations there was only one area—biotechnology research and development, primarily where applied to human health—where it was repeatedly suggested that there might be a significant problem of access to patented technology. This is obviously a field of great public interest. It is also a priority of the scientific community, medical products industries, and clinicians to sustain the remarkable productivity of biomedical research and to achieve its promise to yield highly beneficial and lucrative therapeutic and diagnostic products. The role of intellectual property in promoting and perhaps in some instances impeding this progress has already been the subject of a National Academies’ public workshop (NRC, 1997) and an aspect of several studies (Institute of Medicine, 2003; Institute of Medicine, forthcoming), and it has received attention from many other organizations (Nuffield Council on Bioethics, 2002; United Kingdom Royal Society, 2003; and Korn and Heinig, 2002). As we described in Chapter 2, three concerns have been articulated. The first concern, stated in general terms by Merges and Nelson (1990) and Scotchmer (1991) over a decade ago, is that patents on upstream discoveries, if sufficiently broad in scope, can impede follow-on research and development if access to the foundational intellectual property is restricted. The second concern is specific to biotechnology. In a 1998 Science article, attorney Michael Heller and legal scholar Rebecca Eisenberg hypothesized the emergence of what they termed an “anticommons” in biotechnology, which could result if assembling the rights to use the numerous separate patented building blocks necessary to pursue a particular line of research or product development proved to be prohibitively costly and time consuming or simply impossible, causing a promising prospect to be avoided or abandoned. The authors speculated that the diversity of players with different objectives and commercial experience—university administrations, research faculty, biotechnology research firms, large pharmaceutical companies, and government laboratories—increased the likelihood that gridlock would occur. Some might overvalue their upstream research tool inventions from the perspective of downstream product developers faced with the enormous costs of bringing medical products to market. Others might insist on conditions (for example, reach-through rights, downstream royalties) unacceptable to potential licensees. The third concern is specific to university and other nonprofit sector research per 59   Publicly held corporations must report to the Security and Exchange Commission licensing relationships “material” to their financial performance. Some universities have disclosed licensing data to researchers.

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A Patent System for the 21st Century formers. It is that they could be more adversely affected by the potentially high cost of competing in this arena.60 Faced with these conjectures and a few anecdotes, the committee decided to take the unusual step of initiating a modest interview-based survey of firms, intellectual property practitioners, researchers, and government personnel to derive the first empirical data on whether any of these conditions is occurring or emerging. Drawing upon approximately 70 interviews with people in all of these categories, Walsh and colleagues (2003) found that the preconditions for these results appear to exist. More than in the past, therapeutic products tend to be associated with multiple patents; and public research institutions, the locus of many upstream discoveries, are patenting and licensing more aggressively. With important caveats, however, the authors do not find that these developments are yet impeding research and drug development in a significant way. This is in part because the number of patents required for most R&D projects remains manageable and in part because the various players have improvised arrangements or followed norms that mitigate the intellectual property complexities that exist. What the authors term “working solutions” include, as one would expect, negotiated licenses and royalty payments.61 Patents are also circumvented by inventing around them, using substitute research tools, and locating research activity offshore. Institutional responses include the National Institutes of Health guidelines encouraging research grantees to facilitate access to patented research tools and the steps taken by several research organizations to place results in the public domain, where they become patent-defeating prior art. According to many university and corporate respondents to the survey, one of the most pervasive working solutions is infringement of patents, especially on tools of precommercial laboratory research, in some cases on the presumption that research is legally shielded from infringement liability by a “research exception,” and in other cases on the assumption that patent holders will not sue over research uses. In particular, there is a widely held belief that private firms will not sue university investigators over patent infringement because there is little to be gained financially and a high risk of adverse publicity. The first caveat concerns access to patented research tools that are keys to progress in one or more broad therapeutic areas and “rival-in-use,” that is, they are tools that are primarily used to develop innovations that will compete with one another in the marketplace. Holders of intellectual property on nonrival 60   Iain Cockburn (2004) speculates that “more and stronger” patents could not only hinder research but ultimately make the pharmaceutical industry less productive and its products more costly by inducing excess upstream entry and making contracting more difficult between biotechnology tool companies and pharmaceutical producers. 61   The Cohen-Boyer recombinant DNA technique is an example of a nonrival-in-use research tool patent widely licensed at a reasonable cost.

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A Patent System for the 21st Century research tools tend to charge prices that permit broad access, and frequently charge lower prices to university researchers who intend to use the tools for noncommercial purposes. But when tools are rival-in-use, it is in the interest of owners either to exploit the technology themselves or grant exclusive licenses. The concern here is that when such tools are important inputs into the discovery and development of commercial therapies, and there exists uncertainty about the best way to pursue a given application—no less a range of applications—no one firm’s efforts at downstream development are likely to realize the full potential of the tool. This is because no one firm is likely to see or be able to develop all the different ways that the discovery might be exploited. One example of exclusive access to a foundational discovery that has raised concern—where it has been argued that broad rather than exclusive access to the discovery would better serve society’s interests—is Geron’s exclusive rights to pursue human embryonic stem cell research for three cell types. Other cases of rival-in-use patented technologies that are potentially important inputs into the discovery and development of therapies where exclusive use or licensing has raised similar concerns are described in the sidebar (see Box 3-1). We are not suggesting that these cases represent inappropriate exploitation of the technologies involved. The cost and risk of the technologies’ development would need to be considered. But they do illustrate the kinds of access issues that arise. Although there may be only a few identified controversial instances where restricted access may potentially impede subsequent discovery and development, the consequences for research and medicine of even a rare such occurrence could be large. On the other hand, neither is it clear that less exclusive, low-cost access would on balance serve society’s interests if such access dampened the incentive to develop the research tools from the outset. At this point we can say that concern about access to them is not misplaced. A second caveat relates to university researchers’ use in clinical research of diagnostic tests involving patented technologies. Merz, Cho, and their colleagues (2002) have conducted several studies of the impact on clinical laboratories of royalty rates on patented tests, infringement claims, and refusal to license some tests at all. One study found that 25 percent of laboratory physicians reported abandoning a clinical test because of patents. They also reported royalty rates ranging from 9 percent for polymerase chain reaction to 75 percent for the human chorionic gonadotropin patent. A number of laboratories ceased using the genetic test for hemochromatosis once the patent issued and it was exclusively licensed to SmithKline Beecham. Here, too, the issue is not straightforward because clinical laboratories charge patients or their insurers for conducting diagnostic tests, earning revenue that distinguishes the provision of clinical services from noncommercial research. Further, there has been no evidence that patients lacked access to these tests. The third important caveat is that one of the most prevalent “working solutions”—knowing or unknowing infringement often done or condoned in the belief

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A Patent System for the 21st Century BOX 3-1 Issues of Access to Patented Research Tools in Biotechnology NF-kB (NF-kappa B) Laboratories at Harvard College, the Massachusetts Institute of Technology, and the Whitehead Institute for Biomedical Research discovered a cell-signaling pathway called NF-kB in the 1980s and were awarded a patent (U.S. Patent No. 6,410,516) in 2002 that may cover almost every clinical application of this fundamental signaling pathway. The patent was exclusively licensed to Ariad Pharmaceuticals. Although investigators “at academic and not-for-profit institutions conduct[ing] non-commercial research” may continue working with the technology without a license, according to Ariad, commercial entities must obtain a license. Ariad has sold international nonexclusive sub-licenses to Bristol-Meyers Squibb and DiscoveRx Corporation. In addition to one-time and annual license fees, these licenses also include milestone and royalty payments on products based upon the NF-kB pathway. Furthermore, corporations using products sold by licensed companies may also need to obtain additional licenses from Ariad itself. In 2002 Ariad and the three research institutions sued Eli Lilly, arguing that Lilly’s Evista and Xigris products for osteoporosis and sepsis, respectively, infringe upon their patents since the drugs work via the NF-kB pathway. In support of its lawsuit, Ariad cited several peer-reviewed papers written by Lilly scientists. On May 13, 2003, the U.S. District Court for the District of Massachusetts denied Lilly’s motions to dismiss and for summary judgment. Ariad has approached some 50 other companies for royalty payments on current or future products that function via the NF-kB pathway (Rai and Eisenberg, 2003). COX-2 Enzyme The University of Rochester patented the COX-2 enzyme (U.S. Patent No. 6,048,850), claiming all drugs that inhibit the enzyme and routes for administering such drugs. The university sued Searle/Pharmacia for patent infringement. The U.S. District Court for Western New York dismissed the university’s complaint on the grounds that the discovery in the patent was invalid for lack of “written description” and therefore could not support an infringement claim (University of Rochester v. G.D. Searle & Co., Inc., W.D.N.Y., March 5, 2003). The Court of Appeals for the Federal Circuit affirmed that the patent was invalid (University of Rochester v. G.D. Searle and Co., Inc., 358 F.3d 916, available at 2004 U.S. App. LEXIS 2458, 69 U.S P.Q.2d 1886 (BNA) (Fed. Cir. February 13, 2004)).

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A Patent System for the 21st Century CD34 Johns Hopkins University was awarded a patent claiming all antibodies recognizing CD34, an antigen found on stem cells but not on more differentiated cells. The patentee awarded an exclusive license to Baxter. A rival firm, CellPro, combined two discoveries, one a method for using selectively binding antibodies to enrich bone marrow stem cells and the other an antibody that binds to CD34 (although in a different class of antibodies and recognizing a different binding site on CD34) to produce a cell separator instrument for use in cancer therapies. CellPro declined Baxter’s offer of a $750,000/16 percent royalty nonexclusive license, while other firms accepted these licensing terms. CellPro instead chose to sue to invalidate the patent. CellPro ultimately lost the case, was ordered to pay damages (including willfulness damages, because it was found to have lacked a good faith belief the patent was invalid) and legal fees, and went bankrupt (Bar-Shalom and Cook-Deegan, 2002). OncoMouse Harvard University patented a mouse containing a recombinant activated oncogene sequence that permitted it to be employed as a model system for studying cancer and permitting early-stage testing of potential anticancer drugs. The invention was licensed exclusively to DuPont. After years of negotiations, the National Institutes of Health and DuPont signed a memorandum of understanding (MOU) permitting, among other things, relatively unencumbered distribution of the technology among academic institutions, although under specific conditions. Recently DuPont imposed new conditions on academic licensees (for example, barring use of the technology in industry-sponsored research without taking a commercial license) and began asserting its patent against research institutions that have not accepted the new conditions (A. Neighbour. Presentation to the National Cancer Policy Board, Institute of Medicine, April 23, 2002). Embryonic Stem Cells The University of Wisconsin received a broad patent on its embryonic stem cell discovery in 1998. Its affiliate, the Wisconsin Alumni Research Foundation (WARF), licensed the technology exclusively to Geron, Inc., to develop the cells into six tissue types that might be used to treat diseases and gave Geron options to acquire rights to other issue types. When Geron sought to extend its rights to 12 other tissue types, WARF sued the company in order to offer licenses to other firms. Geron and

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A Patent System for the 21st Century WARF reached a settlement in January 2002, narrowing Geron’s exclusive rights to three cell types, removing its option to acquire other exclusive rights, and granting rights free of charge to academic and government scientists for noncommercial research (Stolberg, 2001; Pollack, 2002). BRCA1 Myriad patented a test for the gene, BRCA1, linked to breast cancer. It allows licensees to perform the tests provided that no fees are charged and the tests are not used for clinical purposes. It also provides reduced-fee tests ($1,200 versus $2,680) for use in NIH-funded projects. Nevertheless, the firm takes the position that giving test results to patients crosses the line from a research test to a clinical test even if other conditions of the license are observed (Blanton, 2002). that the research in question was shielded from liability—appears to have been undercut by a decision of the Federal Circuit Court of Appeals,62 handed down in October 2002 after our survey was completed. Ruling on a claim of a common law research exemption from patent infringement liability, the court in a case brought against Duke University agreed that research “solely for amusement, to satisfy idle curiosity, or for strictly philosophical inquiry” is protected; but it held that the protection does not extend to organized scientific research activity pursued as part of the legitimate business of an institution, whether nonprofit or for-profit. The “business” of a university, according to the opinion, is research, education, and reputation enhancement. A few months later the Supreme Court declined to hear Duke University’s appeal, allowing the decision to stand. The case involved circumstances very different from those arousing concern in the research community. The plaintiff is a former Duke faculty member, the field is laser research, and the patented technology is laboratory equipment. Nevertheless, the holding is in no way confined to those facts. It is difficult to anticipate the effects of this decision. An informal poll of research institutions reported to a September 30, 2002, meeting organized by the Association of American Universities, American Association of Medical Col 62   Madey v. Duke Univ., 307 F.3d 1351, available at 2002 U.S. App. LEXIS 20823, 64 U.S.P.Q.2d (BNA) 1737 (Fed. Cir. 2002).

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A Patent System for the 21st Century leges, Council on Government Relations, and National Association of State Universities and Land Grant Colleges revealed that a number of institutions were receiving more notification letters with respect to patent infringement in the aftermath of the decision.63 University administrators and legal counsel are uncertain what precautions to take to avoid infringement. An increase in full-fledged litigation against research institutions may be unlikely, but it is clear that investigators and their institutions must now pay closer attention to the intellectual property issues involved in their work, with an attendant increase in its cost. Reducing Redundancies and Inconsistencies Among National Patent Systems Although significant international progress has been made on standardizing the length of patent terms, establishing common rules for the publication of patent applications, and reconciling other national differences, important differences in standards and procedures remain among the U.S., European, and Japanese patent systems, ensuring a burdensome redundancy that imposes high costs on users and hampers market integration. With respect to any economically important invention, at least three sets of examiners analyze essentially the same application and search more or less the same prior art.64 This drives up the costs of obtaining and maintaining worldwide patent protection to a level that can be afforded only by the largest multinational corporations. It is estimated to cost as much as $750,000 to $1 million to obtain comprehensive worldwide patent protection for an important invention, and that figure is increasing at a rate of 10 percent per year (Mossinghoff and Kuo, 1998). Equally important, duplication of effort also impacts all three governments, which are coping with the surge in patent applications with at best slowly growing and at worst reduced resources. Impeding full reciprocity or mutual recognition, let alone uniform enforcement of patent rights, are a host of subtle and overt differences in approach, procedures, and standards, some of them technology-specific, many of them subject to ongoing negotiations in the World Intellectual Property Organization 63   The organizations have arranged with the American Association for the Advancement of Science to continue to monitor universities’ experience in this regard. 64   The Patent Cooperation Treaty (PCT), implemented in 1978 under the World Intellectual Property Organization (see description in Appendix A), has created a division of labor chiefly between the industrial countries and nonindustrial countries with limited or no patent examination capabilities by providing for USPTO or EPO advisory searches and, at an applicant’s option, examinations that are frequently accepted by developing countries. Such searches and examinations are available among the trilateral patent offices but are often repeated or duplicated, since applicants frequently file simultaneously under the PCT and in national offices in major markets. The PCT offers applicants an efficient means of filing applications in multiple countries.

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A Patent System for the 21st Century (WIPO).65 Among the principal substantive differences in patent law are the following: Priority of invention. As between two true inventors—as contrasted with copiers—every nation in the world except the United States provides patents to the inventors who first undertake to use the patent system to disclose their inventions and gain protection.66 This is conventionally known as the first-inventor-to-file system of priority. The United States provides a patent to the first person to “conceive” and/or “reduce the invention to practice” (first-to-invent system). The latter gives rise to a number of priority disputes, known as “interferences,” over the timing and identity of invention that are difficult to adjudicate, whether administratively in the patent office or in the courts. The U.S. system nevertheless has strong adherents among individual inventors and small companies. Best mode requirement. U.S. law requires that a patent application disclose the “best mode” of implementing an invention to prevent the applicant from concealing the invention’s significance by describing a trivial or remotely related application. No other country has such a requirement. The best mode requirement is frequently raised as a defense in patent infringement litigation. In other words, an accused infringer asserts that the patent should be invalidated because of the patent owner’s failure to disclose the best mode. Judicial inquiries into best mode require access to inventor records and testimony that are often inconclusive. Grace period. Under U.S. law inventors can disclose their inventions publicly or commercialize them before filing patent applications as long as the applications are filed within one year. The grace period encourages early disclosure, for example, of research results in scientific publications or conferences, or commercialization of an invention without causing inventors to forfeit their rights to protection. Japan has a more limited grace period in time and scope; Europe provides none. Maintaining a Level Field Among Rights Holders Uniform application of the patent law’s rights and obligations was not questioned until the U.S. Supreme Court, in June 1999, struck down a federal law that had denied a state from claiming immunity under the Eleventh Amendment of the Constitution when sued in federal court for patent or other federal intellectual property infringement. In Florida Prepaid Postsecondary Education Expense Board v. College Savings Bank67 the Court said that Congress had not shown 65   WIPO in 2000 resuscitated a set of substantive patent law harmonization negotiations, commonly known as “deep harmonization,” that had been quiescent since 1993. 66   In January 1998 the Philippines abandoned the first-to-invent system, leaving the United States alone in adhering to it. 67   Florida Prepaid Postsecondary Education Expense Board v. College Savings Bank. 527 U.S. 627 (1999).

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A Patent System for the 21st Century such a pattern of state agency infringement or an absence of state remedies that would have justified a removal of immunity. As a result of the decision a public university could be in the position of asserting its patent rights against an alleged infringer while successfully barring a patent holder from recovering damages for its own past infringement. College Savings Bank does not prevent the patentee from enjoining future use of the patented invention. Still, the partial immunity is not available to a private party, including other universities in the same state. As a result, it could have distorting effects. For example, if investigators in a state institution used a patented research tool one time without license to find a profitable pharmaceutical product, the patentee could sue for an injunction to bar future use of the tool, but it would be pointless. Sovereign immunity prevents the patent holder from suing for past damages, even if they turned out to be substantial. Like many other issues arising from recent policy changes, it is not clear how serious a problem the disparity represents. It is not enormous. A state could not set up a systematic program of infringement, for example, to produce low-cost prescription drugs for its Medicaid patients. It could be enjoined in federal court and also sued in a state court for an unconstitutional taking of property. Furthermore, if states began to infringe patents systematically, Congress would have the factual predicate the Supreme Court said was necessary to support a waiver of immunity in federal court. Nevertheless, the committee believes the disparity created by the decisions is not negligible. It puts the United States in the position of being out of compliance with the TRIPS agreement, which provides no exceptions for subunits of government. Further, it may over time affect the choices private firms make in supporting research at public or private institutions. In an analysis for the Senate Judiciary Committee the U.S. General Accounting Office (GAO) reported in 2001 that before the Supreme Court’s decision, state entities were rarely sued in federal court for patent or copyright violations; there had been 58 cases during a 15-year period, less than 0.05 percent of the total number of cases in federal district courts. On the other hand, two-thirds of state universities responded to the GAO that they had received accusations of infringement, usually in the form of cease-and-desist letters, during the same period. Seven of nine institutions responding reported receiving 11-15 complaints, and one institution reported receiving more than 16 complaints. Almost certainly, the number of complaints of university infringement and conceivably the number of lawsuits will increase in the aftermath of the Madey v. Duke ruling that universities in general may not claim a research exemption defense under common law. On the one hand, private university administrations may conclude that they need to make a much more vigorous effort, which could be burdensome for researchers, to guard against infringement suits than do public university administrators. On the other hand, there may develop a perception that private institutions are more reliable partners in collaborative activities with industrial companies.

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A Patent System for the 21st Century SUMMARY The committee concludes that the U.S. patent system, while functioning reasonably well in many respects, most importantly in its rapid accommodation to technological changes and its flexibility in dealing with differences between technologies, is exhibiting a number of characteristics requiring attention and improvement. Although it is not clear that the quality of most patents has declined significantly, there are reasons to be concerned about whether many patents in leading-edge technologies that are drawing substantial investments represent desirable degrees of novelty, utility, and non-obviousness. This appears to be a function both of pressures on the examination process and of interpretations of some patent standards. There are remediable features of the U.S. patent system that undermine its function in disseminating technical information. Delays and costs entailed in resolving questions of patentability, the validity of issued patents, and infringement, although in some respects comparing favorably to those in Europe and Japan, excessively compound the uncertainty surrounding innovation. Difficulties accessing the patented technology necessary to sustain the progress of biomedical research and therapeutic product development have in some cases raised the cost and modified the character of research and in a very few instances have become a serious obstacle. This may become a more significant problem with the greater complexity of research and proliferation of patents on technologies well upstream of commercial products, and in the aftermath of a recent federal appeals court decision denying fundamental research protection from patent infringement liability. Although progress has been made in harmonizing national patent systems, substantial differences in procedures, standards, and substantive law remain and impede achieving reciprocity or mutual recognition of patent search and examination results among the United States, Europe, and Japan. In interpreting the Eleventh Amendment to the Constitution, the United States Supreme Court recently raised a troublesome disparity between state and private institutions with respect to their obligations under federal intellectual property law.