The 1990s brought us companies like Amazon.com, eBay, Netscape, Broadcom, and AOL, to name a few. We discovered web browsers, PDAs, universal email, voice over IP, DSL, broadband cable, cable telephony, Wi-Fi and TiVo, among others. The 1980s brought us companies like Dell, Compaq, Cisco, Microsoft, Qualcomm, Adobe Systems, and Genentech. We discovered personal computers, cell phones, spreadsheets, and genetic engineering. This decade we have Crocs and the iPod. Where has American innovation gone?
John Kao, a Harvard innovation expert, says the United States is experiencing a brain drain as foreign scientists and engineers return to their home countries in search of better opportunities. Even more alarming, other countries are attracting American-born scientists and engineers. Much of our VC industry is investing its resources outside of the US Those VC funds that don’t invest abroad are often part of the walking dead, no longer actively investing.
Why should we care if the United States is no longer the world’s innovation leader? Without innovation, our standard of living is stagnant or in decline. So why have we stopped innovating? Let’s look at the changes since 2000 that would affect the ability of Qualcomm, CISCO, eBay, or Amazon.com to reach their current potential. There are three major such changes since 2000. Sarbanes Oxley makes it much harder to go public today. Changes in patent law make it harder to obtain intellectual property and make it easier to steal innovations. Finally, changes to the accounting rules for stock options make it more difficult to attract talent to start-ups.
When Sarbanes Oxley was passed, the SEC (Securities and Exchange Commission) estimated that the cost of compliance would be $91,000.00 per year for each public company. The most recent estimates of the cost of compliance are between $4.0 million and $5.0 million per year for publicly traded companies. The United States has more than 18,000 public companies, which means it spends about $80 billion a year to comply with Sarbanes Oxley.
Sarbanes Oxley was passed in 2002 as a reaction to corporate and accounting scandals, including those involving Enron, Tyco International, Adelphia and WorldCom. The legislation sets new or improved standards for all boards, management, and public accounting firms of U.S. public companies. The law contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties , and requires the Securities and Exchange Commission (SEC) to implement rulings on the requirements to comply with the new law.
Is the cost of this law worth the incredible price? Has Sarbanes Oxley achieved its goal of protecting investors from fraud? Sarbanes Oxley has cost the American economy at least $400 billion since its passage. The stock market has been flat or in decline since its approval. As a result, it is difficult to argue that this legislation increased shareholder value. The banking scandals of 2008 and 2009 and the Bernie Madoff fiasco make it impossible to suggest that Sarbanes Oxley protected investors from fraud.
Sources report that 100 to 200 publicly owned companies a year, including big names like Dunkin’ Donuts and Neiman Marcus, have chosen to buy out their shareholders and return to private ownership. Many private US companies are holding off on initial public offerings, and more foreign companies are choosing to list on the Tokyo, London or other foreign exchanges instead of the US stock exchanges.
Adding to these problems, Sarbanes Oxley has basically killed off the public market as an exit strategy for tech start-ups, thus reducing investment in innovative start-ups. In the second quarter of 2008, there were no public offerings from Silicon Valley VC-backed companies, a phenomenon not seen since 1978. At $4-5 million per year for a company to go public and comply with Sarbanes Oxley , there should be profits of around $100 million and sales of around $1 billion. Given these astronomical hurdles to an IPO (Initial Public Offering), it’s no surprise that startups no longer view an IPO as a realistic exit strategy. Repealing Sarbanes Oxley is essential unless we want to see Silicon Valley’s status as a hotbed of innovation eroded and see the future invented outside of the United States.
Changes in patent law in the last decade favor technology appropriators over technology creators. eBay’s Supreme Court ruling denied the ability of inventors to assert their basic right to exclude others from the use of their invention. The Supreme Court’s KSR decision changed the standard of what is patentable from an objective standard to a subjective standard. Finally, the US Patent and Trademark Office (USPTO) independently changed the internal standard for which inventions receive patents. This change has caused the authorization rate to drop from around 70% in 2000 to 45% in 2008. Harmonization of our patent laws with the rest of the world has broken the social contract between inventors and society.
The Omnibus Communications and Intellectual Property Reform Act of 1999 requires publication of US patent applications 18 months after the filing date. This Act is part of an effort to harmonize US patent laws with the rest of the world. Patents are commonly viewed as a deal between the inventor and society. The inventor receives a limited-term right to exclude others from using his invention, and the quid pro quo is that the inventor reveals how to practice his invention. The publication rule is a clear violation of this social contract between the inventor and society. Under the publication rule, the society obtains the advantage of disclosure of the invention even if the inventor never receives any property rights in the invention from him.
Before the publication rule, if an inventor found the scope of the claims for his invention too narrow or not allowed, he could withdraw his application and keep his invention a trade secret. Limited claims are easy for a competitor to build around providing little protection in exchange for disclosure of the invention. In other words, if the inventor didn’t like the deal the Patent Office was offering, he could turn it down and keep his invention a secret. Even for inventions that can be reverse-engineered once they’re commercialized, this is a better deal than the publication rule. Under the publication rule, it is easy for competitors to find the inventor’s idea on the World Wide Web and copy the invention. Without publication, a competitor has to spend time and money to reverse engineer an invention.
In 2006, the United States Supreme Court decided eBay Inc v. MercExchange, LLC, 547 US 388 (2006) holding that a permanent injunction should not automatically be issued as part of an infringement judgment. A patent is a legal right to exclude, 35 USC 154, others from making, using, selling (offering for sale), or importing the invention. It is a little known fact that a patent does not give its owner the right to use, manufacture, sell (offer for sale), or import the invention. eBay’s Supreme Court decision denies the patentee’s right to exclude others and substitutes money damages even if the patentee prefers to assert their right to exclude.
In KSR International v. Teleflex, 550 US 398 (2007) the Supreme Court made it easier to find an invalid patent and more difficult to obtain a patent by changing the obviousness standard. To obtain a patent, the invention must be useful, novel and non-obvious. This case overturned 20 years of jurisprudence associated with an objective test of obviousness. The Supreme Court substituted a flexible subject test for obviousness. This more flexible approach increases the uncertainty that an inventor will receive a patent and increases the risk that his patent will be declared invalid if he has to enforce his patent against an infringer. It also increased the costs associated with obtaining a patent and applying for it.
Not to be outdone, the Patent and Trademark Office launched its own assault on inventors. The patent grant rate dropped from around 70% in 2000 to 45% in 2008. The grant rate had hovered between 62% and 72% for several decades and then began a precipitous decline around 2003.
These changes to our patent systems have been nothing short of an outright assault on the rights of innovators.
In 2005, the FASB required companies to start accounting for stock options. Startups used stock options as an important tool to attract human talent from secure positions. Requiring the expense of stock options places a huge burden on start-ups. This burden has resulted in startups giving up on its use. There is no economic justification for spending stock options, since changing the number of shares in a company does not change its income statement. However, the burden of this regulation has taken this important financial tool away from startups and hurt innovation in the US.
American innovation is stagnant because of the regulatory burden we have placed on high-tech start-ups. Both the empirical evidence and the logical case for Sarbanes Oxley, changes to patent laws, and the required spending of stock options fail. Repealing these regulatory burdens on innovators will boost the US economy.
