Kyle Bass and Investor-Inspired IPRs

Prof. Doug Lichtman, UCLA School of Law
June 23, 2015

Hedge-fund manager Kyle Bass has been widely criticized in recent months, with newspaper editorials, advocacy organizations, and even some members of Congress publicly condemning Bass’s strategy of using a relatively new Patent Office procedure to challenge particular pharmaceutical patents while at the same time shorting the stock of the pharmaceutical company that would suffer if the challenge succeeded.  The criticisms in my view are unfounded.  To be sure, Bass is challenging patents for his own financial gain; but the real beneficiaries of Bass’s strategy are members of the public, who over time will see important bad patents invalidated and corresponding drug prices drop.

Start with the basics.  When a patent applicant asks the Patent Office to issue a patent on a particular technology, the government must evaluate that application without the help of interested adversaries.  Indeed, the conversation typically involves only two parties: the applicant, who has a strong motivation to push in favor of patent issuance, and the patent examiner, who might well yearn to serve the public but who inevitably labors under significant resource constraints.  This means that a patent can easily issue even if, in reality, the patent ought not be allowed.  The government simply lacks the resources and information to evaluate patents with high accuracy.

In recent years, the Patent Office has taken an important step toward fixing this problem.  Under a new procedure called Inter Partes Review (IPR), the Patent Office is today open to reconsidering patents that already issued.  Specifically, an interested third party can bring forward evidence that an issued patent actually should not have issued.  If the Patent Office agrees to do so, the patent can be pulled back into examination, but this time with not only the patent holder and the government involved, but also the (presumably motivated and well-informed) third party.

Early statistics indicate that the IPR procedure has been very effective at invalidating patents.  Some commentators express alarm about this, but to me this seems consistent with the idea that the IPR procedure is working.  After all, IPRs were supposed to be a mechanism to target and defeat bad patents, and thus the fact that patents are being targeted and defeated ought not be much of a surprise.   Bluntly, there are a large number of bad patents currently in existence; so if third-party filers target those patents and file IPR requests against them, we should see an IPR process that invalidates a large percentage of the patents considered.  (When shooting fish in a barrel, expect many fish to get shot.)

So where does Kyle Bass fit in?  Bass launched an investment fund that has filed a series of IPRs against patents related to particular drugs.  Bass has not been shy about his plans.  Last year, he publicly announced that he would work to identify bad patents in the pharma space; short the stock of the relevant companies; and then file the necessary IPRs, thereby (a) making public his findings about the patents at issue, and (b) starting a process that could well invalidate the patents and perhaps materially hurt the stocks.  Bass made clear that, in his view, this strategy was a version of doing well by doing good.  Bass makes money to the extent his IPRs reduce the stock price of his target companies, and the public benefits because bad patents are removed and competition therefore increases.

Many people have complained that Bass is abusing the IPR process, but I do not see how.  If Bass files an IPR that is weak on the merits, for instance because the targeted patent is in fact a strong patent that protects a true invention, then Bass’s attack will fail and his short will be unsuccessful.  True, there might be sufficient noise in the stock market such that Bass could file a weak IPR, the stock market could overreact, and Bass could make money simply because he filed the paperwork.  But that game would not work for very long, as Bass’s credibility would quickly be shot and thus the stock market would stop reacting to his legal shenanigans.  Moreover, a tiny, temporary stock move could not possibly be what is motivating Bass.  To make the millions of dollars he needs in order to run a successful fund, Bass needs big moves – and the mere act of filing an IPR will not deliver those; Bass needs to win.

As the process goes on, again Bass’s self-interest aligns nicely with society’s interests.  If Bass’s IPRs are ultimately successful, that means that the Patent Office agreed with Bass that a given patent was in fact a mistake.  Bass makes money if that dud patent is financially important to the company he shorted, and the public benefits because in that case an important barrier to competition is removed.  If Bass’s IPRs are not successful, by contrast, Bass does not make money on his short, and the relevant pharmaceutical company rightly can continue to wield the now-defended patent.  Admittedly, the cost of defending the IPR is a burden, but that number is negligible compared to the revenues generated by these drugs (Bass cannot make money by targeting tiny, unprofitable drugs) and, besides, that cost is incurred only in instances where the Patent Office agrees with Bass that the patent warrants the requested second look.

In short, then, the criticisms of Bass’s strategy strike me as completely unfounded.  Yes, what Bass is doing is not what anyone had in mind when the IPR procedure was first offered as an option.  But that simply means that Kyle Bass is a pleasant surprise.  IPRs are supposed to be used to weed out bad patents, and that is exactly what Bass’s efforts will do.

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