Finding Value

Years ago, I worked for an established New York based law firm. I was assigned to support one of our major clients, a large international pharmaceutical company. As a junior associate I grappled with billing – trying to juggle the minimal value of my limited legal experience with the pressure of meeting the firm’s billable hour requirements. I shared this with the senior partner on the account and, to my surprise, he told me to bill for all of my time and that he would ensure that the firm received “compensation commensurate with the value the firm provided to the client”.

At the time, I wasn’t confident enough to ask how this was accomplished. But I later found out that this partner had a long standing relationship with the client’s CEO. At the end of each year, the two of them would meet over a nice dinner and bottle of wine and review the work that the firm had done the previous year. Among other things, they would discuss the amount and type of legal support the firm had provided and the value of that work to the client. At the end of the meal, they would agree on an annual fee for the following year – usually memorialized on a napkin. Some years the fee increased; in others, it decreased.

I was thinking of this story while attending a meeting with lawyers from a number of San Francisco Bay Area companies and law firms. Under the aegis of the ACC we were together to discuss the devolution of legal services from the halcyon days described above to the present where law firms optimize for profits per partner while in-house legal departments focus on efficiency and value. It was a lively discussion and, although there wasn’t a clear solution, some ideas resonated with me.

1. Legal Education – Law schools (especially in the U.S.) remain primarily focused on theory, rather than practice. As a result, a significant expense for law firms is attributable to providing practical training to recent law school graduates. In turn, this expense is passed on to clients in the form of higher hourly fees. Our legal education system needs to provide better practical training. In this respect it should mirror the residency requirements of medical schools or legal programs in other countries. For example, in Germany, a practice residency is already incorporated in the law school curriculum. In addition, law schools need to recognize that the “legal profession” is also a business for providing legal services. To be successful, lawyers need to be trained in how to manage a competitive business enterprise. Interestingly, future members of our profession already understand this and are focusing on the issue.

2. Legal Media – As a public company, Sun provides a very transparent view into all aspects of our business operations. This transparency drives increased competition in the marketplace for our products and services. Obviously, law firms aren’t required to provide this type of information. However, the limited information that is available focuses on the wrong metrics. Legal media need to shift the focus from metrics like profits per partner to those metrics that are valued by clients. When legal periodicals begin to report firm operating expenses, average cost per billable hour and similar metrics, the legal world will change very quickly – and for the better. Law firms understandably dislike RFPs. In-house legal departments feel the same. Unfortunately, there is no other mechanism for clients (i.e. customers) to ensure that they are getting cost-effective value.

3. Law Firms – Law firms need to better understand that they are both licensed professionals and also employees of a business enterprise in an increasingly competitive (and global) market. This means they need to understand every component of their operating expense and business model. What is the cost of attorney turnover in the firm? What are its core v. non-core technical strengths? Can the firm manage sub-contractors (i.e. other legal service providers) to provide more cost effective services to clients in non-core areas? Does the firm fully understand its customers and does it tailor its services to the customer’s specific needs? (In this regard, I note that I have never had a firm propose a non-standard billing relationship for a specific matter. Instead, I’ve always had to request it.)

4. In-House Legal Departments – We need stop complaining and be part of the solution. This includes not just considering, but engaging firms that provide alternatives to the traditional legal services model. (Some examples – Axiom, Paragon Legal and the recently announced Virtual Law Partners). We also need to be more willing to retain small to mid-sized firms and firms in other geographical regions. Above all else, we need to more actively share information about attorneys and firms that deliver the value that we need as consumers of legal services.

If you want to be part of the dialog, contact the ACC for more details.

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Accounting and the Tour

I love it when July rolls around. It means the Tour de France is underway. Despite the issues with this event in the past few years, I can’t think of a more compelling display of physical endurance, strategy and teamwork. Much to my family’s annoyance, for most of the month I am glued to the TV. But, today I thought I’d pull myself away from the race for the Maillot Jaune to write about a subject that many find equally exciting – Financial Accounting Standards No. 5.

Ok. Perhaps, it’s only accountants who find FAS 5 to be exciting. However, all in-house counsel should be aware of the potential impact of the changes to FAS 5 proposed by the Financial Accounting Standards Board. In general, these changes would lower the threshold for disclosure of certain litigation loss contingencies, as well as require companies to disclose substantially more information about the underlying litigation.

Under the proposed changes, companies would need to provide disclosures for loss contingencies that are more than “remote”. This is a change from the current higher threshold of “probable loss”. Where disclosure is required, the proposed amendments are significantly broader requiring companies to provide “a description of the contingency, how it arose, its legal or contractual basis, its current status, and the anticipated timing of its resolution; a description of the factors that are likely to affect the ultimate outcome of the contingency along with their potential effect on the outcome; the entity’s qualitative assessment of the most likely outcome of the contingency; and significant assumptions made by the entity in estimating the amounts disclosed…”.

While increased transparency clearly benefits shareholders, the changes proposed by FASB create some significant issues. Among them are the potential that the disclosures may:

– enable opposing counsel to determine important elements of a company’s litigation strategy,

– possibly be admissible as evidence as an admission against interest,

– create the potential for waiver of attorney-client privilege and work product immunity, and

– lead to securities litigation if a disclosure later proves to be inaccurate and an investor relied on it.

Underlying this last point is the real difficulty with the proposed changes – that litigation (like The Tour de France) is inherently unpredictable. Despite having almost unlimited information about the riders, their training regimens, racing strategies, and the strength and weaknesses of their respective teams, you might think you would be able to guess who will be wearing the yellow jersey on the final ride into Paris. However, races are frequently determined by events that are uncontrollable and unforeseen – things like inclement weather, road conditions, mechanical problems, accidents and even dogs. Litigation is much the same. Often the outcome of a case depends on your choice of counsel, discovery resources, venue, identifying expert witnesses, success of key motions and the members of your jury. This uncertainty is the reason that most cases in the US are settled.

You can read the proposed amendments here . Comments to FASB are due by August 8th.

And, in case you’re interested, I’m still picking Cadel, but then again, you never know what will happen.

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Firestar

There is an old proverb that we like around Sun that says that “a rising tide lifts all boats”. In the IT industry the “rising tide” is the accelerated adoption of FOSS around the world. As open models begin to displace proprietary, opportunities increase for all members of the open source community – including Sun. So, it’s in our interest to ensure that the market for FOSS continues to grow. We support this growth, in a variety of ways. Some are very visible and others less so. A recent example of the latter involves a patent litigation – not against Sun, but a competitor.

In 2006, Red Hat was sued by Firestar Software, Inc. in the Eastern District Federal Court in Texas. Firestar alleged that Red Hat’s then recently acquired JBoss technology infringed one of it’s patents. Most often these events are viewed (sometimes happily) as a competitor’s issue to deal with. In this case, however, we considered Red Hat both a competitor and a brother-in-arms. And, given the breadth of the Firestar patent and the likelihood that it would be asserted against others in the community, we decided to invest the time and resources in a prior art search.

We also let our friends at Red Hat know early in the litigation of our activities, that we had filed a request with the PTO for reexamination of the patent, and shared copies of the prior art for Red Hat to possibly use it in its defense.

These things take time, but last week, we received a response from the PTO in the form of an office action rejecting all of the claims in the patent based on the prior art submitted by Sun. Obviously, we are delighted to get this validation from the PTO. Firestar has two months to overcome this rejection, but given what we presented to the PTO, we believe it will be a challenge for them.

Unfortunately, the PTO’s response comes a little over two weeks after Red Hat entered into a settlement with Firestar. Although the recent U.S. Supreme Court decision in Quanta Computers v. LG Electronics protects downstream Red Hat licensees through the application of the doctrine of patent exhaustion it doesn’t insulate others in the open source community from future actions by Firestar. It’s our hope that the rejection of the patent through the reexamination process will become final in August eliminating this threat for all members of the open source world.

As I said, “a rising tide…”

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NetApp Litigation – an update

Over the last few months, I’ve had many requests for an update on the litigation between Sun and NetApp. There is clearly quite a bit of interest in the case in the media. Developers are curious whether NetApp will be successful in hindering even greater adoption of Sun’s ZFS open source technology. (Nice to see Apple supporting ZFS.) And, I’m sure NetApp customers are interested in understanding the impact of the 22 patents Sun has asserted in response against NetApp’s product line. So, here’s a summary of where we are.

After NetApp sued Sun, we responded with six reexamination requests on the patents asserted by NetApp. Reexamination is a procedure in which a party submits documents (prior art) relating to a patent to the US Patent Office (PTO) and asks that it reconsider whether that patent should have ever been issued. If the PTO agrees and determines there is a “substantial new question of patentability” (SNQP) it will grant the request and reopen the patent examination process on that patent. Included in our requests was a significant amount of highly relevant prior art that was not considered by the PTO when it first granted the NetApp patents. (By the way, to those of you who submitted prior art – “thank you!”)

Over the last two months, the PTO has granted the first five of our reexamination requests, finding in all the cases that multiple “SNQP” exist for each patent (one request filed in June is still pending). These include, among others, US Patent Nos. 5,819,292; 6,857,001 and 6,892,211, “core patents” according to NetApp. With regard to one NetApp patent, the ‘001 patent, the PTO has issued a first action rejecting all the claims of this patent. Based on the positive response we received from the PTO, we asked the trial court to stay a portion of the litigation. Obviously, it doesn’t make sense to go through the expense and time of litigating a patent in court if the PTO is likely to find it invalid. The court agreed with our request and at least one NetApp patent has thus far been removed from the litigation. We expect to hear more from the PTO on the remaining reexaminations over the course of the year.

In our defense, we have asserted a total of 22 patents covering technology ranging from microprocessors to file system management. The NetApp products accused of infringing Sun patents include FAS6000,FAS9000, FAS3000, FAS2000, V3000, V6000filers, MetroCluster, SnapMirror, SyncMirror, SnapVault, FlexVol, FlexClone, R200 Platform, NearStore Virtual Tape Library, and FAS platforms with SATA drives. Even the recently acquired Onaro products are also subject to claims of infringement of the Sun patents-in-suit. Of note, none of the patents being advanced by Sun in the original case has been challenged by NetApp in the PTO.

A settlement conference was held yesterday before Judge Spero in the Northern District of California. And, it was rather brief. While we entered into the process with a willingness to engage in constructive discussion with NetApp, unfortunately, we weren’t able to resolve the dispute.

Why? It wasn’t for lack of effort. Instead, it’s because our two companies have very divergent views on the future of computing. It has become increasingly clear, that although NetApp originally claimed this case to be about Sun’s alleged patent infringement (an assertion which we are confident we will prove was unfounded), the case is about something else entirely. It’s really about the clash between two different business models, one proprietary, the other open. NetApp admits as much in a declaration of Dave Hitz (a document recently unsealed by the court). It is this difference that is the source of the litigation. And, as more of the world moves away from proprietary models, I expect to see other litigations arise between companies in this area.

To be clear, Sun = FOSS. We have transformed our company and aligned it around the belief that giving away our technology and investing in related communities will create greater adoption of our intellectual property and ultimately redound to the benefit of our shareholders, customers and the open source community. When it comes to Sun’s commitment to open source – “the horse is out of the barn”. Not only that, it’s also had foals. And, their names are Sun Open Storage, OpenSolaris, MySQL, Glassfish, OpenJDK, OpenSparc and…

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Ethics

I read a wonderful quote the other day. It was in an article about former lawyer, Bill Lerach, a name familiar to most corporate attorneys. Mr. Lerach plead guilty to fraud and was recently sentenced to 24 months in prison in connection with a scheme to pay kickbacks to plaintiffs in securities class action cases. At Lerach’s trial, the Assistant U.S. Attorney said of the defendant: “When you conclude no one else in the game has a moral compass, it’s easy to lose yours.”

With this in mind, let me say “thank you” to the employees of Sun Microsystems for having a strong sense of direction when it comes to corporate integrity. You’re the reason we received this recognition for the second year in a row.

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The Patent Arms Race

There’s quite a bit in the press these days about companies (surprisingly, some very large ones) aggressively investing to expand their IP portfolios by purchasing patents or filing for patents on anything that can be imagined – often without stopping to consider whether the “innovation” has utility and is truly novel and non-obvious. Sun is often approached by companies looking to purchase patents (a reflection of the value of our IP) and at times we do sell patents under the right terms, conditions and circumstances.

To some degree, this topic has a very Cold War feel to it with companies growing patent stockpiles to use if attacked or as a form of “mutual deterrence”. But, at some point, a company needs to ask how many patents it really needs. And, that’s exactly what we did about three years ago. Up to that time Sun was filing well over 1,000 patent applications per year. But, in 2005, we made the decision to reduce our patent filings to the point that we had about 700 patents issued last year. And this number may decline in the future. While this is still a sizable number for most companies, it is a significant decline for Sun and occurs during a period in which we have more innovation than at any point in Sun’s history.

Why the change? Part of the reason is financial. On average, it costs more than $20,000 to obtain a U.S. patent and this figure grows significantly when you file around the world. Also, this amount does not include annual annuities required to keep a patent in effect. Being selective in what you patent can result in significant savings. However, the bigger reason for the change is that our focus has shifted from quantity to quality. To this end, we have completely re-architected the manner in which we determine the innovations we will patent. As part of this process, inventions are reviewed by a panel of the chief technology officers from across our different lines of businesses with input from distinguished engineers and other experienced innovators. We apply a significant amount of scrutiny to determine whether something is truly innovative before we submit it to the PTO. For us, it doesn’t make sense to patent everything. Rather, our focus is on patents that represent significant technological innovation. (In this regard, we were happy to see that the Federal Circuit will reconsider the patentability of business methods. )

Aside from our focus on patent quality, there is another reason we are filing fewer patents. It has to do with our business model. Unlike some companies, we don’t have a corporate goal for revenue derived from patents (and patent litigation). Instead, we invest in patents to support our customers and the communities in which we participate. This support can be in the form of a defensive response to an attack on a community or in the form of the assurance provided by the patent licensing provisions of the CDDL or GPLv3. In the end, it’s about delivering innovation to our customers and communities.

If they succeed, we succeed.

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Maker Faire

I had one of those flashes of insight a few months ago. It occurred while I was fixing a go-kart with my youngest son. He was reinstalling the chain guard and as he did he stopped to ask me which way to turn the screw. I replied in my best Dad voice: “If you’re tightening it, you want to turn it clockwise.” His response floored me. He asked: “what do you mean by ‘clockwise?'”

Now mind you this is a bright young lad with good grades in middle school. Yet, he didn’t understand my reference to the movement of the hands of a clock. At first, I was astounded by this gap in his learning. But, then I realized that he and most of his friends don’t wear watches (they use their cell phones or, more likely, given their age, are indifferent to the concept of time). And when they do wear watches, they are digital – not analog. It was then that I began to lament the advent of the digital age. My fear was that we are raising a world of children who have almost unlimited access to information, yet little ability to use this knowledge to create or repair the tangible. At this point in his life, my son is more familiar with on-line tools than the ones in our garage. And, I’m not sure this is entirely a good thing.

So, I was elated when we recently attended the Maker Faire in San Mateo, California. For those not familiar with the event, it is an outgrowth of Make Magazine, which I can only describe as Popular Science for this millennium. The Maker Faire represents the intersection of science + art + shared knowledge + “using your hands to make stuff”. It has everything including incendiary Burning Man sculptures, Steampunk minibikes, astronomy experiments, a Tesla coil machine, demonstrations on how to retrofit your home for grey water usage, electric powered cupcake cars and, of course, the now ubiquitous Diet Coke + Mentos “experiment.” We wandered around for hours, but next year will be there for the entire weekend.

And, my son even purchased a kit to build a solar powered toy car. It gave me a chance to teach him how to solder…and made me feel a little better.

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