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SAN FRANCISCO — Like hungry wolves roving through the financial forest, private equity and hedge funds are always looking for fresh meat, or rather, new investment opportunities. And over the last few months, they’ve been feasting on patents, say attorneys working in the field. While it’s not unusual for investment firms to put money into companies with strong patent portfolios, private equity firms like Altitude Capital Partners and hedge fund companies like alseT IP have begun venturing into corners of the patent world that were previously unexplored for them. “They’re going into more exotic assets,” says G. Larry Engel, a Morrison & Foerster partner who handles private equity deals. “There’s simply too much competition for conventional assets.” Already, the involvement of these investment vehicles in the IP sphere has fueled arguments in patent litigation. In a case earlier this year, defendant McAfee Inc. made an unsuccessful attempt to remove Fish & Richardson from representing DeepNines Inc., an Altitude-backed software plaintiff. At the same time, the security giant accused Altitude of helping to bankroll the litigation as a means of pressuring McAfee into acquiring DeepNines — and thus ensuring Altitude a handsome payout. Thomas Melsheimer, managing principal of Fish & Richardson’s Dallas office, recently said the software giant only raised the issue in a disqualification motion “to try to wave some issues in front of the court” to divert it from the real issues in the case. Beyond litigation, these investments have created varied work for attorneys. Lawyers are setting up IP-centric hedge funds and are conducting due diligence research into every company and patent portfolio that private equity firms are checking out. Commonly known for buying out huge established businesses like Toys �R’ Us, Sealy and Sirius Satellite Radio, private equity has been encouraged by the prospect of multimillion-dollar infringement verdicts and lucrative licenses. And in another corner of the patent world, hedge funds — known for their investments in markets like currency and commodity futures — are offering investors returns from royalty streams that patent owners collect from their licensees. “Within the past two weeks, I’ve had two people call me to talk to them about setting up hedge funds to invest exclusively in IP,” says Edward Black, a partner with Ropes & Gray. NEW ALTITUDE New York-based Altitude Capital Partners was created in July 2005 specifically to invest in intellectual property. The firm puts its money in companies that make products and possess valuable patents — along with those whose sole asset is their IP, says Chief Executive Robert Kramer. One of the firm’s investment targets, 37-employee DeepNines, recently sued McAfee, alleging the security software Goliath owes it royalties for use of a patent that deals with detection of attackers at firewalls. The federal lawsuit, filed last August in Texas, has already gotten nasty. McAfee tried to get DeepNines’ counsel, Fish & Richardson, disqualified. The company argued in March that the firm’s previous work representing it created a conflict of interest. But McAfee also slammed Dallas-based DeepNines for allegedly suing in order to pressure Santa Clara, Calif.-based McAfee to acquire it. “The present circumstances illustrate an emerging practice among some lawyers to help small corporate clients attract private investors to finance costly IP litigation against companies that are large enough to purchase their clients,” Harold Walker, of the Dallas-based Rose Walker firm, wrote on behalf of McAfee. The motion alleges that Altitude Capital Partners and Boston-based America’s Growth Capital teamed up to fund a $10 million litigation “war chest.” A top America’s Growth official then told McAfee interim Chief Executive Dale Fuller that “DeepNines would dispense with the litigation if McAfee would purchase the company for $100 million,” according to the motion. DeepNines’ response to the motion was filed under seal. Fish & Richardson’s Melsheimer says he couldn’t discuss the exact nature of the conversations between McAfee and DeepNines because they were confidential. “Certainly both inside and outside of litigation, companies have talks all the time about investments and acquisitions. There was no threat or extortion or anything like that,” Melsheimer says, adding that “the notion that companies would talk and, in the context of talking, talk about resolving lawsuits and investing in the company — I don’t think there’s anything unusual about that.” U.S. District Judge Ronald Clark decided June 4 that McAfee hadn’t adequately shown that Fish & Richardson’s previous work for McAfee created a conflict of interest. He did not specifically address the “war chest” allegation. Altitude also backs Redwood City, Calif.-based Visto Corp., which makes mobile e-mail software. Visto is suing several companies, including Microsoft Corp. and BlackBerry maker Research In Motion, for infringing patents related to synchronizing information between servers and mobile devices. Manatt, Phelps & Phillips is among the firms representing Visto in those suits. The best known of Altitude’s investments is Great Falls, Va.-based MercExchange, an online auction site whose lawsuit against eBay led to a Supreme Court ruling on when it’s proper to grant injunctions against infringers. The case was sent back to the lower courts and remains active in Eastern Virginia. Goodwin Procter represents MercExchange. THE �T’ WORD Perhaps it’s no surprise that the litigation stemming from Altitude’s holdings has left the private equity firm facing unseemly accusations: that it funds small companies’ court fights to make a slice of the verdict, and that it invests in so-called trolls — companies that produce nothing, but exist solely to hoard patents, extract licensing fees, or sue respectable companies. Altitude’s Kramer says the reality of business is not as black and white. “This is a very tricky issue,” he says. “You’re in the middle of new ground being broken. There’s no right or wrong answer, there’s just different people with different perspectives.” Patents should be judged by their quality, not whether they’re being immediately used to make a product, he says. New York-based alseT IP, named to pay homage to famed physicist Nikola Tesla, offers funds that take advantage of the steady royalty streams that patent holders collect from licensees. AlseT buys out and takes over the royalty stream, giving the patent holder a lump sum, while offering investors returns from continuing royalties. For example, says Morrison & Foerster’s Engel, if a university that collects royalty payments from its patent licenses needs cash to build a new building, it can sell a royalty stream to alseT IP for a sum. AlseT is a Morrison client. The hedge fund’s Web site calls the process “the securitization of royalty income.” “Hedge funds are the ones that have gone most aggressively into IP,” says Ropes & Gray’s Black. RISKY BUSINESS As with any investment, banking on IP is not without risks. Litigation is tremendously costly, and of course, verdicts don’t always end in favor of patent holders — even in Marshall, Texas, the district considered the most patent-friendly in the country. “There’s so much legal uncertainty with it,” says Richard Hsu, a partner at Townsend & Townsend & Crew. That private equity and hedge funds are getting deeper into IP highlights a broader recognition of the profit-generating power of patents in the corporate world, Black says. IBM is credited for being the first to recognize and exploit the strengths of its patent portfolio, and private equity and hedge fund investment is just the latest aspect of that evolution, he says. Now patent auctioneers like Ocean Tomo have recently made the buying and selling of patents far easier than in the past, creating a marketplace for them, attorneys say. “Now there are brokers out there facilitating transactions,” says Hsu. “It’s kind of like trading stocks. That’s the analogy I use. [Patents] are kind of like low-volume stock.”
Jessie Seyfer is a reporter for The Recorder , an ALM publication.

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