Rebuttable

     COLI (Corporate-owned life insurance) has been around for a while. A company purchases life insurance policies (as owner and beneficiary) covering the lives of its employees for two main purposes: (1) to fund employee benefit plans; and (2) to compensate itself for the loss of covered key employees. In the former case, if the company sets up a retiree health care benefit plan for its employees, it can buy life insurances on its employees with face amounts equal to the estimated health care costs of the employees. The life insurance proceeds can subsequently be used to cover those health care costs. In the latter case, the insurance policy is called a "key-man" policy. A company buys key-man insurance policies sufficient to compensate for the losses and expenses to the company, or to buy back an employee-shareholder's shares, if a current key employee-shareholder passes away.

     The federal tax treatments of a key-man COLI can be complicated. However, some of the main tax characteristics of a key-man COLI are:

1. The premiums of the policy are NOT tax deductible for the company;
2. The proceeds of the policy are tax free for the company;
3. The proceeds of the policy MAY be subject to estate tax for the insured employee.

     Characteristic #1 spawned various tax shelters in the 80's and 90's, which led to a series of federal COLI legislations, the most recent one being the COLI Best Practice Act incorporated in the Pension Protection Act, enacted on 8/17/2006. (See here for more details.)

     Characteristic #3, on the other hand, may pose as a problem for a company where an employee-shareholder holds a controlling interest. Internal Revenue Code §2042(2) provides that proceeds of an insurance policy owned by and benefiting entities other than the insured person will be included in the insured's estate if the insured had any "incidents of ownership" on the policy. "Incidents of ownership" includes the power to change beneficiary, to surrender or cancel policy, to obtain a loan against the policy, etc. For a controlling employee-shareholder, this means that his estate MAY have to pay tax on the proceeds of the COLI covering his life, because he does have the above powers over the company. Fortunately, subsequent IRS regulations made it clear that as long as the COLI proceeds are paid only to the company or to a third party for a valid business purpose, the controlling employee-shareholder will not be considered to have "incidents of ownership" on the COLI. (26 C.F.R. §20.2042-1(c)(6))

     Part of the reasons behind this regulation is that the company's stock price should reflect the insurance proceeds to be received by the company. That means the insured person's estate is taxed once already on the higher value of the stocks. Paying estate tax on the insurance proceeds would have been double taxation.

     To be safe, however, a company having a controlling shareholder may want to prohibit (in its shareholder agreement) the company from changing the beneficiary of the COLI to any other entity without a valid business purpose. Or, to take it one step further, to limit the power of the controlling shareholder in managing the COLI.

     A consideration in drafting a shareholder agreement or a buy-sell agreement.

-- Chinatrust's botched attempt to take over Mega Financial

     One of the biggest headlines in the financial industry this year is the surging global merger & acquisition activity. Many of these M&A deals were huge (involving billions of dollars) and likely completed with complicated financial arrangements. The inner workings of most of these financial arrangements will probably not be known to the public for a long time. In one rare instance, however, we did get the chance to peek into the intricate structure of one of such M&A deals. -- The botched attempt by Taiwan's Chinatrust Financial Holding Company (CFHC) to take over Mega Financial Holding Company (MFHC). Particularly, it's interesting to learn how CFHC incorporated derivative instruments into the intricate web of M&A gamesmanship.

     CFHC is one of the large financial holding companies in Taiwan, with ~10,000 employees. In early 2005, Taiwan government announced plans to gradually reduce the number of financial holding companies in the country by half. CFHC consequently decided to increase its stakes in another large financial holding company, MFHC (which has ~8,000 employees). According to Taiwan law, a financial holding company must obtain government approval to invest in another financial holding company. The subsidiaries of a financial holding company, however, are not subject to such a requirement, except that commercial banks are not allowed to hold more than 5% of a single company's outstanding shares.

     Thus, CFHC instructed its banking, insurance, and other subsidiaries to purchase MFHC shares in open markets. By fall of 2005, CFHC had obtained control, through its subsidiaries, of ~6.1% of MFHC shares. That was, however, not enough. CFHC further instructed the Hong Kong branch of its banking subsidiary to purchase ~$390m of structured notes issued by Barclays Bank. The structured notes were linked to MFHC stock prices, and thus would have been equivalent to ~3.9% of MFHC outstanding shares. Thus, by this time, CFHC had effectively controlled ~10% of MFHC.

     In January 2006, CFHC submitted application to the regulator for approval to acquire 5-10% of MFHC in the open market throughout the following year. The plan was announced to the public after the Chinese New Year holiday. MFHC stock surged after the announcement. CFHC then cashed in the structured notes (through a 3rd party), with sizeable profits. Then, most interestingly, the issuer of the structured notes sold the MFHC shares that it used to hedge the structured notes, allowing CFHC to pocket a majority of these shares.

     So, by June of 2006, CFHC had acquired control of ~15.6% of MFHC, and was able to gain 4 seats in MFHC's 15-seat board. If it had gone as planned, CFHC would probably have continued on to control more shares of MFHC, and eventually the board. Things turned sour, however, when regulator questioned the sale of the structured notes through a 3rd party and indicted several top CFHC executives for breach of trust and unfair enrichment. It will now be difficult, if not impossible, for CFHC to takeover MFHC.

     In this botched attempt, CFHC used the structured notes to add 3.9% of MFHC "virtual" shares to what it was able to acquire through its subsidiaries. The additional exposure allowed CFHC greater profits (rightfully or not) when MFHC shares rose after the investment plan was publicly announced. These "virtual" shares, moreover, turned into real shares when the structured notes were redeemed and the hedging stocks sold in the open markets.

     The use of derivatives is probably widespread in M&A deals, limited only by imagination. Derivative instruments, such as credit derivatives, can be rather beneficial tools for risk management or reward enhancement. However, when they are abused, it is very difficult to catch because of their private nature. Tough job for financial regulators!

HAPPY NEW YEAR 2007!!!

     Google rolled out its brand new "Patent Search" tool yesterday. (See here.) I quickly tested the tool. Looks like it includes only issued US patents, not published patent applications. (I am guessing non-US patents and patent applications should be coming soon.)  At this point, the Google Patent Search tool does not offer much more than the search features provided in USPTO web site. (Here.) I did a quick search for the phrase "spinal cord injury" on both the USPTO web site and Google. USPTO returned 1875 results, but Google returned 672. Not sure why yet. Also, for each individual patent, Google Patent Search displays the "Abstract", "Claims", "Citations", and "Referenced By" sections as texts. The "Description" section, however, is only available as images. The USPTO database is all text-based, except older patents.

     I am sure Google will be improving this patent search tool. But what's next beyond patents? How about court records, or other public records? Will Google's free-use business model threaten Westlaw and Lexis? Will consumers like myself be the true beneficiaries of Google's ambition to catalogue whatever there is to be catalogued?

     Good time to be a writer!

     Yesterday, BBC (British Broadcasting Corporation) reported that a well-known Chinese human right lawyer had been "secretly tried" for the charge of "inciting subversion of state power", and could face up to 15 years in prison. (See here.) That news reminded me of the famous (or infamous) phrase in Shakespeare's Henry VI: "The first thing we do, let's kill all the lawyers." Part II, Act IV, Scene II.

     Granted, the particular scene in Henry VI has little to do with a state's abhorrence against a lawyer representing the underdogs. Actually, Shakespeare intended the phrase as a mockery & satire of lawyers' hunger for control & powers. And, it indeed has become the epitome of all lawyer mockeries.

     Let's not forget, however, that there are lawyers who would stand up for justice, liberty, and fairness. That these lawyers might stand in the way of powers. And that Shakespeare's words depict a human right lawyer's precariousness against state powers just as fittingly as a satire mocking lawyer snobbishness. The BBC story attested to it.

Henry VI, Part II, Act IV, Scene II:

Drum. Enter CADE, DICK THE BUTCHER, SMITH THE WEAVER, and a SAWYER, with infinite numbers

CADE: We John Cade, so term'd of our supposed father-

DICK: [Aside] Or rather, of stealing a cade of herrings.

CADE: For our enemies shall fall before us, inspired with the spirit of putting down
          kings and princes - command silence.

DICK: Silence!

CADE: My father was a Mortimer-

DICK: [Aside] He was an honest man and a good bricklayer.

CADE: My mother a Plantagenet-

DICK: [Aside] I knew her well; she was a midwife.

CADE: My wife descended of the Lacies-

DICK: [Aside] She was, indeed, a pedlar's daughter, and sold many laces.

SMITH: [Aside] But now of late, not able to travel with her furr'd pack, she washes
            bucks here at home.

CADE: Therefore am I of an honourable house.

DICK: [Aside] Ay, by my faith, the field is honourable, and there was he born, under
          a hedge, for his father had never a house but the cage.

CADE: Valiant I am.

SMITH: [Aside] 'A must needs; for beggary is valiant.

CADE: I am able to endure much.

DICK: [Aside] No question of that; for I have seen him whipt three market days
          together.

CADE: I fear neither sword nor fire.

SMITH: [Aside] He need not fear the sword, for his coat is of proof.

DICK: [Aside] But methinks he should stand in fear of fire, being burnt i' th' hand
          for stealing of sheep.

CADE: Be brave, then, for your captain is brave, and vows reformation. There
          shall be in England seven halfpenny loaves sold for a penny; the three-hoop'd
          pot shall have ten hoops; and I will make it felony to drink small beer. All the
          realm shall be in common, and in Cheapside shall my palfrey go to grass. And
          when I am king- as king I will be

ALL: God save your Majesty!

CADE: I thank you, good people- there shall be no money; all shall eat and drink on
          my score, and I will apparel them all in one livery, that they may agree like
          brothers and worship me their lord.

DICK: The first thing we do, let's kill all the lawyers.

CADE: Nay, that I mean to do. Is not this a lamentable thing, that of the skin of an
          innocent lamb should be made parchment? That parchment, being scribbl'd
          o'er, should undo a man? Some say the bee stings; but I say 'tis the bee's
          wax; for I did but seal once to a thing, and I was never mine own man since.
          How now! Who's there?

     The Supreme Court has shown sudden interests on patent disputes in recent years. Just this year alone, the Court has determined/heard at least 5 patent cases. See table below.

     Each of these cases can have potentially far-reaching impacts on our patent system, and can mean lots of $ gained or lost for many companies. Many industrial giants have therefore taken advantage of this once-in-a-life-time opportunity and sought to advocate their own interests by submitting amicus briefs to the high court. Many of these amicus briefs expressly supported one particular side. For me, this is an interesting opportunity to find out who supports what.

     In the table below, I have listed some companies who have filed amicus briefs for stronger or weaker patent rights in the 3 cases: eBay v. MercExchange; MedImmune v. Genentech; & KSR v. Teleflex. The info is gathered from Dennis Crouch's blogs, Patently-O. (See here, here & here.)

     In these high-stake cases, traditional manufacturing-based conglomerates (i.e., GE, 3M, du Pont, J&J, Qualcomm) have consistently advocated for stronger patent rights. On the other hand, non-traditional, information-based giants (i.e., Intel, Microsoft, Yahoo, Micron, Cisco, Time Warner) have consistently advocated for weaker patent rights. Such is the bifurcated state of our world of patents!

     My guess is that such a state of bifurcation is a result of how these companies come up with their inventions. More particularly, it hinges on whether the inventions incorporate many public domain, unpatented, components. For the information industry, most of their innovations are intangible contents, software, or processes that embody numerous existent and commonly used technologies. On the other hand, for the traditional manufacturing industries, their inventions are less likely to incorporate unpatented, commonly used machines or processes.

     Given this consistent bifurcation of patent positions in the private sector, the question is whether the Supreme Court will take notice and reconsider the patentability of some subject matters such as business methods and software. In LabCorp, the Court decided not to deal with the question and let a patent on scientific relationships stand. Three Justices (Js. Stevens, Breyer, & Souter), however, dissented and would have invalidated the patent. The same three Justices also joined in eBay to question the validity of business method patents. I think if the Patent Office is unable to develop a more satisfactory examination system for business method or software patent applications, the Supreme Court will soon pick up where it left off.

     Suppose that composition S is an important medicine. It was found, however, that the composition degrades rapidly when it is exposed to the air, generating corrosive acids and causing difficulties in its storage and transportation. Subsequently, Company A discovered that the degradation was due to reactions between the composition and a group of acids commonly present in the air. Because of this finding, Company A was able to further discover that by adding composition W to composition S, the mixture would no longer degrade in the presence of the acids. Company A wants to apply for a patent on the mixture composition. There is, however, one problem. Before Company A's discovery, Company B had already synthesized the mixture of W & S, although at that time the mixture was only used for the purification of composition S, and Company B (or anyone else) did not know the mixture could prevent the reaction between S and the acids in the air. Can Company A obtain a patent for the mixture composition?

     This question doesn't seem too difficult and the law in this area is well settled. -- An inventor cannot obtain a patent on a machine or composition simply because she/he discovered a new way of using it, although the inventor can obtain a patent on the new method.

     As an example, consider Viagra, the wonder drug for men. The chemical compounds contained in Viagra were originally synthesized by Pfizer to treat cardiac diseases, not male impotence. (Pfizer obtained a patent in 1993 for the compounds and for methods of using the compounds to treat various cardiac diseases.) Later on, having discovered Viagra's effectiveness in treating male impotence, Pfizer obtained a new patent on the method of using the compounds to treating male impotence, but not on the compounds themselves. Of course, Pfizer had already held patent on the compounds. If a different inventor discovers another new use of the same Viagra compounds, however, the inventor will still not be able to obtain a patent on the compounds for the newly discovered use, only a patent on the new method.

     This rule seems reasonably clear. However, in a recent case appealed to the Court of Appeals of the Federal Circuit (Abbott Lab v. Baxter) it was not so clear to the district court judge who presided over the trial.

     In that case, what happened was essentially the same story of Company A & Company B that I described at the beginning paragraph, where Abbott was Company A and Baxter was Company B. The main differences were that Abbott did obtain a patent on the mixture composition, and that despite the well-settled law the district court held that the patent was valid even though Baxter held an earlier patent where the mixture had been synthesized. (See here & here for more info.)

     What confused the trial judge was the difference between a new use of a method and a new use of a machine/composition. -- A new use of an existing method can be patentable, if the new use achieves a different purpose. But an existing machine/composition is not patentable simply because a new use of it achieves a different purpose. The judge applies the rule for a new use of method to a new use of machine/composition. Consequently, CAFC reversed the district court's decision and invalidated Abbott's patent.

     Credits for CAFC!

     I have posted several write-ups on spinal cord injury related patents. (See here in the patent archive.) These patents involve technologies in the fields of cellular, molecular, and genetic biology, or other related fields. Even with these discoveries, we understand the search for an effective treatment for spinal cord injury is still an ongoing effort. However, the pace of advancement in these fields during the past 2 decades has been amazing.

     As a testament to the exploding rate of advancement, this year's Nobel Prize in medicine was awarded to 2 American scientists for their works in a new field of genetic biology. -- RNA interference. (See here.) I am not going to touch on the technical details of their works. Suffice it to say that RNA interference allows scientists and doctors to stop the activities of a specific gene. This sounds simple, but the scope of potential scientific and medical applications is immense. For example, if a disease is known to be caused by a specific gene, RNA interference may allow doctors to silence the gene and thus cure the disease. Because of the importance of the discovery of RNA interference, Science Magazine named it in 2002 as the Breakthrough of the Year. And, of course, the Nobel Prize.

     It is also possible to apply RNA interference to treat spinal cord injury. For example, we know some "inhibitor" proteins released after a spinal cord injury prevent the spinal cord neuron cells from re-growing. RNA interference can be used to silence the genes that control the production of these "inhibitor" proteins, which reduces or prevents the production of the proteins and allows the neuron cells to re-grow. (See here.) Some companies have already begun commercial developments in this area. (See here.)

     A lot to look forward to!

     A final note. It may be debatable whether patents are necessary to stimulate innovation, but there is little doubt that patents have contributed significantly to the advancements in medicine. Here, the 2 Nobel Prize winners indeed obtained a patent for their discoveries.

Patent number: US6,506,559

Title: Genetic inhibition by double-stranded RNA

Inventor: A. Fire; S. Kostas; M. Montgomery; L. Timmons; S. Xu; H. Tabara; S. Driver; C. Mello

Assignee: The Carnegie Institution of Washington, Washington, DC; The University of Massachusetts, Boston, MA

Filing date: 12/18/1998 (provisional application filed on 12/23/1997)

Issue date: 01/14/2003

     Deferred compensation plans have become very common in corporate America. Generally, an employer sets up a deferred compensation plan to allow its employees to postpone the payment of a portion of the compensations they have earned. The deferred compensations normally are re-invested and not taxable until when they are actually paid to the employees. The more widely know varieties of deferred compensation plans include pension plans, 401(k)'s, stock-bonus plans, and profit-sharing plans.

     Although the number of deferred compensation plans has grown rapidly, these plans are not without risks for the employees. There is the market risk associated with investment. And there is the credit risk of the employer, who must re-pay the employees. The workers of GM, Delta Airline, and United Airlines recently learned the hard way about this credit risk. (See: "G.M. Freezes Pension Plan of Its Salaried Workers", NYTimes.com; "Delta to dump pension plans", CNN.com; "Airlines lobby for relief on pensions", USAToday.com.)

     In light of these recent sagas related to deferred compensation plans, I find the following patent interesting.

Patent number: US 6,766,303

Title: Method for hedging one or more liabilities associated with a deferred compensation plan

Inventor: D. J. Marshall

Assignee: Goldman Sachs & Co.

Filing date: 10/15/2001

Issue date: 07/20/2004

     The most straightforward way for an employer to hedge its liability associated with a deferred compensation plan is to actually invest the compensations that have been deferred. For example, if the employees participating in a plan have chosen to invest a total of, say, $1m in an S&P500 index fund, then the company can simply buy $1m of the S&P index fund under the plan. This approach, however, ties up the funds, and most employers want to use the deferred compensations for other business purposes. Patent US6,766,303 offers an alternative method to hedge this liability without tying up the funds. -- Total return swaps.

     Basically, the employer would enter into a swap agreement with another party. For a set period of time, the employer agrees to pay the other party periodic interests (normally a floating rate), and in exchange the other party agrees to pay the employer an amount equivalent to the total return of the specified investments in the deferred compensation plan. For example, let's say a plan offers only one investment option, an S&P500 index fund. The employer enters into a total return swap, where the employer pays a floating rate and receives the total return of the S&P500 index. The S&P500 index return that the employer receives from the swap would hedge against its obligations under the deferred compensation plan. With this approach, the employer is not required to tie up funds because no money is exchanged upfront. Additionally, other financial instruments can also be used, such as forward contracts, options, or synthetic forwards.

     The economics of this swap hedging approach is not very different from that of the cash hedging method I mentioned earlier. In cash hedging, an employer can borrow money at a floating rate and then invest the money according to the employees' choices under the plan. In other words, just like in a total return swap, the employer pays a floating rate and receives the total return of the specified investment. If an employer does not have easy access to credits, however, the swap markets may be a more attractive hedging alternative.

     It remains to be seen whether this patent can improve the funding shortfalls in many retirement-type plans. It should be noted, however, that many investment choices do not lend themselves easily to swap-type hedging. For example, many hedge fund companies allow their employees to invest their deferred compensations in some proprietary funds developed within the companies. Because the company may be reluctant to disclose the total returns of these proprietary funds, total return swaps are not good hedging tools for these plans. So, either the companies actually invest the deferred compensation in these funds, or the plans will most likely be unhedged.

     A few months ago in March, I posted a short write-up titled "What else MAY be copyrightable?". (See here.) In that posting, I looked at the 8 categories of creativities that are explicitly protected by the current Copyright Act (literature; music; drama; choreography; picture, graphic, and sculpture; motion picture; sound recording; & architecture), and noticed that these 8 categories are associated with only 2 of the 5 human senses. The 2 senses involved are "sight" and "hearing", and the remaining 3 senses are "smell", "taste", and "touch". The question I raised was whether creative activities involving the other 3 senses MAY also be copyrightable, even though they are not currently protected in US.

     I wasn't aware at that time that a couple of courtroom battles over that same question had been brewing across the Atlantic Ocean in Europe. And, it turned out the outcomes of the battles were determined shortly after my posting.

     In June, the French high court held that a perfume ("Dune" by Dior) was not protected by copyright laws, because perfume-making was a craftsmanship, not an artistic creativity. Three days later, however, the Dutch high court reached the opposite conclusion and held that a perfume ("Tresor" by Lancome) was copyrightable. (See here.)

     I don't have access to full English translations of the 2 courts' opinions, so cannot properly assess the reasoning advanced by the 2 European courts. However, from the info I assembled from the internet, it's not too difficult to come up with a list of considerations with which the courts must have had to grapple. For example:

     Personally, I'd like to see sufficient protection for innovative artistic works. In Holland, a perfume is now protected by copyright. More precisely, the chemical compound that releases a specific scent of a perfume will be copyrighted. However, if I some day decide to create my own perfumes, it would be kind of cumbersome that I'll need to know the exact chemical composition of the perfume I create to get copyright protection or to avoid copyright infringement! Not a career for the faint-of-heart in chemistry!

[This posting is part of a series on spinal cord injury related patents. Previous postings of the series can be found in the Patent archive here.]

Patent number: 6,033,660

Title: Method of treating a nervous system injury with cultured Schwann cells

Inventors:     J. P. Mather; R. Li; & J. Chen

Filing date:     05/10/1995

Issue date:     03/07/2000

     Let me begin with something not directly related to this patent. Dr. Wise Young is a prominent expert in spinal cord injury, and treated Superman, Mr. Christopher Reed, when he was paralyzed from a horse-riding accident. Dr. Young once formulated a multi-step plan for spinal cord injury treatment. The plan consisted of the following steps:

1. Give methylprednisolone (a steroid)
2. Remove any bone that is compressing the spinal cord
3. Stabilize the spine
4. Consider Schwann cell implants as experimental therapy
5. Begin rehabilitation as soon as possible
   

     (See here.)

The 4th step above involves "Schwann cells", which is the focus of patent US6,033,660.

     Schwann cells are found in our peripheral nervous system (PNS), but not in the central nervous system (CNS, which includes the brain and the spinal cord). The neurons in our PNS differ from those in our CNS in one very important respect. -- PNS neurons can re-grow after injury, but not CNS neurons. This observation has stimulated volumes of inquiry and research. It is believed that Schwann cells play a pivotal role in the regenerative capacity of PNS neuron cells. After an injury to the PNS, Schwann cells begin to reproduce in a fast pace. The increased population of Schwann cells secretes large amounts of substances (neurotropic factors) that help guide or facilitate the re-growth of the injured neurons. And then, at the end of this process, Schwann cells form a shield that covers and protects the newly generated neuron cells. This understanding leads to the exciting possibility that Schwann cells may also be used to stimulate re-growth of injured CNS neurons, if they are made available at the vicinity of CNS injuries. That's why Dr. Young suggested that Schwann cell therapy be considered an essential part of CNS injury treatments.

     Many types of therapy for CNS injuries utilizing Schwann cells have been proposed, such as peripheral nerve graft and implantation of guidance channels. These therapeutic methods, however, require abundant supplies of isolated pure Schwann cells. This patent describes a method of isolating and purifying Schwann cells derived from the materials obtained in a small biopsy.

     I will not delve into the technical details of the patent here. Just a quick note on Dr. Young's treatment plan. It seems there have been controversies over the effectiveness of methylprednisolone (the first step) in treating spinal cord injuries. (See here.) To me, however, that is a sign of progress!