Hedge fund managers are always looking for an edge. Lately they've found one by sending patent litigators to court--not to try a case, but as highly informed (and highly paid) observers. Their task: to pick up and quickly report back to the money managers any intelligence that could move a stock.
Litigators have often been called in to evaluate the investment impact of a patent conflict during the course of due diligence for an acquisition. Now hedge funds are moving earlier and faster. They are putting lawyers in the courtroom to report on the outcome of a trial as it is happening. "I hear these stories of Markman hearings; the minute the ruling comes down, 15 guys jump up and run out of the room," says Ron Laurie, of Inflexion Point Strategy, an IP investment bank. "These guys are texting the hedge fund, so they can short the stock." By the time the market-moving information hits financial news services like Bloomberg, the investors get to take their gains.
Hedge fund managers consider their investment strategies to be trade secrets, and none would comment on the record for this story. But Edward Black, a partner in the corporate department of Ropes & Gray and cohead of the firm's Fish & Neave IP Group, says that his firm has done this type of work for several clients. Drug industry investors are well aware of the impact of a single drug losing patent protection, but many scrutinized cases involve other areas of high tech. Investors only want to know one thing, says Black: "They ask who's going to win--they say, we're gonna make a bet, and we can't bet on Ômaybe.' "
Courtroom intelligence can also guide long-term investments. Last October, in a packed Memphis courtroom, Stored Value Systems Inc., an electronic gift card firm, faced a patent challenge that threatened to put it out of business. Rival firm Barry Fiala Inc. had already signed on more than a dozen companies as licensees to its 1999 patent, and it sought an injunction against SVS, a highly profitable unit of Ceridian Corporation.
Naturally, when a verdict came back on November 2 giving Ceridian a victory, Ceridian shares rose. But trading volume on Ceridian hit a 2006 high before the jury issued its verdict--in fact, one day before. Soon activist investor William Ackman, of New YorkÐbased Pershing Square Capital Management, L.P., announced that he owned 11.3 percent of the company. He is now fighting for a spot on the board of directors, and Ceridian's stock has shot up with the prospect of spinning off its profitable Comdata subsidiary, which owns SVS, into a stand-alone company.
Ackman didn't own any Ceridian stock prior to the trial. But his purchases match the progress of the patent trial day for day, says Alan Fisch, a Kaye Scholer partner who defended SVS and who was not involved in Ackman's buys. The second-highest transaction day, according to market data, was the same day as closing arguments. The third- and fourth-highest days were those of the expected jury verdicts. Fisch knows the rules of the game: He has advised high-profile investors on litigation himself.
Despite their desire for a low profile, hedge fund moles aren't invisible. Like smokers forced onto the street by New York City's smoking ban, they have to step outside the courtroom to make their reports. Most U.S. courts don't allow cell phones or BlackBerrys.
