Deterring violations of Federal Securities Law

By Freed Maxick on September 13, 2013
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Freed Maxick provides accounting, auditing, tax and consulting services and serves public and private companies, not-for-profits and municipalities to enhance profitability, save taxes, improve accountability and preserve wealth.

By: Tim McPoland, CPA Director

In certain types of intellectual property (IP) cases, plaintiffs can recover, or disgorge, the profits the defendant reaped as a result of the infringement. Disgorgement has quietly become a potent and heavily relied upon aspect of SEC enforcement strategy in Federal Securities Law, in recent years. But determining the right amount for those profits can be tricky — especially when it comes to allocating revenues and expenses.

There are options

Instead of pursuing damages based on its own lost profits, plaintiffs in a copyright, trademark or trade secret case can choose to pursue “disgorgement of defendants’ profits.” Disgorgement is a remedy not a punishment. Defendants’ profits quite often outpace plaintiffs’ lost profits, thus making disgorgement an attractive remedy for many businesses.

Patent holders can pursue two options, lost profits or reasonable royalties, but not both. The exception is with design patents. For example, the instance when Apple sought $2 billion for a disgorgement of Samsung’s profits from products that infringed upon Apple design patents.

Federal patent law gives design patent holders the right to recover disgorgement without any apportionment of profits that are based on patented and non-patented features in the infringing product. This often isn’t true with other types of IP.

Shifting the burden

A plaintiff that seeks disgorgement is required only to establish gross sales revenue that’s attributable to the infringement. The burden then shifts to the defendant to prove appropriate profit allocation deductions for any expenses. If the defendant fails in this endeavor, the plaintiff will recover the gross revenue amount. Direct expenses (such as product, marketing and distribution costs) usually are deductible. But different jurisdictions will likely have different rules for other types of expenses.

The Ninth Circuit Court of Appeals has previously allowed deductions for a portion of a defendant’s general expenses, including federal income taxes and operating expenses, if they’re material to the generation of revenue. Some courts don’t even allow the deduction of overhead — which can be incurred in support of both infringing and non-infringing activities, while other courts allow overhead deductions that can be attributed to the production or sale of an infringing product.

Defendants in these cases generally have the burden of demonstrating the degree to which infringing and non-infringing activities contribute to gross revenue. Such apportionment can be especially difficult when, for example, infringing material is used in a book that’s mostly original material or an infringed trademark is used on a product that also benefited from strong pricing strategies or distribution channels.

Come prepared

Whether you’re representing the defendant or the plaintiff in a case involving disgorgement of profits, you must come prepared with thorough documentation and analysis. In addition, your financial expert witness should be able to speak authoritatively to both claimed gross revenues and claimed costs and apportionment.

If you have any questions about lost profits, testimony or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.

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