Newegg on trial: Mystery company TQP rewrites the history of encryption

MARSHALL,TX—The story of Michael Jones, his mysterious invention, and the massive patent enforcer he's working with is finally coming out at a patent trial underway in this small East Texas town.

Jones' patent, now owned by famed patent enforcer Erich Spangenberg, has scared corporate America into writing one hefty check after another to avoid a trial just like this one. He and his lawyers say the patent covers the common web encryption scheme of SSL combined with the RC4 algorithm. The sums of those checks were revealed in court here on Tuesday when a TQP attorney displayed to the jury a spreadsheet with many of the payments.

Newegg's largest competitor, Amazon, paid $500,000 to TQP Development, a company owned by Spangenberg that exists to sue over the Jones patent. Microsoft paid $1,000,000.

In all, Spangenberg has earned $45.37 million from the Jones patent. As the inventor, Jones gets a 2.5-percent cut, plus $350 an hour in consulting fees when he does work for TQP. He has made a total of $585,000.

TQP is just one of nine pure licensing companies owned directly by Spangenberg. He owns 22 other companies whose relationship to his patent business isn't clear. Other patent-related companies are owned by his family members.

While the term "patent troll" won't be heard at trial, critics—including Newegg's top lawyer Lee Cheng—view Spangenberg as being one of the biggest players in that business. Newegg's attorney told the jury that Spangenberg's operation was a lawsuit machine right from the start—and Spangenberg owned it. On the witness stand, he didn't back down one bit.

Jones the visionary 

Here's the part of the story that no one disputes: Jones grew up in New Jersey and went to Goddard College. In 1979, he joined a company called Telequip as a part-time engineer. Telequip made coin-dispensing machines, the kind that hook up to cash registers at fast food restaurants and banks. He rose through the ranks, and in 1986 he became president.

Shortly thereafter, he moved Telequip into a new business: encrypted modems. Telequip added encryption features to a standard Rockwell modem of that era and sold them as the Hotline modem. It sold around 30 Hotline models before its modem business went bust. Telequip as a whole was sold, along with its patents, to a manufacturing company called Crane Co. in 2006.

But TQP lawyers say Jones did much more than create a modem business. They describe him as a "visionary" who saw the future of electronic payments. His patent, they say, describes an encryption system used by many modern websites back in 1989, years before the Web existed. "Mr. Jones was thinking about e-commerce before e-commerce was even a phrase," gushed Marc Fenster, Jones' lawyer, during opening statements on Tuesday.

Jones was effectively described to jurors as nothing less than the man who let everyone shop online. "The method that Mr. Jones came up with is the method that people use today to encrypt our data when we buy stuff on the Internet, even almost 20 years later," said Fenster. "Everyone wants better, faster, cheaper. Two out of three is good, but when you get three out of three—they call it genius. Michael Jones' solution was genius."

In the galley of the courtroom, not more than 50 feet away from Fenster as he spoke about the man whose invention allowed online shopping, sat another man who, according to his lawyers—and a more conventional reading of history—also has an invention that has allowed online shopping. Whitfield Diffie, standing out with his long white hair and large beard, waited for his turn to testify that Jones' patent was invalid.

Diffie was one of the inventors of public-key cryptography. In 1977, the technology created a new era in cryptography, allowing two computers that had never spoken to each other before to exchange coded messages. It was a necessary advance for Internet commerce to flourish.

He will be called as an expert later this week. For now, Diffie sits on the bench, silently watching as a lawyer from a Texas patent-holding company tried to weave a new invention myth that supplanted, at least partially, his own role in history.

Jurors got a short dose of the conventional historical record when Newegg lawyer Kent Baldauf gave them a preview of Diffie's testimony. "It's Dr. Diffie's invention that allows credit cards to be encrypted today," explained Baldauf. "He's the one that figured out how you could send information to some remote server that you've never had any contact with before without these keys somehow being pre-set and pre-arranged in a closed system."

Baldauf also raised the basic themes of Newegg's defenses. The patent described symmetric cryptography—two hard-coded modems talking to each other. It wasn't that different in theory than the code books that have been exchanged since ancient times. It had nothing to do with public key cryptography that kept Internet data safe; Newegg therefore does not infringe, he argued.

To boot, to the extent Jones is an inventor at all, he isn't the first. The RC4 cipher was designed two years before Jones' patent filing and was combined with Lotus Notes by Ron Rivest of RSA Security. Rivest wasn't exactly shy about his invention; RC4 stands for Ron's Code 4, Baldauf said.

Jones on the stand

Jones was the first plaintiff's witness. There had been a group swearing-in earlier, so once he was called, Jones simply approached the stand wearing a blue suit, burgundy tie, and wire-rim glasses. He was soft-spoken and had an easygoing, almost guileless demeanor.

He ran through his history working at Telequip, focusing more on the coin machines and other businesses than on the Hotline modem business, the "embodiment" of his patent. He eventually got to explaining why the Hotline modem wasn't successful. Hotline was like a "virtual private network," he explained.

"And at the time we were doing this, in the mid-to-late '80s, the market didn't exist for that," said Jones. "It wasn't until the 1990s that the markets for VPNs really came about. It took many, many years for this technology to broaden out and become useful."

In 1996, he left Telequip. Today, Jones runs a website called JustStrings.com, an online marketplace for strings for musical instruments.

Jones apparently never thought to apply his patent to the Internet, but by 2008 it was in the hands of Erich Spangenberg, who very much wanted to apply it to the Internet. At first, Jones hesitated to get involved in the licensing business. But then he talked to two trusted advisors, including the chairman of the board at Telequip, who reassured him.

"They basically convinced me that this type of work is done all the time in high-tech and that it could be a good thing," Jones said.

In 2011, Jones and Spangenberg struck a deal. Jones would work for TQP as a consultant. He would get paid $350 an hour plus 2.5 percent of any settlement awards. He has been paid $585,000 to date.