Alert January 31, 2007

Trends in Financial Services Patents

Patents Do Apply to Financial Instruments

Armed with a well-stocked patent portfolio, a company can effectively corner valuable markets for a limited amount of time. While this concept is second nature for most makers of tangible products, pharmaceuticals or even software, it is only now becoming widely accepted in the financial services sector. As a result, another battlefield is emerging in which patents are becoming the weapon of choice, and trading floors and back-office processing centers have become the new settings for patent disputes.

As financial institutions moved business processes from paper to computers, technology became a cornerstone of marketplace success. A landmark Supreme Court decision in the late 1990s – State Street Bank and Trust Co. v. Signature Fin. Group, Inc., 149 F.3d 1368 (Fed. Cir. 1998) – confirmed that financial instruments, as well as the underlying business activities of financial institutions, fall within the boundaries of patent law. As a result, savvy financial institutions began to file patents on ways of processing financial data and handling trades. While tentative at first, these efforts have recently skyrocketed as companies realized both the offensive and defensive benefits of patent protection. Not only could large, established companies now prevent competitors from offering financial instruments or processing services similar to their own, but smaller companies found themselves able to secure a particular market niche against powerhouse rivals.

An Explosion of Patent Applications

Reaction to the State Street Bank case and the dot-com boom of the late 1990s flooded the United States Patent and Trademark Office (“USPTO”) with “business method” patents and created a substantial backlog of patent applications requiring review at the USPTO. This was especially true for applications directed to “the practice, administration, or management of financial data,” which, according to recent USPTO statistics, increased six-fold when comparing the number applications filed between 1995-1999 to the number filed between 2000-2004. (See http://www.uspto.gov/web/menu/pbmethod/applicationfiling.htm). The rapid increase in the number of applications initially coupled with questionable examination processes resulted in a high percentage of these patent applications being allowed. However, increased scrutiny and better examination procedures have recently cut the ratio of issued patents to applications down to 5% from a high of 20%. However, due the sheer volume of applications on file there has been a dramatic increase in the number of issued patents affecting the financial services community. That increase continues unabated even today. According to a search of the appropriate USPTO records (namely the relevant subclasses of class 705 – which is the categorization given to business method patent applications), approximately 530 financial service-related patents were issued in 2005, up from an average of 342 for the previous three years.

At least as significant as the sheer numbers is an ongoing shift in focus of recently published patent applications. While many financial-services patents were historically directed toward computer systems and data processing, a growing number of applications attempt to cover the financial instruments themselves. The banks, insurance companies, hedge funds and investment houses that dream up new investment or capitalization schemes now file patents on them as well. And because of the transactional scale of today’s financial marketplaces, the stakes are enormous. In a recent patent litigation, a patent owner sought five cents for each infringing transaction. While a nickel a transaction may not seem onerous, the potential liability for a financial service institution that processes millions of implicated transactions daily can quickly soar into huge potential liabilities.

Getting in the Game

As a result of the growth in the issuance of patents directed to the financial services and financial instruments themselves, patent portfolio management and litigation have gained increased risk-management visibility at financial services companies big and small. Hedge funds, once strangers to the world of intellectual property, have increasingly embraced patent protection to keep key aspects of technology or investment strategies out of their competitors’ hands. Likewise, many “research-based” firms that focus on trading algorithms and portfolio management strategies routinely seek to patent advanced mathematical and statistical techniques with any eye toward license deals with industry leaders. Some hedge funds even acquire issued patents with an eye toward enforcement in an effort to earn returns for their investors.

A Word of Caution

The allure of large profits, however, should not blind financial services companies to the realities of patent procurement. Considerations such as the time and cost it takes to get a patent, the underlying business purpose of obtaining the patent (e.g., offensive use, cross-licensing, increasing the value of the company for future acquisition, etc.) and whether the mandatory publication of the patent will effectively give away certain competitive advantages must be thought through. As an example, suppose a firm develops a new stock-picking technique that provides improved returns. One price of obtaining a patent is the obligation to teach, in gory detail, how to practice the invention. That allows competitors to devise a similar strategy that may produce virtually identical results, but avoids infringement nonetheless. If that’s easy to do, perhaps the stock-picking technique is best kept secret (like a certain soft-drink formula) rather than patented. Though it often takes three years or longer for a patent to issue (and there are no guarantees that a patent will ever issue), most patent applications are published after 18 months. In such cases, the technique is now public but no patent protection has been gained. In other cases, however, the details of a new financial product may be completely transparent or publicly disclosed to comply with securities regulations, so patent publication does no (additional) harm. Where strategically appropriate, a patent can be of great value to the company. Once secured, patent rights not only serve the offensive purpose of walling out potential competitors, but can also provide bargaining chips against competitors with patents of their own.

What Next?

With patents playing an increasingly important role in the financial services market, firms should develop an awareness of the patent landscape in which they operate. For example, an ongoing review of competitors’ patent portfolios (as well as their published patent applications) can provide significant insights regarding their strategies, and if any patents seem uncomfortably close to home, steps can be taken to avoid them (or at least mitigate their impact). More general searches using key terms can also help identify the smaller players that are using the patent system to stake their claims in the marketplace. Monitoring ongoing litigations involving particular patents and/or companies can also be an effective component to a company’s intellectual property strategy. Some companies actively look for opportunities to purchase “dormant” patents that they can put to better use than their current owners.

But the best opportunities are often found by looking inward. One way to start identifying potentially patentable products or processes is to insert a “patent review” or “patent disclosure” step in product and systems development processes. Before offering a new product or service, consider a “clearance” analysis to reduce the risk of infringement. As part of an overall intellectual property strategy, firms often provide primer courses for employees that cover not only patents, but copyright issues (including the use of open source software), trademarks and trade secrets. Many firms also offer incentives to their employees for submitting their ideas to an IP administrator or committee for consideration. Decisions can then be made as to whether the firm should pursue IP protection, and if so, in what form. Employees should also be made aware of what to do (and not do) and whom to contact should they become aware of an IP risk. In particular, members of the technical, sales, marketing, risk management and legal departments should meet regularly to discuss these issues and provide senior management with updates.

Conclusion

It is easy to get caught up in the whirlwind of filing patents and keeping tabs on competitors. However, an intellectual property strategy is not a “one size fits all” proposition. Whether patenting trading systems, using open source software or selecting new branding and trademarks, firms should continuously confirm that whatever approaches are taken, they support an overall business purpose. Companies that can continuously adjust to internal business strategy and market-driven trends will be in the best position to leverage their intellectual property assets.