IP Advisor - January 2007

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.

One area where companies can easily get into trouble is having unlicensed software on company computers. Computer software is protected under the U.S. Copyright Act. The Copyright Act provides for strict liability for possessing or using unlicensed software, meaning that your company may be liable for having unlicensed software, even if management does not know about the software or intend to use it. Additional penalties for intentional infringement also exist. The Copyright Act allows for the recovery of damages between $750 and $30,000 per copy of unlicensed software (with damages that may be reduced below that range for innocent infringement and enhanced above that range in the case of willful infringement). Liability for copies of unlicensed software could add up quickly to a large amount if your company were sued when it was not in full compliance. A typical office computer will have a substantial number of computer software programs, including for example, operating system, e-mail, word processor, spreadsheet, document management, virus protection, graphics, etc. If even one program per computer is unlicensed the liability can be tremendous. Here are 10 simple steps to ensure that your software licensing is compliant and up to date:

1.  Direct all software purchases through a central purchasing or information technology department.

Directing all software purchasing through a central purchasing department, or through your company’s information technology department, will simplify the tasks of controlling software purchases and installation, maintaining records of licensing and installation, and ensuring that unused or outdated software is deleted. Central purchasing has the added advantage of maintaining all of the licenses for the software at a single location and making sure that software is purchased only through proper channels.

2.  Implement a streamlined method whereby business units or departments may rapidly get requests for necessary software approved and filled by a central purchasing department.

In order to get all business units or departments to channel their software purchasing through a central department, it is helpful to implement a simple method whereby different departments may request software purchases and installation and have those requests answered quickly. By providing a mechanism for a prompt response to a software request, it is less likely that an employee will simply go out and “acquire” software outside.

3.  Buy software from an authorized software reseller.

Using a software reseller which is authorized by the company that produced the software ensures that the software is genuine and that the producer will recognize the license provided by the reseller. Most software companies provide lists of authorized resellers on their websites.

4.  Keep detailed records of all purchases and license agreements in your central purchasing or information technology department.

If your company is sued for copyright infringement or presented with a demand for a software audit by a software producer, or one of the two main software industry associations that represent software producers, the Business Software Alliance (BSA) and the Software & Information Industry Association (SIIA), having detailed records will be key to your response. These organizations, when conducting a software audit on behalf of their members, often require a detailed listing of both the number of software installations and proof of the number of licenses. It is therefore important to keep detailed records concerning all software purchases, installations and deletions, as well as the licenses for any software purchased.

5.  Run self-audit software regularly on all of your computers, including laptops that may only be connected to the network periodically.

There are a number of software self-audit tools available that your company can use to create a report on all copies of software presently installed on company computers. This software will allow routine checking to ensure compliance and avoid even innocent infringement. Descriptions of the tools and links to the websites of the providers of self-audit tools are available on the BSA and SIIA websites, http://www.bsa.org and http://www.siia.net.

6.  Include a policy statement in your employment manual concerning software piracy, and discuss that policy with all new employees.

It is good practice to include in your employee manual a policy statement on software that: (i) states that it is the company’s policy to use only licensed software and to observe all the terms and conditions of those licenses; (ii) states that downloading or using unlicensed software may lead to civil or criminal liability and/or disciplinary action by the company; and (iii) sets forth the proper procedure for requesting the installation of any software on a company computer.

7.  Delete all older versions of software when a new version is installed.

When software is upgraded, older versions may inadvertently be left on computers. As any copy of software, even of an older version, is considered an installation requiring another license, any older version of an application should be deleted at the time the new version is installed.

8.  Delete all beta software after the authorized time period for testing expires.

All software that is used by the company during a beta testing period or other time-limited period should be destroyed after the expiration of that period.

9.  Consider locking down all computers to require administrative permission to install software.

The most secure way to ensure that no employee other than a member of the information technology department can install software on a company computer is to require an administrator password to install any software.

10.  Send a member of your information technology department to attend a training course on software license management.

The SIIA sponsors a course for software managers aimed at teaching the skills necessary to manage software licensing issues, which it calls the Certified Software Manager course. Information is available at http://www.siia.net.

The register of copyrights has issued an opinion clarifying which entities can qualify as pre-existing subscription services. The register had been asked to determine whether:

the universe of pre-existing subscription services – defined in 17 USC § 114(j)(11) as services which perform sound recordings by means of non-interactive audio-only subscription digital audio transmissions and which were in existence and making such transmissions to the public for a fee on or before July 31 1998 – [is] limited by law to only Muzak (provided over the DiSH Network), Music Choice and DMX.

The Digital Millennium Copyright Act (DMCA) establishes a market-based system for setting royalty rates paid to copyright owners of sound recordings by entities performing those recordings. Under 17 USC §114(f)(2)(B), rates and terms are established “that most clearly represent the rates and terms that would have been negotiated in the marketplace between a willing buyer and a willing seller.” Congress, however, exempted pre-existing subscription services and pre-existing digital audio radio services from the market-based royalty system. A designation as a pre-existing subscription service or digital audio radio service means that the service will pay royalty rates based upon statutory factors set forth at 17 USC §801(b)(1), potentially resulting in below-market rates. Thus, it is important to determine whether an entity digitally transmitting sound recordings qualifies as a pre-existing subscription service.

SoundExchange, Inc., a company representing copyright owners of digital audio sound recordings, claimed that certain services, including Sirius Satellite Radio, did not qualify as pre-existing subscription services because they were not the same three entities that were in existence and making digital audio transmissions on or before July 31, 1998. Sirius, on the other hand, argued that it was eligible for a statutory license as a pre-existing subscription service because it was performing sound recordings for the DiSH Network, a subscription service that was in existence on July 31, 1998.

The register of copyrights, in its opinion, noted that the dispute between SoundExchange and the companies claiming rights to a statutory license as pre-existing subscription services hinged on whether the term ‘pre-existing subscription service’ refers to the actual business entity (e.g., Muzak and Music Choice) or to the service (e.g., DiSH Network) which was offering music on a subscription basis on or before July 31, 1998. After analyzing statutory language, legislative history and basic principles of statutory construction, the register concluded that the term ‘preexisting subscription service’ “refers to the business entities in existence and making subscription transmissions on or before July 31 1998.” Accordingly, the register denied Sirius’ request to perform sound recordings for the DiSH Network under the statutory license granted to Muzak, the business entity which had made subscription transmissions over the DiSH Network in 1998.

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This article first appeared in World Copyright Law Report on January 25, 2007. If you are interested in subscribing please visit http://www.WorldCopyrightLawReport.com.

Publications

Daniel A. Wilson published “Patent Diligence on a Life Science Company: Ten Steps to Becoming Comfortable on a Budget” in American Venture Magazine’s January 2007 issue. 

Jacqueline Klosek published “Corporate Blogs: Handle with Care” on BusinessWeekOnline on December 14, 2006.

Jacqueline Klosek and Andrew Lurié published “Campaign for Copyright Extension in the UK Faces Latest Hurdle as Gowers Report Is Released” in Global Intellectual Property Asset Management Report’s December 2006 issue.

Jacqueline Klosek published her third book The War on Privacy on November 30, 2006.

 

Upcoming Conferences

Bridging the Gap: Crossing Over into Reality
Date: February 14, 2007
Location: Hotel Pennsylvania, New York, NY
This conference covers a wide range of topics to help attorneys new to the New York State legal system learn about the basics of several general areas of practice, strategies for mediations and depositions and general ethics obligations. Ira J. Levy will co-present a session entitled “Intellectual Property.”

Strategies for Managing Intellectual Property Litigation Summit
Date: February 28, 2007
Location: The Harvard Club, New York, NY
Ira J. Levy will speak on a panel entitled “An Overview of Breaking IP Litigation Issues.” Albert J. Solecki, Jr. will speak on a panel entitled “Trade Secrets and the Protection of Intellectual Property.”

Institutional Investor’s Financial Technology Forum – 2007 Winter Workshop
Date: February 28, 2007
Location: Four Seasons Hotel, Miami, FL
Stephen G. Charkoudian will speak on a panel entitled “Negotiating Outsourcing Agreements.”

Advanced Licensing Agreements 2007
Date: March 1-2, 2007
Location: PLI California Center, San Francisco, CA
Ira J. Levy will speak on a panel entitled “Trademark Licensing from the Inside & Outside.”

Privacy Seminar
Date: March 7, 2007
Location: Goodwin Procter LLP, New York Office, New York, NY
Jacqueline Klosek will speak at the breakfast briefing on “Critical Issues in US and EU Privacy Law.”

Patent Issues for the Non-Specialist
Date: March 15, 2007
Location: PLI New York Center, New York, NY
Stephen G. Charkoudian will speak on a panel entitled “Patent Issues in M&A Transactions.”

Y Combinator Startup School
Date: March 24, 2007
Location: Kresge Auditorium, Stanford University, Palo Alto, CA
Joel E. Lehrer will speak on a panel entitled “IP Issues for Micro-Startups.”

Association of Corporate Counsel
Date: March 29, 2007
Location: Goodwin Procter LLP, Boston Office, Boston, MA
Stephen G. Charkoudian will speak on a panel entitled “IP Traps for the Unwary in M&A Transactions.”

Advanced Licensing Agreements 2007
Date: March 29-30, 2007
Location: PLI New York Center, New York, NY
Ira J. Levy will speak on a panel entitled “Trademark Licensing from the Inside & Outside.” Christopher J. Denn will speak on a panel entitled “Patent and Technology Licensing.” Ira Levy is also chairing the event.

Current and Future Trends in Patent Law – Annual IP Conference
Date: April 20, 2007
Location: Suffolk University Law School, Boston, MA
Edmund R. Pitcher will speak on a panel entitled “For & Against Metabolite Claiming ‘Statutory Subject Matter.’”

Fundamentals of Patent Prosecution 2007: A Boot Camp for Claim Drafting & Amendment Writing
Date: June 20-22, 2007
Location: PLI New York Center, New York, NY
Louis S. Sorell and Marta E. Delsignore will speak at this event. Lou Sorell is also chairing the event.