A federal appeals court decision threatens to embroil the financial services industry in hundreds of patent infringement lawsuits.
In a precedent-setting decision, a panel of the U.S. Court of Appeals for the Federal Circuit ruled July 23 that Signature Financial Group could patent a financial product.
The three-judge panel rejected claims by State Street Bank and Trust Co. that a mutual fund administration system did not qualify for patent protection because it is a "method of doing business."
The court threw out the "method of business" defense, ruling that any business practice that is new and not obvious may be patented.
"This should be a wake-up call to the industry," said Rory J. Radding, a partner in the New York office of the Pennie & Edmonds law firm, which was not involved in the case.
"Financial companies need to start doing due diligence. They need to look at their systems and see if they are potentially infringing on anyone's patents."
Mr. Radding estimated that the industry's liability could exceed $2 billion. Suits could be based on more than 2,000 patents that have been granted financial products in the last two decades, he said.
Financial institutions have generally ignored these patents, believing the "method of business" defense invalidated them. Patent holders would be entitled to every penny banks made from their inventions, plus royalties, he said.
"Imagine suing Visa or MasterCard for every transaction done," he said.
Lawyers said banks should patent all the special programs and systems they use to manage their portfolios.
"This is a double-edged sword," said David W. Roderer, a partner in the Washington office of the Goodwin, Procter & Hoar law firm. "For many banks it could be disastrous. The industry for decades has been replete with copycats.
"But for the innovative side of the industry, this will be good."
The Signature Financial case revolves around the so-called '056 patent, which was issued in March 1993 and covers a data processing system for the hub-and-spoke method of handling mutual funds.
The structure allows several small mutual funds to pool their funds in a partnership, which increases economies of scale and offers some tax advantages.
State Street initially negotiated to license the system from Signature Financial. But talks broke down, and State Street sued to void the patent. A U.S. District Court judge in Boston sided with State Street, ruling that the patent was unenforceable because it involved a method of doing business.
Signature appealed and won. The appeals court ruled July 28 that the system did not involve "laws of nature," "natural phenomena," or "abstract ideas"-the three areas the Supreme Court has said are immune from patent.
Instead, the court said, the system was a combination of formulas and processes that produced a useful result.
As a result, it is a "practical application" that qualifies for a patent.
"We hold that the transformation of data, representing discrete dollar amounts, by a machine through a series of mathematical calculations into a final share price constitutes a practical application," the judges wrote.
The judges then went on to invalidate the "method of doing business" exemption to the patent laws, saying it was "ill-conceived" and never endorsed by an appeals court.
"Business methods have been, and should have been, subject to the same legal requirements for patentability as applied to any other process or method," the court ruled.