In the old fairy tale, there is a troll who lives under a bridge and eats everybody who tries to get across. In the real world today, there are trolls that lurk in the underbelly of the innovation economy and exact a pound of flesh from legitimate companies.

Because their weapon of choice is intellectual property, in the form of patents, they have preyed for years on technology companies, the Googles and Apples of the world, costing them billions of dollars.

But now top banks, like the leading firms in so many industries, are becoming technology companies in their own right. That makes them newly vulnerable to the depredations of these corporate bullies, popularly known as patent trolls.

It also means they need new protections.

One organization that has made itself a bulwark against patent trolls is the LOT Network, a nonprofit consortium of companies that have mutually agreed to grant their fellow members a free license to any of their patents, should those patents fall into the hands of a troll.

In other words, LOT members—a club that includes top technology firms and financial institutions—immunize each other from the threat of being sued. Between them, they hold more than 585,000 patents. Joining the network, then, is equivalent to getting vaccinated against more than half a million diseases all at once.

The consortium was founded in 2014 by Google, Canon and the multinational software companies Red Hat and SAP. Among top American banks, JPMorgan Chase and Wells Fargo are members, and last week, TD Bank Group became the latest financial institution to join.

This move arose from the Toronto company's realization that patent trolls were a growing threat to its future. The $900 billion-asset TD has made such a huge commitment to digital banking that it now has the largest finance-focused patent portfolio in all of Canada, according to Josh Death, its associate vice president of legal.

"While our core products aren't changing—a mortgage is a mortgage is a mortgage—we're leveraging technology more and more," Death said. "The new customer is transitioning to a very digital environment, and we want to be there in a position to service them."

The LOT Network has nearly 100 members, and more than 10% of them are financial institutions or fintech startup, said Ken Seddon, the consortium's chief executive.

"Just as the automobile industry is effectively turning the car into a smartphone on wheels," he said, "banks are incorporating tons of technology from outside their industry. And when you do that, you're basically chumming the waters for patent trolls."

Know Thy Enemy

The official term for patent trolls is "nonpracticing entities," so called because they don't create anything, don't provide any product or service, but instead make money entirely from suing productive businesses.

Another term is "patent-assertion entities," reflecting the fact that they don't use their portfolios of patents for commercial purposes, the way banks and software firms do. They merely assert them against other companies, even when their claim of infringement is shaky at best.

While the goal of such litigation is always the same—to get a payday—patent trolls use various strategies in their shakedowns.

One is what Death calls the "smash-and-grab," in which the infringement claim is dubious but the cost of defending the litigation far outweighs the cost of a small settlement. Another is the "lottery win." In this strategy, the nonpracticing entity does significant due diligence in order to build a strong case, and is prepared to take it all the way in order to score "massive dollars," Death says.

Beginning in 2006, "there was a tremendous explosion in patent suits," and things never returned to the status quo ante, said Eric Schulman, who drafted the original LOT agreement as a legal director at Google and now serves on the consortium's advisory board. Today, 70% of all patent litigation is brought by patent trolls.

Google, Schulman's former employer, has long been one of the biggest targets. At one point, he said, the Silicon Valley giant found itself fighting 100 active patent suits simultaneously.

Big banks are also in the crosshairs. In the past eight years, JPMorgan has been hit with lawsuits involving 104 different patents, according to Seddon.

For most banks this is a new phenomenon. Several years ago, before mobile apps and remote account opening, banks were mostly brick-and-mortar operations—as unappetizing to patent trolls as lamb to a vegan.

That is no longer the case. The more innovation labs banks open, the more fintech partnerships they forge, the plumper and juicier they become in the eyes of trolls.

And the trolls' appetites are not to be taken lightly. The average lawsuit brought by one, if it goes to trial, costs the defending company about $3 million in legal fees alone.

The problem looks even more serious on a national scale. A study by James Bessen and Michael Meurer of Boston University School of Law found that in 2011, American companies were forced to shell out $29 billion in litigation and settlement costs as a result of patent-troll litigation.

That expenditure amounts to an enormous tax on innovation, experts say.

"Our view is, every nickel that a bank is spending defending itself from a patent troll is a nickel that wasn't spent on R&D," Seddon said. "That's a nickel that wasn't spent on making a better product or returning profit to its shareholders. So these patent trolls are doing real harm."

Last year, 3,608 patent-troll lawsuits were filed in the United States. When the LOT Network studied those cases to see what sort of patents were being asserted, it found that more than 80% of them had originally been held by operating companies before somehow winding up in the portfolios of patent trolls.

Because of the expense involved in litigating a patent suit, operating companies don't readily sue one another. But once a troll gets its hands on a piece of intellectual property, all bets are off. That is because it has far more to gain, and far less to lose, than the company being sued.

"Companies sell to these assertion entities," said Seddon, "and then they turn around and sue everybody."

'License on Transfer'

Stopping the flow of IP to patent trolls is almost impossible.

Companies in financial distress might sell off their patents as a quick way to make some cash. Bankruptcy proceedings can result in patents being dumped on the open market, where trolls are only too happy to snap them up.

Crazy as it sounds, some companies even sell willingly to them. Schulman calls the practice a "tragedy of the commons": It doesn't hurt company X to sell its patents to a nonpracticing entity; it only hurts company X when its neighbor, company Y, does the same.

More than three-fourths of the patents used against banks come from outside the world of finance. But while the flow of IP can't be stopped, the IP itself can be neutralized.

LOT stands for "License on Transfer"—it means that if a patent belonging to one of the network's members ends up in another entity's hands, that entity can't use it to sue any of the members.

The 10-page agreement each LOT member signs has just one purpose: to protect companies from frivolous lawsuits and thus preserve their ability to invest in new technologies and services.

Daryl Wooldridge, the global head of IP management for JPMorgan, said in an emailed statement that his bank had already benefited a great deal from its LOT membership, and felt "it provides real risk reduction that gives us a competitive advantage versus companies not in LOT."

What the agreement does not do is prevent members from suing one another—or anyone else—for patent infringement. Nor does it prevent them from licensing their IP normally. As long as a member company holds onto its patents, it can use them and assert them to its heart's content. The agreement is triggered only if one of those patents changes hands.

The original agreement, drafted by Schulman, was 27 pages long and somewhat cumbersome. It was tough for startups to grasp.

When Seddon came on board as CEO in March 2015, his first mission was to simplify the document. The slimmed-down version was issued the following November. In the 12 months since, the LOT Network's membership has swelled from 13 companies to 95. Amazon, Netflix, Fidelity, JCPenney and Slack have all joined the ranks in recent weeks.

Two-thirds of the members are startups. The banks and other large companies each pay a $20,000-a-year fee so that membership will be free for small firms. Patent trolls have recently shifted from targeting huge tech firms to bullying startups, which lack the resources to fight back. About half of the companies sued by patent trolls in 2015 made less than $10 million in annual revenue.

"It is catastrophic for some of these small companies to get even one patent suit brought against them," said Sean Reilly, a senior vice president and associate general counsel of The Clearing House, a payments utility owned by 24 of the world's largest banks..

But the motive for protecting them isn't altruism. In an age when megabanks are relying on small fintech companies for everything from cybersecurity to consumer lending to blockchain experiments, patent suits brought by trolls can cause a lot of collateral damage.

That hasn't stopped companies in the LOT Network from selling their IP. So far, a total of 42,000 patents have been sold by LOT members to companies outside the network. Thirty-five of them have fallen into the hands of patent trolls.

Knocking Out Patents

Many of the patents asserted by nonpracticing entities against operating companies should never have been issued in the first place, said Reilly.

As general counsel for the Patent Quality Initiative, a nonprofit under The Clearing House's umbrella, he has been challenging such patents before the Patent Trial and Appeal Board [under a system set up in 2012]. "If you win, you invalidate the asset," Reilly said. "The patent is completely gone and can't be used to extract new settlements."

The patents he goes after tend to be overly broad and issued relatively late in the development of a particular technology, when no one should receive a patent so general that it overlaps with, and can block, other people's IP. The Patent and Trademark Office will issue such patents, however, if it is unaware the invention has already been described by someone else.

In the last month alone, PQI has filed six challenges against patents it believes were improperly issued. Earlier this year, the nonprofit managed to convince the appeal board to invalidate three patents related to loyalty rewards programs.

To stop patent trolls, PQI is readying its own cross-licensing compact, the Freedom Agreement, which will be made public next year.

Whereas the LOT Agreement is designed to be permanent, the Freedom Agreement is only a three-year commitment—an easier sell to companies' executives and boards of directors.

JPMorgan and Citigroup have already signed on. While it may seem strange for a member of the LOT Network, such as JPMorgan, to join PQI's community, Reilly said he isn't surprised by the overlap. As long as there are enough companies that belong only to one group or the other, some companies will want to join both in order to protect themselves from as many patents as possible.

By 2018, if its current growth rate continues, the LOT Network will contain 1,500 members and more than two million assets. Seddon compares its burgeoning membership to a population gaining herd immunity and slowly vanquishing a once-deadly disease.

Google has already reported seeing a drop-off in patent suits. This year has been "remarkable," with the number of litigations down overall, said Reilly, but the overall risk is still growing.

"Left unchecked, the problem could be massive," Reilly added.

For banks especially, the problem may get worse before it gets better. "Unfortunately, if you want to pursue banking 3.0 technologies," said TD's Death, "there's a high probability you're going to be running into entities that claim some sort of legal position in relation to what you're offering."