Like the gold rush of late 1840s, financial services prospectors are rushing to stake their claim to their firms intellectual property, flooding the U.S. Patent and Trademark Office with applications since the turn of this century.
Patents have long been a mainstay in the computer industry, where an average of 25,000 are granted annually, but theyve been a rarity in the financial services industry. Not anymore.
The number of business-method patent applications from banks and other institutions to the USPTO escalated 15-fold between 1995 and 2002. In 1995, 330 applications were filed, and 126 patents were issued; in 2002, 5,000 applications were filed, with 492 issued.
Thats no surprise to Dale Lazar, a patent attorney at San Francisco- and New York-based Pillsbury Winthrop, who expects to see the number rise even more as banks seek additional revenues streams like licensing fees. Financial institutions must protect and should patent their intellectual property in order to convert valuable ideas into fully realized assets, says Lazar, who urges banks to establish a culture of intellectual property and do IP audits regularly.
Citibank was the first to wake up to the notion that [it is] a high-tech company and what they create has great value, he says, noting that the bank holds the industry record, with 63 patents.
Others top holders include Visa International, with 35; Merrill Lynch, with 24; CheckFree Corp., with 22; InterTrust Technologies Corp., with 21; American Express, with 19; JPMorgan Chase, with 15; MasterCard, with 15; Capital One, with 11; Deutsche Bank, with 11; and First USA Bank, the credit card unit of Bank One, with 8. To no surprise, not one of the 10 financial services firms contacted would discuss the issue.
The variety of patents is endless. Business-method patents run from Citigroups foreign-exchange transaction system to CheckFrees payments platform to Merrill Lynchs stock-option control system. Patents also have been issued for electronic check clearing, inflation-indexed bonds, and swaps and derivatives. Software patents have been issued for mutual funds, annuities, credit risk, ATMs, data warehousing, call centers, credit card accounts, billing systems, annuity contracts, insurance products, artificial intelligence systems, home banking, remote banking, remote securities trading, program trading algorithms, smart cards, e-cash and e-commerce.
Technically, any new and useful process, machine, manufacture or composition of matter is patentable, says Lazar, quoting the legal phrase, except for laws of nature, physical phenomena and abstract ideas. Patents in financial services are but a fraction of the total from all industries. In 2001, for example, the 8,200 filed represented about nine percent of the 88,000 total filed in all industries in the U.S. (78,000 foreign firms also filed for U.S. patents that year). Only 433 ideas in financial services were actually patented.
But what changed everything was the 1998 State Street Bank case, in which the federal circuit court reaffirmed Signature Financials patent protecting the business method used by a platform for financial record keeping. The platform tracked currency fluctuations for a mutual fund that invested in stocks traded in more than one foreign currency.
But the ruling that business method-applications and processesnot just technology and productswere patentable shook the industry to its core, prompting a flood of application filings, says Robert M. Hunt, an economist in the research department of the Federal Reserve Bank of Philadelphia, who has tracked financial services patents since 1998. (He has been following intellectual property patents for more than a decade.) That case contributed to a huge patent boom in the financial services industry, he says.
And why not? Specialized patents can earn $1 million per license yearly, while more common licenses can generate revenues between $10,000 and $100,000 annually. IBM, for example, claims $2 billion in annual licensing revenue. Moreover, patents keep competitors at bay for at least 20 years. Once a product is marked patent pending, competitors often steer away from developing similar products. A patent is a negative right, says Lazar. It doesnt give you the right to do anything. It only gives you the right to stop other people from using your product. You can either stop the competition from doing the same thing, or you can charge them a fee for doing it. Your goal is to be more successful than your competitor. Patents provide you with one more tool in your arsenal to avoid competition.
But there are other reasons, too. The main reason to get a patent is prestige, notes Hunt, who says industry research shows that the primary ways financial institutions earn money is by being first. People imitate them and they get a certain reputation. You become the Big Kahuna. In a case like that, its not clear that the patent makes a difference.
Patents have a downside, howevernotably legal headaches that linger. Although patent-holders have the right to sue if another firm infringes on their patent, the USPTO doesnt police the industry. You better be ready to defend your patent, says Thomas Turano, a partner specializing in IP patents at Boston-based Testa Hurwitz & Thibeault. And that can be expensive. The American Intellectual Property Law Association estimates it costs litigants on both sides of a patent-infringement case between $1.5 million and $2 million to duke it out in court. They often settle these disputes out of court, which is less expensive and where they can be certain of the outcome, he says.
But theres more than one way to remain competitive: Many companies protect their intellectual property by keeping trade secrets proprietary. You keep it secret and never tell anyone, which allows you to retain your competitive advantage, says Turano, noting the USTPO makes details of inventions public once a patent is granted. Of course, you have your employees and programmers sign contracts that they wont release the information, he says, noting that if that confidence is breached, an injunction or legal damages can be sought in the lower-profile civil courts. A firm can choose not to do a patent, which is what many do, says Hunt. Coca Cola, for example, probably maintains one of the nations greatest trade secrets with its formula for the soft drink, which has never been patented.
But Hunt says the vast majority of all patents are not enforced, noting that only 2,000 patent-infringement suits were filed in 2001, the same year 88,000 applications were filed. On Wall Street, investment banks are more collegial, says Hunt. Now that theyre getting more patents, has the equilibrium changed? Do you see more suing or less? One of the things about financial services firms is that they form all sorts of joint ventures all the time. There have been a handful of suits, but not a lot. Its not necessarily the case that what we see in the past will be what we observe in the future.
Some lawsuits can be bruising. In October, eBay and Bank One Corp. mutually agreed to dismiss year-old lawsuits filed against each others units for Web-processing patent infringement. No doubt eBay had had enough: That dismissal came on the heels of a May court decision ordering eBay to pay $35 million to MerExchange for infringing on its patented system of using low-cost terminals and market making computers to create an on-line auction.
And as the industry starts dipping into the patent business, many observers are calling for higher standards and shorter lifespans for patents, which would result in fewer patentsbut higher-quality ones.
Currently, each application costs about $20,000 to prepare and up to $10,000 to take it from filing to issuance, a process usually taking between three and four years. And if the product will be used overseas, banks may need to undergo the patent application process in each country where they operate.
The USPTO has been under heavy criticism over its decision to grant Amazon.com a patent on its one-click order system, a common denominator on Internet shopping sites used for years before Amazons patent application. In 1999, Amazon.com accused rival Barnesandnoble.com Inc. of willfully infringing on its patent and won an injunction, which required its rival to deliberately complicate its payment process. The controversy sparked an amazon.com boycott and raised new questions about whats patentable, particularly in the rapidly evolving area of e-commerce.
While observers say its becoming more difficult to convince the USPTO that a method is unique and not just an incremental improvement over an existing product, it hasnt stopped firms from trying. In November, MasterCard International filed to patent its debit MasterCard hologram, which enables cardholders and merchants to differentiate its debit cards from other MasterCard products. Previously, payment devices included holograms primarily as a security feature, but this product uses them to ensure its identification as debit cards. MasterCard officials declined to discuss the product.
Financial services firms can no longer choose to sit on the sidelines. Lazar warns that many latecomer banks will find themselves vulnerable to infringement litigation from larger players in coming years for failure to obtain patents for their own transaction methodology. Hunt agrees, saying, Financial services firms are going to have to pay a lot more attention to intellectual property. Its going to be an issue and theyll have to be sensitive to it.
There is evidence they already are. In 1998, financial firms spent $1.6 billion on research and development, employing 17,000 scientists and engineers, double and triple 1995 figures, respectively, according to Hunt.
But should all banks get on the patent bandwagon? It depends on the extent to which a bank is an innovator, says Lazar. Some financial services firms are more creative than others. Some are trying to distinguish themselves based on their new products, new thinking, new ways of doing business. Others are more content to allow others to lead and sit back and not be as creative. The more creative the bank, the more need to protect its creativity and convert its ideas into assets. Even the followers will have to worry about the patents that the leaders get. Most banks are still in a kind of an ostrich mode, he says. They think, Lets bury our heads in the sand and hope it doesnt bite us. But banks have to face that they may be charged with patent infringement in the future, so they must think defensively and offensively. One thing is for sure, however: For every dollar spent on filing and protecting patents means one less dollar spent on R&D.
The real question for the financial services industry is an age-old one among patent professionals: Do patents promote or stifle industry innovation? Its too soon to tell in the financial services industry, says Hunt. Just because you have a patent doesnt mean its valuable. The vast majority of patents out there are worthless and are not going to generate economic value. ...We should be skeptical about the traditional argument that if we grant more patents well get more inventions. Economic theory has never said that. But the U.S. has a long history of protecting creative ideas, and that hasnt marred the innovation of Americas inventors, which have included Thomas Edison, the Wright Brothers and Alexander Graham Bell. Lazar points out that one of the first acts of the U.S. Congress in 1778 was to create a patent system. Thomas Jefferson, the first commissioner of patents, granted the first patent to President George Washington for a method of making potash.