United States: The Increasing Importance Of Business Method Patent Protection For Innovations In The Financial Services Sector
(Financial Services Alert – Developments of Note)

1. The Increasing Importance of Business Method Patent Protection for Innovations in the Financial Services Sector
2. SEC Adopts Rules for NRSRO Registration, Reporting and Oversight

3. IDC Issues Report on Boards Oversight of Fund Service Providers

Background on Business Method Patents. Patent protection has been a cornerstone of US industrial development and economic growth for over two centuries, providing protection for a limited period for novel and useful inventions. Patents, as Government sanctioned monopolies for innovations meeting the basic conditions of usefulness, novelty and non-obviousness set forth in the patent statutes, have been a part of the economic landscape from the early days of the country. Today, patents are available in the United States from the U.S. Patent & Trademark Office ("PTO") on inventions useful in the financial services industry (often computer implemented) and popularly known as "business method" patents. Many believe that the recent growth in business method patents was the result of the decision in State Street Bank v. Signature Financial Group, 149 F.3d 1368 (Fed. Cir. 1998), from the Federal Circuit in 1998. State Street held that patent protection was fully available for any invention in the financial services industry (whether computer implemented or not), if that invention met all the required conditions of patentability. The State Street Bank invention was a pure financial method invention: a "hub & spoke" investment structure for mutual funds. However, the reality is that State Street simply rejected the concept of a business method exception in the Patent Law--the PTO had been issuing business method patents for many years prior to that decision.

The State Street decision did heighten awareness about business methods patents. As a result, banks and other financial services companies (FSCs) have responded by filing for patents to protect their intellectual property (IP). Some FSCs have sought patents primarily for defensive purposes. Other FSCs seek patents for more offensive-minded purposes, for example, so that they can protect the market share of their products/services covered by the patents.

Scrutiny of the Patent System by the Supreme Court and Federal Circuit. Until recently, the US Supreme Court could be expected to review one or two patent decisions each term. That has not been the case the past several years, as the Supreme Court has accepted review of a number of cases spanning a wide range of patent issues.

For example, in eBay, Inc. v. MercExchange, L.L.C. 547 U.S., 126 S. Ct. 1837 (2006), the Supreme Court reversed long-standing Federal Circuit precedent in making it harder for a patentholder prevailing in a patent suit to get an injunction.

In LabCorp v. Metabolite, 548 U.S., 126 S. Ct. 2921 (2006), which involved a patent for doctors to detect vitamin deficiencies, a vigorous dissent to the dismissal of that appeal argued that the standards for what is proper patentable subject matter should be revisited. The dissent indicated that the Federal Circuit had opened the door too widely in terms of what types of inventions could be patented. As a result, many expected that the Supreme Court would use the recent decision in Microsoft Corp. v. AT&T Corp., 127 S.Ct. 1746 (2007), to restrict the availability of patent protection for business method inventions and even computer software inventions. But that case was narrowly decided without addressing the proper scope of patentable subject matter.

In the recent KSR v. Teleflex, Inc., et al decision, 127 S.Ct. 1727 (2007), the Supreme Court addressed the standard for when an invention is sufficiently "nonobvious" to deserve a patent. In rendering the KSR decision, the Supreme Court raised the bar somewhat for getting a patent. In effect, the Supreme Court held that PTO patent examiners could apply a more flexible framework in rejecting patent applications for being obvious.

The Supreme Court’s recent decisions have make it somewhat more difficult to receive and enforce patents. However, the availability of business method patents to protect the innovations of FSCs remains intact.

There are two important cases at the Federal Circuit that could potentially affect the availability of patent protection for business method inventions: Ex parte Bilski (BPAI 2006) and In re Comiskey No. 2006-1286 (Fed. Cir.) (2006). These cases might redefine, or at least more precisely define, when an invention is sufficiently tangible and concrete to constitute patentable subject matter, as opposed to disembodied ideas that are too abstract to be the subject of a patent. The Federal Circuit’s holdings in these cases may impact the way in which business method inventions can be patented.

The Importance of Patents to the Financial Services Sector. While the Supreme Court and Federal Circuit attempt to fine-tune the Patent System, the financial services sector continues to aggressively pursue business method patents. For example, a quick search of the patent databases reveals that prominent banks are expending significant resources in seeking business method patents:

• American Express has more than 100 issued patents and more than 200 published patent applications.
• MasterCard has more than 35 issued patents.
• VISA has more than 60 issued patents and more than 20 published patent applications.
• Capital One has more than 25 issued patents and more than 65 published applications.
• Bank of America has more than 40 issued patents and more than 25 published applications.
• Wells Fargo has more than 15 issued patents and several pending applications.
• Schwab has more than 30 issued patents.
• UBS has 5 issued patents and 15 pending applications.

Why is the financial services sector aggressively seeking patents? The short answer is sound business judgment: Executives and general counsel believe that their companies need patents to protect their innovations.

Part of the increase in business method patent applications by FSCs is attributable to the heightened awareness brought on by State Street. Many bank executives simply did not know that their computer-implemented business method innovations could be patented. Traditionally, FSCs have protected their innovations through trade secrets, not patents. Trade secret protection requires secrecy, i.e. tight control of any disclosure of an innovation, as opposed to patent protection which not only permits disclosure but requires it.

Trade secret protection has significant drawbacks. First, the innovation must be kept confidential, which is not feasible for some types of products. If the invention is a front-office process used to deliver goods

or services to the bank’s customers, confidentiality may be impossible, meaning that trade secret law provides no protection.

Trade secret protection can also be defeated by permissible reverse engineering. Assume that a bank develops a groundbreaking new technology for contactless credit cards using an innovative wireless infrared technology. Though protected by trade secrets, the design of this new technology can be copied by a competitor that acquires and reverse engineers the product to determine how it works.

Additionally, the nature of products and services provided by the financial sector has changed in a manner that makes patents more important. Specifically, the financial services sector is now one of the largest developers of software and computer systems. In short, FSCs need patents because they are creating more innovation and technology than at any time in history.

The role of IP protection, particularly patents, in the financial services sector is not much different from other industries. FSCs use patents to protect the innovations in their core products from being copied by others. FSCs also use patents in deals—whether an M&A transaction to sell an entire company or spin off a single division, or a run-of-the-mill technology licensing deal—to enhance the net value proposition of those deals.

Conclusion. Business method patents have become an important component for protecting innovation in the financial services sector. Although emerging case law may impose additional hurdles for getting and enforcing business method patents, they will remain a key part of the business strategy for these companies.

Thomas J. Scott, Jr., and Stephen T. Schreiner are partners in the Intellectual Property practice of Goodwin Procter in Washington, DC. A full treatment of this topic will be published in the IP Law & Technology Journal.

The SEC approved final rules to implement the Credit Rating Agency Reform Act of 2006 ("Rating Agency Act"). The final rules include registration, recordkeeping, financial reporting and oversight requirements for credit rating agencies registered with the SEC as "nationally recognized statistical rating organizations" ("NRSROs"), and replace the no-action letter process of identifying NRSROs. The final rules are substantially the same as the proposed rules (described in the February 6, 2007 Alert) with some modifications to the requirements governing the information credit rating agencies must provide to register as NRSROs. Existing NRSROs (those already identified under the no-action letter process the final rules replace) may apply immediately for NRSRO status under the registration requirements of the final rules, and may continue to act as NRSROs pending SEC consideration of their applications. The remainder of the final rules, those governing NRSRO recordkeeping, financial reporting and oversight, are effective June 26, 2007, the statutory deadline. In adopting the final rules, the SEC indicated that it will monitor the impact of the new NRSRO regulatory program on other SEC rules that use the term "NRSRO," including Rule 2a-7 under the Investment Company Act of 1940, as amended, which imposes credit quality restrictions on the instruments purchased by money market mutual funds.

The Independent Directors Council released a report designed to provide the directors of registered investment companies with practical advice in fulfilling their oversight responsibilities with respect to the following kinds of service providers: administrators, custodians, fund accounting agents, transfer agents and securities lending agents. The report will be discussed in greater detail in a future edition of the Alert