Articles

Derivatives Patents: Some Strategies For Survival

Eric Roman

Last month, Trading Technologies agreed to settle its patent infringement lawsuit against Patsystems PLC, a London-based provider of electronic trading systems for derivatives. In that lawsuit, Trading Technologies claimed that Patsystems was infringing its patents on an electronic trading system for derivatives that displays market depth by way of a ladder-like display. As part of the settlement agreement, Patsystems agreed to pay Trading Technologies a variable royalty of at least ten cents (U.S.) per side for all derivatives contracts that trade through “Dome,” Patsystems’ trading screen, with a minimum royalty of $50 per screen that uses Dome.

Trading Technologies still has infringement actions pending against four of the largest futures exchanges, and against various futures and options software providers, including Refco, Man Financial, and yes – even eSpeed. That eSpeed is being sued for patent infringement is ironic indeed. Espeed was one of the first financial companies to successfully demonstrate just how profitable patents on derivatives-related technology can be. Over the past several years, in fact, eSpeed has aggressively enforced its patents on automatic electronic matching of futures contracts against just about every major derivatives exchange in the industry. So far, eSpeed’s enforcement strategy has resulted in tens, if not hundreds, of millions of dollars in revenue.

Lest anyone think that derivatives-related patent suits are some passing fad, think again. While as recently as five years ago, patents on financial instruments were virtually unheard of, financial institutions are now applying for derivatives patents in ever increasing numbers. In fact, a cursory search of published patent applications on the U.S. Patent and Trademark Office (“USPTO”) Web site reveals dozens of derivatives-related applications currently pending, with titles such as “Method and System for Offering Short Term Derivative Instruments,” “Multi-Asset Participation Structured Note and Swap Combination,” “Real Estate Derivatives Securities and Method for Trading Them,” and “Convertible Financial Instruments with Contingent Payments.”

There is no way of telling exactly how many derivatives patent applications are presently on file, as the USPTO does not publish applications until eighteen months after they are filed. There is no doubt, however, that their number is rapidly increasing. Regardless of what opinion the industry might have of the merit of such patents, one thing is clear. Financial companies must learn to take derivatives patents into account when formulating their business strategy, or they may well find themselves at the mercy of a more patent-savvy competitor.

A. Build A Strong Portfolio Having Long Term Value

So, what is the derivatives industry to do in this increasingly patent-rich competitive landscape? For starters, financial companies must come to terms with the fact that derivatives patents are not a passing fad. They are here to stay. And because they are here to stay, every financial company that deals in derivatives must give thought to building a patent portfolio of its own.

It is important, however, to be selective about what you choose to patent. A large patent portfolio is not necessarily a strong patent portfolio, or a valuable one. Since the process of obtaining a patent can take years, you should obtain patents for only those innovations that are not likely to be obsolete before the patent issues. Moreover, while it is certainly important to try to patent innovations that protect your current business, you can derive a more meaningful competitive advantage from patents that are directed to some future direction for your business, or that of your competitors.

In addition to being selective, you must keep the patent examiner well informed about the prior art. The more vigorous and thorough the USPTO’s examination is, the stronger and more valuable the resulting patent will be. While a typical patent examiner today has access to numerous prior art databases, the examiner will never be as familiar with the prior art as you are. Make the examiner aware not only of prior patents and industry publications, but of the academic literature as well. Work with the examiner to ensure that he understands the prior art, and that any claims that eventually issue are not overreaching. By doing so, you increase your chances of owning a patent that will prove useful in leveraging your investment in the patented innovation.

B. Obtain Clearance Opinions

In addition to developing a strong patent portfolio, financial companies should get into the habit of seeking advice from patent counsel before introducing a new financial instrument. Patent counsel should be asked to investigate the relevant patent landscape, and to provide you with a written opinion about whether you run the risk of infringing a valid patent. A written opinion is valuable for many reasons. The earlier you obtain one, the earlier you will be made aware of potential patent problems, and the less costly it will be for you to adjust course if necessary. An opinion may also help you identify aspects of your new approach that may be, in their own right, innovative and potentially patentable.

But most importantly, should a court find you liable for patent infringement, a competent opinion of counsel may help shield you from an additional finding that your infringement was willful. Willful infringement is punishable by an increase of up to three times the amount of any damages awarded against you. The shield that an opinion may provide against willful infringement is, alone, well worth the cost.

C. Defend Yourself Aggressively Against the Patent Trolls

Finally, financial companies must learn to defend themselves aggressively against charges of patent infringement, from patent trolls in particular. Patent trolls make their living by obtaining patents with broad claims that cover, however undeservedly, (i) the future of innovation in a particular industry, or (ii) an outdated technology that allegedly also encompasses some current innovation. Patent trolls target those deep pockets in the industry that are the easiest marks, and sue them for patent infringement in hopes of obtaining a quick settlement.
The best defense against patent trolls is an aggressive defense. While it may be tempting to settle a case and avoid the cost and uncertainty of patent litigation, such a strategy will only lead to more misery. Every settlement increases the likelihood that your company will be branded an easy mark for future trolls. Avoid simply paying them off. Work with competent patent counsel to assess the strength of every infringement case brought against you. Join forces with other companies in the industry to fight questionable patents in court. Only by taking on an aggressive defensive stance will you find yourself less vulnerable to trolls in the long run.

Conclusion

Financial institutions are gradually coming to grips with the fact that derivatives-related patents, and financial patents generally, have become a permanent part of their competitive landscape. By developing a patent savvy culture, institutional banks and hedge funds alike, guided by experienced patent counsel, will be able to meet the challenge brought on by these patents, as well as reap the rewards of protecting their own investments in innovation.

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