Financial services look to an IP-rich future

Intellectual property dynamics affect an ever increasing range of sectors. Thus, according to Financial Times, 2006 was a record year for patents covering financial innovations. Some 250 patents were issued in the main US financial services category year, almost three times the number issued in 2005. 

While this surge is certainly newsworthy, the interest of financial institutions and financial information suppliers in IP is a longstanding and, for the suppliers, well established. Providers of financial market information, such as Standard & Poor’s or Dow Jones, protect their products, in particular their indices, through registered trademarks or service marks, which assert their brand ownership. On the basis of trademark protection, they have been able to build a profitable and thriving licensing business, and to become the critical raw material of institutional asset management. They did not feel compelled to reinforce their protection via patents.

The introduction of patents in financial services followed the growing use of computers. Thus, the first widely recognised – and contested patent – was filed by Merrill Lynch in the late 1970s and granted in 1982, concerning a combined cash-securities account (Cash Management Account, or CMA) for retail investors and its underlying computer architecture. The patent was challenged by other brokerages but was upheld by courts (which did not prevent brokerages from deploying similar products).

The CMA patent decision stimulated efforts to extend the importance of patents in financial services. The landmark case was the litigation between State Street Bank, which specialised in securities processing, and a software house, Signature, which developed a system of mutual fund price reporting and patented it in 1993.

State Street opposed the patent, which would force it to pay royalties to Signature. After lengthy judiciary procedure, Signature finally won in 1998. This victory affirmed the validity of business methods patents in the US (in Europe their validity is still questioned). What ensured their popularity and visibility was the explosion of internet-based e-commerce. Firms such as Amazon, E-Bay or Priceline sought to reinforce their market strategy through such controversial patents as “one-click” purchase (Amazon), identity verification (E-Bay) or “Name-your-price” auction (Priceline). They used the underlying innovations to establish strong market presence and the patents to deter other potential entrants, particularly smaller firms.

While e-commerce firms were more visible in filing and litigating business methods, financial services firms also became very active. They included not technology firms such as Reuters or Bloomberg but also major financial institutions such as Citicorp, which patented in 1997 an electronic money system, General Electric or Goldman Sachs. Their interest led to the extension of patent coverage.

Thus financial engineering units of investment banks sought to protect by patents the design of new derivatives and other trading instruments. This was a major departure from previous practice, which treated such instruments as part of research.

For example, probably the most famous financial innovation, the Black-Scholes-Merton model for options pricing, has no patent-protection. Its authors rushed to publish it in the most reputable academic journal that would accept their findings, the Journal of Political Economy (Vol. 81, No. 3, May/June 1973). Such altruism would be highly unlikely today, particularly among quants working in financial engineering unit, where secrecy is the rule rather than the exception, with the results that some of the most advanced work in financial theory remains confidential.

An interesting example of the extension of the use of patents is the decision of Ocean Tomo to protect its Ocean Tomo 300 index (discussed in our November 28 blog) not only by trademark but also by a patent.

The proliferation of financial patents is highly controversial. Critics allege that it restrict free flows of information and thus hamper. Furthermore, as it is often the case for business methods, patents are awarded for trivial or well-known products or services. This results in increased litigation. According to Josh Lerner, a Harvard Business School professor, who studied the topic extensively, financial patents are ten times as likely to be litigated as other patents. For him, patents are a hindrance rather a spur to innovation.

Yet, short of a highly improbable major change in legislation, it looks unlikely that the financial patents momentum will slow down. Onthe contrary, as major financial institutions build IP portfolios they will be tempted to become more aggressive both in filing and in licensing their “innovation.” As The New York Times put it: “An intellectual property arms race is escalating on Wall Street.”