Patent Issues Become Cause of Concern for Banks! By Satya Swaroop Patents are one of the issues that cause concern for bankers; little do they realize the importance of safeguarding patents until they are prompted to do so by a lawsuit. Currently banking industry is facing a lot of litigation hovering around financial services patents. The technology and processes that banks possess are unique in many ways. And increasingly, this intellectual property is the source of an institution's competitive advantage. Mr. James Malackowski, president and CEO of Ocean Tomo, a Chicago-based merchant bank that specializes in intellectual property transactions, expressed at a recent symposium on patents hosted by the Securities Industry and Financial Markets Association (SIFMA), that with manufacturing moving to China and servicing moving to India, proprietary innovation is all that's left for U.S. institutions. With a dramatic shift in assets from more tangible to more intangible form, there is a large controversy as to selection of those assets that are patentable against those that are not. Initially, it appeared as if banks' intellectual property would be covered by patents. The judgment accorded in the Boston-based State Street Bank & Trust case, in 1998, and it was declared that the financial services industry technology and processes warranted protection. It is no longer classified amongst trade secrets but is patented as a proprietary product/know-how. The progress banks have made in obtaining patents, however, may be hindered by the judgment in the Bilski case where it was asserted that a company cannot file a patent on something as intangible as a business process, especially if it does not involve a machine (i.e., a computer) in some manner. "The Bilski case will directly impact the financial services industry since it addresses a patent on a method of managing consumption risk costs of a commodity [with no computer apparatus]," explains Esther Lim, a Washington, D.C.-based partner with the law firm Finnegan, Henderson, Farabow, Garrett & Dunner. "Today there's a lot of uncertainty around what's eligible for patent protection." This is a big issue for the financial services industry because many of the cases deal with innovation around software and processes With the State Street case, the court was very clear that business methods and financial processes should not be treated differently. This is a very big deal for financial institutions. The court will consider whether the application is eligible subject matter, whether the method is a physical transformation of an article, and whether it's appropriate to consider the Federal Circuit decision on State Street and whether that should be overruled. It is very difficult to get a patent on business methods. "The courts struggle to determine what is and is not a business method. The patenting authorities go by the principle that the more tangible it is the better. It is difficult when you're dealing with a mathematical algorithm, for example. Is the mathematics used to generate a tangible result or an increased utility of something that will translate into a benefit you can see? That's the question." Furthermore, software can be quite complex and very difficult to comprehend. Hence due to a lack of understanding and technical knowledge necessary for many of today's patent applications -- including those from the financial services industry the situation becomes very challenging.. "It's very difficult to get a quality patent in financial services because there's not enough understanding and experience in financial services space. Most of the authorities in question are people from engineering or chemical specialty area. Surely they're not former traders or bankers. There clearly needs to be more specialized understanding of financial services technology and processes; according to Daniel Marovitz, Deutsche Bank's (Frankfurt; US$1.3 trillion in assets) head of product management, global transaction banking. in London. "Software patents are easier to understand," he says. "But if you have an algorithmic pricing structure for something like credit default swaps, that's difficult to grasp -- you need a more specific understanding. Furthermore, since this is a mathematical process, it's hard to find patentability. After all, it is challenging to prove someone was using your particular algorithm." Making matters worse with regard to issuing patents, is the increasing complexity of the mathematics used in financial services products and processes. There has been a steady progression in the complexity of financial products and the level of basic mathematical background needed to understand them. Banks today are hiring a lot more people with Ph.D.s in mathematics, since domain experts make such complex products; it becomes more difficult to break it down in a manner that the courts can understand their nature. There is a difference in the authorities issuing patents and the courts who have to interpret them and enforce them at the time of infringement of the patent. Despite the uncertainty surrounding patents, however, banks should not shrink away from pursuing them. Banks are spending billions on new technology, but they don't have a culture of going after patents, the internal development teams at banks work like the research and development organizations at software companies -- the largest banks are among the largest software developers in the world. But they lose touch with the value of their products in the overall market. This raises another question with which banks struggle: Do they keep their technology a trade secret, or do they bring it public and apply for a patent? "Patents, copyrights and trademarks are very public, so you cannot keep your innovation guarded. The tradeoff is difficult to envisage and is left on individual banks to uphold. Market forces however impel banks to consider applying for patents. One factor in this push is outsourcing. Despite conflicting reports on the growth of outsourcing, the practice remains a popular mode of operation in the financial services industry. As a result, experts believe, there will continue to be an increase in the number of financial services patent applications. According to Jeremy Sokolic, vice president of marketing with New York-based CashEdge, which just underwent the arduous patent application process itself for a payments solution, banks are fairly conservative around patents. "They realize the patent situation is important," he says. "As they increasingly outsource, they don't want to get in a relationship with a vendor only to find another vendor has a similar patent. As the trends of outsourcing and software-as-a-service continue, IP will become more important to the banking industry." With outsourcing comes an increased awareness among financial institutions of IP issues. "I spoke to a bank that's outsourcing development of an application that it wants to bring to market quickly," he recalls. "They outsourced the development to China and Russia -- two countries that don't do well with protecting IP. So this bank wanted to take advantage of the expertise in emerging markets but security became a big cloud over the deal." Locking Down Intellectual Property However, there are ways to protect this proprietary information, just as there are methods to secure any sensitive data within an enterprise. In fact, many of the best practices for protecting IP are similar to security solutions used to safeguard customer data. The key to protecting intellectual assets is to capture the critical information and IP at the point of origin. With IP today, most of it goes out the door before it's even captured, you need to determine what information you have that is of value and capture it quickly. IP is at even greater risk today because of the widespread use of Web-based applications. Banks use scanning software to look for these vulnerabilities, such as the use of open-source software and back doors, in their applications so they can shut this down, some banks even lack an awareness of the fact that their IP are exposed. Banks worry a lot about customer data -- now they are starting to worry about the IP and the application itself. "The NSA [National Security Agency] once called the copier 'the spy's best friend,'" Drab relates. "What happens when a document is printed or copied? This is a critical area because you can have all the network security in the world in place, but it means nothing once something is printed." Drab adds that there is technology available that can track printed documents and help prevent them from being copied. For instance, he says, firms can use holograms, microtext (text that is embedded into a document at 1/100th of an inch) and invisible infrared coding embedded into a document to ensure the authentication of the original document. Having a good internal control system As with other data security, an important component of protecting IP is monitoring employees, says Finnegan Henderson's Lim, who points to non-compete clauses and confidentiality agreements as important tools. "These must dovetail with your IP strategy," she asserts. "It's important for financial institutions to have clear documentation that they own the process. When you file for a patent, you assign the right to the invention to the company [not the employee]. These are just good business practices." That's if a bank can determine who does and doesn't qualify as an "employee." "Many banks use outsourcers, employ temporary workers, have partners -- and all need to access the bank's network in some manner," comments Deutsche Bank's Marovitz. "Banks are going to need a semi-permeable/selectively permeable membrane for access control. As organizations become global, the boundary between who is an employee and who isn't becomes more complex." It's important to address these issues up front when hiring new employees or entering a partnership with a third party and to remain proactive, adds Fish & Richardson's Hudnell. "This is a legal issue and you have to make sure you have the protocols in place to ensure there are no problems down the line," he says. "These legal agreements must also be updated periodically." Patents may not be top of mind for most bank technology executives, but these days, maybe they should be, say experts. In the wake of recent patent litigation against banks, the industry is starting to call for tougher legislation around the granting of patents. Banks are in the business of making money. The technology they develop isn't necessarily their core business; therefore, although the technology is vital to what banks do, it often doesn't occur to them to patent what they develop -- unlike a company in the high-tech space. Often banks find themselves the victims of suits brought upon them by smaller, independent entities or inventors. Something is very wrong with the situation, these litigants aren't making products based on their patents but are instead suing companies that are using [the disputed patents] and are actually contributing to the economy." Meting Challenges The nature of patentable items in financial services is unique; the financial industry has business methods and back-office processes that are part of larger, nondifferentiated systems. These processes can contain systems with multiple functions in them, each perhaps containing an item that has been patented. In many cases, the bank doesn't learn of this until it's too late. The challenge for financial institutions is harnessing their innovation and getting patents for them, It's not easy for a [bank tech executive] to make time to sit down and talk to a patent attorney, but they need to now. Exposure in banks over proprietary products is manifold and there has to be good system whereby all intellectual property rights are protected and patents are kept in secured environment.