Futures Patent Litigation: A New Competitive Force
by Mark Young and Gregory Corbett
The futures industry was surprised in 2001 when the Chicago Board of Trade, Chicago Mercantile Exchange, and New York Mercantile Exchange were sued for infringing a patent that seemed to broadly encompass any method for the electronic trading of futures and related options.
The Wagner patent, named for inventor Susan Wagner (a former executive director at the Commodity Futures Trading Commission), is now owned by eSpeed, Inc., a spin-off of bond brokerage firm Cantor Fitzgerald LP. Rather than fight it out in court, the defendants settled the case and agreed to pay eSpeed tens of millions of dollars. In fact, through settlements and licensing agreements, eSpeed has collected nearly $50 million in fees attributable to the Wagner patent from some but not all futures exchanges that trade electronically. And the Wagner patent is only one of a portfolio of several patents that eSpeed has asserted against its competitors.
But now the tables have turned. Last month, Trading Technologies International, a Chicago-based software company, sued eSpeed for infringing TT’s recently-patented software platform that allows screen traders to see a range of bids and offers available in the market before placing an order. [Editor’s note: Subsequent to the writing of this article, TT filed another lawsuit and simultaneously reached a settlement with Goldenberg Hehmeyer & Co., under which TT dropped its infringement claims in return for Goldenberg agreeing to pay a license fee.]
Patent Rights and Business Methods
The eSpeed cases are just the tip of the patent infringement litigation iceberg. Like many business sectors, recent changes in patent law have sparked a marked increase in patent litigation involving the financial services sector.
The U.S. economy embraces the presumption that competition is beneficial because it leads to more choices, lower prices, higher quality, and greater incentive to innovate. But even the framers of the Constitution realized that providing for exclusive rights in intellectual property would encourage innovation and serve the national interest. Thus, Article I of the Constitution establishes a patent system whereby “[w]hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent ….”
Nevertheless, courts for many years found certain types of inventions to be unpatentable subject matter, such as phenomena of nature, mathematical algorithms, and until fairly recently, business methods. In 1998, however, the U.S. Court of Appeals for the Federal Circuit held in State Street Bank & Trust Co. v. Signature Financial Group that business methods could be patented.
The effects of State Street were seen immediately in the U.S. Patent and Trademark Office. Starting in 1999, computer, software, and financial services companies rushed to file thousands of patent applications related to business methods. The PTO reports that “class 705” business method application filings skyrocketed from about 1300 in 1998 to 8700 in 2001.
After State Street, many financial services-related activities have been claimed and found to be patentable business methods. For example, patents have been issued on methods of administering insurance policies, managing investments, trading securities, calculating interest rates, transferring funds, and banking online. The PTO now has issued thousands of business method patents, many of which are directed to the financial services industry.
A patent portfolio can be rendered largely useless if the patents are not enforced or licensed. That is why patent infringement litigation in the financial services industry has exploded.
Financial Services Patent Litigation
In the first few years after State Street, the focus of business method patents remained on e-business applications, while the financial services industry remained largely unaware of the possible broader uses of such patents. However, publicity surrounding eSpeed’s enforcement of its Wagner patent and other cases has considerably raised the profile of financial services patents.
For example, in 2001 a patent holder sued the Chicago Stock Exchange and 10 other parties for infringing its patent purportedly covering Select Sector Spider funds. In 2003, a federal judge ruled that the patent was invalid because the claimed Spider funds were previously known in the industry.
In 2003, Reuters sued Bloomberg for infringing three patents on electronic trading technology. Similarly, last year, eSpeed sued another rival, BrokerTec USA, for infringing its patented online order system used extensively throughout the U.S. Treasury securities market. Earlier this year, a federal judge refused to stop BrokerTec from using its system pending trial, reasoning that an injunction could have adverse implications for the U. S. Treasury securities market and give eSpeed a trading platform monopoly.
The financial services industry is well aware that eSpeed collected nearly $50 million from enforcing its Wagner patent (purchased for just over $2 million). The industry knows that if eSpeed succeeds against BrokerTec, it could gain a substantial competitive advantage in the U.S. government securities market. And competitors know that Reuters’ patent infringement suit seeks to keep Bloomberg out of the interbank foreign exchange market.
Because the stakes are high, aggressive enforcement of patent portfolios can be expected to be more than a passing trend in the financial services industry.
Trading Technologies v. eSpeed
Now it is eSpeed’s turn to be sued for patent infringement. Earlier this year, TT received two patents related to its MD Trader system, a component of its X_Trader trading software developed by TT’s CEO Harris Brumfield. eSpeed operates and markets futures trading software that is used by its customers. TT alleges that eSpeed’s futures trading software infringes U.S. Patent No. 6,766,304 and U.S. Patent No. 6,772,132.
The invention claimed by the TT patents is directed to a graphical user interface for displaying the “market depth” of orders to buy or sell futures contracts. For example, many common trading interfaces allow a trader to see the most recent or the best bid and ask price (highest bid, lowest ask). But the invention disclosed in the TT patents specifically allows a trader to place orders while viewing the “market depth” by seeing multiple bid and ask prices in a dynamic display.
eSpeed may take a cue from the defendants in its Wagner case and seek to invalidate the TT patents. To do so, eSpeed needs to demonstrate that TT’s invention was known in the industry before 2000, when the patent applications were filed.
In comparison, the defendants who tried to invalidate eSpeed’s Wagner patent were required to show that the Wagner invention was not novel as of 1983. (That kind of proof can be difficult to find. Even so, a document from the late 1960s was discovered eventually that called the validity of the Wagner patent into question.)
But anticipating such a possible fight over the validity of its patents, TT recently issued a release stating that its patented software is “radically different” from the preexisting trading systems. TT stated that it submitted “extensive prior art” to the PTO and that “only 20%” of similar filings are allowed by the PTO. In any event, TT maintains that it “intend[s] to protect” its intellectual property, and it has not offered its software “to the world out of sheer generosity.”
Financial Method Patents and Patent Thickets
As more and more financial services patents are issued, patent holders are likely to continue to pursue their litigation remedies, as experience has shown in other business sectors. The possible economic policy implications of this trend have not gone unnoticed.
In a lengthy report issued last year after extensive hearings, the Federal Trade Commission (“FTC”) acknowledged that the issuance of invalid patents stifles, rather than promotes, innovation. The FTC recognized (especially with respect to business method patents) that companies are often held hostage in a “patent thicket” where “patents are often questionable” and actually stifle innovation and harm competition “by increasing entry barriers.”
For example, instead of continuing to litigate a lengthy and expensive case over the invalidity of a patent, companies may choose to settle and pay hefty license fees to patent holders. Those costs may be passed along to individual customers. At a certain point, as new and overlapping business method patents emerge in the field of financial services, companies may be faced with real “entry barriers” arising from their competitors’ patent litigation decisions.
The FTC’s greatest concern in this area appears to be the PTO’s granting of patents of questionable validity. Such patents can be used to deter competition and prevent innovation, while the high cost of patent litigation often forces accused infringers to license patents that may be invalid.
Further, the FTC recognizes that it is “particularly difficult” for the PTO to locate prior art to establish patent validity in the field of business methods because State Street only recently prompted the wide-scale issuance of such patents.
Innovative financial service business methods should, of course, be recognized, rewarded and encouraged. For that reason, the power of the patent holder is considerable. In the highly competitive world of financial services (and especially futures), winners and losers can be determined by who gets sued and what level of license fees a patent holder charges.
Improving Financial Services Method Patents
Congress, the PTO, and the FTC are aware of some of the issues created by the issuance of financial services method patents of questionable validity. In 1999, Congress responded to State Street by creating a new “prior use” defense, now codified at 35 U.S.C. § 273, insulating from infringement those who have used a business method at least one year before the effective filing date of a patent.
And in 2000, the PTO addressed this perceived issue by implementing its “second pair of eyes” review program, whereby a more senior examiner takes an additional look at each business method patent application. Through this program, the PTO reports that it has reduced the allowance rate of “class 705” business method patents from 55% in 2000 to under 30% in 2002. The PTO has also hired new examiners and provided them with special training in these areas. There are now more than 120 examiners in “class 705” compared to less than 20 examiners in 1999.
Despite recent changes in the way financial services method patents are processed at the PTO, the FTC remains concerned about the issuance of patents of questionable validity. Part of the problem, suggests the FTC, is that patents are prosecuted on an ex parte basis. PTO examiners must locate on their own relevant prior art beyond what is submitted by the patent applicant. The FTC notes that such “difficulties are particularly acute” in “new fields” such as financial services business methods.
Thus, the FTC has proposed that these “difficulties” may be partially remedied by allowing industry competitors to challenge patent validity quickly through a new post-grant opposition process. The FTC has called on Congress to enact an administrative process that would allow for the resolution of any validity questions well before defendants are faced with substantial litigation costs.
The Financial Services Industry Adapts
The financial services industry did not grow up with patents. Perhaps understandably, some in the industry fear that patents will stifle industry growth. The FTC acknowledged that industry leaders generally agree that too many questionable business method patents are issued. And though lobbying efforts led to the enactment of the prior use defense and other procedural changes, should the PTO do more?
Relatively few published patents or articles related to financial services business methods exist. Any measure that increases the PTO’s knowledge and resources of relevant prior art is likely to reduce the issuance of questionable patents. Thus, one possible proposal is that the PTO should consult federal agencies with expertise in a particular substantive area, such as the CFTC for futures markets, before issuing financial services method patents that could affect millions of market users and the worldwide competitive playing field.
The CFTC was created to be an independent, expert agency for futures and options markets. Requiring the PTO to consult the CFTC when a patent application intersects with the CFTC’s area of expertise could assist the PTO’s evaluation of any prior art. Changes to PTO procedures are not without precedent, and have been enacted by Congress to foster competition and reduce market uncertainty. For example, in 1999 Congress enacted measures requiring most patent applications to be published after 18 months.
Conclusion
The financial services industry was thriving before State Street, and it will continue to thrive after the introduction of patents onto the scene. But the landscape has undeniably changed. Patent infringement lawsuits will continue to be filed, and money will continue to be made by patenting and enforcing financial business methods. For financial service firms, including those in the futures industry, patents involve both offensive and defensive strategies. An interplay of multiple and complex factors affect the development of these strategies. New facets of the patent process are emerging all the time, as firms seek to live on the cutting edge. The TT v. eSpeed patent litigation is just the next episode in what will undoubtedly be a very long saga. Z
Mark Young is a partner and Gregory Corbett is an intellectual property associate in the Washington, D.C. office of the law firm of Kirkland & Ellis, LLP.
