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FINANCIAL SERVICES USING NEW BUSINESS METHODS ENABLED BY SOFTWARE ARE NOW PATENTABLE IN THE U.S. WITH EXTRATERRITORIAL EFFECTS

by John B. Moetteli, Esq., © 1999
This is a first draft of an article published in the May, 1999 issue of:
The Journal of World Intellectual Property Law, Werner Publishing
Jacques Werner, editor
P.O. Box 5134
CH-1211 Geneva 11
Switzerland

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OUTLINE
A. Introduction
B. Statutory Subject Matter for Patent Protection and «Ancient» Practice
C. The New Paradigm : State Street
i. The District Court's Analysis
ii. Before the Federal Circuit
iii. The «Mathematical Algorithm» and «Business Method» Exception
iv. But all is not patentable
D. Extraterritorial Effects
E. Conclusions and Implications

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Note from John Moetteli: This paper is an unedited, pre-publication draft. It is to be read and not copied. Footnotes have been stripped from the draft (these will be added later). The final version of this work, including a more extensive treatment of extraterritorial effects and some current comments from the European Patent Office, is posted here in PDF format.

A. Introduction

In State Street Bank & Trust Co. v. Signature Financial Group, Inc., 47 USPQ2d 1596, (Fed. Cir. 1998), the U. S. Federal Circuit Court of Appeals overturned a lower court's ruling denying that a new business method was patentable, and clearly stated that the fact that the invention is a new method of doing business will no longer prevent someone from obtaining a patent where his invention satisfies the patentability standard that has existed since 1952. In January of the year, the U.S. Supreme Court denied a petition for certiorari. Now, where also Diamond v. Diehr, 450 U.S. 175, 182 (1981) may have left doubts, today it is clear: the long-standing business method and mathematical algorithm exceptions to patentability are essentially dead. Little now stands in the way of those who will try to use the patent monopoly to establish a comparative advantage in the financial services industry. Wall Street, welcome to the world of patents!

To begin to appreciate the sweeping nature of the State Street decision, it is helpful to understand what effect it has had on the patent practice. Examining some of the companies which are benefiting from patent protection is also instructional. Finally, we examine how this affects the practice of corporate attorneys, their clients, and software developers, whether or not they actively conduct business in the United States.

B. Statutory Subject Matter for Patent Protection and «Ancient» Practice:

Title 35 U.S.C. § 101 of the patent statute of the United States states that . . .

Whoever 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 therefor, subject to the conditions and requirements of this title.

Since 1952, Section 101 has defined the subject matter for patentable inventions. Despite the highly inclusive language of the statute, the Manual of Patent Examining Procedure ("MPEP"), the unabridged manual of the U. S. Patent laws including the rules and regulations governing patent practice, stated the following:

Though seemingly within the category of process or method, a method of doing business can be rejected as not being within the statutory classes.

The case from which the above quote is taken was decided in 1908. Therefore, patent practitioners have, since as early as 1908, advised clients who sought counsel with respect to a new business method, that they need not consider patent protection further. According to the «business methods exception», such innovations are not patentable.

C. The New Paradigm: State Street

Thanks to State Street Bank & Trust's willingness to challenge a patent, Signature Financial Group's innovation, and a little competition, this has all changed. A case involving these parties, the primary subject of this article, State Street Bank & Trust Co. v. Signature Financial Group, Inc., 47 USPQ2d 1596, (Fed. Cir. 1998), was decided by the United States Court of Appeals for the Federal Circuit in July of 1998.

In State Street, Signature Financial Group, Inc. ("Signature", the defendant-appellant) appealed from the decision of the United States District Court for the District of Massachusetts granting a motion for summary judgment in favor of State Street Bank & Trust Co. ("State Street", the plaintiff-appellee), finding Signature's Patent invalid on the ground that the claimed subject matter is not encompassed by statutory subject matter capable of being patented.

Now to briefly discuss the background, Signature is the assignee of a patent entitled "Data Processing System for Hub and Spoke Financial Services Configuration." The patent is generally directed to a data processing system (the "system") for implementing an investment structure which was developed for use in Signature's business as an administrator and accounting agent for mutual funds based in countries investing using various foreign currencies. In essence, the system, identified by the proprietary name HUB AND SPOKE_, facilitates a structure whereby international mutual funds («spokes») pool their assets in an investment portfolio («hub») organized as a partnership. This investment configuration provides the administrator of a mutual fund with the advantageous combination of economies of scale in administering investments coupled with the tax advantages of a partnership.

State Street and Signature are both in the business of acting as custodians and accounting agents for multi-tiered partnership fund financial services. State Street negotiated with Signature for a license to use its patented data processing system. When negotiations broke down, State Street brought a declaratory judgment action asserting invalidity, unenforceability, and noninfringement and then filed a motion for partial summary judgment of patent invalidity for failure to claim statutory subject matter under § 101. The motion was granted and, subsequently, State Street appealed.

i. The District Court's Analysis:

The district court began its analysis by construing the claims. According the court, when independent claim 1 is properly construed in accordance with § 112, para 6, it is directed to a "machine" (i.e., a computerized system) which, of course, is proper statutory subject matter under § 101. The district court nevertheless concluded that the claimed subject matter fell into one of two alternative, judicially-created exceptions to statutory subject matter which was mentioned above, namely the "mathematical algorithm" exception and the "business method" exception.

ii. Before the Federal Circuit:

The Federal Circuit held that declaratory judgment plaintiff State Street was not entitled to the grant of summary judgment of invalidity of the patent under §101 as a matter of law, because the patent claims are directed to statutory subject matter.

The Federal Circuit stated that according to the plain and unambiguous meaning of § 101, any invention falling within one of the four stated categories of statutory subject matter, i.e.:

. . . any new and useful [1] process, [2] machine, [3] manufacture, or [4] composition of matter . . .(emphasis added)

may be patented, provided it meets the other requirements for patentability set forth in Title 35, namely, those found in §§ 102, 103, and 112, para 2(2).

In its analysis, the court noted that the repetitive use of the expansive term "any" in § 101 shows Congress's intent not to place any restrictions on the subject matter for which a patent may be obtained beyond those specifically recited in § 101. Indeed, the Supreme Court has acknowledged that Congress intended § 101 to extend to "anything under the sun that is made by man." Thus, the Court made clear that it is improper to read limitations into § 101 on patentable subject matter where the associated legislative history indicates that Congress clearly did not intend such limitations.

iii. The "Mathematical Algorithm" and "Business Method" Exceptions:

The Supreme Court has identified three categories of subject matter that are unpatentable, namely "laws of nature, natural phenomena, and abstract ideas." These exceptions apply until "reduced to some type of practical application, i.e., 'a useful, concrete and tangible result.'"

Unpatentable mathematical algorithms are identifiable by showing they are merely abstract ideas constituting "disembodied concepts or truths that are not 'useful.'" From a practical standpoint, this means that to be patentable, an algorithm must be applied in a "useful" way.

As an alternative ground for invalidating the patent under § 101, the district court relied on the "business method" exception to statutory subject matter. Concerning this exception, the Federal Circuit stated that, in their opinion, this exception was "ill-conceived" and that they therefore "lay it to rest". According to the court, this exception has merely represented the application of "some general, but no longer applicable legal principle, perhaps arising out of the 'requirement for invention'--which was eliminated by § 103". "Since the 1952 Patent Act, business methods have been, and should have been, subject to the same legal requirements for patentability as applied to any other process or method". One can't help but get the impression that the Federal Circuit intended that patent practitioners take note of this, due to the fact that many have been advising clients that the business methods exception prevents such inventions from receiving patent protection.

The Federal Circuit concluded as follows:

Today, we hold that the transformation of data, representing discrete dollar amounts, by a machine through a series of mathematical calculations into a final share price, constitutes a practical application of a mathematical algorithm, formula, or calculation, because it produces "a useful, concrete and tangible result"--a final share price momentarily fixed for recording and reporting purposes . . .

Having been given a brief historical sketch of the patent practice, the reader should more fully understand how significant this decision is.

Still further, the court noted that the invention is a machine programmed with the hub and spoke software which admittedly produces a "useful, concrete, and tangible result." This renders "such inventions [] statutory subject matter, even if the useful result is expressed in numbers, such as price, profit, percentage, cost, or loss".

iv. But not all is patentable:

Lest the reader begin to think that almost anything is now patentable, the Federal Circuit sites some examples of non-patentable, "business method" subject matter. These are not unpatentable just because they are business methods per se. Rather, they are not patentable because they fail to meet the other criteria of the patent laws (not statutory subject matter, not novel or are obvious). Below are the three examples of business method patents which the court cited as not being patentable:

A. A business methodology for deciding how salesmen should best handle respective customers.

B. A 'system' for aiding a neurologist in diagnosing patients.

C. A simple bookkeeping program which registered cash transactions and checked accounts written specifically for restaurants.

Concerning the first two, the court noted that neither of the alleged 'inventions' in those cases falls within any §101 category. Therefore, these are not patentable because they did not statutory subject matter (although the claims were technically «machine» claims, the court found that the claims were in fact unstatutory process claims disguised as statutory «machine» claims). Concerning the third example, the court stated that "[i]f at the time of [the patent] application, there had been no system of bookkeeping of any kind in restaurants, we would be confronted with the question [of] whether it were patentable under the statute."

Today, in all editions of the MPEP published since 1996 (those published since the Diehr decision was handed down), the paragraph of § 706.03(a), dealing with the business method exception has been deleted. This section now states the following:

Office personnel have had difficulty in properly treating claims directed to methods of doing business. Claims should not be categorized as methods of doing business. Instead such claims should be treated like any other process claims.

The Federal Circuit made the effort to state that this revised section of the MPEP describes "precisely the manner in which this type of claim should be treated". "Whether the claims are directed to subject matter within § 101 should not turn on whether the claimed subject matter does 'business' instead of something else".

D. Extraterritorial Effects:

One might fairly question what good having a U.S. patent is when his business is located in Switzerland, for example. Firstly, having a U.S. patent enables the owner to prevent sale of the product in the United States, a significant portion of the market for almost any international business. This would be infringement based on 35 U.S.C. §271(a)-(c). In other words, if the patent includes claims to a computer encoded with the software, then importation or sale or merely offering to sell the computer with the software would infringe the patent. If the patent includes claims written to a method encoded in a computer-readable medium, then the patent owner could prevent unauthorized importation into the United States of the program stored on a disk, for example.

However, there is 35 U.S.C. § 271(g) which states the following:

Whoever without authority imports into the United States or offers to sell, sells, or uses within the United States a product which is made by a process patented in the United States shall be liable as an infringer, if the importation, offer to sell, sale, or use of the product occurs during the term of such process patent . . .

This means that process patent protection is extraterritorial is a sense in that anything created by the patented process, subject to exceptions mentioned below, may not be used or sold in the U.S. Therefore, by having a U.S. patent, one may exclude access of the information which is the end result of a patented method of doing business to the U.S. market. For instance, if Signature had been successful in obtaining process patent protection for the HUB AND SPOKE_ system, they could prevent access of the output of this process to American mutual funds or American mutual fund users. If the Internet is contemplated as a means of distributing information which is the "product" of a process or method claim, then, given the as yet unresolved question as to whether offering information on the Internet from a server outside the United States is an infringement of the patent, this makes doing so a risky endeavor. Of course, issues of personal jurisdiction are raised in such situations.

Still further, 35 U.S.C. §271(b) states that whoever "actively induces infringement of a patent shall be liable as an infringer". There is no stipulation that this person need to be within the territorial boundaries of the U.S. when this inducement takes place. This means that the executive director of a bank who calls someone anywhere in the world for the purpose of enticing or pressuring another person to infringe the patent may also be found an infringer.

Therefore, in a global financial system, not being able to access the U.S. market may provide de facto worldwide protection in so far as economies of scale or some other business factor, such as the location of major clients in the U.S. play a significant or controlling role in a competitor's decision as to whether to deploy a similar system.

E. Conclusions and Implications:

This decision has far-reaching implications. First, of course, patents for new business methods that otherwise meet the criteria of patentability are patentable. This gives innovators a comparative advantage over "me too" competitors. To gain a perspective of the range of industries which this decision effects, consider some examples of Business Method-related Patents already granted in the U.S. (these represent the pioneering fields as these patents were filed before the State Street decision). Such patents include those granted for home shopping, smart card technology, credit card account management, e-cash/e-money, e-commerce, electronic funds transfer instruments, fail safe on-line financial systems, integrated billing systems, program trading algorithms, remote banking, home banking, back office software, insurance plans and products, artificial intelligence to aid in making underwriting and loan decisions, mutual funds, and annuity contract management. For example, in the field of Internet banking alone, 22 patents have issued. Also, more than 510 patents have been granted in the field of banking to date, most of these in the last two years.

The extent of the implications of this decision and, therefore, how one responds to them, depends on one's perspective. Attorneys should consider auditing their form contract clauses to ensure that patentability of business methods and computer software in general is dealt with in a satisfactory manner. A clause should be added (or an existing clause revised) to ensure that software development contracts deal with the question of just who owns the patent rights in the software.

If this is not dealt with, it may be possible that although a client owns the copyright in software created for them by a contractor-developer, the client may infringe a patent which the developer may obtain at some future date. In light of this possibility, if the client does not want to reserve the patent rights for himself and such rights are not dealt with in the contract, then the fact that intellectual property rights are being created for the developer at the expense of the client may be used by the client to negotiate a reduction in the price of the development services. Alternately, the software developer may wish to assign copyrights to their client but reserve patent rights. This permits the developer to rewrite the source code, thus avoiding infringing the client's copyrights, and yet it permits the subsequent filing of a patent application which describes the invention at a higher level via flow charts or via the rewritten source code. At the very least, to avoid the possibility mentioned above (that of the client's subsequent infringement of software, the development of which he funded), the development contract should make clear that a license is granted to the client which will permit the client to use the software, even after any patent for an invention, which the development process gave birth to, issues to the developer.

Also, attorneys should consider notifying their clients that it may be wise to modify their employment agreements and vendor contracts to implement a culture of confidentiality. This is because public disclosure anywhere in the world or sale or use in the U.S. together with one year's passage of time bars patentability in the U.S.

From a software developer's perspective, through the use of a properly drafted contract clause, it is now clearly possible to exploit the client's need to develop new software for the client's own use in order to develop new software for marketing to other clients. In this manner, the developer is able to transfer some of his research and development costs on to their client.

Of course, patentability is a double-edged sword. Depending on the business, it will be wise to perform a patent search to determine whether funding and implementation of a new development project might lead to the infringement of a third party's patent rights. This could be the case even where one recreates the source code completely. Certain databases are available for performing these searches, though there is likely much more software which is unavailable for searching than there is on such databases.

Business rivals may wish to take advantage of the fact that a competitor is "suppressing or concealing" business method or other software and file for broad patent protection on an independently developed means of accomplishing the same task. By doing this, it may be possible to stop an competitor despite the fact that they may have been the first to develop the software.

Investors may wish to research whether a target company is actively securing patent rights vis-ą-vis other companies in the industry. Those companies which do not own software patents could be left out in the cold in a world where having an interesting patent portfolio is critical to bringing another party to the negotiating table to obtain licenses in critical technologies via cross licensing. Companies which have no technologies to offer may simply be excluded from certain businesses.

Concerning the extraterritorial effects of U.S. patents, these simply cannot be ignored in a global business environment, particularly in a global Internet environment. Therefore, a U.S. software patent search should be performed before committing to any long-term or capital-intensive project. Further, U.S. patent protection should be sought for any technology which might afford a patent holder a global competitive advantage. In addition, in the rare case that the U.S. market is not of interest, yet implementation of a method patented by someone else in the U.S. on a portion of the Internet is of interest, consideration should be given to blocking access to the information product of the method for those who would try to access the information from the U.S. or any other country in which others have obtained patent protection.

Despite the benefits of patenting software technology, there are drawbacks. One of these drawbacks is the fact that patenting software is expensive. For those who cannot justify the investment (between 10,000 and 20,000 CHF), publication of a description of the software and of its source code may be the answer. Once the technology is published, it is no longer possible to obtain patent protection in Europe (unless a patent application was filed before publication). In the U.S., publication starts the one year grace period ticking. Anyone who files a patent application on this technology after a year from this publication, will not be able to obtain a valid patent. Today, it is a simple matter to publish software. On the Internet, for example, software may be published at no cost through the Software Patent Institute, found at http://www.spi.org, or through another organization at http://www.freepatents.org.

In sum, new business methods enabled by software are patentable in the United States. Conducting business in a global environment now offers new opportunities and potential snares. In addition to monitoring a competitors moves in the markets, one should now monitor competitor's activities before the U.S. Patent and Trademark Office. Further, it is wise to proactively plan for the eventuality of being threatened with suit for patent infringement by identifying patentable technologies with which a patent portfolio can be developed. Having a patent portfolio will give you the currency with which to bargain with others who might otherwise try to shut your vital business activities down with the threat of a patent infringement suit.

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Feel free to contact the author via e-mail at moetteli@patentinfo.net , should you have further questions.

This article is subject to copyright. Publication and distribution rights are reserved.

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