Business method patents: good or bad for the U.S. financial services?

PaymentNews pointed to a research paper title “Business Method Patents and U.S. Financial Services” authored by Robert M. Hunt of the Philadelphia Fed.

As any researcher in knowledge economics would know, maximizing the value of knowledge for society is a difficult problem:  on one hand, you need to provide the proper incentives for innovators to invent (typically a patent system that provides a time-limited monopole), and on the other hand you want this knowledge to be used as fast as possible by as many people. Finding the right balance is not easy. This is a subject I’m really interested in, and business method patentability is a very interesting on its own, so I went through the paper. Here are my notes.

Here is the most important part IMO from the conclusion:

There is at present very little evidence to argue that business method patents have had a significant effect on the R&D investments of financial institutions. It is possible that the availability of business method patents has encouraged more entry and R&D by start-up firms or more efficient trading of technologies. At present, however, these represent intriguing possibilities and not outcomes that have actually been measured. In short, we still cannot determine whether financial patents are creating value for the U.S. economy.
The combination of significant technological overlap among firms, elastic patent boundaries, inadequate enforcement of disclosure requirements, and weak patentability standards raises at least the theoretical possibility of perverse outcomes (Hunt 2006). In such environments, firms may obtain more patents but perform less R&D, since the fruits of such efforts would be subject to an innovation tax imposed by rival firms.

My thoughts:
I think this area of patents is still evolving and regulators are still learning how to best optimize the value of the U.S. economy of patent issuance. There is a risk that startups be issued business method patents that other FIs license only to see themselves fought to death by large FIs in court. I don’t think it will be a big problem for niche markets, but it would be interesting to see what a court would decide if consulted on the non-obviousness of a business method patent issued to a small firm and which possibly has a huge impact/potential to many large FI players.

More excerpts:

A decade after the State Street decision, more than 1,000 business method patents are granted each year. Yet only one in ten are obtained by a financial institution. Most business method patents are also software patents.

That’s 10 business methods per year coming from a FI. Wow! The remainder of the article is basically trying to explain why these numbers are so low. Probably most of banking related business method patents come from startups (ex. SmartyPig has a patent on their business method).

Financial exchanges and the central bank are more research intensive than credit intermediaries (banks and thrifts).

I don’t think that will come as a surprise to anyone. I wrote earlier about the innovation problem at banks (I should have precised credit intermediaries as I’m well-aware that innovation is thriving in the investment side of banks).

Number of financial industries rely heavily on standard setting arrangements esp. payments networks and financial exchanges.

The article seems to imply here, if my understanding is correct, that business method innovation requires multiple parties to implement it, which means it’s hard for any one party to patent it at the same time that it seeks others to use (license if it’s a patent). That’s as if you had to pay to use a standard…

Lerner (2006) finds that business method patents are litigated at a rate 27 times
higher than for patents as a whole.

The reason for this is that the legal aspects of business methods patentability is still evolving. This might be another reason why business patents are few. It’s easier to keep them as good old trade secrets when possible, than try to patent them only to have to pay an army of lawyers to litigate them.

The article also talks about the legitimacy of licensing a patent and fighting in court in validity at the same time.

3 thoughts on “Business method patents: good or bad for the U.S. financial services?”

  1. An often overlooked result of BMPs, especially in the financial sector, is the disincentives they create for new companies to enter markets and, inversely, the patent trolls they help to create. BMPs have the unfortunate effect of allowing seemingly obvious processes to be protected–this can create a prohibitively expensive barrier to new companies entering new industries. If companies do not double check each and every seemingly obvious process, they could very well end up infringing.

    The other effect is to create patent trolls. Companies, especially in the immediate aftermath of State Street, had every incentive in the world to grab as many BMPs as possible and then use those to become a company whose only business lies in litigating against “infringers.” An excellent example is the company DataTreasury out of Plano, TX. This company was once involved in bio-technology, but immediately after State Street nabbed several very generically worded business method patents on the process of scanning checks electronically. After Congress passed a law in 2003, The Check 21 Act, which sought to make the entire financial industry switch from paper check processing to electronic processing and transfer, DataTreasury pulled out their patents, fired 98 of their 100 employees, hired the largest law firm in Texas, and ever since their only business has been in suing banks who are trying to comply with Congress’ wishes. I bring up this example because 1) it is a textbook case of the problems with BMPs in the financial sector, 2) Congress recently requested a GAO review of DataTreasury. This is a clear sign DC is considering acting at least on this specific case.

    There was a Politico article a couple of weeks ago on this review:

    Anyway, just wanted to provide a different angle on the issue

  2. @Mar the first aspect you mention (loose boundaries of BMPs and the resulting increased risk of accidental infringement) in your comment is talked about towards the end of the paper. The author uses the metaphor of a territory with fluctuating boundaries leaving visitors with uncertainty as to whether they are on the good/wrong side of the boundary. What the author says is that creates incentives to patent and disincentives to innovate. I think this is what you are describing.

  3. I just read that story on Policico about the Texas-based DataTreasury and there seems to be uncertainty about that is going on there. Because, as Guillaume clarifies, the boundary for BMP is obscure DataTreasury has ravenously held to their patents and it has definitely decreased innovation for the financial sector. It seems like this company is using patents to bully the financial sector while being very secretive about what they are doing. The Politico story talks about an upcoming GAO review that will hopefully shine light on what is actually happening. I wasn’t quite sure what to think about BMP but having seen how they work in practice, it is obvious that they are a bad idea and that they disincentivize innovation.

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