Assessing the patentability of financial services and products.

• Author: Price, Douglas L.
• Position: Report

1. INTRODUCTION

   This paper examines the patentability of business methods, specifically those that are related to financial products. Traditionally, business methods have been excluded as unpatentable subject matter under 35 U.S.C. [section] 101. (1) In the late 1990's, State Street Bank & Trust entered negotiations with Signature Financial Group, Inc. for a license on a patented method of valuing a Mutual Fund product commonly known as a Master-Feeder fund. (2) When negotiations broke down, State Street challenged the validity of that patent. (3) The appellate court decision examined two exceptions to patentable subject matter: the mathematical algorithm exception and the business method exception. (4) The court ruled that a mathematical algorithm by itself is an abstract idea, and not patentable, but when it is used to yield a useful, tangible result, it is transformed into patentable subject matter. (5) The court went on to vitiate the business method exception, and stated that business methods are patentable if they satisfy the normal prongs for a patent: subject matter, utility, novelty, and nonobviousness. (6)

   The State Street Bank & Trust Co. v. Signature Financial Group, Inc. case, which has been extensively commented on, caused a tremendous uproar in the patentability of business methods, particularly in the financial industry. Since this 1998 decision, there has been a flood of patents submitted for business methods. While the Federal Circuit Court of Appeals intended to clarify business method patent law, the State Street decision served to further obfuscate this area of intellectual property jurisprudence, and may potentially have profound ramifications on our financial markets.

2. HYPOTHESIS

   Should business methods be patentable? This question cannot simply be answered in the affirmative or negative. This area of law is highly controversial because it is all based on a matter of degree, and is highly subjective. All legal conundrums share the same problems of ambiguity, but this body of law is fundamentally problematic and difficult to predict.

   By way of illustration, a Mutual Fund is simply a company, just like IBM or General Motors. The distinction lies in that while most companies produce a product or service, all that a mutual fund does is make investments, so it is referred to as an Investment Company. A typical open-end mutual fund obtains it price per share, or Net Asset Value ("NAV") by the following formula: Total Net Assets divided by Shares Outstanding. (7) The formula itself is not patentable subject matter. It is simply an abstract idea and falls under the mathematical algorithm exception, whereas a method by which a custodian, such as State Street, uses to compute a NAV, will likely be patentable. (8) The line of demarcation is extremely blurry, and this paper will survey the scope of patent rights as it pertains to various financial products.

3. PATENT LAW 101

   Patent law, like so many other areas of codified law, begins broadly and then carves out exceptions. (9) The field is analogous to Income Tax Law in which Section 61 of the Internal Revenue Code defines income as "income from whatever source derived," and then goes on to clarify and create exceptions in case law and regulations. (10) In general, for a patent application to be successful, it must meet three requirements of: patentable subject matter, novelty and nonobviousness. (11) Much of the controversy surrounding the threshold patent requirements focuses on the determination of what is patentable subject matter.

   The United States Code defines patentable subject matter stating, "whoever invents or discovers any useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefore, subject to the conditions and requirements of this title." (12) Thus, Congress lays out the four main categories of inventions that are patentable subject matter. (13) The Supreme Court then goes on to exclude laws of nature, natural phenomena, and abstract ideas from patentable subject matter. (14) The mathematical algorithm exception and the business method exception flow from these exceptions, both of which have been completely revamped. (15)

   1. Business Method Exception

      The business method exception, a judicially created exception, basically states that methods of doing business do not fall within any of the four categories of statutory subject matter. (16) For years this exception provided a bright-line rule to measure what is patentable subject matter, although the rule was tenuous at best, since it was created in dictum. (17)

      The genesis of the business method exception is found within the Hotel Security case. (18) In this case, a method of handling order slips in a restaurant was patented. (19) The purpose of this method was to "prevent fraud and speculation by waiters and cashiers in hotels and restaurants." (20) The court determined that this method of handling order slips was something that was already practiced in the restaurant business, and therefore, invalidated the patent because it lacked novelty. (21) The court also stated that this patent would not pass muster under the obviousness element, because this process was sure to have naturally evolved in the restaurant business. (22) The patent in this case fails due to lack of novelty and nonobviousness, but the court then goes on in dictum to state, "A system of transacting business disconnected from the means for carrying out the system is not, within the most liberal interpretation of the term, an art." (23) From this dictum, the courts formed this ethereal rule to guide them on many patent cases. Thus, although it appears on its face that the business method exception is a precedent which can guide inventors seeking patent protection, in reality it is a vague and amorphous concept which most courts simply side step by invalidating patents based on other exclusions. (24) Indeed, even before 1998, there were many indications that this exception was weakening. (25)

      Other cases followed to support the business method exception. In the case Loew's Drive-In Theatres v. Park-In Theatres, the disputed patent involved a system of parking cars in an open lot so as to maximize the viewing of the movie screen without obstruction. (26) The court held that although a novel idea existed, a physical invention or manifestation is required for a patent to be valid. (27)

   2. Mathematical Algorithm Exception

      The mathematical algorithm exception to patentable subject matter comes from the notion that a mathematical formula or theorem, such as E=M[C.sup.2] is not patentable because it is merely an abstract idea. The exception begins with the Benson case, in which the disputed patent involved a method of converting binary-coded decimal numerals into pure binary numbers. (28) The Supreme Court invalidated this patent, because the process did not transform one thing into another tangible result. (29) The court stated that an idea, in and of itself, is merely an abstract concept and not patentable subject matter. (30) As a policy matter, the court feared that granting a patent such as this, "would wholly pre-empt the mathematical formula and in practical effect would be a patent on the algorithm itself." (31) Thus, the court appeared concerned with the slippery slope that such a precedent would create which would inhibit invention by not allowing inventors to use various math formulas.

      Next to follow was Parker v. Flook, concerning a patent claim for a mathematical algorithm that calculated alarm limits for a chemical process. (32) The process did not affect the means of setting off the alarm, but was only novel in the sense that it described a better method to calculate these limits using a known mathematical algorithm. (33) The court extended the Benson case to exclude not only mathematical algorithms, but also the processes that utilize them. (34) The court notes that the mere inclusion of a mathematical algorithm as part of the invention does not invalidate it, but when the invention itself is merely the application of the algorithm, it is invalid. (35)

      The last in the trilogy of cases to come down on this subject is Diamond v. Diehr. (36) Diehr involved a patent for a process of molding raw synthetic rubber into refined products. (37) The process employed a computer using a mathematical formula that controlled the molding process so it would work more effectively. (38) The Supreme Court held the patent valid, stating, "when a claim containing a mathematical formula implements or applies that formula in a structure or process which, when considered as a whole, is performing a function which the patent laws were designed to protect (e. g., transforming or reducing an article to a different state or thing), then the claim satisfies the requirements of Section 101." (39) Although this case was not explicit as to how it should be reconciled with Benson and Flook, it suggests that when an algorithm is part of a process that produces a physical result, in this case an industrial product, it should be patentable.

      Over the next several years, the Court of Customs and Patent Appeals attempted to formulate an improved test for determining the scope of the mathematical algorithm exception. (40) The test was the synthesis of three cases known as the Freeman-Walter-Abele Test. (41) The first step in the test is to determine whether a mathematical algorithm is directly or indirectly cited as defined in Benson. (42) Next, if an algorithm exists, the court will examine whether it applies to a physical element of the claim or if the patent claims the algorithm itself. (43)

      The Federal Circuit laid out the last permutation of the mathematical algorithm exception in Alappat, in what is sometimes referred to as the "Means" Test. (44) The patent in this case consisted of a mathematical algorithm that processes data from an electrical input in a...