Protection and Exploitation of Financial Services Software

From Riker Danzig Intellectual Property UPDATE

Computer driven, financial services software can be patentable, even if the software does little more than calculate numbers used to manage assets. In State Street Bank & Trust Co. v. Signature Financial Group Inc.,1 issued July 23, 1998, the United States Court of Appeals for the Federal Circuit held that financial services software is patentable subject matter because it produces a useful, concrete and tangible result. This decision, which also announced that the so-called business method exception is no longer viable, has far reaching significance for the financial services industry. Financial institutions are now enabled to license internally developed software, but are also at risk for infringing financial services software patents owned by others.

Patents have historically covered a myriad of technological advances, from traction wheels for locomotive steam engines to recent developments in genetic engineering. Patentable subject matter extends to "[w]hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof...."2 Indeed, the Supreme Court has acknowledged that patents can extend to anything under the sun that is made by man.3 This expansive concept of patentable subject matter has been restricted by the courts. Laws of nature, natural phenomena, and abstract ideas are excluded from patentability on the basis that they constitute basic tools of scientific and technological work. The grant of a patent monopoly within this class of subject matter would hinder Article I, Section 8 of the U.S. Constitution, which authorizes grant of patents to "promote the Progress of ... useful Arts."4

The scope of these exceptions to patentability has been long debated. The State Street decision by a three-judge panel of the Federal Circuit Court circumscribes the exception against mathematical algorithms and lays to rest the idea that business methods are unpatentable subject matter.

Earlier Rulings on Computer Programs
The State Street ruling is a welcome decision in light of the continuing struggle by the courts to distinguish between patentable subject matter and unpatentable abstract ideas, and in particular, the notion that "mathematical algorithms" (i.e, abstract ideas) and "business methods" constitute unpatentable subject matter. The unpatentability of mathematical algorithms, and hence the unpatentability of computer software, has been particularly problematic in view of recent technological advancements in the computer industry. In early decisions, the Supreme Court established metes and bounds for patenting mathematical algorithms. The first of these cases, Gottschalk v. Benson5 , held that a method for converting numerals expressed as binary-coded decimal numbers, which was useful in devising programs for digital computers, was unpatentable. According to Benson, no patent could be obtained for a method, an essential component of which consisted of human mental participation.

This ruling was extended by Parker v. Flook6 where it was held that an unpatentable mathematical formula did not become patentable subject matter by the addition of "conventional, post-solution applications." In essence, the Court held that the discovery of a phenomenon of nature or mathematical formula cannot support a patent unless there is some other inventive concept in its application. In the final chapter of this trilogy, the Court ruled that a process for curing synthetic rubber, which included in one of its steps the use of a mathematical formula and a programmed digital computer, constituted patentable subject matter. The Court, in Diamond v. Diehr7, found that inasmuch as the subject matter was nothing more than a process for molding rubber products and not a mathematical formula, "an application of a law of nature of mathematical for mula to a known structure or process may well be deserving of patent protection."8 The Court carefully distinguished both Benson and Parker as involving attempts to patent new mathematical formulae or algorithms in the abstract.9

The Court of Customs and Patent Appeals10 struggled with the implications of these cases, eventually articulating the two-part Freeman-Walter-Abele11 test. This test poses two queries. First, does the invention recite a mathematical algorithm, formula or mental step? If not, then the subject matter is patentable. If so, the second prong is evaluated. That is, does the invention involve the application of the algorithm, etc. to specific physical elements or processes. The ramifications of this test were far-reaching: computer software was patentable only if directed to physical apparatus or process steps capable of carrying out the particular software function.12

Subsequently, the patenting of computer software was made much easier by In re Alappat.13 This case essentially relaxed the physicality requirement, holding that computer software becomes physical apparatus when run on a general purpose computer. Thus, computer software configured to run on a general purpose computer is considered to be patentable subject matter.14 As exciting as this decision was, the water was somewhat muddied by In re Warmerdam,15 in which the court iterated that what was important was not whether a mathematical algorithm was recited, but whether the process to which the invention was directed went beyond simply manipulating abstract ideas or natural phenomena. In the wake of these cases, patent practitioners were left with a series of convoluted rules to guide them in preparing patent applications directed to computer software.16

Meanwhile, the notion that business "plans" and "systems" were unpatentable abstract ideas, even though they may not be dependent on the aesthetic, emotional or judgmental reactions of a human, was coming into vogue. The earliest decision in this area held that systems for transacting business, such as bookkeeping systems, were unpatentable as being abstract and not residing in a process.17 However, this doctrine had a somewhat tortuous history because subsequent decisions, purportedly decided on the business method exception were, in fact, decided on other grounds.18 The exception has been berated as an unwarranted encumbrance to the definition of statutory subject matter.19

Thus, the stage was set for the Court to clarify the "physicality" requirement of the mathematical algorithm exception and determine whether the business method exception is a valid legal principle. The facts in State Street Bank & Trust Co. presented just the right opportunity to address these issues.

The State Street Facts
State Street Bank and Trust ("State Street") and Signature Financial Group, Inc. ("Signature") both serve as administrators and accounting agents for mutual funds. Signature is the assignee of U.S. Patent No. 5,193,056 (the "''056 patent") entitled "Data Processing System for Hub and Spoke Financial Services Configuration." The patent is directed to an investment system that allows an administrator to monitor and record financial information flow, and make all calculations necessary for maintaining a partnership portfolio and partner fund (Hub and Spoke) financial services configuration. The data processing system claimed by the '056 patent facilitates pooling of assets from various mutual funds (Spokes) into a single investment portfolio (Hub) organized as a partnership. The Hub and Spoke configuration consolidates the costs of administering the funds and also provides the tax advantages of operating as a partnership.

More specifically, the patented data processing system allows a mutual fund administrator to: 1) monitor and record the fi nancial information flow and make all calculations necessary for maintaining a partner fund configuration; 2) allocate the assets for two or more Spokes invested in the same Hub on a daily basis; 3) determine the percentage share that each Spoke maintains in the Hub; 4) consider daily changes in the valuation of the Hub's investment securities and calculate the relative value of each Spoke's assets; 5) allocate among the Spokes the Hub's daily income, expenses, and net realized and unrealized gain or loss to determine a true asset value of each Spoke and accurately calculate the allocation ratio between or among the Spokes; and 6) track all relevant data for the Hub and each Spoke on a daily basis so that income, expenses, gains, or losses can be calculated at year end for accounting and tax purposes for the Hub and for each publicly traded Spoke. The system operates on a personal computer including software capable of performing the various functions recited in the claims of the '056 patent.20

Following unsuccessful efforts to negotiate a license agreement for the '056 patent, State Street brought a declaratory judgment action in Massachusetts District Court asserting invalidity, unenforceability, and non-infringement of the '056 patent, followed by a motion for partial summary judgment for failure to claim statutory subject matter under 35 U.S.C. . 101, which was ultimately granted by the District Court. In reaching its decision, the District Court applied the Freeman-Walter-Abele test, finding that although the '056 patent claims do not directly recite a mathematical formula, the data processing system is an apparatus specifically designed as a means for solving a mathematical problem. Under the second prong of the test, the Court found that the invention provided no further physical activity sufficient to warrant patentability.21

The Court's Decision
On appeal by Signature, the Court of Appeals for the Federal Circuit ("CAFC") reversed the decision and remanded the case to the District Court. Writing for the panel, Judge Giles S. Rich first commented on the District Court's claim construction of the patent's "machine" claims written in means-plus-function form. Exemplary portions of the broadest claim (Claim 1) include a: (a) computer processor means; (b) storage means; (c) initialization means; and (d)-(g) means for processing the daily data regarding assets in the portfolio and allocating such data among each fund.22

The CAFC pointed out that the District Court construed the claims (specifically, independent claim 1) as reciting a means for solving a series of mathematical problems, i.e., a process claim, as distinguished from a machine claim, with the "means" clause comprising the various steps in the process. Only where the patent specification does not include supporting structure for the means recited in the claims should a machine claim be viewed as a process claim. Since the specification of the '056 patent included ample structural support for the means recited in independent claim 1, that claim, properly construed, defines a machine. However, the CAFC noted that the District Court's error was of no matter, as long as claim 1 falls within one of the four enumerated classes of statutory subject matter, of which "machine" and "process" were both included.

Judge Rich next addressed the District Court's conclusion that the patent claimed a mathematical algorithm or a business method, both of which were excluded from patent protection. Pointing to the expansive nature of 35 U.S.C. . 101 as well as the repetitive use of the broad term "any" in the statute, the Court concluded that it is improper to read any limitations into the Supreme Court's pronouncement that . 101 is to extend to "anything under the sun that is made by man."23 With that background, Judge Rich expanded on the mathematical algorithm exception.

The C ourt noted that not every mathematical algorithm is precluded from patent protection - only those that are nothing more than abstract ideas. Where a mathematical algorithm was reduced to a practical application that produced "a useful, concrete and tangible result," patent protection is available. Previous examples of patentable algorithms include the use of mathematical calculations to control a computer display and produce a specific output, and transformation of electrocardiograph signals using mathematical calculations.

Thus, 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 and even accepted and relied upon by regulatory authorities and in subsequent trades.24

The Court further noted that the Freeman-Walter-Abele test, has little if any applicability to determining the presence of statutory subject matter. Instead, the focus in this inquiry should be directed to the essential characteristics of the invention, and in particular, whether the invention has practical utility.

The Far-Reaching Effect of State Street
By the State Street decision, the CAFC clearly and unequivocally held that an invention involving inputting, calculating, outputting, and storing of numerical data (i.e., crunching numbers) is patentable so long as the invention produces "a useful, concrete and tangible result." This is so even where the useful result is "expressed in numbers, such as price, profit, percentage, cost, or loss," as is the case with the data processing system claimed by the '056 patent. State Street also lays to rest any continued misunderstanding as to the applicability of the Freeman-Walter-Abele test for determining the presence of statutory subject matter. After State Street, physicality is no longer a necessary prerequisite for patenting of computer driven software.

Finally, in discussing the inapplicability of the business method exception to statutory subject matter, the Court laid "this ill-conceived exception to rest."25 "Business methods have been, and should have been, subject to the same legal requirements for patentability as those applied to any other process or method."26 The mere fact that the claimed subject matter does "business" instead of something else should not be determinative of whether claims are directed to statutory subject matter. Whether patent claims are directed to business methods is not determinative of patentability. Rather, normal precepts of patentability apply.

The effect of the State Street decision will be far-reaching. What was previously considered by many as being unpatentable (e.g. financial software), is now clearly entitled to patent protection. Financial institutions can now exploit their intellectual property rights through licensing, leveraging strategic alliances and other financially rewarding means.


1 State Street Bank & Trust Co. v. Signature Financial Group, No. 96-1327 (Fed. Cir. July 23, 1998).BR> 2 35 U.S.C. . 101.
3 Diamond v. Chakrabarty, 447 U.S. 303, 309-10, 206 U.S.P.Q. 193 (1980).
4 In Diamond v. Chakrabarty, the Supreme Court explained that "[t]he laws of nature, physical phenomena, and abstract ideas have been held not patentable. Thus, a new mineral discovered in the earth or a new plant found in the wild is not patentable subject matter. Likewise, Einstein could not patent his celebrated law that E=mc2; nor could Newton have patented the law of gravity. Such discoveries are 'manifestations of ... nature, free to all men and reserved exclusiv ely to none.'" Id. at 309 (quoting Funk Bros. Seed Co. v. Kalo Inoculant Co., 333 U.S. 127, 130, 76 U.S.P.Q. 280 (1948) (citations omitted)).
5 409 U.S. 63, 175 U.S.P.Q. 548 (1972).
6 437 U.S. 584, 57 L. Ed.2d 451, 98 S. Ct. 2522, 198 U.S.P.Q. 193 (1978).
7 Diamond v. Diehr,450 U.S. 175, 67 L. Ed.2d 155, 101 S. Ct. 1048, 269 U.S.P.Q. 1 (1981).
8 187, 67 L. Ed.2d 155, 101 S. Ct. 1048, 269 U.S.P.Q. 1.
9 191, 67 L. Ed.2d 155, 101 S. Ct. 1048, 269 U.S.P.Q. 1.
10 The predecessor court to the Court Of Appeals For The Federal Circuit.
11 Gleaned from In re Freeman, 573 F.2d 1237, 197 U.S.P.Q. 464 (C.C.P.A. 1978); In re Walter, 618 F.2d 758, 205 U.S.P.Q. 397 (C.C.P.A. 1980) and In re Abele, 684 F.2d 902, 214 U.S.P.Q. 682 (C.C.P.A. 1982).
12 This was accomplished by writing "means-plus-function" language into the patent claims defining the invention. "Means" language is authorized under 35 U.S.C. . 112, paragraph 6, as a way to include the means disclosed for performing a function as well as equivalents thereof.
13 33 F.3d 1526, 31 U.S.P.Q.2d 1545 (Fed. Cir. 1994).
14 However, the patent application claims must be drafted in means-plus-function language.
15 33 F.3d 1354, 31 U.S.P.Q.2d 1754 (Fed. Cir. 1994).
16 See e.g. Turkevich, In re Alappat: The End of 'Mathematical Algorithm' Confusion?, 11 Computer Lawyer 1 (1994).
17 160 F. 467 (2d Cir. 1908).
18 See e.g. In re Howard, 394 F.2d 869, 157 U.S.P.Q. 615 (C.C.P.A. 1968) (finding that patent claims invalid for lack of novelty and therefore did not have to reach the issue of whether a method of doing business is inherently unpatentable).
19 In re Schrader, 22 F.3d 290, 296-98, 30 U.S.P.Q.2d 1455 (Fed. Cir. 1994) (Newman, P., dissenting). 20 State Street, supra, slip op. at 2.
21 "Quite simply, it involves no further physical transformation or reduction than inputting numbers, calculating numbers, outputting numbers, and storing numbers. The same functions could be performed, albeit less efficiently, by an accountant armed with pencil, paper, calculator, and a filing system." 927 F. Supp. 502, 515, 38 U.S.P.Q.2d 1530 (D. Mass. 1996).
22 State Street Bank & Trust Co., supra, slip op. at 3.
23 Diamond v. Chakrabarty, supra, 447 U.S. at 309-10, 206 U.S.P.Q. 193.
24 State Street Bank & Trust Co., supra, slip op. at 5.
25 Id. at 6.
26 Id.5.