The number of patents on investment instruments, including derivatives, is growing rapidly and lawyers and bankers are split over whether this will encourage firms to spend more time and money researching new instruments or whether it will prevent the development of liquid markets. Derivatives-related pending patents include one for an automated over-the-counter derivatives trading system, a method and device for evaluating financial derivatives using sparse grids and derivatives trading methods that use a variable order price and a hedge transaction. In addition, derivatives giants, such as JPMorgan, have sought to protect innovative trades, in its case the Microsoft employee options trade, by filing for patents. Stephen Glazier, a partner with Kirkpatrick & Lockhart in Washington, D.C., estimates there are thousands of financial product patents issued or pending.
Firms that patent innovative products can prevent competitors from using them for 20 years. "The owner of a patent can, in effect, have a monopoly on that financial product," said Glazier. "You're going to see players in the financial industry develop patent portfolios, which they have never done before, and try to make them a profit center," he said.
John Squires, chief patent counsel with Goldman Sachs, said licenses typically go at rates at which most firms would be willing to pay. At the same time, patent holders can limit license distribution to ensure the cost of making the product is worth the benefits it returns. "If the product is instantly out the door and commoditized, the equation becomes difficult to justify," said Squires, explaining that Goldman Sachs's non-qualified deferred compensation plan liability hedging would not have been produced without patent protection.
Although protecting an idea sounds good in practice, some bankers think it won't catch on. Eric Glicksman, a managing director in the equity-linked products division at Wachovia, thinks there are too many hurdles and resources needed in this licensing game. "Firms just won't do it," he said. Rather than obtain a license, a firm will get legal advice on how to tweak its competitor's product. Investors whose primary relationship manager is at one bank won't defect to another based on its claim to patented products. So, in all likelihood, no one will end up in court over this, he said.
In addition, Glicksman said patenting derivatives will stifle innovation. Glazier said, "Patenting stifles copying innovation and promotes making innovation."
"Some banks have looked internally for patentable products, just in case firms start attacking one another," said Scott Kursman, v.p. of the Securities Industry Association. "But no one is looking to prosecute these patents."
In theory, patenting products shouldn't affect the status quo, Squires said. Patented products are new and do not take from what is already out there. "But there is often a divergence between theory and practice," he said.
