Industry Set to Battle Patents via Courts, Rewrites, M&A

The Illinois Supreme Court’s recent rejection of an appeal by the International Securities Exchange marked the final nail in the coffin of a long-running dispute between ISE and the Chicago Board Options Exchange and others, in which ISE sought to list options on the S&P 500 and Dow Jones Industrial Average indexes, which are licensed exclusively to CBOE. Ultimately, the courts ruled in favor of CBOE, upholding previous decisions that allowing ISE to list options on the indexes would infringe the index providers’ intellectual property.

In this case, the IP of content itself was in dispute. However, with so much value now embedded in communications technology and data delivery mechanisms, disputes are now arising over the IP of technologies used to distribute data as much as the data itself.

“Normally, when licensing data, the concern is more about the IP rights of the content. But now, companies are also concerned about the mechanism by which the data is delivered, so I would be looking to add language to a contract that encapsulates this,” says Mauro Viskovic, partner at Kranjac, Manuali & Viskovic, who specializes in corporate and securities law, including the structuring of contracts between data suppliers and clients.

For example, the infringement lawsuit brought against users of the FIX-FAST data compression protocol by IXO/Realtime Data is forcing exchanges and firms to abandon the standard and suffer the effects of higher bandwidth consumption, for fear of exposure to litigation. CME Group, for example, which has been heavily involved in efforts to develop data standards that mitigate the cost impact of rising derivatives data traffic, is removing certain field operators that might be subject to the litigation from its FAST deployment—a task that should be complete in early November.

Daniel May, director at Chicago-based low-latency technology vendor SpryWare and co-creator of the FAST Protocol (along with Swedish developer Pantor Engineering), was understandably upset at the exchanges’ decisions to abandon the protocol, criticizing how patents and IP are governed: “This highlights the completely dysfunctional state of the US patent system, one that allows ‘patent trolls’ to extort legitimate businesses…. [Meanwhile] firms are reverting back to code and algorithms that are decades old, and using archaic methods solely because they pre-date thousands of dormant patents that ‘may’ one day become a liability,” he said (IMD, May 21)

Paul Schaafsma, principal at NovusIP, a Chicago-based law firm that specializes in IP and patent law for the finance and technology sectors, says the patent system and the complexity of processes being patented may unwittingly stifle innovation and lead to inferior developments. “Sometimes people design around a patent [to avoid infringement]… and end up with worse technology as a result,” Schaafsma says.

For example, removing certain fields from FAST may save users from costly litigation but lead to less efficient data compression and higher bandwidth costs, whereas exchanges initially played down the lawsuit’s role in the changes, saying that cheaper bandwidth made compression less important.

“I would have to disagree that compression is no longer needed,” says an executive at a FIX development vendor. “It depends on the use case: If you have access to lots of venues, then bandwidth is not that cheap, so compression becomes important because you don’t want to spend a lot of money on getting data—especially if your strategy depends on getting data from a lot of venues.”

Sources say CME is disputing the litigation—though officials decline to comment on this, saying only that the exchange is focused on developing a replacement data distribution protocol.

“Looking to the future, we are evaluating replacing the FIX-FAST protocol entirely,” says Ari Studnitzer, managing director of enterprise architecture at CME Group. “The OPRA-connected exchanges have already announced their migration from FIX-FAST to an OPRA proprietary protocol. And we are cognizant that the value of an industry protocol is in its acceptance by the industry at large. If CME is the only exchange using it, then it’s not an industry protocol, so if customers are moving away from it, there’s no point in us using it, either.”

However, Studnitzer says any new data protocol will—far from featuring inferior workarounds—improve performance over FAST.

“Some of the disadvantages of FIX-FAST, including the time delay associated with encoding and decoding, will be addressed by CME Group’s new protocol, perhaps with a binary datafeed. This will be based on the new binary protocol being developed within FIX Protocol Limited to promote broad acceptance and cost savings for our customers, as we don’t want to go back to each exchange having proprietary protocols that don’t deliver value for customers,” he says. “The new protocol is in development and we are targeting late 2013 or 2014 for implementation.”

At an Enterprise Technology Summit organized by Bloomberg Link earlier this summer, panelists debated not only the potential for patents to drive lawsuits and influence new development, but for them to drive M&A activity, too, by acquiring companies with existing lineups of patents that cannot be challenged by competitors. That ability to make focused, strategic acquisitions around IP can be a competitive advantage for companies with the resources to take advantage of it—though companies should use M&A-acquired patents judiciously rather than as a revenue-generator, said Ned Hooper, chief strategy officer at Cisco Systems.

“The reason for protecting patents is that we spend billions of dollars each year developing our product portfolio… [but] we don’t monetize those patents, apart from through selling our products,” Hooper said.

Companies without the resources to acquire patents may ally with larger companies with a track record of innovation and sharing access to open standards. “I’m hoping that the trading community can try to make better choices about the technology out there and align itself with technologies backed by large players,” says the FIX developer. “For example, one technology that has come up in discussions at FPL is protocols developed by Google—and the good thing about that is that you have an 800 lb gorilla behind it.”

For others, the solution is to demand indemnification from suppliers—and use other suppliers if incumbents refuse to offer protection. “When representing customers… I always look for a representation that nothing [in a vendor’s service] violates any third-party patents, and that they will indemnify the client if something comes up,” Viskovic says, adding that if a vendor declines, clients should decide whether that vendor’s content or service is worth the risk.