Will Robo-Advisers Raise the Ire of Patent Trolls?

Legal wrangling over intellectual property may make life tougher for online wealth managers.


The juror box sits empty in the Los Angeles Superior Court courtroom in Los Angeles, California, U.S., on Thursday, Sept. 13, 2007. A jury began deliberating on Sept. 10, whether music producer Phil Spector is guilty of second-degree murder in the 2003 shooting death of former actress Lana Clarkson. Photographer: Jamie Rector/Bloomberg News


Last month a lawsuit filed by GRQ Investment Management against Financial Engines caught the attention of market participants tracking the rise of so-called robo-advisers. Co-founded by legendary economist William Sharpe, Financial Engines is a Sunnyvale, California–based online adviser focused on defined contribution pension plans and individual investors; it has $824 billion under administration and $92 billion under management. Plano, Texas–based GRQ alleges that the firm has infringed upon GRQ’s patents on systems used to provide computer-based advisory services (see also “As Robo-Advisers Gather Assets, the Model Remains Unproven”).

The suit, filed in U.S. District Court for the Eastern District of Texas, is the latest in a string of intellectual-property cases that may affect the business models of online automated advisory firms. In 2011 Wealthcare Capital Management, a Richmond, Virginia–based registered investment adviser and the owner of software provider Financeware, sued Swiss bank UBS, claiming patent infringement on financial planning methods used in Financeware’s platform. The claim revolved around third-party software that UBS financial advisers used to create financial plans for individual clients. UBS surprised the financial community when it opted to settle the dispute out of court, along with PIEtech, the bank’s software vendor, for an undisclosed sum.

These and similar legal actions could cause problems for the rapidly emerging online advisory sector because they are attempts at defending patents that are partly based on methodology. The fear is that broad interpretations could include business practices previously considered immune to claims of intellectual-property theft. For advisers using software to automate asset allocation and financial planning, even programs developed in-house with unique coding may accidentally overlap with a patent.

Financial services aren’t the only industry facing increased legal action by intellectual-property portfolio managers, also known as patent trolls, which acquire existing patents to enforce them when allegedly infringed upon by companies with business operations. The number of suits filed in the U.S. by patent trolls climbed to 3,134 in 2013, according to data provider PatentFreedom, a part of San Francisco–based RPX Corp. That tally was almost 20 percent higher than in 2012 and accounted for more than half of the year’s patent infringement suits.

In a 2013 report to U.S. Congress, the Government Accountability Office found that the surge in litigation was largely driven by the fact that “software-related patents often had overly broad or unclear claims.” The report also noted that “the potential for large monetary awards from the courts, even for ideas that make only small contributions to a product, can be an incentive for patent owners to file infringement lawsuits.”

Patent litigation can have a disastrous impact on smaller firms. “There are companies whose sole purpose is to sue anyone that might infringe on a patent from a nonoperating company,” says John Frankel, founding partner of ff Venture Capital. “This creates quite a dynamic for a start-up, and patent litigation can end up being an unfair burden on them,” adds Frankel, who launched New York–based ff to focus on early-stage investments after spending more than two decades with Goldman Sachs Group.

Some critics argue that the bigger threat of overzealous intellectual-property defenses is the risk of stifling innovation. “Technological or other innovation in our industry is never the result of huge investment or back-breaking intellectual effort that should be rewarded with exclusive use of the invention to the extent that it forecloses others from inventing similar things and thereby slows our progress,” contends Thomas Peterffy, founder and CEO of Interactive Brokers.

Peterffy generally frowns on the awarding of patents in the financial services industry, but as a defensive measure, his Greenwich, Connecticut–based online brokerage has applied for several of its own to cover proprietary technology that it provides to clients for free. Many litigious intellectual-property owners don’t actually provide goods or services, he notes.

“I am especially opposed to patent protection for inventions that are not actively used by their inventors,” says Peterffy, who in the 1970s and ’80s played a key role in the development of electronic trading of securities and the adoption of algorithmic trading models, particularly for derivatives. Interactive Brokers, which has existed in its current form since 1993, has more than 800 staff and some 268,000 customer accounts.

Although concerns over intellectual-property suits in the financial services industry may be justified in the near term, legal experts note that recent case history could favor operating companies. “The Supreme Court opinion in Alice Corp. v. CLS Bank is an important decision relating to the patentability of software,” says David Schwartz, professor of law and co-director of the Center for Empirical Studies of Intellectual Property at the Illinois Institute of Technology’s Chicago-Kent College of Law. “However, the effects of the decision, which came out in June of 2014, will take some time to sort out.”

The U.S. Supreme Court quashed Alice’s lawsuit against CLS Bank International, a New York–headquartered specialist in currency settlement services, ruling that its claims for a patent governing software that manages electronic escrow funds transfer were vague to the point of abstraction. According to Schwartz, the case will have an important bearing on similar suits. Until the courts offer more clarity, though, online advisers appear to remain vulnerable to attempts to enforce older patents.

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