The news is in: London is in the throes of an economic boom and many believe the City has replaced Wall Street as the centre of the international financial services industry. Much of this is the result of a regulatory regime that is perceived as being flexible and workable, and thus a welcome antidote to the stringent Sarbanes-Oxley legislation in the US. But whatever the exact cause, there seems little doubt that the UK capital is enjoying a tremendous surge in the volume of deals it handles.

The risk radar

We have mentioned the benefit of forethought in relation to IP risk analysis. Figure 1 is a chart that UBS has suggested to monitor and assess its risk. This kind of regular review and analysis enables the bank to identify and assess potential risks early and to undertake a strategic remediation of those risks. Experience shows that if the right internal and external personnel are involved (including industry experts, software and product developers and, of course, lawyers), risk can be minimized and benefit enhanced. It could be adopted in many other areas. Figure 2 is an example of the way in which a risk radar might be constructed. Once an IP-related risk has been identified and its magnitude (which is a function of both its likelihood and its severity) assessed, it will be assigned to a specific section of the radar that reflects its status. The way we have placed the risks in each section is one possibility only. The placing will, of course, vary depending on the exact nature of any individual issue at hand. Risks will need to be evaluated continuously in order to be accurately categorized and for appropriate resources to be allocated to the task of reducing or eliminating them. Generally, we would expect few IP risks to threaten the survival of a financial institution's business, although such threats can and do occur. The premise of the risk radar is relatively simple: if more risks appear in the red or amber sections, the way in which the business is run may need to change. The goal of any risk manager will be to move identified risks from the right side of the radar to the left – with the ultimate aim of eradicating them altogether. Figure 1: Risk management Figure 2: Risk radar

At the heart of London's success are its financial institutions. While they are not traditionally viewed as IP-heavy businesses, much of their strength comes from the wealth of knowledge and expertise that they have amassed over the years: from know-how relating to the ways they do business, to the software used to calculate the smallest fluctuation in commodities being sold thousands of miles away, to the way in which such information is presented to customers. It is easy to see how the presence (or absence) of appropriate IP rights could have severe consequences. For example, what would happen to a financial institution if it was prevented by a court from using a crucial patented technology in a trading system, if it lost the right to use its brand name, or if it was barred from trading in derivatives that were based on (and named after) a proprietary market index?

As every risk manager knows, it is when things are going well that people are most tempted to cut corners. The best-practice guide, carefully crafted to minimize risk in slower times, is pushed to one side as the deals roll in and the deal-makers increasingly begin to see compliance as an irritating brake on the wheels of their profitable activities. The nature of global business means, however, that the impact of an IP disaster would be felt not simply in one territory, but across the entire spectrum of a bank's international operations. Banks must be alive to the IP risks that exist in different jurisdictions – for example, some jurisdictions (notably the US) are much more inclined to grant patents in respect of software and business methods. The fact that no such patent exists in the UK might not help the bank in question if a part of the patented transaction or system is based in one of those jurisdictions.

This article outlines some of the IP-related risks that are present in today's markets and on which the authors have advised recently. We have attempted to weight the general risks we discuss, although it will always be necessary to carry out a rigorous evaluation of each threat. We have also suggested methods for representing such risks graphically, using ideas made available to us by Rupert Jolley and the UBS legal and compliance team, to whom we extend our grateful thanks.

Patent trolls

Corporate entities that procure patents in order to license them, rather than to use them to manufacture products or supply services (so-called patent trolls), have occupied a prominent position on IP radars worldwide over recent years.

While no one can quite agree on the definition of a patent troll, the consequences of an attack are quite clear and alarming. Patent trolls infamously use the threat of an injunction to extract exorbitant licence fees from alleged infringers, in the knowledge that even a small risk of an integral system being shut down can be enough to force a monetary settlement. Even if the threat of an injunction does not exist, the risk of being forced to pay, for example, an account of profits generated by the use of the patented technology, or a hefty royalty for using an existing IT system, is unappealing. Add to this the high costs of any patent infringement litigation, the uncertainty of being able to develop a work-around, and the need to spend valuable personnel time on what should be historic issues, and the reasons why many alleged infringers are tempted to settle are obvious. But settlement is seldom a long-term solution, since it simply encourages similar threats in future. Managing exposure to patent trolls has therefore become a key concern of legal departments the world over. A number of tactics can be employed to avoid having any contact with them and to mitigate the damage that they can cause (such as freedom to operate checks, initiating official opposition or re-examination procedures, strategic licensing and obtaining patent infringement insurance where available). In those cases where such contact is unavoidable, normal strategy becomes a matter of taking good legal advice to ensure that your litigation tactics are suited to the challenge of fighting the troll. This can be a costly business, but one that is justified given the severity of the risks to a business.

It is clear that businesses must obtain proper advice relating to the patent terrain in all key jurisdictions in which they operate in order to avoid patent trolls. Since the worst case scenarios – temporary/permanent injunctions that affect business critical software and/or damages or an account of profits – have an immediate and dramatic effect, we have placed patent trolls as a potentially high risk in our radar.

Licensing data/indices

The explosive growth of derivatives markets in recent years has given rise to one of the hottest IP topics of the moment. Derivatives are priced by reference to an underlying asset, which is often an entire market. As such, a market index is often chosen as representing that market.

To take an example, a particular derivative might be based on the hypothetical PM100 precious metals index. This gives rise to a number of IP issues. First, the term "PM100" would most likely be a registered trade mark of the company behind the relevant market (say, the PMDAQ). That company might object to a rival marketing a product with a name that is the same as/similar to their registered trade mark and might be able to stop that use. Secondly, the underlying data making up the PM100 index would be controlled by the company behind the PMDAQ, and they might well regard it as proprietary. Although the index values themselves might be publicly available, the use of this data could be protected by the IP rights (such as rights in confidential information, databases and copyright) of the market-maker.

The underlying issue is clear; the market-makers do not want others to use their market data to set up secondary products or markets without appropriate payment, yet they do not want to be prevented from using third parties' data themselves. It is tempting to think that it is unlikely that a challenge would be brought, as many financial institutions cross-license data (a result which benefits all those who can bring something to the table). However, the stakes have recently been raised for bourses across Europe as a result of the expansion of rival trading platforms such as the so-called "Turquoise" project to set up a rival equities trading platform. These platforms will give rise to their own market data and it remains to be seen how the banks involved will set about protecting that data from, and licensing it to, others.

As competition increases and profit margins become ever more vulnerable, these are ripe areas for disputes. The use of trade marks can usually be kept within legal bounds with sufficient forethought. We have given these a low risk rating. Use of data involves far more complex facts and law, and an interim injunction to stop a new launch at the last moment could have disastrous financial and reputational consequences. We have therefore given these a high risk rating.

Funds and trade mark issues

One IP issue that crops up frequently for financial arrangers and investment companies is that of names which can be used for investment vehicles and funds. Where a special purpose vehicle (SPV) is to be set up, are the available names limited only by what company names have already been registered at Companies House? Or are registered and unregistered trade marks also of relevance? The answer, of course, is the latter, but this is often something that is overlooked by financiers (and even finance lawyers).

To take the example of an SPV that issues bonds as part of a securitization, this company will take a particular corporate name, which will also appear on the transaction documents and the bonds that are to be issued. If the company is unlucky or imprudent (or both), it might discover that the chosen name has been registered as a trade mark for a relevant class of goods or services. The owner of that mark might, at any stage in the transaction, pop up to demand licence fees for the use of the trade mark. In the absolute worst case scenario, these demands could be backed with the threat of an injunction requiring the arranger to change the issuer's name and postpone the launch of the securitization. In the case of an investment fund, money spent on advertising that fund would be entirely wasted in the event that its name subsequently had to be changed in order to deal with a trade mark infringement issue.

While the above outcomes are unlikely with proper forethought, this is clearly a case where it is better to be safe than sorry. We have therefore classified this risk as medium in our radar.

Regulatory run-ins

Today's international financial institutions often assume an intricate role in their clients' businesses, acting not only as lenders, but also as company advisors, co-sponsors and underwriters. They amass a great deal of information on both their clients and the industries in which they operate, much of which is confidential. The complexities surrounding financial institutions' obligations under data protection laws and their duties of confidence to their customers have been thrown into sharp relief by the recent spate of subpoenas issued by the US Department of Justice (DoJ) in connection with a wide-ranging investigation into internet gambling.

Despite the fact that online gaming is not illegal in many jurisdictions outside the US and that most of the banks and businesses that have received subpoenas are publicly traded in London or other European countries, the DoJ is demanding the bank records, emails and other documents concerning the financial institutions' clients. Armed with comprehensive investigative powers, the US authorities appear to be unconcerned by the fact that a great deal of the data is held in Europe, not in the US, where most of the institutions also have offices. Such data, of course, is protected by both European and national legislation concerning when, and to whom, it may be disclosed.

The banks therefore find themselves facing a dilemma. The high-profile series of arrests of gambling companies' principals in various US states has revealed just how seriously the DoJ is taking its investigation and has rendered anyone on the receiving end of a subpoena extremely nervous. On the one hand, they must uphold whatever duties of confidentiality they may have towards their clients and may also be under a statutory obligation to inform them of the disclosures they are being compelled to make. On the other, a recipient of a subpoena could suffer serious consequences if it were not to deal appropriately with its demands. It remains to be seen how this situation will be resolved, but it is clear there is a need for very careful consideration of all the issues. The potential for damage to the institution's crown jewel, its reputation, is plain.

The severe penalties that can be imposed on a company for failing to comply with its regulatory obligations (including criminal sanctions against individuals within that company) means that potential regulatory issues will normally be classed as a medium to high risk on an IP radar.

Defensive patenting

A recent article in the Financial Times in the UK (Banks lay traps for copycats, January 8 2007) focussed on the patents arms race that has ensued following a decision by the US courts in the late 1990s (in the State Street case) that allowed business method patents in the US. As mentioned above, the position is different in Europe, but the question is whether banks and financial institutions should nonetheless be making every effort to register patents wherever and whenever they can in order to have a counter-attack ready in the event of litigation. Many would argue that they should.

In the US, and, with careful drafting, in Europe, patents can be obtained to protect business methods and software, two of the key assets which make financial institutions profitable. New financial products become well-known, and therefore open to competition, within a very short time after their launch. Patenting the innovative aspects of IT systems and financial structures is, where possible, a means of protecting a competitive advantage. Patents are a public notice to third parties that an institution is claiming a monopoly right to an idea. Their ability to prevent competitors from using that idea, even in a different form, goes beyond the protection afforded by copyright and rights in confidence. Patents are a powerful weapon in rapidly developing markets, first to keep a competitive edge, and then as a bargaining chip when an institution is itself accused of patent infringement. Their public nature can, however, be a disadvantage, as the institution may prefer to keep its ideas confidential. Since the ability to patent is lost if an idea is made public prematurely, many businesses have formal procedures in place to ensure that they can make an informed choice as to whether or not to patent, rather than losing the opportunity to do so through lack of forethought.

Having a patent portfolio has a number of benefits which can alleviate exposure to risk. We have classed them as a low risk (and, indeed, a potential benefit).

Catriona Smith

Nicola Dagg

Mark Ridgway

Kathryn Carlile

© Catriona Smith, Nicola Dagg, Mark Ridgway and Kathryn Carlile 2006. Catriona Smith and Nicola Dagg are partners in the IP group of Allen & Overy LLP in London and Mark Ridgway and Kathryn Carlile are associates in the group