Magicians, Reputation Trolls, Tsunamis and Floods: Has Patent Protection for Financial Innovation Encouraged Financial Institution Creativity?

Abstract

Before the watershed 1998 State Street decision in the United States, financial innovations were thought to be largely unpatentable. However that decision signalled a new financial patent flood (600+ per year since 2000) resulting from an application torrent (8,000+ patent applications per year since 1999) and followed by a patent litigation tsunami (3000+ actions in 2005 alone.) The article examines whether this new patent is likely to encourage financial innovation among globally competing financial institutions. Our tentative no answer follows evidence presented here and follows from conclusions reached in earlier work. Earlier we found that innovation has an important positive effect on financial institution common stock returns. When we rank firms by propensity to innovate, propensity to innovate is positively related to long run stock market returns. But to return a-greater-than-normal profit, financial innovation must be kept secret. In light of this, our question can be rephrased thus: Have the visible patent seekers been high-return innovators or low-return imitators? While these are still early days in the history of intellectual property protection in finance, the initial evidence supports our theory of secrecy and suggests the answer is that imitators have obtained more patents than innovators. However patent applicants can choose to hide their patent appeal from public view until the patent itself is issued. The vast majority of financial patent applications have been thus secreted. This is also consistent with the proposition that profitable financial innovations require secrecy We conclude with a summary of the negative implications of these developments for patents' effect on the propensity to innovate.