Bob: from the Negotiations with Espeed Was There Any Pressure from the Rest of the Industry

Expo 2004 Tuesday, October 26, 2004, 2:30 pm FIA Law & Compliance Division Presents: Patent Pending

-Chair: Robert Paul, Vice President, Law, Cargill Investor Services Inc. -James Falvey, General Counsel, Eurex US -Matthew Kelly, Chief Intellectual Property Counsel, Chicago Mercantile Exchange Inc. -Joe Laughon, Partern, Clifford Chance (US) LLP -Walt Lukken, Commissioner, Commodity Futures Trading Commission -Nick Weinreb, Group Head of Regulation, Euronext.liffe

Bob Paul: (Welcomes Audience and Panel, Introduces Panel) Joe can you give us a quick overview of the issues and terminology? When he has done that we are going to segue into talking about the latest issue which is the settlement that has been reached between Trading Technologies and Goldenberg Heymeyer which has lots of implications over ISV’s and the way a lot of the FCMs currently conduct their business.

Joe Laughon: Unlike most of the people on the panel, I'm a lawyer with an outside firm and I do a lot of work with the financial services industry. My opinions aren't necessarily those of my firm. Trading Technologies and Goldenberg Hehmeyer was just mentioned. NYMEX v. ICE and NASDAQ v. Archipelago, people probably have heard about these cases. They are all intellectual property related litigations, but they involve different aspects of IP so I thought I'd give a primer on the ground rules for what these IP rights are.

The first and most formidable right in my view anyway is a patent right. It is a federally granted right. It is a right to exclude. It is a negative right. If you own the patent you can prevent a third party from making, using, selling or offering to sell anything that is covered by the claims in your patent. It doesn't necessarily give you, as the patent holder the right to practice the patent yourself. Sadly, for defendants in patent cases, independent development is not a defense. If you are completely unaware of a pending patent application or even an issued patent and you stumble within the scope of its claims, it is no defense to you. Ignorance is not bliss in patent law.

Copyrights, in contrast, while still being a federal right, are somewhat different. Copyrights protect works of authorship and compilations. They do not protect facts. The rights granted to a copyright owner are the rights to prevent a third party from reproducing, distributing, or preparing derivative works of a copyright work. So much of the index litigation and the pricing litigation deals with copyrights. The courts are not entirely consistent or clear yet on what rises to the level of copyrightability in the futures world. A lot of the pending litigation is dealing with that issue, in particular the NYMEX/ICE litigation. Now that the antitrust aspects of that case have been resolved with the dismissal of the antitrust counterclaims, it is now approaching the merits of the

Let me turn to the trademark issue which can be state or federal issue. To digress to copyrights for a moment, and this is an important point, independent development is a defense under copyright law. To prove copyright infringement, you must show access and substantial similarity to the copyrighted work. If you came up with your work on your own, you have a complete defense against copyright infringement.

Trademarks are both federal and state law rights. It's really a branding issue. If you come up with a name that covers your product or your index or your exchange, you are entitled to prevent others from using that brand in a confusingly similar way. That was the main cause of action in the NASDAQ v. Archipelago litigation; Lanham Act claims. Archipelago is an electronic exchange that is a secondary market for the QQQ ETFs, and NASDAQ tried to shut that down because they weren't licensed by NASDAQ to trade.

Trade secrets. There aren't a lot of cases currently pending that you would be aware of dealing with this area.Trade secrets are state law rights. Infringement again requires access or a breach of a confidentiality agreement. Just last week I saw a very interesting suit that was filed in the U.S. District Court, Southern District of New York in which an ex parte temporary restraining order was issued. The case was filed by Deutschebank against JP Morgan Chase, and it involves some defecting employees who left Deutschebank and were setting up a program to issue a complex CDOs or collateralized debt obligations. The outcome is going to turn on the issue of misappropriation and breach of non-disclosure agreements.

When you get into the current disputes with the CME, CBOT and S&P, which others will speak to, the main issue is a license or a contract issue. What is being licensed may or may not be independently protectable under the intellectual property laws, but if you take a license to use, say, the S&P 500 Index only for a certain field of use and you expand it to another field of use that your license doesn't cover, then you can be sued for breach of contract. A perfect example there is a couple of years ago, McGraw-Hill, which owns S&P, sued Vanguard who was licensed to use the S&P 500 for certain financial products. Vanguard decided to try to use it for an ETF product contending that its existing license covered the new product. The court disagreed and an injunction was issued which prohibited Vanguard from launching a type of ETF after a lot of money had been spent on regulatory approvals and full page Wall Street Journal ads about the launch. So you can get in as much hot water under a breach of license agreement as you can with any other specie of intellectual property right.

I'll get into the TT/Goldenberg case. Probably most of you know from reading the trade press that there were two suits. They were patent suits. The patents were issued very recently and are directed to an electronic trading system that shows bids and offer spreads. It's a laddering, if you will, that shows the depth of the market in futures contracts. Before the TT/Goldenberg suit, eSpeed had been sued by TT. That suit is ongoing and in its early stages. Thereafter, the TT/Goldenberg suit was filed. Two days

© Futures Industry Association 2 later the parties entered into a settlement agreement in which Goldenberg agreed that the patents were valid, that they were infringed and that they were going to pay royalties. It is a mix of royalties. For the first year, Goldenberg agreed to pay 5 cents per contract, thereafter it is ten cents per contract and there was a figure that was built in for fixed income trades. There are a number of covenants and representations in the settlement agreement which is suppose to be confidential. I think the settlement agreement will loom large, though not dispositively, in the TT litigation with eSpeed.

Bob Paul: Let me ask about settlement agreements and their effect on subsequent litigation. Jim Falvey’s former employer, ICE, was the first entity to settle with eSpeed as they were getting their feet under themselves to launch their world wide campaign to collect on the Wagner patent. The theory was they would get $5 million or so from ICE and they could use that to fund their other litigation. Plus they would have a precedent from, although new, a very well respected exchange that had major players in the market as part owners. Now we see the exact same thing happening with TT and Goldenberg where before most of us are even aware that TT is pursuing patent litigation and becoming the eSpeed of the 21st century, they cut a deal with Goldenberg. I have read the quotes that it was the most expedient thing to do from a business standpoint that Goldenberg conceded that they were infringing and they would pay up. But does this set a dangerous or powerful precedent for TT to take the settlement and also the licensing fees from Goldenberg Heymeyer in order to walk up and down the street seeking similar settlements as people anticipate they will. It is not obviously as powerful as legal precedent - it is not a cited case - but are a lot of brokers likely to pay because they cannot afford not to? This is a question for anyone on the panel.

Joe Laughon: One of the major differences with this settlement and the other major settlement is there was a lump sum payment to build up the war chest in the other settlement. This settlement involves ongoing royalties. I am not aware that there was any lump sum fee. More importantly, though the royalty rates that were agreed to may have some evidentiary value in a subsequent litigation on what the damages ought to be, they are not controlling. And I think from a litigant’s perspective, the third most important thing is that in the eSpeed cases on the Wagner patent, there had been what is called “Markman hearings”. This is where the court will tell the jury and the parties what the claims of the patent mean. It is binding on the parties; it is a ruling of law. The parties never got anywhere near that in the TT/Goldberg litigation so that there is really no precedent for other parties to look at to see whether they are in the scope of these claims or not. It is just what two parties agreed to.

Bob Paul: While we are on this issue. Jim Falvey you are probably restricted on saying anything but can you tell us what ICE was thinking when it settled with eSpeed? During the negotiations with eSpeed was there any pressure from the rest of the industry not to settle. How sensitive is the industry to this? Were you under any duress?

© Futures Industry Association 3 Jim Falvey: I will do a few disclaimers quickly. I am not here with ICE. I do work for Eurex US, but I will say that these views are my own and not of either company. I will speak generally why someone would want to settle a lawsuit early on. There is an opportunity especially in patent litigation which might have a wide impact, to try and get out of the potential liability quickly and hopefully as painlessly as possible. It is breaking away from the pack and there could be repercussions from other people that are being pursued by that patent owner. But from a business point of view you look at it and say how much is this going to cost to litigate it and can you potentially get out a little cheaper early especially before there has been any lawsuit filed against you. As was pointed out earlier, there was a decision in the eSpeed case on the Markman hearing which took it to another level. It wasn’t a judgment per se on the validity of the patent, but it was out there. The ICE settlement was an attempt to get out of a potential lawsuit, as quickly and painlessly as possible, which I think is a consideration that a business in any industry has to think about when being approached with patent litigation. The downside, of course, is that these are public settlements most often and as a result anyone who has every registered anything with the patent office, and about 50% of the world has, is going to be knocking at your door saying you violated my patent. And even if some of them are absolutely crazy patents, and I know Matt can speak to many of them (he’s shared some of them with me on our train rides into the city), you still have to deal with them. So that is the downside. Directly on your question if ICE was under any duress, there was none at the time of settlement because ICE’s intentions were not public.

Bob Paul: As long we are on settlements and eSpeed, let me ask Matt about them from the CME’s standpoint. I guess the $5 million that ICE spent looked pretty good compared to the CME and CBOT settlement for $15 million I know that was a tough decision for the exchanges to make but I know many in Chicago believe that was the right decision. Can you give us any insight into how that decision was made, and would you care to speculate on the merits of the case if it had not happened that way?

Matthew Kelly: Let me correct a couple statements. ICE’s settlement was $2 million for five years, so they did not get $5 million up front and I don’t think eSpeed was strapped for cash. So whether they got the $2 million today or five years later would not have effected the litigation that much. ICE settling did have an impact on us. It set a precedent and I think it helped solidify in eSpeed’s mind the opportunity they had in front of them. So if it did not affect the defendants it certainly effected the plaintiff by having something under their belt with a substantial payment stream. So CME, CBOT as well as NYMEX eventually settled with eSpeed. NYMEX was in separate litigation. CME and the CBOT settled at the same time. There are many factors driving why you would settle. We were a week or two before the trail and that is the time you have your next big spike in legal fees. That month of legal fees can be very dramatic. As for the CME, we were on the verge of going public and to have a litigation pending when you are going public could

© Futures Industry Association 4 have an adverse effect as well as we wanted to get back to the business of being an exchange and get this behind us. Jim raised a good point that once you have fed the sharks the sharks come back and other sharks come with them. Even with a small settlement, you invite others with patents come after you. Sure enough the CME is in another patent suit today.

Bob Paul: Continuing along the eSpeed line, I want to ask Nick as the token foreigner to what extent has eSpeed taken its fight, or others have taken their threats, overseas?

Nick Weinreb: Not in any effective sense. Anyway, our attitude was to resist anyhow. The advice we were getting is that what we were from the UK doing would not bring us into their sphere of influence. And we were particularly concerned that if we settled for providing services from the UK into the US, then we would be potentially open to similar claims not only from the US but also from any other jurisdiction, and that seemed a very slippery slope. And having gone through demutualization to become a listed company, we did not want to put ourselves in a position of being subject to a continuing stream of potential claims. So in summary, our position was “resist” rather then “settle”.

Bob Paul: Just to give Commissioner Walt Lukken an opportunity to talk, I want to ask him about the role of the government and the regulatory agencies in these fights. These are all civil cases between or among private litigants, but at stake are either the markets themselves or major segments market participants and how they conduct business. In the eSpeed suit against Brokertec, eSpeed was seeking a preliminary injunction against Brokertec and against other leading systems, such as Garban, for trading government securities. The court requested that the government speak out, and through the Department of Treasury they provided a statement of the US government interest in the matter. I think they spoke through the Solicitor General. They were weighing the need to protect intellectual property through the patent laws versus the need for price dissemination. But here there was an extra little twist, and I think this was determinative of governmental interest, and that was keeping the price of government securities down. That if eSpeed would do anything that would impinge on Brokertec or other competitors from running a more efficient government market it would ultimately mean the US government was paying higher interest on its debt. So that in this case the US government had a vested interest beyond protecting the markets, that was the government policy interest of keeping all of our taxes down. And it was interesting that the statement of the government’s interest contributed or was part of the record that led to a dismissal of the action for the preliminary injunction. Do you see a role for the CFTC to play in these litigations? Do you wait for the court to ask you to come in, or if you see a public interest is the CFTC likely to step in and assert it.

Walt Lukken: That is a good question. I have the same disclaimer as the others, that my opinions are my own and not the CFTC’s. From a thirty thousand foot level, as policy makers, we look at

© Futures Industry Association 5 the trends in the industry. The largest in the last ten years include this industry turning into a competitive industry and technology taking over the industry. The intellectual property issues are a cross section of the broad trends. Certainly, we at the CFTC have turned from being a utility regulator to a referee of the competitive forces out there. As a result, the industry has looked for private sector ways to protect itself, whether it is intellectual property laws or Sherman Act antitrust laws. We are seeing all of this at the agency and siding on those matters.

In the beginning I want to say that the right to property is a very important issue for our economic system in the US. Important enough that it was written into the Constitution that Congress should develop a law. That said, the CFTC needs to consider whether there is an overriding public interest in limiting or terminating intellectual property protection. There is nothing in our statute that goes to intellectual property. We certainly have a general savings clause that even though we have exclusive jurisdiction over futures contracts, there are savings clauses for other federal laws, which probably includes the intellectual property laws. It is the purpose of our Act to promote responsible innovation and fair competition among markets. The problem that is brought up here is what happens when innovation hinders competition, as some are talking about within the intellectual property area. The FTC has studied this and there are a lot of instances where patent protection harms competition and innovation. It is because too many questionable and vague patents are being issued. Part of this increase in patent applications is due to the State Street case, where the court found that business method patents are protected property rights.

There are more people using patent protection now days and I think the role of the CFTC is three fold. The first, which Mark Young brings up in his article in Futures Industry Magazine, is that the U.S. Patent and Trademark Office might want to use expert agencies when issuing patents. I think this is a great idea. Instead of trying to pick up the broken pieces after the patents are already issued, the CFTC should be consulted earlier to determine where there is prior art in this area. So I would encourage our agency to extend our arm to the Patent and Trademark Office to ensure good patents are issued.

I put upon the screen today a copy of the Jennings Patent. This gentleman, Ruben Jennings, back in 1858 developed a trading pit. The patent said, “The pit shall provide sufficient standing room where persons may stand and trade with any other person on any other part of the platforms. --It has great acoustic advantages over a flat floor.” This obviously is a patent that was vague and common sense. Regardless, he started to go after the Chicago exchanges and eventually this patent was overturned. Had the CFTC been involved, we might have prohibited this patent from ever being issued in the first place.

Of course the second way, which was mentioned earlier, is amicus briefs. The SEC has been very active in this area; the CFTC less so. This is something we should consider as we provide expertise during consideration of these cases.

© Futures Industry Association 6 Lastly, is whether we should be directly over-riding patent protections. As I said, I think that is a high bar. Patents are a right of protection in the US, a constitutional protection. I don’t think it is something that we should lightly tread in-to, unless they contain anticompetitive clauses. CFTC Core principle 18 talks about boards of trade having to do things in the least anticompetitive manner.

Bob Paul: Let me stop you there. Can I ask you whether the CFTC is comfortable as a matter of law that your powers under the CEA can trump the patent law?

Walt Lukken: I think that is obviously case specific. I am not aware of the CFTC trying to do that. The question you posed is the CFTC involved at all; these are private court cases. Part of the problem in the ICE/NYMEX case is that there was a suit for a copyright infringement and a counter suit on anti-trust claims. The court kicked it back to the CFTC, citing Trinko, where the Supreme Court acknowledged that when there is a regulatory presence looking at the competitive forces of an industry, that the court is less willing to weigh in on the Sherman Act and other anti-trust considerations and will instead defer to the regulatory agency of choice. The questions are: Do we have to act in this area? Does this compel us to act? Do we have the proper authority to act? These are the things we are going to have to balance. Are the competitive forces enough to cause us to override these important constitutional protections? That is why I am here -- to listen. These are the things we will be considering as we talk about these cases.

Joe Laughon: I have a couple of strings to pick up after that series of comments. You mention the Government’s statement of interest in the eSpeed/Brokertec suit. You are quite correct, Bob, that that was in the stage of a preliminary injunction hearing. The Court’s decision denying the preliminary injunction turned largely on the systemic risk and the higher price risk of government securities, but that “public interest” factor is not present when they go to trial on the merits. That is going to full decision on whether or not the patent is valid and whether or not it has been infringed. As I said from the outset, a patent is a right to exclude. If the patent is held valid and infringed, should eSpeed choose it can refuse to grant a license. It will get compensated for past infringement but it can seek a permanent injunction on an ongoing basis. The prospect of it is a very powerful tool which sometimes incentivizes people who are sued, in addition to the litigation costs to take the license if one is available.

As to challenging patents, you don’t have to wait to get sued. There are procedures in the Patent Office now and there is pending legislation for other procedures. For example, there is what is known as a re-examination proceeding. A re-exam can be initiated by a specific person who comes up with some good prior art that you think invalidates a patent. A re-exam can be done anonymously. That is called an exparte re-exam. There are serious consequences if you try to have a patent re-examined and lose. There are also public interest groups who will exhort the Patent Office to either re-examine or to sua sponte review an improperly granted patent. I don’t know if you have read about it, but

© Futures Industry Association 7 Microsoft’s FAT patent is a core patents in the software industry was just re-examined at the behest of a public interest group and the first Office Action from the Patent Office held the patent invalid. Microsoft is going to get a chance to respond to the Action, but that is a situation where you don’t wait to get sued, you get to proceedings back to the PTO.

There is a pending piece of legislation that tries to track American law with European law to establish an opposition proceeding. We don’t have anything like that now, but in Europe when a patent is issued there is a period of time where an interested party or general member of the public can come back to the patent office and say you shouldn’t have allowed this patent and here is why. If you successfully oppose the patent, the office will reverse its decision to issue. And Walt’s point is well taken. The Patent Office doesn’t necessarily have the prior art data bank in the financial services field to examine these patents fully. I have been around long enough to have heard the argument before and I heard it twenty five years ago in the biotech industry. Over time the Examiner’s gain expertise, but they do appreciate help. Following the State Street decision, a trade association on the securities side cooperated with the PTO in efforts to establish a prior art database that the PTO could access to better examine pending applications. There are a lot of things going on that haven’t been done before.

Bob Paul: I’ll just ask you a basic legal point which I should know the answer to but don’t. For prior art, do you need to only establish that the method or the process had been devised but not necessarily used. The reason I ask that, going back to the eSpeed case, I think many of us read in the media shortly after the Chicago exchanges settled that Richard Sander had said that he had developed a process very similar to the time-price method that was subject of the eSpeed patent. Low and behold he discovered in his basement a paper that he wrote on it 20 years before when he was a professor at Cal Berkley, I think I am getting these facts straight. The fact that he had written the paper, let’s assume that is was published or at least circulated in academia, would that possibly qualify for the kind of prior art that might undermine Susan Wagner’s ability to patent the same process?

Joe Laughon: The answer is unequivocally yes and the very same issue came up in the Mopex patent litigations. Mopex is an entity that had fundamental patents on the basic ETF structure and had sued a number of exchanges trading ETFs. One exchange obtained summary judgment against Mopex invalidating using the Mopex’s Kiron patents. The piece of prior art used to invalidate those patents, and by the way did a service to anybody who was lined up to be sued, was a regulatory exemption filing that had been filed with the SEC for a nearly identical product more that one year before the Kiron patents were filed. It was publicly available, but to my knowledge the product was never issued, it was just a report that anticipated what was claimed in the Kiron patents.

Bob Paul: By the way, before I continue to pepper the panel with questions, I want to make it clear that the floor is open at all times if anyone has a question or comment. We want this to

There are two things that Walt mentioned that I wanted to pick up on. One being the NYMEX/ICE litigation which really tries to answer the question “Do exchanges own their prices?” I will start with Nick on this question then I will work my way down the line over to Matthew and find out what different exchanges think about the “copyright ability”, I think is the right intellectual property pew, for price ownership.

Nick Weinreb: We are focusing on a very difficult question about whether an exchange owns its own prices and if so for how long and why. Particularly with derivatives exchanges, because inevitably we are all required by our regulators to ensure that the prices of derivative products stick very closely to the prices of the underlying. For example, if you are listing a copper contract, you don’t own the price of physical copper in any sense, so to what extent does the derived price of the copper futures contract actually belong to you? This is particularly the case as you get closer to expiry and delivery when you expect full price convergence. So I think there is a large degree of uncertainty about how much you can put your hand on your heart and say ‘actually, all this is ours’. Now clearly any exchange considers real-time trading information coming out of its order book to be proprietary information, commercially valuable information, which they want to sell to quote vendors. We would very clearly take the view that trading information is indeed valuable information for a limited amount of time, say 20 minutes or a half hour. However, I think is much more difficult if each exchange protects fully all of its information, regarding it all as equally sensitive and equally valuable and preventing people from using it for any purposes at any time. I think one has to end up with a reasonable compromise with allows for the fact that information, once it is stale, is no longer really valuable and deserving to be protected to the same extend as real-time – and hence commercially valuable - information.

Bob Paul: That raises the question that if you have the right as an exchange to sell your prices to a vendor so that they can distribute it to the public, would you have the right to discriminate. This becomes a public policy question, that I will sell it to any vendor but I will not sell it to my competitor exchange or they can’t use it for pricing their own contracts or any other purposes. Is there a public policy question there or should the exchange, to the extent that they do have copyrightable interest or ownership of their price, have different standards if they are trying to get it out to the public or trying to protect if from the competition of another exchange.

Walt Lukken: Well I think it is a tough question and the general rule of anti-trust law is that people can choose who they deal with. And I think the general policy as cited in the ‘Trinko’ case by the Supreme Court is that in a non-anti-competitive way they can pick and choose who they deal with. On the other side, as a regulator in this industry, we have Core Principals that say the exchanges shall make certain public pricing information. Whether

Bob Paul: Jim, since you were at LIFFE and now with Eurex US, what do you think about the ability of exchanges to protect their prices from other exchanges.

Jim Falvey: Before I answer that Bob, it is interesting having been at two effectively start-up companies, ICE and now Eurex US, to watch the existing players in the marketplace utilize all strategic weapons at their disposal including, now, intellectually property which I think is relatively new to the derivatives industry. The NYMEX/ICE case involved copyright principally. By way of background, as most of you probably know, the OTC industry relies heavily on futures settlement prices. With many swaps, for example, the floating price is settled off of existing exchange data. That is particularly the case in the energy industry where NYMEX is the benchmark for Henry Hub Natural Gas as well as WTI Crude Oil. The OTC industry has actively utilized those prices through the encouragement of NYMEX for many years to the point where NYMEX is referenced in the ISDA Master Agreement. So if you are trading in the OTC market, the NYMEX price is what you settle off of. You are using the NYMEX price and you don’t at the moment have to license that price by referring to the final settlement price. ICE comes along and automates that process. They created an efficient matching system where firms in the OTC space, exempt commercial entities, can get together and meet and then they go off by way of their ISDA agreements and settle with each other as appropriate at the NYMEX final settlement price. NYMEX didn’t like that, and they are utilizing an intellectual property argument – copyright - as a strategic weapon against ICE.

Having worked at the CME, it is interesting to review the development of market data, how exchanges view market data protection and, traditionally. I have done some of this research myself. Traditionally, you couldn’t patent market data, although who knows today, and you couldn’t trademark it. Copyright was also ruled out as a legal tool, until NYMEX filed its lawsuit. So the one remaining IP protection was trade secrets. That is why if you have ever signed or reviewed one of the market data agreements, you have seen very extensive trade secret protection included in the document . Trade secret protection is accomplished through contract. Traditionally, exchanges viewed real-time quotes, those that are typically 10 minutes old or less, as having value and protectable as a trade secret. Anything older was considered unable to be protected, so exchanges used to be happy to give the data away for free and encourage its use in the OTC marketplace.

(Question): Given that TT is an organization that is dependent on the success of the futures organizations, what were they thinking with regard to what good this patent and the enforcement of it really does for the futures industry.

© Futures Industry Association 10 Bob Paul: This is kind of a rhetorical question, but I want to ask the panelists what advice do you have for the industry, the FCM’s and the exchanges with regard to future litigation. Should they deal independently or should they collectively bargain with TT? And just to add a little bit more to this, I have heard that TT’s Mr. Harris Blumfield is interested in starting his own exchange.

Matthew Kelly: I am not sure I can address all those things that you pointed out. Generally, TT has been issued two patents and they have two more patents that should issue shortly. They are all related to click-based trading and I think most people in the audience probably know the details. The other ISVs are making competitive products and eSpeed has a competitive product, which is one of the reasons why they were sued. What can the ISVs do? They could do anyone of the things you suggested: they could collectively bargain and they could collectively work together to fight the patents even before they are sued. Also, they could design around the patents. For every patent, there is another 10 ways of doing it or maybe 200 ways of doing it. Some people might prefer to do it the way that is covered by the patent and pay the license fees, other people might want to design their system differently enough to avoid the patent. There is just an endless number of ways to avoid a patent and I think many of the ISVs are thinking about their options. Some have screens that are clearly not infringing these patents. Others are evaluating what they want to do or if they want to work together. In other IP litigations, for example the eSpeed case, the Chicago Board of Trade, the CME as well as the NYMEX actually did form a joint defense agreement and worked together to look for prior art, and they shared analysis as well as sharing some experts. Such cooperation happens prior to litigation and in the litigation context. Recently the U.S. Patent Office has started publishing patent applications so you might be able to identify problems before they get out of the patent office. This allows you to analyze your options earlier on.

Bob Paul: Does anyone else want to comment on that question?

Joe Laughon: From a pure IP perspective, the answer to your question is how much ammunition do you have? Here, I am not talking about money. Every body is talking about fighting the patents, but you mentioned designing around. This is what patent opinions are for; if you have a system that can be modified with a little bit of software it may not infringe. That is the other shoe that has to fall before there is any liability. In addition, I have read a lot of press about the TT litigation, and everybody is saying “oh I did this long ago but I never thought to patent it”. Well after the decision in State Street came out, the patent laws were amended to address that problem and it is called the “prior user defense”. If you can document that you were indeed using the patent more than one year before the filing of that patent, it is a complete defense to you and if behooves you to save records and have good memories.

© Futures Industry Association 11 Bob Paul: I personally think you are less likely to tweak something hoping it might be protected than take a more affirmative role in finding prior art. I also think it is a matter of leverage. When I was at OneChicago we found ourselves negotiating with TT and Rolf and Nolan to provide our prices to customers or else the exchange wouldn’t have any customers. Our parent exchanges would never have to do that because their prices were already so valuable in and of themselves. So it becomes far more than just a legal question, it is a question of who has the power and who can flex their muscle. You are not going to go to battle hoping your tweak of the patent is going to save you, but I think this prior art aspect sounds like there have been major breakthroughs and as discussed in the Mark Young article in Futures Industry magazine, you probably have a better chance of winning that in the business context now than you might have had a couple years ago.

(Audience) : People at the exchanges said “We have a lot of prior art,” but still decided to settle their patent infringement case. Many people believed at the time that settling was part of a business strategy because it would serve as a barrier to entry to other competitors.

Matthew Kelly: I don’t think any exchange would pay 10 or 15 million dollars to establish barriers to entry; it is just too much money. I don’t think the settlement really created barriers to entry, because, for example, it didn’t stop Eurex from coming into the U.S.

(Audience): If TT filed a patent and you could prove that a year earlier you had that technology yourself then would you be safe from a lawsuit from TT?

Joe Laughon: That is essentially correct. What the prior user defense aimed to take into account was that those in the financial services industry tried to keep these systems proprietary. They didn’t make them public so they did not qualify as pure prior art because they were not in publication or in public use. So for people who fall into this category, if you can document your systems were doing this even if it didn’t qualify under the old statute as prior art, it is a defense that will get you off the hook. However, it is personal defense and will not invalidate the patent like the Kiron patents I mentioned earlier which was invalidated on the basis of prior art.

(Audience): If our software then was proprietary, can we choose now to take it public?

Joe Laughon: You cannot boot strap back to behind the patent holder’s filing date. That is his priority, the date he filed, and you can’t retroactively take something that was proprietary and not public then publish it and tuck it back under the prior art category.

(Audience): Since the discovery of prior art with the Wagner patent, have any new suits been filed pertaining to the Wagner patent?

© Futures Industry Association 12 Joe Laughon: Once the New York Mercantile Exchange settled their case. I’m not aware of other litigation on that patent. There is another interesting story with a patent and that is the Frasier patent in the Brokertec litigation. I mentioned earlier that the preliminary injunction was primarily on public interest grounds. However, the Court made quite clear it had seen enough evidence in the preliminary injunction hearing and briefing that the Court had serious questions about the validity of the patent. That is going to be litigated again too.

Bob Paul: Let me go back to the TT case. I also want to hear what Matt has to say about ownership of prices, because the CME has always been a leader in that area. But in connection with the TT/eSpeed series of cases, and of course the great irony now is that TT is seeking a preliminary injunction against eSpeed and eSpeed has been seeking help from the industry to oppose this horrible, preliminary injunction. I think Matt or Jim mentioned this earlier, but all of a sudden these IP cases have become prevalent in the futures industry and they never existed before. It is not even that they have become secondary to futures trading, they have become for eSpeed the primary source of revenue and interest. I don’t know what eSpeed did before the Wagner patent, but they have become a professional plaintiff, and TT has gone from being a major ISV provider and now it seems that everybody is focused on them as a plaintiff. Is this the electronic age, or the litigious age, or is there not enough money to be made in the futures business? Anyone have any thoughts on how we got there?

Matthew Kelly: I don’t think it is as unique as one might think. Some people spoke about the biotech industry, they had a boom of both patenting and litigations. If you go back historically, this explosion of patents in a very narrow industry has happened time and time again. There was an explosion in the early 1800s in the railroad industry. Then all the railroads were making quite a bit of money. They were worried about getting land access and building the railroads. A number of inventors and consultants to the industry starting patenting everything from brakes to sirens to control systems. They started suing the railroads left and right. The industry went through a patent cycle just like any other business cycle. In the internet boom, Amazon.com got the one click patent, and others got patents by taking existing processes and putting them on the internet, and there was a boom in litigation there. Each of these industries do eventually settle down, but sometimes that institutes a change. The ISVs are thinking about patents; they probably never thought about them before. There are exchanges who may have never thought about patents and now, many of the exchanges are filing patent applications. I think by filing for patents it will help level out the playing field, because fewer bad patents will get though as well as the patents will be distributed more across the space instead of being concentrated in one or two areas.

© Futures Industry Association 13 Bob Paul: So after you go through this patent mania, you see the patent office get more experienced people looking at the patents. And it won’t be as easy to get one through the examiners?

Matthew Kelly: Yes, the patent office will get better over time. Also the companies will get more sophisticated. The semi conductor industry and computer networks companies actually do what is called cross-licensing. IBM cannot think about how many patents it has in the networking or semiconductor industry versus their competitors, so a group of them get together and just say all is fair among our group and they stop suing each other because the cost of litigation is too high.

Bob Paul: Any anticipation of that happening in this industry where everyone knows everybody else?

Matthew Kelly: I think the unique thing about this is that we are going through an area of rapid innovation both at the CME and other exchanges. New types of products and the number of new products coming out is just exploding as well as innovations by the ISVs and the software developers. And some of the sophisticated systems behind the scenes that are developed by the brokers. This has caused rapid change in short period of time.

(Audience): CME came out with their earnings and they are up 89% over the same quarter in 2003. I will bet if you looked at the ISV industry you would be hard pressed to find an ISV whose earnings were up 89% or if they even had earnings. Is there something wrong with the system where the exchanges are reaping all of these benefits and it could it be that the TT patent case is significant enough that it can disrupt the balance of power and reorganize it so that it is possible to have a healthier, more broader based ISV industry. There are some who argue that we don’t have an ISV industry because you cannot have an industry if you don’t make money.

Bob Paul: Well my experience is there are exchanges and there are exchanges. You can have the upstart exchanges like OneChicago and then you can have the superpowers like the CME and LIFFE. If you are a fledging exchange those ISVs look like pretty good business. Sometimes it is not David and Goliath, or it is David and Goliath, but going the other way. I am not sure there is a huge balance discrepancy where the exchanges have all the power over the ISVs. But you will have to save this discussion for a more intellectual panel?

(Audience): Is there any proof that patents actually foster innovation in the financial industry.

© Futures Industry Association 14 Bob Paul: Can the exchanges tell us where protection of their intellectual property rights has helped them develop a product or at least hold an edge that they rightfully deserved?

Nick Weinreb: That is a good question. It is clearly very difficult. A lot of what exchanges do is common to all exchanges. To trade an interest rate futures on an electronic market looks pretty much the same wherever you are trading -how they match the trades according to an algorithm, how things go through the system and are cleared and margined. Where it is useful to have protection is when you are doing something that is very different. A good example is the sort of product several of us have introduced in the last few years that is priced not off of the government bond yield but on the swap curve. All of us have tried to come up with unique ways to specify swap futures. In these cases it is helpful to be able to protect is a proprietary instrument even though to the outside world they might look fairly similar to the other instruments. But there is a fine line between what should be protected and what should be in. the public domain for the common interest.

Walt Lukken: Part of the problem is that some of these patents are overly vague and it is very expensive to litigate them to prove that they are not valid patents. So I think what the PTO is trying to do is develop mechanisms to make that transaction less costly and to build a prior art database in the financial services industry, maybe using the expertise of the CFTC, and allow ex parte individuals to go in and prove them wrong. But the underlying premise is that patents are very valuable instruments -- constitutionally protected property rights that are meant to promote innovation and progress in scientific discovery and we should remember that. What we should concentrate on is granting valid and specific patents, not broad, common sense patents that are so expensive to litigate.

Jim Falvey: Looking at it from a business point of view, there are really two reasons you would seek intellectual property protections of some sort. That is offensive and defensive. The offensive is for a revenue source and, perhaps in some cases, a significant revenue source. The defensive approach is to seek to protect yourself from these litigation matters we have been talking about.

Matthew Kelly: I think we are still too early in the process to have examples where someone has received a patent and the rest of the industry saying I don’t want to infringe his patent, I don’t want a license, I want to invent around it. He sends his engineers to a think tank to look for a better way of doing it and comes up with a better mousetrap and then other competitors come up with their own better mousetraps and then instead of having everyone in sync with the same mousetrap, even though it is a pretty good one, you’ll have some diversity in the marketplace and you will have a variety of mousetraps to use.

© Futures Industry Association 15 Joe Laughon: That is very good question. One of the founding fathers said of patents as “adding the fuel of self interest to the fire of genius”. It was truly designed to spur innovations, the thought being that if you will grant to an inventor for a limited period of time a sufficient monopoly to recoup his investment, that in the long run it will be better for society as a whole. The last comment was correct that in the futures side we are probably too early in the game to see that theory play out and bare fruit. We surely have seen it in semiconductors and biotech and railroads.

(Audience): On the issue of protectability of settlement prices, I was wondering purely from the intellectual property standpoint, is there a continuing protectable interest once the information is put into the public domain? If an exchange releases their prices to CNBC and they are widely reported, would there be a protectable interest at that point?

Joe Laughon: There are two concepts, one that was alluded to that is more of an unfair competition issue, it is called “hot news” that is when someone has created something that is not necessarily protectable, but it is proprietary and valuable for a period of time, then they are entitled to protect it under the unfair competition doctrine of “hot news”. Back to the copyright side. “Gone with the Wind” is in the public domain but that does not give you the right to reproduce it. Just because it is out in the public domain does not mean it is free to take. And in the NYMEX/ ICE case, the initial question is “are the settlement prices properly the subject of the copyright protection that is afforded by the statute?” If that is so, then is what ICE is allegedly doing a violation of a valid copyright by reproducing, redistributing or preparing derivative works? These are the essential questions to determine liability and that is what the Court is looking to now that the antitrust claims are gone.

Walt Lukken: I would just chime in. One of the fundamental purposes of our act is price discovery. And how does this historically date back? Well, it is meant to allow exchanges to discover prices for agricultural producers and farmers, for utilization in the regular course of interstate business. This was our constitutional hook; this was interstate commerce. The question we have to grapple with is is the swap business “interstate commerce?”. Is this “price discovery” in the 21st century? What is “interstate commerce” and is it different because the producers are end users and ICE is a competitor? How do you delineate it? Certainly the issue of “price discovery” will factor into the ultimate decision the CFTC makes.

Matthew Kelly: One of the factors to keep in mind is that we always talk about intellectual property in the four quadrants. We have trademarks, trade secrets, copyrights and patents, and settlement prices and market data kind of fall into some of those categories but maybe not squarely. There is legislation on Capitol Hill and it has been there for a number of years to create a new type of right. It is usually under the rubric of the “Database Protection Act.” There have been many different names on the bill. There is a missing protection that should

© Futures Industry Association 16 exist now that we are in a more computerized environment that may not have been needed before. So that in addition to the copyright and the “hot news” protections, there is a possibility of new legislation to protect real time data as well as settlement prices. But this probably will not happen before the NYMEX v. ICE case is settled one way or the other.