Statement of James Toupin, General Counsel, U.S. Patent and Trademark Office

Testimony Before the Subcommittee on Select Revenue Measures
of the House Committee on Ways and Means

July 13, 2006

Introduction

Chairman Camp, Ranking Member McNulty, and Members of the Subcommittee:

Thank you for inviting me to testify today on the patenting of business method inventions, and specifically on those business method patents concerning tax strategies. Patents in this area are a topic of considerable interest and debate and, as has been the case in the past with certain other categories of invention, concerns have been raised about whether business methods involving tax strategies should be patentable.  I commend the Subcommittee for holding this hearing.

U.S. Patent System

In order to understand the patentability of business method inventions, I believe it is helpful to first review the underpinnings of the U.S. patent system itself and the role of the United States Patent and Trademark Office (USPTO) in administering this system.

The basis for our patent system is found in Article 1, Section 8, Clause 8 of the Constitution, which provides that Congress shall have the power:

"To promote the progress of science and useful arts, by securing for limited times to . . . inventors the exclusive right to their . . . discoveries."

Thus, in order to promote the disclosure of new inventions, a patentee is given the right, for a limited time, to exclude others from making, using, offering for sale, or selling the invention in the United States. 

Following this Constitutional authority, our Founding Fathers designed an extremely flexible patent system based on principles that have proven remarkably adaptable in supporting over 200 years of economic and technological change.  The uniformity and flexibility of the patenting standards of novelty, non-obviousness, adequacy of disclosure, and utility -- coupled with the incentives patents provide to invent, invest in, and disclose new technology -- have allowed millions of new inventions to be developed and commercialized.  This has enhanced the quality of life for all Americans and helped fuel our country's transformation from a small, struggling nation to the most powerful economy in the world.  Equally as impressive, the patent system has withstood the test of time.  This is powerful evidence of the system's effectiveness in simultaneously promoting the innovation and dissemination of new products and processes and the creation of new industries and jobs.

Patentability Criteria and “Business Methods”

In administering the U.S. patent laws, the USPTO takes its direction on what subject matter is patentable from Congress and our reviewing courts. The current Act that details the standards of patentability, the Patent Act of 1952, specifies four basic statutory requirements that must be met to obtain a patent: (1) the claimed invention must define eligible subject matter and have utility; (2) it must be novel; (3) it must not have been obvious to a person having ordinary skill in the art at the time the invention was made; and (4) it must be fully and unambiguously disclosed in the text of the patent application to show that the inventor had possession of the claimed invention upon filing and that the skilled practitioner would be able to practice the claimed invention without undue experimentation.

Before it grants a patent, the USPTO examines each patent application to determine whether it meets these four criteria, as set forth in title 35 of the U.S. Code. With respect to the statutory requirement of eligible subject matter, 35 U.S.C. 101 states that any person who "invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent…" subject to the conditions and requirements of the law. Thus, the threshold inquiry as to whether subject matter is eligible to receive patent protection is whether an invention is "new and useful" and whether it fits into one of the enumerated categories.

The courts have recognized the breadth of this statute. In the landmark case of Diamond v. Chakrabarty, 447 U.S. 303 (1980), the U.S. Supreme Court acknowledged that Congress intended the statutory subject matter under 35 U.S.C. 101 to include "anything under the sun that is made by man." The Supreme Court also noted that there are limits to patentability. Indeed, in Diamond v. Diehr, 450 U.S. 175 (1981), the Court explicitly identified three specific areas of subject matter that are excluded from patent protection. These three areas are: (1) laws of nature, (2) natural phenomena and (3) abstract ideas. Thus, an invention directed towards a pure algorithm or manipulation of abstract ideas with no practical application is not patentable.

The broad coverage of the Patent Act helps assure that the patent system is equally available to provide stimulus for innovation in all areas, not just some.  The growth and importance of computers have led to a significant increase in investment and development in computer-related processes, particularly with regard to electronic commerce. This has inevitably led to more individuals seeking patent protection in these areas. In response to this increased patent activity, a number of cases arose in the 1990s involving issues of defining the boundaries of patent eligibility. Accordingly, the Court of Appeals for the Federal Circuit rendered a series of decisions following the Supreme Court in Diehr and Chakrabarty that further defined patentable subject matter. I would like to briefly discuss these cases, which very clearly set forth the standards for patentability according to our patent law.

In the case of In re Alappat, 33 F.3d 1526 (Fed. Cir. 1994), the Court of Appeals for the Federal Circuit, sitting en banc, overturned the USPTO and found that inventions that include mathematical formulas or algorithms are not unpatentable if they are practically applied. Thus, the mere presence of an algorithm within an invention does not exclude the entire invention from patentability. The key question to be answered is whether the claimed invention, when looked at "as a whole," is an abstract idea, such as a disembodied mathematical concept, or whether the invention produces a practical application, which achieves a "useful, concrete and tangible result."

Four years after In re Alappat came the most well-known case with regard to business methods: State Street Bank and Trust Co. v. Signature Financial, Inc., 149 F.3d 1368 (Fed. Cir. 1998). The State Street case involved a patented data processing system that transformed data representing discrete dollar amounts into a final share price momentarily fixed for recording and reporting purposes. The Federal Circuit noted that a process, machine, manufacture, or composition of matter employing a law of nature, natural phenomenon, or abstract idea may be patentable subject matter even though a law of nature, natural phenomenon, or abstract idea would not, by itself, be entitled to such protection. As such, the court held that a machine programmed to transfer data which represents discrete dollar amounts into a final share price through a series of mathematical calculations does, in fact, constitute the practical application of a mathematical algorithm, formula, or calculation because it produced a "useful, concrete and tangible result." The final share price resulting from this process enabled investors and their brokers to make investment decisions for investment and tax advantage purposes.

The significance of State Street goes beyond its immediate holding. The Federal Circuit in State Street explicitly rejected the notion that a "business method" exception exists in United States patent law, thereby ending any notion that inventions deemed to be business methods, by whatever criteria, would be excluded from patentability on that basis alone. Thus, the State Street decision clarifies that an invention deemed to be a "business method" will be treated in the same manner as any other method or process invention. In other words, the patent system is technology neutral and there shall be no disparate treatment for different categories of inventions. This principle was reaffirmed by the CAFC in 1999, where the court remanded the case of AT&T Corp. v. Excel Communications, Inc., 172 F.3d 1352 (Fed. Cir. 1999) to the district court and concluded that had the court applied the proper analysis, the claimed telephone call tracking method fell comfortably within the "broad scope of patentable subject matter under § 101."

Business Method Filing Information

While State Street did not change United States law and practice, it did create a new awareness that business method claims could be patented. For example, in fiscal year 1998 there were fewer than 1,500 filings in the U.S. classification area 705, which includes much of what is commonly known as computer-implemented "business method" inventions. By contrast, there were approximately 9,000 filings in fiscal year 2001; approximately 7,400 filings in fiscal year 2002; approximately 7,700 filings in fiscal year 2003; approximately 8,200 filings in fiscal year 2004; and approximately 8,200 filings again in fiscal year 2005. 

The change in the understanding of the law that led to this expansion of business method patent applications created challenges for the USPTO and the business community.  In particular, because business methods had been commonly not regarded as eligible for patenting, examiners did not have available to them an extensive database of prior art in the form of existing patents.  Accordingly, in a number of business areas, the Office undertook extensive outreach to the concerned public to assure its access to the best possible information on published business methods.  In the initial period after the State Street decision, allowance rates for business method patent applications were relatively high, but with the Office’s and the public’s increasing focus on this art, the allowance rate has fallen.

As of mid-year, fiscal year 2006, the allowance rate for business method applications was approximately 20%, which is lower than the overall USPTO patent allowance rate of approximately 54% at mid-year.

Today, the computer-implemented “business method” area includes business practices in many fields such as health care management, insurance and insurance processing, reservation and booking systems, financial market analyses, point of sale systems, tax processing, inventory management, accounting and financial management.

In fiscal year 2005 we hired 36 patent examiners in the business method area for a total of 132 examiners.  Our goal for fiscal year 2006 is to have a total of 160 examiners in this area by the end of the year.

Recently, subclass 36T in Class 705 has been established and dedicated to tax strategies.

We have identified 41 issued patents related to tax strategy.  Further, 61 published applications, not yet examined, relate to tax strategy.

The average pendency to first office action in the tax strategy area is approximately 44 months and the average pendency to issue or abandonment is approximately 50 months.  Currently, applications in this area filed in May 2001 are receiving their first office action.

Issuance of Patents Related to Tax Strategies

As discussed, the USPTO is charged with examining patents following certain patentability criteria as enacted by Congress and interpreted by the courts.  In examining patent applications, the Court of Appeals for the Federal Circuit has recognized that the utility requirement under 35 U.S.C. 101 is “not high.”  Juicy Whip, Inc. v. Orange Bang, Inc., 185 F.3d 1364, 1366 (Fed. Cir. 1999).  Importantly, the Federal Circuit has stated that there is no clear provision that allows the USPTO to reject an invention solely on the grounds that the invention may be against public policy, specifically: 

The requirement of "utility" in patent law is not a directive to the Patent and Trademark Office or the courts to serve as arbiters of deceptive trade practices. Other agencies, such as the Federal Trade Commission and the Food and Drug Administration, are assigned the task of protecting consumers from fraud and deception in the sale of food products.  Cf. In re Watson, 517 F.2d 465, 474-76, 186 USPQ 11, 19 (CCPA 1975) (stating that it is not the province of the Patent Office to determine, under section 101, whether drugs are safe). As the Supreme Court put the point more generally, "Congress never intended that the patent laws should displace the police powers of the States, meaning by that term those powers by which the health, good order, peace and general welfare of the community are promoted."  Webber v. Virginia, 103 U.S. (13 Otto) 344, 347-48, 26 L.Ed. 565 (1880).  Of course, Congress is free to declare particular types of inventions unpatentable for a variety of reasons, including deceptiveness. Cf. 42 U.S.C. § 2181(a) (exempting from patent protection inventions useful solely in connection with special nuclear material or atomic weapons). Until such time as Congress does so, however, we find no basis in section 101 to hold that inventions can be ruled unpatentable for lack of utility simply because they have the capacity to fool some members of the public.  Juicy Whip, Inc., 185 F.3d at 1367-68.

The USPTO has issued patents to inventions that may arguably be illegal at least in certain jurisdictions, and may be considered to be immoral or offensive by some.  For instance, a patent to a method of producing alcoholic liquids from which certain toxic chemicals had been removed (1,785,447 issued December 16, 1930) issued during Prohibition, even though the method could be used for then-unlawful purposes.  Other examples include a radar detector (7,023,374 issued April 4, 2006) the use of which is unlawful in some jurisdictions; a device for use in cock fights (6,928,960 issued August 16, 2005); a gambling device (6,540,609 issued April 1, 2003); a method of euthanizing a mammal (5,290,775 issued March 1, 1994); and a method of preparing ricin toxin useful for toxicological warfare (3,060,165 issued October 23, 1962).  In issuing these patents, the USPTO has endeavored to carry out its mission to grant patents as allowed by law, and to refrain from making policy decisions not within its legal authority.  To cite the USPTO Board of Patent Appeals and Interferences (BPAI) in the context of an application for a gambling device, "this Office should not be the agency which seeks to enforce a standard of morality."  Ex parte Murphy, 200 USPQ 801 (Bd. Pat. App. & Interf. 1977).

Hence, a wide range of products, services and processes may be patentable, but their sale or use is subject to applicable federal, state and local rules and regulations.  Accordingly, while the USPTO may grant a patent on a tax strategy, that patented strategy should not be practiced or marketed unless it complies with applicable law, rules and regulations administered by the Internal Revenue Service.

Examination Process of Tax Strategy Patents

The examiner who is assigned a patent application involving a tax strategy examines that application using the same statutory requirements for patentability under 35 USC 101 (useful), 112 (disclosure requirements), 102 (novel), and 103 (non-obvious) as that examiner would use in examining any other technology.  In determining novelty and obviousness, the examiner consults a variety of databases directed to the subject matter being examined to find the best prior art.  For applications involving tax strategies, the resources include U.S. Patent databases, foreign databases, IRS databases available to the public, and a significant number of commercial databases directed to accounting, finance, and banking.  The examiner also has a library dedicated to finance and accounting subject matter. 

Moreover, if in the course of examination, the examiner identifies a tax strategy claimed or disclosed, the examiner will, under Rule 37 CFR 1.105, request from the applicant information as to which section or sections of the tax code are applicable so that those sections may be consulted. 

Importantly, in order to gain knowledge and improve our examination of applications relating to tax strategies, the USPTO is working on developing two significant relationships.  Specifically, the USPTO has partnered with the IRS and is currently developing a partnership with the American Bar Association's Section of Taxation (ABA) to pursue training and information exchange opportunities.  The partnership with the IRS has resulted in training by the IRS for our finance examiners on financial products, wealth transfer, and pensions. The USPTO also provided a modified Patent Examiner Initial Training (PEIT) for non-examiners for selected IRS employees. Topics included: (a) statutory requirements of a patent application; (b) concept of prior art under 35 USC 102 and 103; (c) patentability under 35 USC 102 and 103;  (d) identifying and searching relevant databases; and (e) and post-grant review procedures by the USPTO for issued patents. We are looking at proposed training by the ABA that would complement the training received by and provided to the IRS.  We are also discussing follow-up training with the IRS on tax strategy issues.

Thus, as it has in other areas of business method practice, the USPTO is actively seeking assistance to assure that it has the best possible information and understanding of the tax strategy area.  While the USPTO does not employ outside sources or “experts” as consultants in the examination of specific patent applications directed to tax strategies, we are developing the expertise necessary to examine these types of applications.  Moreover, the publication of applications now allows participation by third parties in the examination process. 

Publication of Applications

Approximately 90% of patent applications are published 18 months after the earliest effective filing date, although an applicant may request that the application not be published if the invention has not been and will not be the subject of an application filed in a foreign country that requires publication 18 months after filing.  Following publication, the application for patent is no longer held in confidence by the USPTO and any member of the public may gain access through our website to the entire file history of the application.

Third-Party Participation During the Examination Process

The Patent Act places limitations on the USPTO’s ability to entertain third-party submissions in examining patent applications.  In particular, 35 USC 122(c) requires the USPTO to ensure that no protest or other form of pre-issuance opposition may be initiated after an application is published except on consent of the applicant.  Accordingly, under 37 CFR 1.291 and 1.99, although a third party may file a protest against a pending application before the date it is published or allowed, once an application is published or a notice of allowance mailed, a third-party may only submit prior art, without comment. 

After the patent is granted, there are other procedures by which a third party may challenge an issued patent. 

USPTO Review and Third-Party Participation After the Patent Issues

Post-grant review of patent claims takes place before the USPTO under certain circumstances, including when: (1) a patentee files an application to reissue a patent to correct at least one error in the patent, (2) an applicant and a patentee claim the same invention and an interference is declared between the patentee and the applicant, and the applicant seeks judgment based on unpatentability of patent claims, and (3) a patent owner or third party requests the reexamination of a patent.

Congress has incrementally added to the range of proceedings within the USPTO’s jurisdiction under which third parties can invoke Office review of issued patents. Ex parte reexamination, enacted in 1980, permits a third party to petition for reexamination of the patent.   In 1984, section 135 of the Patent Act was amended to allow issues of patentability, as well as priority, to be included in interference proceedings.   As part of the American Inventors Protection Act of 1999 (AIPA), Congress created inter partes reexamination, whereby the third party could participate in the reexamination proceeding and appeal to the USPTO’s administrative Board of Patent Appeals and Interferences.The AIPA’s inter partes reexamination practice was expanded in 2002 to afford third parties the right to appeal to the CAFC.

The most common third-party participation is through reexamination proceedings.  An important check on patent quality relates to the occasions when prior art (i.e., printed publications and patents) is brought to the USPTO’s attention that may raise a substantial new question of patentability.  Often, this evidence may be identified and submitted by a third party, such as a commercial rival that wishes to challenge the patent’s validity.  Congress established this administrative procedure for the USPTO to take a second look at an issued patent and consider questions of validity during the life of the patent.

However, although Congress has increased, through these amendments, the USPTO’s role in helping guarantee the efficacy of the patent system after patent issuance, none of these procedures alone, or collectively, has proven sufficient to optimize the USPTO’s post-grant capability.

Accordingly, the USPTO recommended a new post-grant review procedure in its 21st Century Strategic Plan.  A version of such a procedure is currently under consideration in Congress.  It would serve as a quicker, lower cost alternative to expensive litigation in reviewing patent validity questions. Such a procedure would complement rather than displace ongoing quality-focused initiatives at USPTO, which include measures to address the hiring, training, certification and retention of an adequate number of examiners.  The USPTO will work with Congress and other stakeholders in developing a post-grant review procedure that effectively serves the interests of the patent community.

Conclusion

We recognize that the patentability of tax planning strategies has raised a number of concerns in Congress, the Internal Revenue Service and the financial services community.  We look forward to working with all interested parties to make sure those concerns are appropriately addressed in a manner consistent with applicable law, rules and procedures.

Thank you.