ITG Claims Liquidnet’s Patent “Procured by Fraud”

Competition between Investment Technology Group and Liquidnet just got a lot stiffer. ITG, which was first sued by Liquidnet in late 2006 for patent infringement, recently filed an amended complaint against Liquidnet, claiming that the relevant patent granted to Liquidnet Holdings by the U.S. Patent and Trademark Office is “invalid, unenforceable, and procured by fraud.”

ITG’s filing states that “documents that have recently been provided to ITG reflect that Seth Merrin and the other named inventors of the ‘834 patent did not invent what is claimed in the patent.” Merrin and colleagues at Liquidnet Holdings filed a provisional patent with the PTO (Patent and Trademark Office) on October 19, 2000. On November 14, 2006, the PTO granted their patent, No. 7,136,834. A week later, Liquidnet sued ITG in Delaware. That lawsuit was moved to New York last year.

In its current complaint, ITG says it is seeking “relief and vindication” of ITG’s and its subsidiaries’ rights vis-à-vis the patent granted to Liquidnet, dubbed the ‘834 patent, as well as damages based on Liquidnet’s “tortious interference with ITG’s prospective business relations.” ITG is asking for damages in excess of $200 million, attorneys fees and punitive damages.

In its 43-page amended complaint, filed with the U.S. District Court for the Southern District of New York on January 10, ITG reports the real inventor of the core of Liquidnet’s patent is Richard Holway, who developed the method that’s at the heart of Liquidnet’s patent for a business called Harborside. Harborside was an alternative trading system that began operation in 1999 as a subsidiary of broker-dealer Jefferies Group. Harborside+, a version of the crossing platform that was subsequently relaunched as an independent broker-dealer by Jefferies and Thomson Financial, shut down its operations in 2005.

Holway left Harborside+ in late 2002. He is now the CEO of Firefly Capital, a broker-dealer and provider of an execution management system.

ITG’s amended complaint was filed by Investment Technology Group Inc., ITG Inc., ITG Solutions Network Inc. and Macgregor Group Inc. against Liquidnet Holdings, the parent company of Liquidnet Inc. ITG, a publicly traded company, declined to comment for this article. Liquidnet said it couldn’t comment on pending litigation.

ITG’s complaint filing alleges that in 1998 “several of the named inventors [in Liquidnet’s ‘834 patent] were retained by Richard Holway to do specific contract work in connection with the implementation of an electronic trading system invented by Mr. Holway known as ‘Harborside.’” Patent ‘834 is held by Seth Merrin, Damian Kosofsky, Kevin Lupowitz and John Halloran.

According to the ITG filing, on or around September 15, 1997, Holway conceived of an electronic trading system, called Harborside, that would enable buyside traders to find large blocks of stock by matching indications of interest. The system would be integrated with buyside traders’ order management systems.

On February 5, 1998, Holway described the system in an email to John Shaw, an executive at broker-dealer Jefferies Group, and noted that he’d spoken with principals at several OMSs, including Merrin Financial, about establishing interfaces to Harborside. Merrin Financial was a firm founded by Seth Merrin, now CEO of Liquidnet, in 1985. That company developed what’s considered the first buyside trade OMS in 1987.

Holway advised Shaw that Jefferies, which had agreed to launch the Harborside block trading system, hire a “neutral middleware consultant under contract to write the interface for Harborside to the various commercial & proprietary OMS blotters with ownership retained by us….I have spoken with principals at VIE Technologies who have the expertise and interest in this type of project.” Holway joined Jefferies Group to oversee the implementation of the Harborside system in the spring of 1998.

VIE Systems, a middleware software vendor, had been founded in 1997 by Merrin and Eric LeGoff. ITG’s filing says Holway did not know at the time that Merrin was a co-founder of VIE. VIE was hired to write the relevant interfaces. ITG’s filing quotes from emails to and from VIE executives about the Harborside system as well as from the non-disclosure agreements signed by various parties involved in development work related to the Harborside system.

Jefferies launched the Harborside system on or about May 25, 1999, according to the ITG filing. Two weeks earlier, on May 11, Holway filed a provisional patent application for the Harborside system with the PTO. Shaw of Jefferies filed a provisional patent application relating to features of the Harborside system on May 14. In May 2000, Holway, Shaw and five others filed related non-provisional patent applications, which were consolidated in 2002 and published by the PTO in January 2003. That patent is still pending.

After the Harborside launch in May 1999, Merrin and LeGoff sold VIE to a company called New Era of Networks. In November 1999 they formed Liquidnet Holdings. Merrin was the chief executive officer and LeGoff the chief operating officer. Liquidnet was formed, according to ITG’s complaint, to “develop a system, employing, inter alia, the Harborside ideas and technology that had been disclosed to them in confidence by Mr. Holway and others at Jefferies.” The filing states that Merrin and LeGoff hired Lupowitz and Kusofsky from VIE and Halloran from Merrin Financial to build the Liquidnet system. That system launched in 2001.

On October 19, 2000 Merrin, Lupowitz and Kusofsky filed with the PTO a provisional patent application for their Liquidnet invention. On April 12, 2001, they and Halloran filed a non-provisional patent application. On November 16, 2006, the PTO granted them the patent.

ITG’s filing reports that “The Harborside system was on sale and in public use in this country more than one year prior” to Merrin’s and his colleagues’ filing for a provisional patent, and more than two years prior to their non-provisional patent application. “The Harborside system is prior art to the ‘834 patent,” according to ITG’s filing. The filing further says that Liquidnet’s executives “derived and based their patent application on the Harborside system.”

ITG’s filing states that individuals filing for patents must disclose to the PTO “all information known to that person to be material to patentability. Violation of this duty constitutes inequitable conduct and fraud and renders the patent unenforceable for all time.” According to ITG, knowledge of the Harborside system was “material to patentability because the Harborside system is the closest prior art to the ‘834 patent and establishes, by itself, that the claims of the ‘834 patent are unpatentable.”

ITG’s complaint says that Merrin et. al. never told the PTO during the six and a half years of their patent application process “that their alleged invention was derived from and based on the Harborside system. This information was intentionally withheld from the P.T.O.” ITG also says Merrin et. al. never told the PTO that the Harborside system was on sale and in public use one year prior to their provisional patent application and two years before their non-provisional patent application.

In addition, ITG’s complaint alleges that on Dec 10, 2004, Merrin et. al. made false statements about Harborside to the PTO. ITG notes that Liquidnet’s executives told the PTO that Harborside had copied the Liquidnet system and certain features of that system.

In its complaint, ITG notes that it and its subsidiaries had contractual and business relationship with two “third parties” for the expansion of its block trading system business prior to Liquidnet’s lawsuit. ITG said that Liquidnet knew of these busine ss relationships.

Referring to ITG and its subsidiaries, ITG’s filing states that “Plaintiffs nearly consummated a business deal with two third-party entities to employ Plaintiff’s trading technology and that deal fell through because of defendant’s [Liquidnet’s] bad faith and sham assertion of the invalid and unenforceable ‘834 patent in this lawsuit.” The filing adds that “As a result of Liquidnet’s tortious assertion of the ‘834 patent, Plaintiffs have suffered damages in excess of $200 million.”

ITG’s assertions come at the start of a year that could potentially see Liquidnet file for an initial public offering. Merrin last year said Liquidnet is considering an IPO for 2008. Thomas H. Lee Partners, one of the biggest private equity firms in the U.S., is Liquidnet’s largest investor.

In 2005, Liquidnet also sold a minority stake for $250 million to two private equity firms, Summit Partners and Technology Crossover Ventures. Steve McLaughlin of Financial Technology Partners, the investment bank that advised Liquidnet on the transaction, said that year that Liquidnet could be valued at $1.8 billion.

Liquidnet currently is one of the largest ATSs in the U.S., by share volume executed. In the third quarter of last year, Liquidnet had a record average daily volume of 60.9 million shares in U.S. equities. That represented a 31 percent increase over the average daily volume in the third quarter of 2006. ITG does not provide volume figures for POSIT, its crossing platform that competes with Liquidnet, but industry executives say POSIT’s average daily volume is smaller than Liquidnet’s but in a similar range.

While Liquidnet has been expanding its business to Canada and Europe and has focused on plans for the future, ITG last June faced strong criticism from one of its largest investors, hedge fund D.E. Shaw, because its share price that had declined 17 percent over the previous 12 months despite a 34 percent increase in revenues. D.E. Shaw said ITG should sell some or all of its businesses or, failing that, should launch an aggressive share buyback program to boost the price of its shares.