CHARLES MORGAN THE PRUDENTIAL INSURANCE COMPANY OF AMERICA MR. MORGAN: Good morning, I'm Charles Morgan, I am Vice President, OPEB Funding. OPEB Funding is a business unit of the Prudential Asset Management Company. We fondly know of it as PAMCO. PAMCO is a wholly_owned subsidiary of The Prudential Insurance Company of America, the largest insurance company in the United States. PAMCO offers investment management and related administrative services to US employee benefit plans, foundations, endowments and other domestic and foreign institutional clients. I have to say I've done a lot of flip_flops this morning and yesterday, listening to the other people talk as to whether I'm really relevant here. I think I'm going to be asking you to make a fairly significant shift in context as I give you my remarks. I'm really here to give you an anecdote __ sort of a horror story. We are an old industry. The insurance industry in this country has been around for hundreds plus years, Prudential has been around since 1875. We have old products that have been expressed on paper, copyrightable, that are now finding, in manual systems to implement those old products, they are now finding new expression in electronic form, implemented through new systems that also use software and computers. And here I am, a former tax lawyer, who now finds himself running a small business with The Prudential. Prudential has 100,000 employees; my little business has eleven employees. So I listened to the conversations about big organizations against the little guy, the innovator, and wonder where I fit because I am both. I am not a patent lawyer, and I am not a software expert. All I know about software is that I use it every day. As I mentioned, I work in OPEB Funding, O_P_E_B stands for Other Post Employment Benefits. OPEB Funding offers institutional investors financing solutions for their retiree healthcare liabilities. If you read the paper today, Clinton and his agenda includes healthcare reform, it's a big part of my life. My work is different from traditional pension benefits, this is post retirement healthcare benefits that I work with. Our primary product is a flexible premium group life insurance contract. The contract offers the employer participating life insurance, but also a broad array of investment accounts similar to pension accounts. Typically it is purchased by a trust, and the employer uses that trust to finance the cost of those benefits. Now, our product development work for this product that we're selling began in 1987. We're highly regulated. We had to file with state insurance departments for approval of our forms, their content are dictated in large part by the states. Our first state approval occurred in 1989, in April. Our first product installation occurred in August of 1989. Our system development work paralleled that timeframe, and built on existing Prudential systems already used for very similar products. Now, I should note that our product took a very old idea; that is, a life insurance contract and a trust to fund employee benefits, and updated it by employing a group insurance wrapper rather than an individual policy wrapper. And that was a significant innovation only because legal impediments in our industry were perceived to say it was not possible to do it. We did it. I then turned to our lawyers and I said, "How do I protect this innovation?" They said, "You cannot, you cannot patent a life insurance contract. You can copyright it, but you can't patent it". Much to our surprise, you issued a patent, we call it the (Premit Patent) in 1992, covering a system employing a VEBA trust, V_E_B_A, which in turn purchases variable life insurance contracts to fund retiree healthcare benefits. An employer contributes money to the VEBA and obtains a tax deduction. The money is invested in the insurance contracts, eventually it's distributed in the form of healthcare benefits through a health claim system. The patent owner has approached our clients and prospective clients, advising them that we would owe him royalties as a percentage of the investments in our group variable life insurance product, and that we would try to pass the cost back to them, which we would. The inventor __ or the invention, that is, covered by the patent is comprised of numerous elements, including a VEBA trust, a variable life insurance contract, a couple of healthcare liability calculation systems for financial accounting and tax accounting purposes, a death claim collection system and a health claim payment system among other elements. Significantly, the patent owner has focused on collecting royalties solely from Prudential and exclusively with respect to our group variable life insurance contract; that is, the life insurance contract segment of this invention. Now, why would we, Prudential, owe the patent owner royalties on this? All we're doing is selling a variable life insurance contract. We do not perform most of the functions comprised of the segments in the invention. While it is true that we do have death claim systems, those systems are inherently connected with the business of selling and administering life insurance contracts. We also have healthcare systems connected with our group health insurance businesses. But it would be merely coincidental if we happened to administer a health claim system for a client who purchases our variable life insurance product. The focus of his royalty claims on the insurance contract segment of this, quote "invention" unquote, suggests that he merely wanted to patent a variable life insurance contract, something that we thought was not possible. To accomplish his objective, he merely surrounded the contract with sufficient quote "system trappings" unquote, to justify issuance of the patent on his invention and persuaded you to issue it. Now, he has not implemented any of those systems, he has merely patented the concept. The patent fails on three conditions of patentability. The invention is not new. It is perfectly obvious to a person in the field, and it is merely a method of doing business. The Prudential has been in the business of selling life insurance since 1875. We've been in the employee benefit business since the 1920s. We have worked with pension liabilities for more than half a century. We have worked with healthcare liabilities for decades. Individual life insurance products have been used to fund pension liabilities since at least the 1940s. The Internal Revenue Service even issued a ruling, what we call PS No. 58, in the 1940s, to cope with pension funding with pension trusts investing in life insurance contracts. Now VEBAs, an important part of this supposed invention, came into unique prominence for funding retiree healthcare liabilities in the late 1980s, only because Congress enacted ERISA in 1974 and DEFRA in 1984, thereby curtailing the other tax_motivated devices employed previously. Originally called "Retired Lives Reserves", several IRS rulings in the 1960s and early '70s established the foundations of the tax deductions that ultimately were codified by DEFRA in 1984. Life insurance policies and VEBAs were favored funding instruments for Retired Lives Reserves even before Congress codified the rules. The essential role to be played by VEBAs prospectively was obvious to anyone in the insurance industry, the benefits consulting community, anyone who had worked with pension plans, trusts, life insurance and Retired Lives Reserves. VEBAs are not new, they're not unusual. A VEBA is just name that Congress put on a 501C9 trust in the Internal Revenue Code. You go read it, and that's the label in the section. The primary purpose of the trust is to secure the asset from the employer's creditors so employees like you and me will get the promised benefits. Section 501 of the Internal Revenue Code has been there ever since 1954 and has antecedents going back to the '39 code. The Prudential has been a leader in the development and use of record keeping and other systems required to support life, health and annuity and pension products. We employed the earliest computers doing the 1940s for statistical purposes, during the '50s we installed the earliest machines from IBM. Our computer systems became a substantial part of our business in the '60s with the automation of our policy and group pension administration. Prudential developed the first medical and dental claims systems in the United States in the '70s. One of our major life insurance systems contains tens of millions of lines of code, that require 750 people simply to maintain in. In our group insurance and PAMCO operations alone, we have more than a hundred major applications in development or under maintenance. Our annual budget for systems applications runs into the many hundreds of millions of dollars. If I'd had time to research it, I'd daresay we're upwards of a billion annual. Notwithstanding that big investment, we have not pursued patents within Prudential, we haven't stockpiled them. And I asked our patent lawyer how many he was aware of, he knew of none. I was interested in the picture painted yesterday, the big guy against the little guy, as I said, we have not been using these as a tactic, and we may well have to turn to that. In my little business, when confronted with this patent I have only a few very unpleasant options. I can shut myself down, I can spend a lot of money on lawyers, pursue royalty litigation or litigation to get rid of the patent or I can pay a royalty which is what I see as nothing more than a ransom, extortion. THE PTO re_examination process was not available to me for the reasons that Lee Patch mentioned this morning. Now, I only have two more brief paragraphs with my suggestions, but they're echoes of what you have heard already today. You need to introduce rigor into your research of prior art. People like us are available to you, you ought to seek us out and learn a little bit from the community that is affected by the patent application. I agree with those comments wholeheartedly. I am not a patent lawyer. It was obvious to me that that's something you need to do, and I applaud these hearings as a first step in hearing about that sort of thing. I don't see the software patenting issue as the real issue, I see the real issue is research into obviousness and newness. That really about sums up my comments except to say that in the financial services community, we have a very broad spectrum of products which at one extreme or the other have significant differences. At any point in between those two extremes, the line drawing exercise for you and me is incredibly difficult. And applying new expressions to age_old products like this needs to proceed with care. COMMISSIONER LEHMAN: Thank you very much. MR. MORGAN: Okay. Thank you. COMMISSIONER LEHMAN: Next up and finally, our final witness for the morning is Les Earnest.