Category: Digital Services: Pandora

Five Things Congress Can Do to Stop Tens of Millions of “Address Unknown” NOIs

Copyright reform is on the front burner again after the passing of the  Register of Copyrights Selection and Accountability Act by a vote of 378-48.   But there’s another problem the Congress needs to fix that won’t require legislation in the short run:  The mass filing of tens of millions of “address unknown” notices under the archaic compulsory license for songs.

I’m going to assume that readers know the general background on the millions of “address unknown” NOIs filed with the Copyright Office under a loophole in the Copyright Act (Sec. 115(c)(1)).   If that is Geek to you, see my recent paper on mass NOIs for more complete analysis (or previous posts on MTS for the armchair version of the story.   The first distinction to remember is that we are only concerned in this post with song copyrights and not the sound recording.  This story implicates songwriters and publishers, not artists and record companies, and it only applies to the government’s compulsory license for songs, a uniquely American invention.

In a nutshell, Amazon, Google, Pandora, Spotify and other tech companies are serving on the Copyright Office tens of millions of “address unknown” notices of intention to obtain a compulsory license to make and distribute recordings of certain types of songs.  Under what can only be called a “loophole” in this compulsory license, a service can serve these “address unknown” NOIs on the Copyright Office if the owner is not identifiable in the Copyright Office public records.  The Copyright Office stands in the shoes of the “address unknown” copyright owner to receive and preserve these notices.

On the one hand companies like Amazon, Google, Pandora and Spotify say that they can’t find these millions of song owners, while at the same time at least some of the same companies brag about how comprehensive and expensive their song databases are (like Google’s Content ID) or their agents puff up the agent’s own massively complete song databases as “the worlds largest independent database of music copyright and related business information.”  And yet, these same companies and their agents can’t seem to find songwriters whose names, repertoire and contact information are well known, or whom they already pay through their own systems or through their agent.

The Database Double Loophole Trick

Here’s the loophole.  First, the loophole requires a very narrow reading of Section 115(c)(1) of the Copyright Act, a 40 year old statute being applied to NOIs served at a scale the Congress never intended.  If the song owner isn’t found in the public records of the Copyright Office, even if the digital service or its agent has actual knowledge of the song copyright owner’s whereabouts, the digital service can say they are not required to look further.

Even if you buy into this willful blindness, these digital services may not be looking at the complete public records of the Copyright Office.  The only digitized records of the Copyright Office are from January 1, 1978 forward, and my bet is those easily searchable records are the only records the services consult.  That omits the songs of Duke Ellington, Otis Redding, The Beatles and five Eagles albums not to mention a very large chunk of American culture.

The Copyright Office records from before 1978 are available on paper, so the pre-78 songs are still in the public records (which is what the Congress contemplated in the Copyright Act).

The identifiers are just not “there” if you decide not to look for them.  However, it is not metaphysical, it is metadata that exists in physical form.  This is the “double loophole”.

The Double Triple:  New Releases

Another category of song copyrights that will never be in the public records of the Copyright Office in their initial release window are new releases with recently filed but not yet finalized copyright registrations.  The Copyright Office itself acknowledges that it can take upwards of a year to process new copyright registrations.  This allows “address unknown” filers to bootstrap a free ride on the back of Congress during that one-year period.

No Liability or Royalties Either:  Trebles All Round

Once a company serves the “address unknown” NOI on the Copyright Office, songwriters are arguably compelled by the government to permit the service to use their songs.  Filing the “address unknown” NOI arguably allows the service to avoid liability for infringement and also–adding insult to injury–to avoid paying royalties.  If the NOI is properly filed, of course.

In current practice, a mass “address unknown” NOI is usually a single notice of intention filed with a huge attachment of song titles with the required fields, such as this one Google filed for Sting’s “Fragile”, the anthem of the environmental movement (which was clearly filed incorrectly as the song was registered long ago):

sting-fragile-google-noi

The number of mass “address unknown” NOIs being posted by the Copyright Office on an almost daily basis suggests that tech companies now view mass “address unknown” NOIs as the primary way to put one over on songwriters and the Congress, too.  Companies like Amazon, Spotify, Google, Pandora and others are using this heretofore largely unused loophole on a scale that flies in the face of Chairman Goodlatte’s many hearings in the last session of Congress on updating the Copyright Act.

This “address unknown” practice also undermines the efforts of Chairman Goodlatte and Ranking Member Conyers to modernize the Copyright Office.  Indeed, based on the very lopsided vote on HR 1695 the Register of Copyrights Selection and Accountability Act, it is clearly the desire of the overwhelming majority of Members of Congress, too.

March Spotify NOI Filings

What Can Be Done?

Congress can play a role in in providing immediate relief to songwriters by stopping the mass “address unknown” NOIs or at least requiring the Library of Congress and the Copyright Office to take steps to verify the NOIs are filed correctly.

At the moment, the government takes away property rights from the songwriters by means of the compulsory license without taking even rudimentary steps to assure the public that the “address unknown” NOI process is being implemented correctly and transparently.

Here are five steps the Congress can take to rectify this awful situation.

  1.  Stop Selling Incomplete Data:  Congress should instruct the Library of Congress to stop selling the post 1978 database until due diligence can be performed on the database to determine if it is even internally correct.  It appears that many if not all the mass “address unknown” NOI filers use the LOC database to create their NOIs.  It is also highly unlikely that this database will include new releases.  Congress can simply instruct the Librarian to stop selling the database.loc-prices-databases
  2.  Stop Accepting “Address Unknown” NOIs With Compressed File Attachments: Congress should instruct the Library of Congress and the Copyright Office to immediately cease accepting “address unknown” NOIs with compressed files as attachments for what appears to be a single NOI.  These compressed files are so large in most cases that songwriter can never uncompress them on a home computer to determine if their songs are subject to “address unknown” NOIs.  Google in particular is a major offender of filing huge compressed files.  Each compressed file contains tens of thousands of song titles.Google March NOIs
  3.  Require Accounting Compliance with Copyright Office Regulations:  Long standing regulations require that anyone relying on an NOI must file mostly and annual statements of account reflecting usage of the songs subject to the NOIs.  The tech companies serving mass NOIs are not rendering these statements and thus fail to comply with the transparency requirements of Copyright Act.  All of the “address unknown” NOIs served during 2016 are out of compliance with the regulations, and all “address unknown” NOIs served in the first quarter of 2017 are likewise out of compliance.  Congress should instruct the Copyright Office to require monthly and annual statements of account be filed with the Copyright Office for anyone who has relied on these NOIs as required by the regulations.  All statements of account should be certified in the normal course as required by the regulations, and made available to the public by posting to the Copyright Office website.
  4. Require the Library of Congress to Create a Searchable Database of NOIs:Congress should instruct the Library of Congress to create a single database maintained online that is maintained by an independent third party and is searchable by songwriters in a manner similar to a state unclaimed property office.  That database needs to be updated on a regular schedule.  Given the size of the compressed files served to date, it is essentially impossible for songwriters to determine if NOIs have been filed on their songs.  This is particularly true as the NOIs are served on an effectively random basis, so even if songwriters were able to search, they would essentially have to search all the time.
  1.  Pay Royalties Into A Permanent Trust Account:  Given that it is highly likely that the mass NOIs filed to date have a significant number of errors, it is also likely that songwriters will become entitled to payment of royalties retroactively if these errors are ever caught.  Therefore, the Congress should require that royalties should be paid to a trust account maintained at the Copyright Office and held in perpetuity like a state unclaimed property office.  Of course, it is equally likely that the song copyright owners will be entitled to terminate any purported license under 17 USC Sec. 115(c)(6).  These payments should be based on actual usage and not black box.  This is another reason why the statements for “address unknown” NOIs should be public.

What started in April 2016 as a trickle of NOIs from a handful of companies has now expanded exponentially.  Based on Rightscorp’s analysis in January 2017, some 30 million “address unknown” NOIs had been filed–and that did not include the dozens of “address unknown” NOIs filed by Spotify in March 2017 alone which themselves likely total over a million songs.

NOI Table
Top Three Services Filing NOIs

April, 2016-January 2017

 Number of NOIs Per Service
Amazon Digital Services LLC 19,421,902
Google, Inc. 4,625,521
Pandora Media, Inc. 1,193,346

It is rapidly becoming standard practice for tech companies to try to pull the wool over the eyes of the Congress by leveraging an apparent loophole and they are doing it on a grand scale.

As we have seen with everything else they touch from the DMCA to royalty audits, the tech companies will continue this loophole-seeking behavior until they are forced to stop.  Since no one at the Library of Congress seems to have the appetite to right this wrong, the Congress itself must step in.

Ultimately Congress should fix the loophole through legislation, but in the meantime most of the harms can be corrected overnight by policy changes alone.

Fighting for a Straight Count: Does Streaming Accounting Cost More than the Royalties?

When you drill down on exactly what goes into tracking and accounting for songs and recordings on streaming services one thing becomes apparent:  No matter how much you automate, those systems are expensive and the royalties are minuscule.  This is in large part because of the revenue share method of royalty payments that creates a vastly more complex accounting world than a simple per-use penny rate would require.  It’s time to make that change to simplify the reporting.

A recent post by a founder of a digital distributor gives you a sense of the complexity involved:

It’s easy to figure out how much an artist made. But if you want to figure out how much each collaborator is owed from each stream… now you’re looking at millions of rows in hundreds of royalty reports from dozens of sources — every month.

Payments are paid in fractions of cents.

Did I say fractions? I meant 20 decimal places.

Did I say cents? I meant 30 different currencies.

Did I say 30 different currencies? I meant a 350-row exchange rate lookup table. “Customer currency: Swedish Krona, royalty currency: Ukrainian Hryvnia” is a thing (and so on, and so on).

Did I say a 350-row exchange rate lookup table? I meant a different table every month — from every streaming provider.

This gives you a look under the hood of the number of transactions that are inherent in a royalty system that pays every time an end user listens to a track.  It also informs why artists and especially songwriters are royally cheesed about the sharp decrease in the size of their royalty payments.

The hidden transaction costs of the configuration shift from album bundles to singles with  the coming of iTunes was challenging but was at least manageable.  The shift from singles to individual streams is cost multiplier of significant proportion above the shift from albums to digital singles.  I would submit that not only is the cost not manageable, but when distributors promote themselves based on their ability to handle twenty decimal places to the right, it probably never will be.

When a firm’s costs exceed revenue, the firm must either take on debt, sell equity or shut down the insolvent business or business unit–or delay paying royalties, more about that later.  Royalty accounting is, of course, a core business function of distributors, but it is also a core function of the parties receiving those royalties out to twenty decimal places to the right–record companies and music publishers.  There are even more accounting costs incurred by the labels and publishers in calculating the artist or writer shares and their own share of revenue, which will cause the decimal places to increase–to the right.

What this means is that in order to stay in business, be able to meet contractual obligations and pay their artists or writers, royalty systems must be able to handle a new level of complexity they were never before required to process.  Sound expensive?

Add to this complexity that many digital music services use the compulsory mechanical license that requires monthly statements and a true-up annual accounting signed by a CPA and no audit right–instead of quarterly or semi-annual accounting with an audit right.  Even if a publisher is accounted to monthly and pays writers quarterly or semi-annually, the publisher still bears the cost of processing the monthly accounting.  The frequency of ingesting these monthly payments may compound the transaction costs at the publisher and songwriter level.

One technique employed in the Pandora on-demand song license (paragraph 6(a)) is to defer both payment of mechanicals and royalty statements until the revenue payable is $50.  While this may seem reasonable on its face, it’s not–for largely the same reasons that the Copyright Office rejected this approach (37 CFR Sec. 210.16(g)(6)).  Pandora’s license is clearly a variation on the law, which limits the deferral to $5 (not Pandora’s $50) and requires that Pandora pay any deferred royalties on the Annual Statement of Account.

That means that the service cannot write itself an indefinite interest free loan with the songwriters money and not tell the songwriter it is doing so.  And, of course, you can’t audit statements you don’t receive.

Holding these sums is one way to finance the cost of running these accounting systems that deliver ever-smaller fractions of a penny paid to songwriters and artists.  That should sound familiar–new money used to pay old obligations.  Does the name Madoff come to mind?

It’s also important to note that in a revenue share world where money is allocated based on a core calculation of uses of your catalog divided by all songs used on the service in a month, that fraction will produce an ever smaller share of revenue if the rate of change in your catalog titles is less than the rate of change in the number of all songs on the service. (This will likely be true even if the service revenue increases, because your share of it will decline on a relative basis.)

So what is twenty decimal places today, could be even more decimal places in a year or two.

Where the industry went wrong was in the beginning when services got us to buy into the idea that getting something was better than piracy and that we owed the services a chance to find an audience.  When the revenue shared was low and higher margin goods were the focus, that was one thing.

The current state of plays is another thing altogether and revenue share deals for per listen payments require a level of complexity we can’t continue to support.

And yes, that means you, Facebook negotiators.

How Accurate are Music Subscription Service Subscriber Numbers?

All of you who subscribe to the New York Times, fly Quantas, use any of a number of mobile carriers or who are in the 6th month of your third Spotify 30 day (or 90) free trial may be interested in this post.

According to Billboard in a story titled “Spotify Officially Hits 50 Million Paid Subscribers“, the “official” announcement came from a tweet:

I found this intriguing–how did we go from “Spotify Officially Hits 50 Million Paid Subscribers” in the headline to a tweet that doesn’t really say the same thing?  Maybe like this?

screenshot_20170224-140304

First, what makes a tweet “official”?  Much less “official” totals of “paid subscribers”?  Finding out may be like asking what makes ketchup “fancy”.

w27cz

Newspaper subscriptions have long been verified by a company specializing in verifying circulation.  Television has the Nielsen ratings, music has Soundscan, and so on.  None of these systems are perfect, but they make it harder to outright misrepresent success in a business where frequently the only people who really know how well they are doing are the people who would like you to believe they are doing well.  This is nothing new, it’s as old as moral hazard.

The quest for truth leads one to independent verification services.

spotify-clown-car
A clown car for 6 million streams

Reuters reported the same story with a more subdued headline: “Spotify Says It Reached 50 Million Subscribers“.  A little more factual, a little less Kool Aid.

This is important because I have yet to find anyplace that Spotify actually says the 50 million subscribers were “paid”.  The press leaped to that conclusion, but Spotify did not say that.

And neither does Apple, a company which is already public and has to be careful what they say about the money they are making or not making.  Yet somehow nobody transforms Eddie Cue’s statement that Apple has “well past 20 million subscribers” into an “official” statement implying a verified number of “paid” subs.

Actually–it may well be that there is a significant revenue difference between “paid subscribers” and “subscribers”.  As the Music Industry Blog wrote last year:

[T]here is a more important story here: Spotify’s accelerated growth in Q2 2016 was driven by widespread use of its $0.99 for 3 months promotional offer. Which itself comes on the back of similar offers having supercharged Spotify’s subscriber growth for the last 18 months or so. In short, 9.99 needs to stop being 9.99 in order to appeal to consumers.

As Spotify has been “dominant” in the music subscription business for a while now (and yes, I mean that in an antitrust sense of “dominant”), it seems that it’s high time for someone to independently audit the veracity of the number of their subscribers.

Or would the Securities and Exchange Commission like to rely on a tweet?

 

 

Big Tech’s Latest Infringement Loophole: Mass Filings of NOIs to Avoid Paying Statutory Royalties (Part 2)

co-nois-1
“1 NOI” Means “1 Excel file for the NOIs Filed That Day, each Excel file contains tens of thousands of songs

As noted in Part 1 of this post, Google, Amazon and others are filing what are reportedly “millions” of “address unknown” NOIs with the U.S. Copyright Office.  I fully expect that Pandora will eventually do the same for its on-demand service and Spotify is likely to do the same.  Note–this type of carpet bombing of NOIs would not have helped Spotify in the David Lowery litigation because David Lowery registered his copyrights that are the subject of that litigation.

If you click here, you will find the most recent iteration of these massive NOIs, which apparently are being posted on a regular basis.  The screenshot above is the first page of these filings on the Copyright Office site, most of which came this month (September 2016).

Each Excel file can be downloaded–a word of warning, even the zipped files are large and may take a while to open on an average home computer.

Remember what you are looking at in these files–this is the list that results from comparing the list of sound recordings that the services are using to the data dump that the service purchases from the Library of Congress.  Take a tip–you’ll never find the page on the LOC website unless you know where to look, which is right here.

loc-prices-databases

Willful Blindness on Song Titles

This is an overwhelming amount of data, so in order to have any idea what is really going on, spot checking will be required.  And since it’s Google, you know there’s a scam afoot, your challenge is just to figure out which scam it is this time.  (Of course the entire exercise is a scam, but leave that to one side for now.)

Scam # 1 appears to be treating any song title that has any text in it other than the actual song title as a song for which the owner cannot be identified.  Here’s two examples from Sting in the Google 9/16/16 NOI file:

sting-fragile-google-noi

Of course, the song “Fragile” is registered, but Google’s filing claims that there is a different song “Fragile (Live)” that is not registered by that title.  Google has, no doubt, sent another NOI for the song “Fragile” (or has a direct license) and if so has actual knowledge of the song copyright owner.

And here’s the loophole–by claiming that “Fragile (Live)” is an “unknown” song, Google can try to get out of paying for the live version.  (Because how would you know that “Fragile” performed by Sting for which you know the copyright owner is the same as “Fragile (Live)” performed by Sting for which you now claim to be shocked that is the same song–unless, oh, maybe if you listened to the two?)  The government’s compulsory license says this:

sec-115-noi-unknown

If you search for live recordings in Google’s NOI filings, you will find many, many live recordings by artists such as Bob Dylan, Heart, Quincy Jones, Lynyrd Skynyrd and Chicago.  And then there’s the medleys like “Hotel California Dreaming” which lists the Eagles writers with John and Michelle Phillips of the Mamas and the Papas.

Not to mention a ton of foreign songwriters who are under no obligation to register their songs with the U.S. Copyright Office.

Let’s also set aside for the moment whether the recordings that Google has listed on their certified filing are all lawfully distributed–some certainly look like bootlegs to me.  Of course “bootlegs” these days have to include illegal live recordings posted on YouTube and then stream ripped into mp3 files to be distributed through Tunecore, CD Baby or someone else who doesn’t pay much attention to where the recordings come from and then subsequently distributed through Google–who invented the game.

So what appears to be happening is that Google and Amazon (which has hired MRI, I believe) are playing the willful blindness game.  What can be done about it?

That will be the subject of the next and final part of this post.

 

Big Tech’s Latest Infringement Loophole: Mass Filings of NOIs to Avoid Paying Statutory Royalties (Part 1)

If the music-tech industry has one major failing from which all of their messaging and legal problems flow, it is their fascination with loopholes that predictably harm creators.  Whether it’s YouTube’s nefarious reliance on a tortured interpretation of the DMCA safe harbors that bears no relation to the law, Pandora and SiriusXM’s bone headed refusal to pay statutory royalties on pre-72 sound recordings (not to mention Pandora’s purchase of a radio station in a failed attempt to pay songwriters lower royalties), Spotify’s absurdly unnecessary collision with Taylor Swift over windowing, the MIC Coalition’s ridiculous manipulation of the Department of Justice on 100% licensing, or Amazon’s bizarre fascination with compulsory licenses for which songwriters have no audit right, these companies rival each other in the undignified pursuit of loopholes.

And in particular, loopholes that hurt songwriters who can’t afford the litigation and lobbying machine that is always the not-so-veiled threat brought by all these companies.  The latest debacle is no different–mass filings of NOIs to avoid paying mechanical royalties because of a loophole that is detritus left over from the 1909 Copyright Act that is being manipulated to benefit the rich Silicon Valley companies at the expense of songwriters.

Yes, that’s right.  They’d rather pay enormous sums in filing fees that vastly exceed any royalties payable just to get out of paying royalties at all.  You have a better chance of recovering an old utility deposit from a state unclaimed property office than you have of getting mechanicals once you fall victim to this latest move.

I have been reliably informed that Google, Amazon and Music Reports among others are filing “millions” of “address unknown” NOIs with the Copyright Office based on a database that these companies are purchasing for tens of thousands of dollars from the Library of Congress (remember that the Copyright Office is under the jurisdiction of the Library of Congress).  And by the way–once they file this NOI, they don’t pay royalties until the copyright owner can be identified in the records of the Copyright Office.  Regardless of how easily the copyright owner could be found in other readily accessible databases.

Mystified?  I will explain.  Rest assured, you’re not the only one who is surprised.  And remember that bit about the utility deposit, we’ll come back to that one.

As you read this post, remember one thing–it didn’t have to be this way.  This is all happening for the same reason.  Google, Amazon, Spotify, and likely soon Pandora (for its yet-to-be-launched on demand service) are all far more likely to take the legalistic and aggressive route rather than reach out to the songwriting community to work cooperatively to find a solution.

One music tech executive told me, we decide what’s fair and then we jam it down your throat.

That doesn’t work.

Mechanical Licensing and the Compulsory License

For one reason or another, the U.S. Government has a tradition of being very interested in regulating songwriters.  The Copyright Act of 1909 established the baseline rules that compel songwriters to license their songs and sets the terms on which those songs are licensed including the royalty rate.

Even if you are not troubled by this degree of attention that is probably the original wage and price control, it would be nice if the USG is going to pay enough attention to songwriters that they set the price at which they can license their work, that the same USG not forget to raise that rate for 60-odd years.

That’s right–the government set the mechanical rate in 1909 at 2 cents and refused to raise it until 1978 (as part of the 1976 Copyright Act revision).  Adjusted for inflation, that 2 cent rate would now be about 80 cents.  Instead, it’s been 9.1 cents for the last 10 years.

The current compulsory license law was crafted in 1909 and slightly amended in 1976, and amended again a couple times to include the concept of “digital phonorecord deliveries” which essentially makes that compulsory applicable to streaming.

The 1976 Act also got rid of the copyright registrations that formed the basis of copyright under the 1909 Act with the exception of requiring a registration to sue for statutory damages and attorneys fees in a copyright infringement lawsuit.  (Not quite that straight a line, but that’s where we ended up.)

But here’s the twist–the compulsory license rules are a notice based system.  A music user who intends to use a song that is subject to the compulsory license must send a notice to the copyright owner.  These notices are called a “notice of intention” or “NOI”.  If you’re going to require an NOI, then how do you deal with copyright owners who cannot be found?

There was an easy answer to this that derives from the registration requirements–look them up in the Copyright Office.  If the copyright owner can’t be identified in the records of the Copyright Office, then the music user can send a notice to the Copyright Office which the Copyright Office then publishes.  Just like when your state publishes a list of unclaimed utility deposits, closed bank account balances, etc.

Now we all know that nobody uses the records of the Copyright Office to find a copyright owner, or if they use those records they don’t use them exclusively.  Most people will look first at the PRO databases, cue sheets, publisher websites, other materials like that.  When all else fails, then they look at the Copyright Office.  This is partly due to the lag time between filing a copyright registration and receiving a conformed copy of that registration (which is when it is “official”).

There is also another public record maintained by the Copyright Office called the “recordation section”.  This is where people file documents relating to works of copyright, such as a notice of assignment or a mortgage of copyright (which is kind of like a UCC-1 financing statement).  The recordation section requires paper filings and typically only ingests a handful of titles from a large acquisition.  That results in a filing of “‘Yesterday’ and 10,000 other songs” or something along those lines.

In other words, the recordation section is not all that reliable either–and neither is dispositive because there hasn’t been a registration requirement for decades.  Is it a good practice to register?  Yes.  Is it required to have valid copyright?  No.

And it’s particularly not required for non-US songwriters.  In fact, there’s a good argument that a registration requirement in order to enjoy your rights (such as the statutory mechanical royalty, however poorly handled by the government) is actually barred by the Berne Convention’s prohibition on formalities.

Yet, the U.S. Copyright Act allows a valid compulsory license to issue for a copyright owner who may be listed in the PRO databases, may be a foreign copyright owner, or be under license (even direct license) for other songs with the same music user–if that copyright owner of a particular song cannot be identified from the public records of the Copyright Office–as determined by the music user.

Now why is this a moral hazard that should not be resolved by the music user?

Because the Copyright Act also provides that the music user filing that “address unknown” NOI is not required to pay royalties until that copyright owner is identifiable in the public records of the Copyright Office.

And who decides if the NOI is properly filed for the right song title?  That’s right–the music user.  Who is incented to play games with the song metadata?  That’s right–the music user.

So what comes next should be of no surprise given the bad advice that these giant companies receive about their artist and writer relations.

Continued in Part 2.

 

 

Pandora Sees the Light On Audit Rights

Music industry licenses that require a music service to pay a royalty to a copyright owner have traditionally included what’s come to be called an “audit clause”.  Because so much information required to actually confirm that royalties are paid properly is under the control of the person doing the paying, the control of that information by the party in whose interest  lies the underpayment creates significant moral hazard.

Under Pandora’s new version of the direct publishing license for their on-demand streaming service currently being circulated by MRI, we get some good news.  Here’s why….

In the MRI license Pandora has dropped many of the restrictions on royalty compliance examinations (commonly called “audits”) that it tried to get the Copyright Royalty Judges to impose on artists and record companies through the sound recording statutory license.  SoundExchange conducts these audits under the compulsory license on behalf of featured artists, nonfeatured artists and sound recording owners.

This will, no doubt, come up on one of the appeals of the CRJs, so hopefully the ruling of the Copyright Royalty Judges (called “Web IV”) on this issue will now be moderated by reality in the form of this new Pandora commercial benchmark.  And we all know how important Pandora’s contracting practices are for benchmarking the law the rest of us must live under.

Digital services are new to royalty audits and have perpetuated the charade started with the very record companies these services are quick to criticize–this time that somehow only certified public accountants have the qualifications to conduct royalty audits of the services.

There is a great tradition in record deals of trying to load up as many restrictions as possible on the artist’s auditor to suppress the number of “inbound” audits coming at the record company.  Almost all record companies will drop the CPA requirement, because in reality everyone knows that royalty compliance has nothing to do with GAAP, financial statements or any of the other tools of the CPA’s trade.  More on this below from a Warner Music Group executive.

Royalty compliance examinations are a science of knowing where to look, knowing when you’re being lied to, and having the means to hold feet to the fire.  And due to the complexity of streaming and its billions of lines of royalties, an auditor also needs to have the technical expertise, staff and systems to manage enormous volumes of data.

This is not a knock on CPAs, but that expertise has nothing to do with GAAP or the skill set tested by the CPA licensing examinations.  The reason that a digital service traditionally wants a CPA requirement is that (1) it is usually more expensive (unnecessarily so), and most importantly (2) very few CPAs do royalty compliance examinations of digital services so the service is likely to be audited by someone who doesn’t know where–or how–to look.  (All due respect to CPAs, but royalty compliance–especially the specific skill set required for digital service audits–is simply not part of their training.)

The National Association of Broadcasters went even further in the recent Web IV proceeding with the full-throated support of Pandora’s CFO Michael Herring–under the CRJ’s new rules not only must a compulsory license audit be conducted by a certified public accountant, that CPA must also be licensed in the jurisdiction where the audit is conducted.  This is another one of the real howlers enunciated with a straight face by the Copyright Royalty Judges in their Web IV determination recently published.  (See the final determination paragraph G6.)

Not even the evil record companies ever tried to get away with this licensing requirement under the audit clauses of record deals, probably because they would have been laughed out of the room.  Unfortunately, that’s not possible with the government’s boot on your throat in the form of the Copyright Royalty Judges.

Warner Music Group executive Ron Wilcox gave an excellent summary of this issue in his Web IV testimony (at p. 15):

WMG’s agreements generally do not require that a certified public accountant (“CPA”) perform royalty audits with its digital partners. Auditors who conduct royalty audits of digital services generally do not draw on the set of skills required to pass the CPA exam.

Rather, royalty auditors must be able to understand the technical systems that WMG’s partners use, to interpret data those systems maintain and generate, and the like. For example, a royalty auditor may have to examine a streaming service’s server logs and content databases to determine the accuracy of the service’s statement of performances and royalty payments.

This could require understanding how the service’s systems record digital performances, how those records are retained, and how those records are used to generate royalty statements. In addition, royalty auditors must be familiar with some of the unique conventions and jargon in the music industry as well as the royalty terms applicable to each service provider.

For instance, auditors need to understand how to calculate a pro-rata share from a label pool, how performances are defined in the relevant contracts, and how to account for non-royalty-bearing plays.

Because royalty audits require extensive technical and industry-specific expertise, in WMG’s experience a CPA certification is not generally a requirement for conducting such audits. To my knowledge, some of the most experienced and knowledgeable royalty auditors in the music industry are not CPAs.

For some unknown reason, the Copyright Royalty Judges chose to disregard this testimony from one of the most experienced and knowledgeable executives in the music business.  Who happened to get the issue exactly right, by the way.

So the CRJ’s disconnected ruling on this issue was unfortunate.  Especially so because this ruling affects all SoundExchange audits–conducted on behalf of artists, musicians, vocalists and record companies.  The CRJ’s ruling makes an already difficult practice Jesuitical in the extreme and adds untold expense and inefficiency to an already cumbersome process.

But good news has come to light–actually great news.  Pandora has seen the error of their ways on this issue and has dropped both the CPA requirement and the licensing requirement in its most recent push for direct licensing conducted by MRI.  This is truly great news and indicates a welcome change of heart at Pandora.

Here’s the new language in Pandora’s announced streaming service:

Audit: In order to enable PUBLISHER to be satisfied that it is being accounted to on an accurate and timely basis in connection with the Pandora Services (including by verifying that the calculation of all financial information is correct), PUBLISHER may appoint an independent third-party auditor (“Auditor”) to examine and make copies and extracts of Pandora’s books, records and server logs related to the use of PUBLISHER Compositions and fulfillment of Pandora’s obligations under this Agreement (collectively, the “Accounting Materials”), such audit to occur at Pandora’s offices and at PUBLISHER’s expense.

This is a triumph of reason over the absurdly out of touch positions taken during Web IV by Pandora, NAB and others, and should immediately be brought to the attention of the appeals court to conform the audit regulations in line with the Pandora commercial benchmark.

 

What is Texas Pacific Group Up To with Pandora and Spotify? Something? Anything?

by Chris Castle

As I’ve noted a couple times, convertible debt financing is all the rage with digital music service these days.  Deezer turned to it after a busted IPO in France, and now both Pandora and Spotify went there.  What’s attractive about debt?  Different reasons depending on the company’s situation.

Convertible debt is a special form of (usually) secured or collateralized loan that looks like any other loan except that it is convertible into the shares of the company.  The amount of time between the funding of the notes and the call on the debt gives the company some running room.  Given that the shares of the company may be worth less (or worthless) at the time the note converts, there’s usually some equity kickers in there along with a pretty bullet proof “event of default” clause.

Depending on how much money is involved and the negotiating position of the lender (usually near infinite leverage at this point), it’s possible for the lenders to effectively take over the company.  If you’re in the management team, that kind of thing can ruin your whole day.

When a company has already been to the well  in the public equity market like Pandora, sometimes going a third time is just not in the cards.  This is particularly true when the company’s share price is going the wrong direction, like Pandora.

Pandora 4-4-16

For Spotify, I’ve already speculated that the main reason Spotify would like converts is because it avoids establishing a valuation for the company.  This can either be a clever move or a desperation hail Mary.  Since both Pandora and Spotify are suddenly in the debt business in a big way (Pandora $300,000,000 and Spotify $1 billion) something common to both caught my eye and that is Texas Pacific Group (or “TPG”).

According to the Wall Street Journal and Bloomberg, TPG is a lender in Spotify’s $1 billion line of convertible debt.  As Spotify is not publicly traded (and I presume these are not publicly traded bonds), we don’t have all the details you’d get in a public offering.  But it looks to be a pretty rich deal for the lenders as you would expect.

According to the WSJ:

Private-equity firm TPG, hedge fund Dragoneer Investment Group and clients of Goldman Sachs Group Inc. [which probably means Sean Parker] participated in the deal, which has been signed and is expected to close at the end of this week, these people said.

But wait, there’s more:

In return for the financing, Spotify promised its new investors strict guarantees tied to an IPO. If Spotify holds a public offering in the next year, TPG and Dragoneer will be able to convert the debt into equity at a 20% discount to the share price of the public offering, according to two people briefed on the deal. After a year, that discount increases by 2.5 percentage points every six months, the people said.

Spotify also agreed to pay annual interest on the debt that starts at 5% and increases by 1 percentage point every six months until the company goes public, or until it hits 10%, the people said. This interest—also called a “coupon” and in this case paid in the form of additional debt, rather than cash—is commonly used in private-equity deals but rarely seen in venture funding.

In addition, TPG and Dragoneer are permitted to cash out their shares as soon as 90 days after an IPO, instead of the 180-day period “lockup” employees and other shareholders are forced to wait before selling shares, the people said.

TPG and Dragoneer will buy $750 million worth of the deal, with the remainder going to clients of Goldman Sachs Group Inc., which advised on the financing, according to people familiar with the deal.

Spotify indicated to new investors it plans to go public in the next two years, people familiar with the matter said.

It’s possible to get more expensive money, but that would involve credit cards.  One thing I feel confident in guaranteeing about TPG, they got their pound of flesh.  And for Spotify–this deal looks pretty desperate.

As an aside, the Bloomberg reporting continued the thoughtless canard:

[L]ike other streamers, Spotify makes losses because it has to pay high fees to the music labels. On about 1 billion euros ($1.1 billion) of revenue in 2014, Spotify suffered an operating loss of 165 million euros, with some 70 percent of costs going to pay labels.

Wrong–the reason that Spotify loses money is because it is trying to maintain a near vertical growth curve.  Remember “get big fast”?  The mantra of the Dot Bomb Collapse?  And then there’s that nasty bit of not actually paying songwriters or bothering to get a license.

But TPG also turned up at Pandora where they got a board seat.  According to a Pandora press release:

[Pandora] is expanding the size of Pandora’s board from nine seats to 10 seats with the addition of Anthony J. “Tony” Vinciquerra, a technology, media and telecom expert with over 30 years of industry experience. Vinciquerra will join the board as a Class III Director and will be included in Pandora’s proxy statement for election at the 2017 Annual Meeting of Stockholders.

Mr. Vinciquerra has a background working very successfully for that well-known milktoast, Rupert Murdoch.  I find it interesting that within a month of Mr. Vinciquerra joining the board Brian McAndrews is out and Pandora is reportedly selling the radio station it bought for the sole purpose of sticking it to songwriters.  Hard to say if Mr. Vinciquerra is kicking ass and taking names, but ousting the guy who championed dropping $450 million on Ticketfly, antagonizing creators to the point of rank hostility and did not understand the definition of payola might be a step in the right direction.

Whether he can do the same for Spotify is an open question.

pandora_500_billboard_cover

Who knows?  Peace could be breaking out all over.  And that would be nice for all of us.

 

What’s Next for Pandora?

Tim Westergren has returned to Pandora as the company’s CEO.  He’s got a golden opportunity to change how Pandora is viewed–we all want Pandora to succeed, but there’s little support for the path the company has been on for years now.  The 42% decline in Pandora’s stock price over the last 12 months hasn’t been helped by the company’s rocky relationship with the vendors of their main product: music.

pandora stock price

With some analysts giving Pandora a fair value stock price of $7, here’s a little unsolicited advice.

Overhead:  Pandora’s overhead is out of control.  They will blame it on royalties, but a closer look shows that the company has a problem with its operating costs that they would like you to ignore (hence the $7 fair value price target).

Pandora 2015 YOY

Integrity:  Westergren arrives at Pandora in a much different point in the zeitgeist than when he founded the company in terms of artist relations.  He made a huge misstep by associating himself with a string of attempts to lower Pandora’s royalty payment to artists and songwriters all of which have either outright failed or created more hostility than they ever would be worth.  In an atmosphere where artists are increasingly suspecting digital music services of cooking the books or operating without licenses, Pandora needs to be doing it better than the next guy.  Westergren doesn’t want to get stuck with Pandora’s “Enron moment”.

Legislation: Pandora backed the failed Internet Radio Fairness Act that was designed to lower artist royalties and created a huge backlash from the artist community.  Some refer to its spectacular failure as “lobbying malpractice.”  One time can be chalked up to bad advice. Don’t make it twice.

Litigation Against Compensating Artists: Pandora became the poster child for refusing to pay royalties on recordings made prior to February 15, 1972 which has come to be known as the “Pandora loophole”.  This would mean that if you were to record “Sophisticated Lady” or “Hello Dolly” tomorrow, Pandora would pay you but not the estates of Duke Ellington or Louis Armstrong.  In a move reminiscent of Spotify’s settlement with the NMPA, Pandora settled with just the major labels and is continuing to litigate against the class lead by The Turtles.  Westergren should settle Pandora’s case and treat all artists fairly.  Again, bad advice can get forgiven if the company does the right thing.  Avoid having loopholes named after your company on a go forward basis.

Litigation Against Compensating Songwriters:  Pandora has lead the way in using the rate courts against songwriters at great expense to ASCAP and BMI.  While Pandora is reportedly trying to make direct agreements with publishers, the company is using the rate courts to drag songwriters through the muck.  Westergren should stop trying to litigate royalty rates and ask yourself if you really saved that much money compared to your own legal fees and brand damage.

Lobbying With MIC Coalition:  Pandora is a member of the MIC Coalition, an alliance of companies against songwriters and artists—companies with a combined market capitalization of over $2 trillion.  (I stopped counting at $2 trillion dollars as I get confused by that many zeros to the left of the decimal place like I get confused by zeros to the right of the decimal place on Pandora’s royalty payments.)  There’s no good reason for Pandora to be in the MIC Coalition–whose first official act was to file an antitrust complaint against SESAC.  That’s right–because Google, Clear Channel (iHeart) and all the rest need protection from songwriters.  (The MIC Coalition even had a fake panel at SXSW moderated by their lobbyist who failed to identify her connection to the “McCoalition”.)

MIC Coalition

Tim Westergren built the better mousetrap, but it’s managed to catch a rat.   By pursuing a path of high integrity and fair dealing with creators, Pandora might have a chance to make it.  It would be a shame to see it go under.  Westergren’s brief should be to do everything he can to get the creative community back on board instead of looking like a stock-rich bubble boy having breakfast at Buck’s.