Will Digital Aggregators Lead the Industry on Transparency with Spotify and Others?

The Music Managers Forum UK have criticized the “secrecy” arounds Spotify’s deals with major labels.  According to Complete Music Update:

The UK’s Music Managers Forum yesterday welcomed the news that Spotify had reached a new deal with Universal Music. However, the trade body criticised the continued secrecy that surrounds the deals made between the major record companies and the streaming services. This secrecy means that artists signed to or distributed by those labels are not allowed to know the specifics of how their music is being monetised.

The same criticism could equally be made of non-statutory, statutory, or direct agreements by digital aggregators like CD Baby, Tunecore, LyricFind, Pledge Music, the Orchard and Loudr, each of which offer varying degrees of transparency of their own books, much less the deals they’ve made with digital services on behalf of the artists, songwriters, labels and music publishers appointing them as agents for relicense of music.  (Loudr, for example, has recently started participating in the most obscure licensing process of all, the mass NOI registrations with the Copyright Office.  Read more about that on another series of MTS posts or my recent article in an American Bar Association journal.  At least with mass NOIs, songwriters know what their royalty is–zero.)

Loudr NOIs
Mass NOI Filings by PK Interactive on behalf of Loudr

It is probably fair to say that there is no disclosure of the actual terms of the direct licenses between these aggregators and the services concerned.  It may also be possible that no one has ever asked the aggregators for the terms of their deals.

That’s a real head scratcher because arguably those aggregators have an even greater obligation to disclose these terms given they cater to many artists, songwriters, music publishers and labels who are unlikely to have the means–even if they have the right–to conduct a royalty examination of any of these companies.  However big a problem anyone has with major labels, every major label artist and major publisher songwriter takes their “audit” rights for granted.

It would be very simple for aggregators to disclose the terms of their deals or to at least summarize them so that artists or songwriters who are considering who to sign with could compare payouts.  It’s fine to tell people what their royalty split, flat fee, or distribution fee might be, but the assumption is that the revenue stream being shared is identical from one aggregator to another.

Also remember that it is common for music services to pay “nonrecoupable” payments to labels–just like it was for record clubs.  This comes in the form of “breakage” or “technology payments” or other ways to keep the money from being called a royalty.  We know this very likely happens with major labels although the amounts are not disclosed–hence the MMF UK’s beef.  We have no way of knowing if it happens with digital aggregators or even what the basic terms of the deals are, which makes it difficult to conduct a desktop audit (the precursor to a full-blown field audit), much less an exhaustive royalty examination.

So let’s not limit the transparency concern to just the major labels.  The digital aggregators could easily lead the way forward by posting the terms of their deals with digital services.  Unless of course the problem lies as much with the digital services as it does with the labels.

 

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 Actit 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.

Spotify IPO Watch: Will Spotify’s “IPO” Be a Cautionary Tale for Stock-for-Royalty Deals?

The Wall Street Journal and other business news outlets are reporting that the much anticipated Spotify initial public offering may not look like what everyone was expecting and may end up not looking much like what almost everyone was thinking it would look like.

If you asked anyone in the music business over the history of Spotify, they would probably tell you that this time was different.  This time MTV wasn’t going to build a business on our backs–we had the Spotify stock.  So if the “tech guys” go into their mysterious counting house and come out with billions, then the people who built and invested in the one product that they all depend on would be treated fairly this time.  The people who really invested in the only product these companies sold–music–would be along for the ride.

Time will tell if that will turn out to be true, but it’s starting to look like there are some serious questions about what will be in the pot at the end of the rainbow, or even if the rainbow will actually end at all.

The assumption all along has been that Spotify will float what’s called a “full commitment underwriting” as opposed to a “busted underwriting” aka Deezer.  In a full commitment underwriting, an underwriter (like Spotify banker Goldman Sachs) agrees to buy all the shares of the issuing company that are available–generally less than all, maybe around 25% of the shares issued and outstanding on an “as-if-converted” basis (an important distinction in Spotify’s case that we will come back to).

What actually happens then is that the issuer doesn’t actually sell shares to the public in the traditional sense, they instead sell shares to underwriters who then sell the shares to the public.  The underwriters usually have a lead (like Goldman Sachs) who then puts together an underwriting syndicate to buy up all the shares that are available.

The proceeds, aka money, from those shares sold to the underwriters go into the issuing company’s treasury, aka bank account.  Thus the primary function of the IPO is fulfilled-raising money for the issuing company.  The company passes the market risk to the underwriters in return for locking in a share price.  So far the shares have not be available to trade, although all of the regulatory hurdles will have been met by this point, SEC clearances, etc. (a final approved Form S-1, for example).

The underwriters then sell the shares are then registered for sale to the public by licensed broker dealers with the idea that the underwriters will get at least a “2 handle” or “3 handle” on the first day of trading because there is a lot of enthusiasm for the stock with the retail stock market.  That means that the underwriters will double or triple their money (give or take) overnight, plus get some nice fees for doing the work and taking the market risk off of the issuer’s books.

The underwriters don’t want a whole bunch of shares of stock crowding into the market and interfering with the 2x or 3x (or more x) that they plan on making.  That’s why issuers have lock up agreements with certain investors (especially insiders) that prevent the sale of shares for anywhere from 90 to 180 days after an IPO.  That’s also why there are some executives (like Pandora’s Tim Westergren) who sell a predetermined number of shares on a predetermined date, which is almost always a sign of a “10b5” agreement that allows insiders to gradually cash out over a fairly long period of time (while not “trading” as in both selling and buying the company’s shares).

So what does all this mean for Spotify?  According to the Wall Street Journal, Spotify is not going the full commitment underwriting route at all–but remember, none of this is coming from the company directly, so they could still back out.  But they’re not denying the story so  far.

Spotify evidently is skipping the underwriting step altogether.  MTS readers will recall in our “Spotify IPO Watch” series that I was skeptical about Spotify’s ability to put together an underwriting syndicate, and the decision to skip an underwriter is being passed off as a way to save some millions in fees.  That’s whistling past the graveyard–those fees are high, but are more than justified if the IPO raises a bunch of money which is usually the point.

According to the Wall Street Journal:

The Swedish company, last valued at $8.5 billion, is seriously considering not holding a public sale of shares. Instead it is exploring simply listing its shares on an exchange in what is known as a direct listing, according to people familiar with the matter. It wouldn’t raise money—the hallmark of an IPO—or use underwriters to sell the stock.

The approach has advantages for Spotify and its existing investors. It could enable the firm to save tens of millions of dollars in underwriting fees, prevent its existing holders from having their stakes diluted, and enable executives to publicly tout the company ahead of its listing, unlike a strictly regulated IPO, the people said….

In direct listings, early investors would be subject to less stringent lockups governing the sale of insiders’ shares and the company could avoid the first-day trading pop that characterizes many IPOs shepherded by underwriters. They are good for some investors but also indicate a company potentially left money on the table. Having a public stock would also give Spotify’s investors and employees the opportunity to cash in their shares.

There are risks to this approach, whose consideration by Spotify was earlier reported by Mergermarket. With market forces determining the share price from the outset, the company’s public debut could be more volatile and unpredictable. Also missing would be the large blocks of stock underwriters typically allocate to investors they believe will hold the shares for the long term and promote trading stability.

Spotify last year issued a $1 billion convertible bond to parties including TPG and Dragoneer Investment Group. The interest rate of 5% increases 1 percentage point every six months until the company goes public, giving it a potential incentive to pursue a listing sooner rather than later. If it lists directly, Spotify would likely need to renegotiate terms of the facility, one of the people said.

Spotify had agreed that the investors could convert the debt into equity at a 20% discount to the share price if an IPO takes place one year hence. If it takes place later, the discount increases. Since this wouldn’t be a typical public offering, it may not trigger a conversion. So Spotify may need to negotiate with the investors a price at which they would receive equity.

I find it hard to believe that sophisticated investors like Texas Pacific Group and Dragoneer will be bamboozled by Spotify taking a loophole on their IPO.  The rest of the shareholders–hard to say.

One thing is almost certain–that “need to negotiate” the WSJ refers to is almost certainly going to result in more stock or cash or relief from lockups or some preferential goodie going to the bond holders who very likely have a first position security interest on all the assets of the company as collateral for their $1 billion plus loan.  (Assuming, of course, that a direct registration doesn’t constitute an event of default under the loan that could allow the bondholders to take over the company.)

It is also almost certainly going to result in other “investors”–the stock for royalties folk–not getting those same benefits.

Stay tuned–Spotify may give us the best argument yet for not taking equity-in-lieu of cash in companies that should be paying royalties like everyone else.

 

 

 

 

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?