Category: Digital Services: Spotify

Chronology: The week in review, Spotify layoffs, mechanical rate increase, FTC on copyright issues in AI

What Spotify needs is a good pandemic.  

Harsh?  Not really, at least not from a share price point of view. Spotify’s all time highest share price was during the COVID pandemic.

Spotify CEO Daniel Ek and the press tells us that Spotify is cutting 1,500 jobs which works out to about 17% of Spotify employees. Which works out to a pre-layoff workforce of 8,823.  So let’s start there—that workforce number seems very high and is completely out of line with some recent data from Statista which is usually reliable.

If Statista is correct, Spotify employed 5,584 as of last year. Yet somehow Spotify’s 2023 workforce grew to 9200 according to the Guardian, fully 2/3 over that 2022 level without a commensurate and offsetting growth in revenue. That’s a governance question in and of itself.

Why the layoffs? The Guardian reports that Spotify CEO Daniel Ek is concerned about costs. He says “Despite our efforts to reduce costs this past year, our cost structure for where we need to be is too big.” Maybe I missed it, but the only time I can recall Daniel Ek being vocally concerned about Spotify’s operating costs was when it came to paying royalties. Then it was full-blown poor mouthing while signing leases for very expensive office space in 4 World Trade Center as well as other pricy real estate, executive compensation and podcasters like Harry & Meghan.

Mr. Ek announced his new, new thing:

Over the last two years, we’ve put significant emphasis on building Spotify into a truly great and sustainable business – one designed to achieve our goal of being the world’s leading audio company and one that will consistently drive profitability and growth into the future. While we’ve made worthy strides, as I’ve shared many times, we still have work to do. Economic growth has slowed dramatically and capital has become more expensive. Spotify is not an exception to these realities.

Which “economic growth” is that?

But, he is definitely right about capital costs.

Still, Spotify’s job cuts are not necessarily that surprising considering the macro economy, most specifically rents and interest rates. As recently as 2018, Spotify was the second largest tenant at 4 WTC. Considering the sheer size of Spotify’s New York office space, it’s not surprising that Spotify is now subletting five floors of 4 WTC earlier this year. That’s right, the company had a spare five floors. Can that excess just be more people working at home given Mr. Ek’s decision to expand Spotify’s workforce? But why does Spotify need to be a major tenant in World Trade Center in the first place? Renting the big New York office space is the corporate equivalent of playing house. That’s an expensive game of pretend.

Remember that Spotify is one of the many companies that rose to dominance during the era of easy money in response to the financial crisis that was the hallmark of quantitative easing and the Federal Reserve’s Zero Interest Rate Policy beginning around 2008. Spotify’s bankers were able to fuel Daniel Ek’s desire to IPO and cash out in the public markets by enabling Spotify to run at a loss because money was cheap and the stock market had a higher tolerance for risky investments. When you get a negative interest rate for saving money, Spotify stock doesn’t seem like a totally insane investment by comparison. This may have contributed to two stock buy-back programs of $1 billion each, Spotify’s deal with Barcelona FC and other notorious excesses.

As a great man said, don’t confuse leverage for genius. It was only a matter of time until the harsh new world of quantitative tightening and sharply higher inflation came back to bite. For many years, Spotify told Wall Street a growth story which deflected attention away from the company’s loss making operations. A growth story pumps up the stock price until the chickens start coming home to roost. (Growth is also the reason to put off exercising pricing power over subscriptions.) Investors bought into the growth story in the absence of alternatives, not just for Spotify but for the market in general (compare Russell Growth and Value indexes from 2008-2023). Cutting costs and seeking profit is an example of what public company CEOs might do in anticipation of a rotational shift from growth to value investing that could hit their shares.

Never forget that due to Daniel Ek’s super-voting stock (itself an ESG fail), he is in control of Spotify. So there’s nowhere to hide when the iconography turns to blame. It’s not that easy or cheap to fire him, but if the board really wanted to give him the heave, they could do it.

I expect that Ek’s newly found parsimony will be even more front and center in renegotiations of Spotify’s royalty deals since he’s always blamed the labels for why Spotify can’t turn a profit. Not that WTC lease, surely. This would be a lot more tolerable from someone you thought was actually making an effort to cut all costs not just your revenue. Maybe that will happen, but even if Spotify became a lean mean machine, it will take years to recover from the 1999 levels of stupid that preceded it.

Hellooo Apple. One big thinker in music business issues calls it “Spotify drunk” which describes the tendency of record company marketers to focus entirely on Spotify and essentially ignore Apple Music as a distribution partner. If you’re in that group drinking the Spotify Kool Aid, you may want to give Apple another look. One thing that is almost certain is that that Apple will still be around in five years.

Just sayin.

Mechanicals on Physical and Downloads Get COLA Increase; Nothing for Streaming

Recall that the “Phonorecords IV” minimum mechanical royalties paid by record companies on physical and downloads increased from 9.1¢ to 12¢ with an annual cost of living adjustment each year of the PR IV rate period. The first increase was calculated by the Copyright Royalty Judges and was announced this week. That increase was from 12¢ to 12.40¢ and is automatic effective January 1, 2024.

Note that there is no COLA increase for streaming for reasons I personally do not understand. There really is no justification for not applying a COLA to a government mandated rate that blocks renegotiation to cover inflation expectations. After all, it works for Edmund Phelps.

The Federal Trade Commission on Copyright and AI

The FTC’s comment in the Copyright Office AI inquiry shows an interesting insight to the Commission’s thinking on some of the same copyright issues that bother us about AI, especially AI training. Despite Elon Musk’s refreshing candor of the obvious truth about AI training on copyrights, the usual suspects in the Copyleft (Pam Samuelson, Sy Damle, etc.) seem to have a hard time acknowledging the unfair competition aspects of AI and AI training (at p. 5):

Conduct that may violate the copyright laws––such as training an AI tool on protected expression without the creator’s consent or selling output generated from such an AI tool, including by mimicking the creator’s writing style, vocal or instrumental performance, or likeness—may also constitute an unfair method of competition or an unfair or deceptive practice, especially when the copyright violation deceives consumers, exploits a creator’s reputation or diminishes the value of her existing or future works, reveals private information, or otherwise causes substantial injury to consumers. In addition, conduct that may be consistent with the copyright laws nevertheless may violate Section 5.

We’ve seen unfair competition claims pleaded in the AI cases–maybe we should be thinking about trying to engage the FTC in prosecutions.

Chronology: The Week in Review, Eric Schmidt Spills on his “Bait” to UK PM, Musk on AI Training and other news

Elon Musk Calls Out AI Training

We’ve all heard the drivel coming from Silicon Valley that AI training is fair use. During his interview with Andrew Ross Sorkin at the DealBook conference, Elon Musk (who ought to know given his involvement with AI) said straight up that anyone who says AI doesn’t train on copyrights is lying.

The UK Government “Took the Bait”: Eric Schmidt Says the Quiet Part Out Loud on Biden AI Executive Order and Global Governance

There are a lot of moves being made in the US, UK and Europe right now that will affect copyright policy for at least a generation. Google’s past chair Eric Schmidt has been working behind the scenes for the last two years at least to establish US artificial intelligence policy. Those efforts produced the “Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence“, the longest executive order in history. That EO was signed into effect by President Biden on October 30, so it’s done. (It is very unlikely that that EO was drafted entirely at Executive Branch agencies.)

You may ask, how exactly did this sweeping Executive Order come to pass? Who was behind it, because someone always is. As you will see in his own words, Eric Schmidt, Google and unnamed senior engineers from the existing AI platforms are quickly making the rule and essentially drafted the Executive Order that President Biden signed into law on October 30. And which was presented as what Mr. Schmidt calls “bait” to the UK government–which convened a global AI safety conference convened by His Excellency Rishi Sunak (the UK’s tech bro Prime Minister) that just happened to start on November 1, the day after President Biden signed the EO, at Bletchley Park in the UK (see Alan Turing). (See “Excited schoolboy Sunak gushes as mentor Musk warns of humanoid robot catastrophe.”)

Remember, an executive order is an administrative directive from the President of the United States that addresses the operations of the federal government, particularly the vast Executive Branch. In that sense, Executive Orders are anti-majoritarian and are as close to at least a royal decree or Executive Branch legislation as we get in the United States (see Separation of Powers, Federalist 47 and Montesquieu). Executive orders are not legislation; they require no approval from Congress, and Congress cannot simply overturn them.

So you can see if the special interests wanted to slide something by the people that was difficult to undo or difficult to pass in the People’s House…and based on Eric Schmidt’s recent interview with Mike Allen at the Axios AI+ (available here), this appears to be exactly what happened with the sweeping and vastly concerning AI Executive Order. I strongly recommend that you watch Mike Allen’s “interview” with Mr. Schmidt which fortunately is the first conversation in the rather long video of the entire event. I put “interview” in scare quotes because whatever it is, it isn’t the kind of interview that prompts probing questions that might put Mr. Schmidt on the spot. That’s understandable because Axios is selling a conference and you simply won’t get senior corporate executives to attend if you put them on the spot. Not a criticism, but understand that you have to find value for your time. Mr. Schmidt’s ego provides plenty of value; it just doesn’t come from the journalists.

Crucially, Congress is not involved in issuing an executive order. Congress may refuse to fund the subject of the EO which could make it difficult to give it effect as a practical matter but Congress cannot overturn an EO. Only a sitting U.S. President may overturn an existing executive order. In Mr. Schmidt’s interview at AI+, he tells us how all this regulatory activity happened:

The tech people along with myself have been meeting for about a year. The narrative goes something like this: We are moving well past regulatory or government understanding of what is possible, we accept that. [Remember the antecedent of “we” means Schmidt and “the tech people,” or more broadly the special interests, not you, me or the American people.].

Strangely…this is the first time that the senior leaders who are engineers have basically said that they want regulation, but we want it in the following ways…which as you know never works in Washington [unless you can write an Executive Order and get the President to sign it because you are the biggest corporation in commercial history].

There is a complete agreement that there are systems and scenarios that are dangerous. [Agreement by or with whom? No one asks.]. And in all of the big [AI platforms with which] you are familiar like GPT…all of them have groups that look at the guard rails [presumably internal groups of managers] and they put constraints on [their AI platform in their silo]. They say “thou shalt not talk about death, thou shall not talk about killing”. [Anthropic, which received a $300 million investment from Google] actually trained the model with its own constitution [see “Claude’s Constitution“] which they did not just write themselves, they hired a bunch of people [actually Claude’s Constitution was crowd sourced] to design a “constitution” for an AI, so it’s an interesting idea.

The problem is none of us believe this is strong enough….Our opinion at the moment is that the best path is to build some IPCC-like environment globally that allows accurate information of what is going on to the policy makers. [This is a step toward global governance for AI (and probably the Internet) through the United Nations. IPCC is the Intergovernmental Panel on Climate Change.]

So far we are on a win, the taste of winning is there.  If you look at the UK event which I was part of, the UK government took the bait, took the ideas, decided to lead, they’re very good at this,  and they came out with very sensible guidelines.  Because the US and UK have worked really well together—there’s a group within the National Security Council here that is particularly good at this, and they got it right, and that produced this EO which is I think is the longest EO in history, that says all aspects of our government are to be organized around this.

While Mr. Schmidt may say, aw shucks dictating the rules to the government never works in Washington, but of course that’s simply not true if you’re Google. In which case it’s always true and that’s how Mr. Schmidt got his EO and will now export it to other countries.

It’s not Just Google: Microsoft Is Getting into the Act on AI and Copyright

Be sure to read Joe Bambridge (Politico’s UK editor) on Microsoft’s moves in the UK. You have to love the “don’t make life too difficult for us” line–as in respecting copyright.

Google and New Mountain Capital Buy BMI: Now what?

Careful observers of the BMI sale were not led astray by BMI’s Thanksgiving week press release that was dutifully written up as news by most of the usual suspects except for the fabulous Music Business Worldwide and…ahem…us. You may think we’re making too much out of the Google investment through it’s CapitalG side fund, but judging by how much BMI tried to hide the investment, I’d say that Google’s post-sale involvement probably varies inversely to the buried lede. Not to mention the culture clash over ageism so common at Google–if you’re a BMI employee who is over 30 and didn’t go to Carnegie Mellon, good luck.

And songwriters? Get ready to jump if you need to.

Spotify Brings the Streaming Monopoly to Uruguay

After Uruguay was the first Latin American country to pass streaming remuneration laws to protect artists, Spotify threw its toys out of the pram and threatened to go home. Can we get that in writing? A Spotify exit would probably be the best thing that ever happened to increase local competition in a Spanish language country. Also, this legislation has been characterized as “equitable remuneration” which it really isn’t. It’s its own thing, see the paper I wrote for WIPO with economist Claudio Feijoo. Complete Music Update’s Chris Cook suggested that a likely result of Spotify paying the royalty would be that they would simply do a cram down with the labels on the next round of license negotiations. If that’s not prohibited in the statute, it should be, and it’s really not “paying twice for the same music” anyway. The streaming remuneration is compensation for the streamers use of and profit from the artists’ brand (both featured and nonfeatured), e.g., as stated in the International Covenant on Economic, Social and Cultural Rights and many other human rights documents:

The Covenant recognizes everyone’s right — as a human right–to the protection and the benefits from the protection of the moral and material interests derived from any scientific, literary or artistic production of which he or she is the author. This human right itself derives from the inherent dignity and worth of all persons. 

Just a Story: Netflix Corporate Biopic of Daniel Ek

FRANKIE FOUR FINGERS

It’s a nice story, but it’s just that. Just a story.

from Snatch, written by Guy Richie

You may have noticed that there is a multi-part Netflix miniseries called “The Playlist” that is based on this book:

“The Spotify Play: How CEO and Founder Daniel Ek Beat Apple, Google and Amazon in the race for audio dominance” is an English translation of Spotify Inifrån, the Swedish book that all of this is based on, which I understand is loosely translated as “Spotify Untold” or as the inside story of Spotify. How it got from “Spotify Untold” to a title straight out of a corporate comms department of failed English majors is anyone’s guess. But notice that the book has now been refocused on the really important story–ahem–of how Daniel Ek crushed the competition and secured his monopoly on global music, or as he calls it “audio”.

For these authors to refer to music as “audio” is very much in line with the story of Spotify’s business model that Daniel Ek tells to Wall Street (which is, in all likelihood, the important audience for all this from Spotify’s perspective). Listen to any Spotify earnings call and you’ll hear what I mean.

The somewhat maniacal focus on global dominance is also interesting when you think about the fact that Daniel Ek uses the 10:1 voting stock he retains to be in global control of music streaming which may explain why Spotify’s algorithms always seem to say “Bieber.” He might want to be a bit careful about the “dominance” word.

Just in time for the Netflix debut, Spotify’s stock has tanked. Which begs the question of why Spotify was ever a public company to begin with. But that’s a story for another day. Here’s what “beating” Apple, Google and Amazon looks like (the straight red line across the bottom of the chart is where Spotify closed on its first day of trading):

You’ll notice that this chart is the relative growth on a percentage basis of all these stocks measured over the same time period. Spotify briefly outperformed the others during COVID, but now is easy to find because it is the one with the minus sign in front of its growth rate.

The Publisher’s Weekly review of the book kind of sums it up:

The authors display more enthusiasm toward Ek than readers are likely to have (they call frequent lies in his personal life “entrepreneurial hustle,” and spend pages writing about the “headaches” behind his multimillion-dollar homes), and let some of his surprising claims slide as quirks, as with an account of Ek insisting Steve Jobs was calling him to breathe over the phone and intimidate him. 

I think if you do the timeline of this Steve Jobs anecdote, you will find it particularly odd because Steve was kind of busy at that time. He was busy dying. Which makes the anecdote both troubling and kind of sick.

I happened to have a chat with a Hollywood film executive–let’s call him/her “Bubba”–about the Netflix miniseries and the odd way that a book in Swedish was set up for production at Netflix at lightning speed without ever being on a best seller list or gaining an audience.

“Smell that?” said Bubba, doing an impression of Robert Duvall in Apocalypse Now. “Nothing else in the world smalls like that. Smells like…astroturf.”

Really? I said. Which part?

“All of it,” Bubba said. “But look, it’s just a story. A bunch of workers got paid to tell a story that some rich guy wanted told a certain way. Those workers may go on to do something important like send their kid to college or write the next Citizen Kane or Chinatown. Or Dirty Harry for that matter. But this month they could pay for gas and their mortgage. Just another day in Hollywood. Let’s get the steak tartare.”

So lots of questions about how this book came to be written and miniseries came to be made. The solution is likely the same as it is for radio payola–disclosure.

Streaming Remuneration:  An answer to global cultural dominance by European/US Streaming Services

Streamers Lack of Local Cultural Contribution

Look at Spotify’s “Global Top 50” playlist on any day and the world’s biggest music service will show all or nearly all English language songs. With few exceptions these songs are performed by Anglo-American artists released by major record companies.  

These “enterprise” playlists largely take the place of broadcast radio for many users where Spotify operates and Spotify competes with local radio for advertising revenue on the free version of Spotify.

Spotify’s now former general counsel told the recent inquiry into the music streaming economy conducted by the UK Parliament’s Digital, Culture, Media and Sport Committee, “Our job is sucking users away from radio”[2] and Spotify uses its market power to do just that.  

However, Spotify has not been subject to any local content protections that would be in place for local radio broadcasters.  Enterprise playlists that exclude local music contributes to the destruction of music economies, including performers.  Local performers struggle even more to compete with Anglo-American repertoire, even in their own countries.  

Due to this phenomenon, local artists are forced to compete for “shelf space” with everyone in their local language and then the Anglo-American artists and their record companies.  This also means that local artists compete for a diminishing share of the payable royalties.  The “big pool” revenue share method of royalty compensation is designed to overcompensate the English-language big names and reduce payments to artists performing in other languages in their own country.

Local Content Rules 

Many countries implement local content broadcast rules that require broadcasters to play a certain number of recordings performed by local artists or indigenous people, songs written by local songwriters in local languages, or recordings that are released by locally-owned record companies.

Because streaming playlists, especially Spotify enterprise playlists or algorithmically selected recordings, are an equivalent to broadcast radio, there is a question as to whether national governments should regulate streaming services operating in their countries to require local content rules.  Implementing such rules could benefit local performers and songwriters in an otherwise unsustainable enviornment.

The Fallacy of Infinite Shelf Space

Because Spotify adds recordings at a rate of 60,000 tracks daily (now reports of 100,000 tracks daily) and never deletes recordings, there is a marked competitive difference between a record store and Spotify.  In the record store model, artists had to compete with recordings that were in current release; in the Spotify model, artists have to compete will all recordings ever released.  

Adding the dominant influence of Anglo-American recordings on Spotify, the “infinite shelf space” simply compounds the competitive problems for non-English recordings.

Streaming Remuneration Helps Solve the Sustainability Crisis

The streaming remuneration model requires streaming services—not record companies—to pay additional compensation to nonfeatured and featured performers.  Streaming remuneration would be created under national law and is compensatory in nature, not monies in exchange for a license.  Existing licenses (statutory or contractual) would not be affected and remuneration payments could not be offset by streamers against label payments or by labels against artist payments.

Each country would determine the amount to be paid to performers by streaming services and the payment periods.  Payments would be made to local CMOs or the equivalent depending on the infrastructure in the particular country.

European Corporate Dominance 

It must also be said that the two founders of Spotify hold a 10:1 voting control over the company through special stock issued only to them.  This means that these two Caucasian Europeans control 100% of the dominant music streaming company in the world.  For comparison, Google and Facebook have a similar model, while Apple has a 1 share 1 vote structure as does Amazon (although Jeff Bezos owns a controlling interest in Amazon).  

The net effect is that the entire global streaming music industry is controlled by six Caucasian males of European descent.  This demography also argues for local content rules to protect local performers from these influences that have produced an English-only Global Top 50 playlist.

Local governments could consider whether companies with the 10:1 voting stock (so-called “dual class” or “supervoting” shares) should be allowed to operate locally.

Countries Can Respond to Streaming’s Homogenized Algorithmic Playlist Culture

Many national cultural protection laws have a history of sustaining local culture and musicians in the face of the Anglo-American Top 40 juggernaut. There is no reason to think that these agencies are not up for the task of protecting their citizens in the face of algorithms and neuromarketing.

Thinking Outside the Pie: @legrandnetwork Study for GESAC Highlights Streaming Impact on Choking Diversity and Songwriter Royalties

Emmanuel Legrand prepared an excellent and important study for the European Grouping of Societies of Authors and Composers (GESAC) that identifies crucial effects of streaming on culture, creatives and especially songwriters. The study highlights the cultural effects of streaming on the European markets, but it would be easy to extend these harms globally as Emmanuel observes.

For example, consider the core pitch of streaming services that started long ago with the commercial Napster 2.0 pitch of “Own Nothing, Have Everything”. This call-to-serfdom slogan may sound good but having infinite shelf space with no cutouts or localized offering creates its own cultural imperative. And that’s even if you accept the premise the algorithmically programed enterprise playlists on streaming services should not be subject to the same cultural protections for performers and songwriters as broadcast radio–its main competitor.

[This] massive availability of content on [streaming] platforms is overshadowed by the fact that these services are under no positive obligations to ensure visibility and discoverability of more diverse repertoires, particularly European works….[plus]  the initial individual subscription fee of 9.99 (in Euros, US dollars, or British pound) set in 2006, has never increased, despite the exponential growth in the quality, amount of songs, and user-friendliness of music streaming services.

Artists working new recordings, especially in a language other than English, are forced to fight for “shelf space” and “mindshare”–that is, recognition–against every recording ever released. While this was always true theoretically; you never had that same fight the same way at Tower Records.

This is not theoretically true on streaming platforms–it is actually true because these tens of millions of historical recordings are the competition on streaming services. When you look at the global 100 charts for streaming services, almost all of the titles are in English and are largely Anglo-American releases. Yes, we know–Bad Bunny. But this year’s exception proves the rule.

And then Emmanuel notes that it is the back room algorithms–the terribly modern version of the $50 handshake–that support various payola schemes:

The use of algorithms, as well as bottleneck represented by the most popular playlists, exacerbates this. Furthermore, long-standing flaws in the operations of music streaming platforms, such as “streaming fraud”, “ghost/fake artists”, “payola schemes”, “royalty free content” and other coercive practices [not to mention YouTube withholding access to Content ID] worsen the impact on many professional creators….

This report suggests solutions to bring greater transparency in the use of algorithms and invites stakeholders to undertake a review of the economic models of streaming services and evaluate how they currently affect cultural diversity which should be promoted in its various forms — music genres, languages, origin of performers and songwriters, in particular through policy actions.

MTS readers will recall my extensive dives into the hyperefficient market share distribution of streaming royalties known as the “big pool” compared to my “ethical pool” proposal and the “user centric” alternative. As Emmanuel points out, the big pool royalty model belies a cultural imperative–if you are counting streams on a market share basis that results in the rich getting richer based on “stream share” that same stream share almost guarantees that Anglo American repertoire will dominate in every market the big streamers operate.

Emmanuel uses French-Canadian repertoire as an example (a subject I know a fair amount about since I performed and recorded with many vedettes before Quebecoise was cool).

A lot of research has been made in Canada with regards to discoverability, in particular in the context of French-Canadian music, which is subject to quotas for over the air broadcasters which however do not apply to music streaming services. The research shows that while the lists of new releases from Québec studied are present in a large proportion on streaming platforms, they are “not very visible and very little recommended.” 

It further shows that the situation is even worse when it is not about new releases, including hit music, when the presence of titles “drops radically.” It is not very difficult to imagine that if we were to swap Québec in the above sentence with the name of any country from the European Union [or any non-Anglo American country], and even with music from the European Union as a whole, we could find similar results.

In other words, there may be aggregators with repertoire in languages other than English that deliver tracks to streamers in their countries, but–absent localized airplay rules–a Spotify user might never know the tracks were there unless the user already knew about the recording, artist or songwriter. (Speaking of Canada, check the MAPL system.)

This is a prime example of why Professor Feijoo and I proposed streaming remuneration in our WIPO study to allow performers to capture the uncompensated capital markets value to the enterprise driven by these performers. Because of the market share royalty system, revenues and royalties do not compensate all performers, particularly regional or non-featured performers (i.e., session players and singers) who essentially get zero compensation for streaming.

Emmanuel also comments on the imbalance in song royalty payments and invites a re-look at how the streaming system biases against songwriters. I would encourage everyone to stop thinking of a pie to be shared or that Johnny has more apples–when the services refuse to raise prices in order to tell a growth story to Wall Street or The City, measuring royalties by a share of some mythical royalty pie is not ever going to get it done. It will just perpetuate a discriminatory system that fails to value the very people on whose backs it was built be they songwriters or session players.

We must think outside the pie.

Is There Something Rotten in Sweden? Spoxit continues as Obamas Ankle Spotify

One of the sure signs of a bubble is when those invested in the bubble narrative deny the obvious. Southern California real estate is replete with examples. Another sign is when there are too many people invested in the narrative. The British corporate raider and financier Sir James Goldsmith was asked why he got into all cash the summer before the 1987 stock market crash. The apocryphal story is that it was because he got a stock tip from his barber. Facts, dear readers, facts are stubborn things.

One such fact surfaced this week–the Obamas are exiting their exclusive podcast deal with Spotify according to Yahoo News (citing Bloomberg). Now let us accept as a given that the Obamas as a brand are still one of the strongest personal brands in the world–in a brand shoot out with fellow podcasters on the Big Stream it ain’t even close. Meghan and Harry? Please.

But get a load of the reasons given. First there’s this one:

The former first couple’s media production company, Higher Ground, will split with Spotify after the streaming giant declined to make an offer to renew their deal, Bloomberg reported on Thursday, citing people familiar with negotiations.

Huh? “Declined to make an offer”? The thing about talent is that it doesn’t come around twice. If you were lucky enough to get into business with real stars, you hang on for dear life. Granted that statement sounds a bit like press release BS to keep the Obamas from looking greedy, but it’s not greedy to want the next deal point–it’s just creativity and smart business to keep that talent feeling ike the best place in the universe to work on that creativity is in your house.

High Ground’s departure follows a number of disagreements with Spotify, such as how frequently the Obamas would feature in output, and over exclusivity of shows, including the former president’s podcast with Bruce Springsteen, according to Bloomberg.

Say what? How often do the Obamas “feature in output”? As many times as they want. If you’ll pay $100 million for Joe Rogan (or whatever the 9 figure number actually is), you will understand that the deal is basically about freedom, like this:

The first show under the Obamas’ Spotify deal, “The Michelle Obama Podcast,” was among the platform’s most popular podcasts during its exclusive run, though Spotify later made it available on rival podcast apps. Barack Obama also hosted his own Spotify show called “Renegades: Born in the USA,” alongside musician Bruce Springsteen.

So let’s get this straight–the Spot will pay big bucks for Rogan and the naming rights to the Barcelona football club and their Camp Nou stadium, but turn around and be cheap and petty with Barack and Michelle Obama.

Right.

As I told the UK Competition and Markets Authority, do not mistake muscle for genius. Spoxit is on the move.

Spotify ESG fail: Governance

[This is an extension of Spotify’s ESG Fail: Environment and Spotify’s ESG Fail: Social. “ESG” is a Wall Street acronym often attributed to Larry Finkat Blackrock that designates a company as suitable for socially conscious investing based on its “Environmental, Social and Governance” business practices. See the Upright Net Impact data model on Spotify’s sustainability score. As of this writing, the last update of Spotify’s Net Impact score was before the Neil Young scandal.]

Spotify has one big governance problem that permeates its governance like a putrid miasma in the abattoir: “Dual-class stock” sometimes referred to as “supervoting” stock. If you’ve never heard the term, buckle up. I wrote an extensive post on this subject for the New York Daily News that you may find interesting.

Dual class stock allows the holders of those shares–invariably the founders of the public company when it was a private company–to control all votes and control all board seats. Frequently this is accomplished by giving the founders a special class of stock that provides 10 votes for every share or something along those lines. The intention is to give the founders dead hand control over their startup in a kind of corporate reproductive right so that no one can interfere with their vision as envoys of innovation sent by the Gods of the Transhuman Singularity. You know, because technology.

Google was one of the first Silicon Valley startups to adopt this capitalization structure and it is consistent with the Silicon Valley venture capital investor belief in infitilism and the Peter Pan syndrome so that the little children may guide us. The problem is that supervoting stock is forever, well after the founders are bald and porky despite their at-home beach volleyball courts and warmed bidets.

Spotify, Facebook and Google each have a problem with “dual class” stock capitalizations.  Because regulators allow these companies to operate with this structure favoring insiders, the already concentrated streaming music industry is largely controlled by Daniel Ek, Sergey Brin, Larry Page and Mark Zuckerberg.  (While Amazon and Apple lack the dual class stock structure, Jeff Bezos has an outsized influence over both streaming and physical carriers.  Apple’s influence is far more muted given their refusal to implement payola-driven algorithmic enterprise playlist placement for selection and rotation of music and their concentration on music playback hardware.)

The voting power of Ek, Brin, Page and Zuckerberg in their respective companies makes shareholder votes candidates for the least suspenseful events in commercial history.  However, based on market share, Spotify essentially controls the music streaming business.  Let’s consider some of the  implications for competition of this disfavored capitalization technique.

Commissioner Robert Jackson, formerly of the U.S. Securities and Exchange Commission, summed up the problem:

“[D]ual class” voting typically involves capitalization structures that contain two or more classes of shares—one of which has significantly more voting power than the other. That’s distinct from the more common single-class structure, which gives shareholders equal equity and voting power. In a dual-class structure, public shareholders receive shares with one vote per share, while insiders receive shares that empower them with multiple votes. And some firms [Snap, Inc. and Google Class B shares] have recently issued shares that give ordinary public investors no vote at all.

For most of the modern history of American equity markets, the New York Stock Exchange did not list companies with dual-class voting. That’s because the Exchange’s commitment to corporate democracy and accountability dates back to before the Great Depression. But in the midst of the takeover battles of the 1980s, corporate insiders “who saw their firms as being vulnerable to takeovers began lobbying [the exchanges] to liberalize their rules on shareholder voting rights.”  Facing pressure from corporate management and fellow exchanges, the NYSE reversed course, and today permits firms to go public with structures that were once prohibited.

Spotify is the dominant streaming firm and the voting power of Spotify stockholders is concentrated in two men:  Daniel Ek and Martin Lorentzon.  Transitively, those two men literally control the music streaming sector through their voting shares, are extending their horizontal reach into the rapidly consolidating podcasting business and aspire soon to enter the audiobooks vertical.  Where do they get the money is a question on every artists lips after hearing the Spotify poormouthing and seeing their royalty statements.

The effects of that control may be subtle; for example, Spotify engages in multi-billion dollar stock buybacks and debt offerings, but has yet makes ever more spectacular losses while refusing to exercise pricing power.  

So yes, Spotify is starting to look like the kind of Potemkin Village that investment bankers love because they see oodles of the one thing that matters: Fees.

On the political side, let’s see what the company’s campaign contributions tell us:

Spotify has also made a habit out of hiring away government regulators like Regan Smith, the former General Counsel and Associate Register of the US Copyright Office who joined Spotify as head of US public policy (a euphemism for bag person) after drafting all of the regulations for the Mechanical Licensing Collective;

Whether this is enough to trip Spotify up on the abuse of political contributions I don’t know, but the revolving door part certainly does call into question Spotify’s ethics.

It does seem that these are the kinds of facts that should be taken into account when determining Spotify’s ESG score.

Spotify’s ESG Fail: Social

Investopedia ESG criteria

[This is an extension of Spotify’s ESG Fail: Environment]

I started to write this post in the pre-Neil Young era and I almost feel like I could stop with the title. But there’s a lot more to it, so let’s look at the many ways Spotify is a fail on the Social part of ESG.

Before Spotify’s Joe Rogan problem, Spotify had both an ethical supply chain problem and a “fair wage” problem on the music side of its business, which for this post we will limit to fair compensation to its ultimate vendors being artists and songwriters. In fact, Spotify is an example to music-tech entrepreneurs of how not to conduct their business.

Treatment of Songwriters

On the songwriter side of the house, let’s not fall into the mudslinging that is going on over the appeal by Spotify (among others) of the Copyright Royalty Board’s ruling in the mechanical royalty rate setting proceeding known as Phonorecords III. Yes, it’s true that streaming screws songwriters even worse that artists, but not only because Spotify exercised its right of appeal of the Phonorecords III case that was pending during the extensive negotiations of Title I of the Music Modernization Act. (Title I is the whole debacle of the Mechanical Licensing Collective and the retroactive copyright infringement safe harbor currently being litigated on Constitutional grounds.)

The main reason that Spotify had the right to appeal available to it after passing the MMA was because the negotiators of Title I didn’t get all of the services to give up their appeal right (called a “waiver”) as a condition of getting the substantial giveaways in the MMA. A waiver would have been entirely appropriate given all the goodies that songwriters gave away in the MMA. When did Noah build the Ark? Before the rain. The negotiators might have gotten that message if they had opened the negotiations to a broader group, but they didn’t so now they’ve got the hot potato no matter how much whinging they do.

Having said that, you will notice that Apple took pity on this egregious oversight and did not appeal the Phonorecords III ruling. You don’t always have to take advantage of your vendor’s negotiating failures, particularly when you are printing money and when being generous would help your vendor keep providing songs. And Mom always told me not to mock the afflicted. Plus it’s good business–take Walmart as an example. Walmart drives a hard bargain, but they leave the vendor enough margin to keep making goods, otherwise the vendor will go under soon or run a business solely to service debt only to go under later. And realize that the decision to be generous is pretty much entirely up to Walmart. Spotify could do the same.

Is being cheap unethical? Is leveraging stupidity unethical? Is trying to recover the costs of the MLC by heavily litigating streaming mechanicals unethical (or unexpected)? Maybe. A great man once said failing to be generous is the most expensive mistake you’ll ever make. So yes, I do think it is unethical although that’s a debatable point. Spotify has not made themselves many friends by taking that course. But what is not debatable is Spotify’s unethical treatment of artists.

Treatment of Artists

The entire streaming royalty model confirms what I call “Ek’s Law” which is related to “Moore’s Law”. Instead of chip speed doubling every 18 months in Moore’s Law, royalties are cut in half every 18 months with Ek’s Law. This reduction over time is an inherent part of the algebra of the streaming business model as I’ve discussed in detail in Arithmetic on the Internet as well as the study I co-authored with Dr. Claudio Feijoo for the World Intellectual Property Organization. These writings have caused a good deal of discussion along with the work of Sharky Laguana about the “Big Pool” or what’s come to be called the “market centric” royalty model.

Dissatisfaction with the market centric model has led to a discussion of the “user-centric” model as an alternative so that fans don’t pay for music they don’t listen to. But it’s also possible that there is no solution to the streaming model because everybody whose getting rich (essentially all Spotify employees and owners of big catalogs) has no intention of changing anything voluntarily.

It would be easy to say “fair is where we end up” and write off Ek’s Law as just a function of the free market. But the market centric model was designed to reward a small number of artists and big catalog owners without letting consumers know what was happening to the money they thought they spent to support the music they loved. As Glenn Peoples wrote last year (Fare Play: Could SoundCloud’s User-Centric Streaming Payouts Catch On?,

When Spotify first negotiated its initial licensing deals with labels in the late 2000s, both sides focused more on how much money the service would take in than the best way to divide it. The idea they settled on, which divides artist payouts based on the overall popularity of recordings, regardless of how they map to individuals’ listening habits, was ‘the simplest system to put together at the time,’ recalls Thomas Hesse, a former Sony Music executive who was involved in those conversations.

In other words, the market centric model was designed behind closed doors and then presented to the world’s artists and musicians as a take it or leave it with an overhyped helping of FOMO.

As we wrote in the WIPO study, the market centric model excludes nonfeatured musicians altogether. These studio musicians and vocalists are cut out of the Spotify streaming riches made off their backs except in two countries and then only because their unions fought like dogs to enforce national laws that require streaming platforms to pay nonfeatured performers.

The other Spotify problem is its global dominance and imposition of largely Anglo-American repertoire in other countries. The company does this for one big reason–they tell a growth story to Wall Street to juice their stock price. In fact, Daniel Ek just did this last week on his Groundhog Day earnings call with stock analysts. For example he said:

The number one thing that we’re stretched for at the moment is more inventory. And that’s why you see us introducing things such as fan and other things. And then long-term with a little bit more horizon, it’s obviously international.

Both user-centric and market-centric are focused on allocating a theoretical revenue “pie” which is so tiny for any one artist (or songwriter) who is not in the top 1 or 5 percent this week that it’s obvious the entire model is bankrupt until it includes the value that makes Daniel Ek into a digital munitions investor–the stock.

Debt and Stock Buybacks

Spotify has taken on substantial levels of debt for a company that makes a profit so infrequently you can say Spotify is unprofitable–which it is on a fully diluted basis in any event. According to its most recent balance sheet, Spotify owes approximately $1.3 billion in long term–secured–debt.

You might ask how a company that has never made a profit qualifies to borrow $1.3 billion and you’d have a point there. But understand this: If Spotify should ever go bankrupt, which in their case would probably be a reorganization bankruptcy, those lenders are going to stand in the secured creditors line and they will get paid in full or nearly in full well before Spotify meets any of its obligations to artists, songwriters, labels and music publishers, aka unsecured creditors.

Did Title I of the Music Modernization Act take care of this exposure for songwriters who are forced to license but have virtually no recourse if the licensee fails to pay and goes bankrupt? Apparently not–but then the lobbyists would say if they’d insisted on actual protection and reform there would have been no bill (pka no bonus).

Right. Because “modernization” (whatever that means).

But to our question here–is it ethical for a company that is totally dependent on creator output to be able to take on debt that pushes the royalties owed to those creators to the back of the bankruptcy lines? I think the answer is no.

Spotify has also engaged in a practice that has become increasingly popular in the era of zero interest rates (or lower bound rates anyway) and quantitative easing: stock buy backs.

Stock buy backs were illegal until the Securities and Exchange Commission changed the law in 1982 with the safe harbor Rule 10b-18. (A prime example of unelected bureaucrats creating major changes in the economy, but that’s a story for another day.)

Stock buy backs are when a company uses the shareholders money to buy outstanding shares of their company and reduce the number of shares trading (aka “the float”). Stock buy backs can be accomplished a few ways such as through a tender offer (a public announcement that the company will buy back x shares at $y for z period of time); open market purchases on the exchange; or buying the shares through direct negotiations, usually with holders of larger blocks of stock.

Vox’s Matt Yglesias sums it up nicely:

A stock buyback is basically a secondary offering in reverse — instead of selling new shares of stock to the public to put more cash on the corporate balance sheet, a cash-rich company expends some of its own funds on buying shares of stock from the public.

Why do companies buy back their own stock? To juice their financials by artificially increasing earnings per share.

Spotify has announced two different repurchase programs since going public according to their annual report for 12/31/21:

Share Repurchase Program On August 20, 2021, [Spotify] announced that the board of directors [controlled by Daniel Ek] had approved a program to repurchase up to $1.0 billion of the Company’s ordinary shares. Repurchases of up to 10,000,000 of the Company’s ordinary shares were authorized at the Company’s general meeting of shareholders on April 21, 2021. The repurchase program will expire on April 21, 2026. The timing and actual number of shares repurchased depends on a variety of factors, including price, general business and market conditions, and alternative investment opportunities. The repurchase program is executed consistent with the Company’s capital allocation strategy of prioritizing investment to grow the business over the long term. The repurchase program does not obligate the Company to acquire any particular amount of ordinary shares, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion. The Company uses current cash and cash equivalents and the cash flow it generates from operations to fund the share repurchase program.

The authorization of the previous share repurchase program, announced on November 5, 2018, expired on April 21, 2021. The total aggregate amount of repurchased shares under that program was 4,366,427 for a total of approximately $572 million.

Is it ethical to take a billion dollars and buy back shares to juice the stock price while fighting over royalties every chance they get and crying poor? I think not.

Spotify’s ESG Problem: Environment Fail

Spotify has an ESG problem, and a closer look may offer insights into a wider problem in the tech industry as a whole. If a decade of destroying artist and songwriter revenues isn’t enough to get your attention, maybe the Neil Young and Joe Rogan imbroglio will. But a minute’s analysis shows you that Spotify was already an ESG fail well before Neil Young’s ultimatum.

Streaming is an Environmental Fail

I first began posting about streaming as an environmental fail years ago in the YouTube and Google world. Like so many other ways that the BIg Tech PR machine glosses over their dependence on cheap energy right through their supply chain from electric cars to cat videos, YouTube did not want to discuss the company as a climate disaster zone. To hear them tell it, YouTube, and indeed the entire Google megalopolis right down to the Google Street View surveillance team was powered by magic elves running on appropriate golden flywheels with suitable work rules. Or other culturally appropriate spin from Google’s ham handed PR teams.

Greenpeace first wrote about “dirty data” in 2011–the year Spotify launched in the US. Too bad Spotify ignored the warnings. Harvard Business Review also tells us that 2011 was a demarcation point for environmental issues at Microsoft following that Greenpeace report:

In 2011, Microsoft’s top environmental and sustainability executive, Rob Bernard, asked the company’s risk-assessment team to evaluate the firm’s exposure. It soon concluded that evolving carbon regulations and fluctuating energy costs and availability were significant sources of risk. In response, Microsoft formed a centralized senior energy team to address this newly elevated strategic issue and develop a comprehensive plan to mitigate risk. The team, comprising 14 experts in electricity markets, renewable energy, battery storage, and local generation (or “distributed energy”), was charged by corporate senior leadership with developing and executing the firm’s energy strategy. “Energy has become a C-suite issue,” Bernard says. “The CFO and president are now actively involved in our energy road map.”

If environment is a C-suite issue at Spotify, there’s no real evidence of it in Spotify’s annual report (but then there isn’t at the Mechanical Licensing Collective, either). “Environment” word search reveals that at Spotify, the environment is “economic”, “credit”, and above all “rapidly changing.” Not “dirty”–or “clean” for that matter.

The fact appears to be that Spotify isn’t doing anything special and nobody seems to want to talk about it. But wait, you say–what about the sainted Music Climate Pact? Guess who hasn’t signed up to the MCP? Any streaming service. There is a “Standard Commitment Letter” that participants are supposed to sign up to but I wasn’t able to read it. Want to guess why?

That’s right. You know who wants to know what you’re up to.

Next: Spotify’s “Social” Fail: Rogan, Royalties and The Uyghurs

The Economics of Recoupment Forgiveness

Can Forgiveness Be Compulsory?

There is a drumbeat starting in some quarters, particularly in the UK, for the government to inject itself into private contracts and cause a forgiveness of unrecouped balances in artist agreements after a date certain–as if by magic.  Adopting such a law would focus Government action to essentially cause a compulsory “sale” by the government of the amount of every artist’s unrecouped balance due to the passing of time for what is arguably a private benefit.

Writing off the unrecouped balance for the artist’s private benefit would essentially cause the transfer to the artist of the value of the unrecouped balance to be measured at zero–which raises a question as to the other side of the double-entry if the government also allows a financial accounting write off for the record company investor  but values that risk capital at zero.  Government action of this type raises Constitutional questions in the U.S., and I suspect will also raise those same types of questions in any jurisdiction where the common law obtains.  We’ll come back to this.  It also raises questions as to why anyone would risk the investment in new artists’ recordings if the time frame for recovery of that risk capital is foreshortened. We’ll come back to this, too.

What’s Wrong with Being Unrecouped?

Remember—being unrecouped is not a “debt” or a “loan”.  It’s just a prepayment of royalties by contract that is conditioned on certain events happening before it is ever “repaid.”   There is no guarantee that the prepaid royalties will ever be earned.

One of the all-time great artist managers told me once that if his artist was recouped under the artist’s record deal, the manager was not doing his job.  The whole point was to be as unrecouped as humanly possible at all times.  Why?  Because it was free money money bet that may never be called.  Plus he would do his best to make the label or publisher bet too high and he was never going to let them bet too low.

Another great artist manager who was representing a new artist who went on to do well before breaking up said that once he realized he was never going to be recouped with the record company it was a wonderfully liberating experience.  He’d talk them into loads of recoupable off-contract payments like tour support, promotion and marketing that made his band successful and that he didn’t share with the label.  Tour support is only 50% recoupable?  How much will you spend if it’s 100% recoupable?

Get the idea?  We’re starting to hear some rumblings about a statutory cutoff for recoupment of a term of years.  First of all, I would bet such a rule in the U.S. if applied retroactively would be unconstitutional taking in violation of due process under the 5th Amendment.  Regardless, whichever country adopts such a rule will in short order find themselves with either no record companies or with vastly different deal points in artist recording agreements subject to their national law.  (See the “$50,000 a year” controversy from 1994 over California Civ. Code §3423 when California-based labels were contemplating leaving the State.  We’re way beyond runaway production now.)

Record Company as Banker

Let’s imagine two scenarios:  One is an unsigned artist trying to finance a recording, the other is a catalog artist with an inactive royalty account.  They each illustrate different issues regarding recoupment.

Imagine you went to a bank to finance your recordings.  You told the banker I do some livestreams, here’s my Venmo account statements and I have all this Spotify data on my 200,000 streams that made me $500 but cost me $10,000 in marketing.  Most importantly of all, your assistant thinks I am really cool, if you catch my drift.

I want to make a better record and I think I could get some gigs if clubs ever reopen.  My songs are really cool.  I need you to lend me $50,000 to make my record and another $50,000 to market it.  (Probably way more.)  I don’t want a maturity date on the loan, I don’t want events of default (meaning it is “non recourse”), you can’t charge me interest, I don’t want to make payments, but you can recoup the principal from the earnings I make for licensing or selling copies of the recordings you pay for.  I’ll market those recordings unless my band breaks up which you have no control over.  As I recoup the principal, I’ll pay you in current dollars for the historical unrecouped balance.  I keep all the publishing, merch and live.  And oh, if you want you can own the recordings, but understand that I will be doing everything I can to try to get you (or guilt you or force you) to give me the recordings back regardless of whether you have recouped your “loan” which isn’t a loan at all.

Deal?

Catalog Fairness

Then consider a catalog artist.  The catalog artist was signed 25 years ago to a term recording artist agreement with $500,000 per LP on a three firm agreement that didn’t pan out.  After tour support, promotion, additional advances to cover income tax payments, the artist got dropped from their label and broke up with a $1,000,000 unrecouped balance.   In the intervening years, the artists went on to individual careers as songwriters and film composers, but none of those subsequent earnings were recoupable as they got dropped and were under separate contracts.  Another thing that happened in the intervening years was the label went from selling CDs at a $10 wholesale price through their wholly owned branch distribution system to selling streams at $0.003 each through a third party platform with probably triple the marketing costs.

The old recordings eventually dwindled below 1,500 CD units a year for a few years, and in 2005 the label cut them out, but continued to service their digital accounts with the recordings as deep and ever deeper catalog.  After a few sync placements, earnings reached zero for a couple years and the royalty account was archived, i.e., taken off line.  Streaming happened and now the recordings are making about $100 a year until one track got onto a Spotify “Gen Z Afternoon Safe Space Tummy Rub” playlist and scored 1,000,000 streams or about $600 give or take.  When the royalty account was archived, it had an unrecouped balance of $800,000 in 1995 dollars.  So the $600 gets accrued in case the catalog ever earns enough to justify the cost of reactivating the account—which means the artist doesn’t get paid for the recordings because they are unrecouped but they also don’t get a statement because they’ve had an earnings drought.  Like most per-stream payments, it would cost more to account for the $600 on a statement than the royalties payable.

Bear in mind that adjusted for inflation—and we’ll come back to that—the $800,000 in 1995 dollars would be worth $1,366,866.14 today.  But because the record company does not charge either overhead, interest, or any inflation charge, the historical $800,000 from 1995 is paid off in ever-inflated current dollars.

As the artist managers said, the artists long ago got the benefit of getting essentially a no-risk lifetime royalty pre-payment (it’s not really correct to call it a “loan” when there’s no recourse, maturity date, payments, interest rate or repayment schedule) and long ago spent the money on a variety of business and personal expenses.  Which potentially enhanced their careers so they could get that film work later down the line.  Or more simply, a bird in the hand.

Do You Really Want Monkey Points?

If you want to see what would happen if this apple cart were rocked, take a good look at a good corollary, the “net profits” definition in the film business, or what Eddy Murphy famously called “monkey points.”  Without getting into the gory details, studios will typically play a game with gross receipts that involves exclusions, deductions, subdistributor receipts, advances, ancillary rights, income from physical properties (from memorabilia like Dorothy’s slippers), distribution fees, distribution and marketing expenses, deferments, gross participation, negative costs, interest on the negative cost, overbudget deductions, overhead on negative cost and marketing costs (and interest on overhead)…shall I go on?  And then there’s the accounting.

The movie industry also has a concept called “turnaround”.  Turnaround happens when Studio A decides (usually for commercial reasons) it is not going forward with a script that it has developed and offers it to other studios for a price that allows it to recover some or all of its development costs usually with an override royalty.  Sometimes it works out well–after a very long time, the project may become “ET.”  Would artists prefer getting dropped or having their contracts put into turnaround?

The point is that while it may sound good to make unrecouped balances vanish after a date certain, people who say that seem to think that all the other deal terms will stay constant or even improve for the artists after that substantial risk shifting.  I seriously doubt that, just like I doubt that venture capitalists who fund the startups that bag on record companies would give up their 2 or 3x liquidation preference, full ratchet anti-dilution protection, registration rights or co-sale agreements.

Should 5% Appear Too Small

But did the unrecouped balance actually vanish?  Not really.  The value was transferred to the artist in the form of forgiveness of an obligation for the artist’s private benefit, however contingent.  That value may be measured in an amount greater than the historic unrecouped balance.  Is this value transfer a separate taxable event?  Must the artist declare the forgiveness as income?  Can the record company write off the value transferred as a loss?  If not, why not?  I can’t think of a good reason.  If anything, valuing the “taking” in current dollars would only correct the valuation issue and could amplify the tax liability of the transfer.

As you can see, wiping out unrecouped balances sounds easy until you think about it.  It is actually a rather complex transaction which immediately raises another question as to when it stops.  Why just signed artists?  Why not all artists?  Songwriters?  Profit participants in motion pictures or television?  Authors?  All of this will be taken into account.

King John and the Barons: Don’t Tread On Me

Setting aside the tax implication, were such government action to take the form of a law to be enacted in the United States, it would prohibit a fundamental right previously enjoyed under the 5th Amendment to the U.S. Constitution (one of the Amendments known as the “Bill of Rights”).  The “takings” clause of the 5th Amendment states “…nor shall private property be taken for public use, without just compensation.”  In fact, such government action would implicate the fundamental rights expressed in the 5th Amendment and applied against the states in the 14th Amendment to the Constitution.  The 5th Amendment derives from Section 39 of Magna Carta, the seminal constitutional documents in the United Kingdom (dating from 1215 for those reading along at home) and was central to the thinking of Coke, Blackstone and Locke who were central to the thinking of the Founders.

In the U.S., such a law would likely be given a once over and strictly scrutinized by the courts (including The Court) to determine if taking unrecouped balances from a select group of artists, i.e., those signed to record companies, is the only way to get at a compelling government interest in promoting culture even though the taking would be pretty obviously for the private benefit of the artists concerned and only benefiting the public in a very attenuated manner. In other words, will treating a select group of pretty elite artists (at a minimum those signed vs. those unsigned) satisfy the strict scrutiny standard applied to a government taking of private property with no compensation.  (This distinction also smacks of a due process violation which is a whole other rabbit hole.)  I suspect the government loses the strict scrutiny microbial scrub and will be required to compensate the record company for the taking at the fair market value of the unrecouped balances.

Because I think this is pretty clearly a total regulatory taking that is a per se violation of the 5th Amendment, I suspect that a court (or the Supreme Court) would be inclined to hold the law invalid on Constitutional grounds and simply stop any enforcement.

Failing that strict scrutiny standard, a court could ask if the zeroing of unrecouped balances with no compensation is rationally related to a legitimate government interest.  I still think that the taking would fail in this case as there a many other ways for the government to promote culture and even to encourage labels to voluntarily wipe out the unrecouped balances at some point such as through a quid pro quo of favorable tax treatment, changing the accounting rules or offsets of one kind or another on the sale of a catalog.

Running for the Exits

If anything, I think that government acting to cut off the ability to recoup at a date certain with no compensation (which sure sounds like an unconstitutional taking in the US) would necessarily make labels start thinking about compensating for that taking by moving out of those territories where it is given effect (or at least not signing artists from those countries).  Such moves might make artists start thinking about moving to where they could get signed.

Or worse yet, it would make labels re-think their financial terms and re-recording restrictions.  Overhead charges and interest on recording costs would be two changes I would expect to see almost immediately.  And that would be a poor trade off.

Iterative Government Choices

The choice that artists make is whether to sign up to an investor like a record company who wants a long-term recoupment relationship against pre-paid royalties.  If you don’t like a place, don’t go there and if you don’t like the deal, don’t sign.

Any government that contemplates taking unrecouped balances must necessarily also contemplate offering artists grants to make up the shortfall due to signing contractions.  This could include for example the host of grant funding sources available in Canada such as FACTOR and the many provincial music grants.  And those grants should not come from the black box thank you very much.

On the other hand, I do see a lot of fairness in requiring on-demand services to pay featured and nonfeatured artists a kind of equitable remuneration like webcasters and satellite radio do, which is paid through on a nonrecoupment basis directly to the artists in the US.  While they may criticize the system that produced the recordings that have made them rich beyond the wildest dreams of artists, songwriters or music executives (except the ones the services hire away), that doesn’t mean that they shouldn’t pay over to creators some of the valuation transfer that made Daniel Ek a multibillionaire while artists get less than ½¢ per stream.

So the takeaways here are:

  1. Wiping out unrecouped balances with no compensation is likely illegal.
  1. Creating a meaningful and attractive tax incentive for record companies to wipe out an unrecouped balance conditioned on that benefit being passed through to artists is worth exploring.  (Why wait 15 years to give that effect?)  This may be particularly attractive in a time of rising taxable income at labels.
  1. Requiring the services to pay a royalty in the nature of equitable remuneration on a nonrecoupment basis is a way to grow the pie and get some relief to both featured and nonfeatured artists.  This new stream is also worth exploring.