Four years ago, Arlo Gilbert and two friends launched a company called iCall to market a Voice-over-IP application that lets users make free or low-cost phone calls around the world via computer. Since then, more than 4 million copies of the software have been downloaded. A 2007 front-page New York Times story featured the company as one of several VoIP services whose success suggested that a new era of free landline calls for all was near.

Last year Gilbert set his sights on a new market: cell phone users. Why not offer them a version of iCall so that they, too, could make inexpensive long-distance calls by connecting either to other carriers’ networks or to VoIP — whichever was cheapest and most accessible?

Gilbert decided his first target would be Apple’s iPhone. Right away, he hit a snag. For Gilbert to market iCall software to iPhone users, Apple would have to approve it and make it available through its App Store. Apple, it turned out, wasn’t eager to do that. And it didn’t have to.

By now, technology has converged to the point that it’s hard to find a device not meant to perform multiple interactive functions. The iPhone is a case in point: a hand-held wonder that can make calls, surf the Web, take pictures, send e-mail and — thanks to the thousands of third-party software applications created for it — do everything from help you find a car in a crowded parking lot to provide you with the name of a song playing on a nearby jukebox.

But who is this all-purpose gadget’s ultimate master? Is it the company that made and sold it, or is it the person who bought it? And what about a software developer who thinks he or she has come up with something that iPhone owners might like? Should Apple have veto power over whether its customers are exposed to that idea?

The U.S. Copyright Office is about to answer these questions. In October the agency will complete its triennial review of proposed exemptions to the federal Digital Millennium Copyright Act. One of those proposals would allow individuals to “jailbreak” an iPhone — that is, to circumvent copyright protection built into the operating system so that unapproved software that lets users download unapproved applications can be installed.

While Apple hasn’t yet pursued jailbreakers, it fiercely opposes the exemption. In a brief filed with the copyright office in February, the company insists jailbreaking constitutes infringement of its software, harms the phone’s reputation by opening it to bugs and increases opportunities for piracy. “The iPhone is much more than just a telephone,” the brief states, “and its value to the consumer is enhanced by the availability of high-quality applications that add functionality of all sorts to the device.” In other words, you can’t separate the software from the hardware — and Apple will decide how to enhance the hardware’s value.

The Electronic Frontier Foundation sought the exemption, staff attorney Fred von Lohmann says, because it believes Apple is exploiting copyright laws to protect its business interests and those of its iPhone partner, AT&T. By deciding whether entrepreneurs like Arlo Gilbert get access to the iPhone platform, von Lohmann says, Apple can stymie innovation for reasons totally unconnected to copyright. He likens it to giving automakers the power to decide who can fix cars. “Sure, GM might tell us that for your own safety, all servicing should be done by an authorized GM dealer using only genuine GM parts,” he says. “But we’d never accept this corporate paternalism as a justification for welding every car hood shut and imposing legal liability on car buffs tinkering in their garages.”

The jailbreaking issue is probably the most prominent conflict now playing out that raises questions about whether, 11 years after its passage, the DMCA is being enforced beyond its original intent — but it’s not the only one. Others involve whether game-console owners can install independently purchased microchips in their machines; whether DVD owners can save copies of legally purchased discs to their computer hard drives; and, yes, whether car owners can take their vehicles to whichever repair shop they choose. The questions pit guardians of established interactive platforms against those who want to tinker with those platforms. Each side accuses the other of hurting the economy, either by aiding piracy or by stifling innovation. Add in consumers’ desire to make the most of the technology that’s been put into their hands, and it starts to look like something’s got to give.

As big a hit as the iPhone is, the App Store — a kind of iTunes for the phone — may be even more popular, and not just with consumers. A number of software developers have made their mark via Apple-endorsed applications. App sales, meanwhile, have given Apple a nice financial boost. One Piper Jaffray analyst estimates that the App Store could produce as much as $1.2 billion in revenues and $254 million in profits this year.

But, as Arlo Gilbert learned, not everyone gets to play. Gilbert submitted an application to become an approved vendor last October. Six months of frustration followed. Apple wound up rejecting the iCall app several times before approving it in March. Then, Apple upgraded to a new 3GS operating system — one that didn’t support the approved version of iCall. Though a bare-bones version is available for free via iTunes, Gilbert says he is angry to have spent $500,000 developing a more sophisticated version, only to have, in his view, Apple effectively sabotage it.

That all explains what led Gilbert to thoughts of jailbreaking. If iPhone users could open the operating system, he wouldn’t need Apple’s approval to offer them his product. The catch: anyone engaging in jailbreaking can be prosecuted or sued for violating the DMCA’s section 1201.

Section 1201 — which begins: “No person shall circumvent a technological measure that effectively controls access to a work protected under this title” — is something that content creators lobbied hard for prior to the DMCA’s passage. Without it, they argued, distributing electronic versions of movies, music, video games and other copyrighted material would be a risky endeavor. Since its adoption, the measure has been used as envisioned — to fight piracy. But critics question how effective it’s been, and whether it’s now being used improperly. “Ten years of history has made it clear that it has been an utter failure,” says von Lohmann. “Just look at Pirate Bay, BitTorrent and all the P2P sites. However, the circumvention provisions have been very, very good at preventing competition and innovation.”

And that’s how Arlo Gilbert sees it. In his mind, Apple is using section 1201 to protect its relationship with AT&T and to exert market control over software developers at the expense of efforts to innovate. His belief prompted Gilbert to travel to Washington, D.C., in May to recount his App Store experience during a hearing led by U.S. register of copyrights Marybeth Peters.

“Consumers really benefit from a jailbroken phone because they get to control it,” he argued at the hearing. “They get to use this device as it should be used, which is as a powerful computer.”

Apple won’t respond to specific arguments in favor of jailbreaking. Instead, a spokesman points to the company’s 27-page brief. In the filing, Apple’s Fenwick & West lawyers say jailbreaking would “destroy the technological protection of Apple’s key copyrighted computer programs.” Beyond that, the brief positions Apple as a significant guardian of copyright control by saying the iPhone is part of a “larger ecosystem.” How large? The company claimed in follow-up comments submitted to the copyright office in July that if jailbreaking is legalized, “a local or international hacker could potentially initiate commands … that could crash [cell phone] tower software, rendering the tower entirely inoperable to process calls or transmit data.”

Without commenting on that doomsday scenario, Wiley Rein partner Bruce Joseph agrees with Apple. Joseph, who has represented content owners, Internet service providers and the wireless industry, says: “Circumvention often involves complex attacks using black box circumvention devices, many of which assume control over the device, and once you’ve assumed control over the device, only the hacker’s imagination limits what you can do.”

Hackers aren’t the only ones who dream, of course, which makes rules that limit people’s imaginations a delicate proposition. Consider the controversy over microchips used to modify video game consoles. Section 1201 bans these so-called mod chips because they let those who install them bypass digital rights protections and play pirated games. “The mere fact [that] they have to break our locks, that’s where you run into problems,” says Jodi Daugherty, Nintendo of America’s senior director of antipiracy. “At Nintendo, we have to deal with piracy rings coming from Hong Kong and China all the time. We know these devices help break access controls and allow people to gain access to pirated software.”

In 2007, aided by Nintendo and other software makers, federal authorities staged what they hailed as the largest-ever crackdown on mod-chip distribution. Working under the auspices of the U.S. Department of Homeland Security, investigators executed 32 search warrants in 16 states. Two years later, a review of federal court records suggests that what was dubbed “Operation Tangled Web” produced only a handful of convictions, mostly of small-time chip sellers.

One person convicted of a copyright crime after being snared in a separate raid says that even his own lawyer didn’t believe mod chips had legitimate uses. “I had six or seven federal law enforcement officers with bulletproof vests storm into my home with guns. It was crazy,” this person says. “My lawyer said, ‘You have to plea on this, and if you take it to trial, this is going to cost you another $800,000, and you could get five years in prison.’” Reluctantly, he took a plea, paid a fine and went to jail.

Mod chips made headlines again in August when Homeland Security agents arrested Matthew Crippen, a 27-year-old Californian, and charged him with two felony counts of violating the DMCA by running a home business installing the chips in game consoles. Crippen, who faces ten years in prison, told Wired following his arrest that he charged $30 a pop to modify consoles for owners to play legally made backups of games they’d bought legitimately.

Observers say such arrests highlight a serious problem. “Mod chips are a good example of how 1201 has served both an antipiracy role it was intended for but also a much more worrisome role,” says New York University law professor James Grimmelmann. “Using a mod chip, a person can do all sorts of interesting things that don’t have anything to do with piracy, like improving the console’s media player.”

In fact, mod chips aren’t banned everywhere, which creates its own problems. This year, the United States put Canada on its “priority watch list” of nations engaged in IP abuse. One reason: a failure to get tough on mod chips.

The Section 1201 tug-of-war isn’t confined to VoIP startups or the video game underground. Last fall, RealNetworks, Inc., announced plans for a $30 product called RealDVD that would let DVD owners save digital copies of discs to their hard drives. Real knew that the product would cause controversy. After all, it required breaking copyright controls to work. To make it more palatable to movie studios, Real CEO Robert Glaser said “significant barriers” had been built in to block peer-to-peer sharing of RealDVD copies.

Hollywood was unmoved. The Motion Picture Association of America sued Real for violating the DMCA and got a temporary injunction blocking the product’s release. In April the case went to trial before U.S. district court Judge Marilyn Hall Patel in San Francisco. Before a packed courtroom, Leo Cunningham, a Wilson Sonsini Goodrich & Rosati attorney for Real, argued that the product would actually “enhance” a DVD’s value, because owners would have the ability to make backups that he said were protected under copyright law’s fair use doctrine. Bart Williams of Munger, Tolles & Olson, who represented the MPAA, countered that making backups is not a fair use. Besides, Williams said, RealDVD was largely based on the work of Ukrainian hackers. In August, Patel issued a preliminary injunction banning RealDVD.

Those who side with Williams call the fair use defense bogus. Says O’Melveny & Myers partner Robert Schwartz: “I smirk when I hear talk about someone needing the ability to make a backup. I own DVDs, they sit in my den, and I can play [them] on my computer whenever I want. Why is it that I need a backup?” Schwartz also disputes the claim that widely enforcing section 1201 kills new ideas: “I play the world’s smallest violin for those who say that more effective piracy tools dash innovation.”

As for jailbreaking, von Lohmann sees a possible precedent for the exemption in one granted in 2006. That exemption unlocked cell phones so that consumers could switch wireless carriers without giving up their handsets. Cell carriers fought the exemption on the basis that the phone software was copyrighted work. The copyright office disagreed, explaining that “the purpose of the software lock appears to be limited to restricting the owner’s use of the mobile handset to support a business model, rather than to protect access to a copyrighted work itself.”

The issue is not fully analagous to jailbreaking, says Mark Stachiw general counsel of Metro PCS, which sells low-cost calling plans, and has asked that the “unlocking” exemption be extended for three years. Still, Stachiw says he sees “crossover features” between the two exemptions, citing VoIP provider Skype as the kind of company that would likely benefit if both are granted.

Those who favor jailbreaking also find support for an exemption in court cases where section 1201 has provided the basis for a legal claim. Lexmark v. Static Control is one such case. At issue was a microcontroller that Lexmark embedded in printers so that they would accept only authorized toner cartridges. Not coincidentally, Lexmark earned a great deal of licensing revenue from the ink and toner aftermarket at the time. When Static Control introduced a toner cartridge with a chip that tricked Lexmark’s microcontroller, Lexmark sued, claiming a DMCA violation. In 2004 the 6th U.S. Circuit Court of Appeals ruled that circumventing an ink cartridge lock does not violate the DMCA. The decision led many, including NYU’s Grimmelmann, to conclude that the courts would keep a close eye on DMCA enforcement. “Where it’s gotten into trouble,” Grimmelmann says, “[is] in the application of 1201 that [doesn't] have anything to do with explicitly protecting copyright materials.”

How will the copyright office rule on jailbreaking? For now, no one is making predictions. In the meantime, Arlo Gilbert may take some comfort in knowing that it’s not just the little guys that Apple seeks to stifle. In July the company rejected Google Voice‘s App Store application. Gilbert may also take solace in what came next: the Federal Communications Commission’s announcement that, for non-DMCA reasons, it would be looking into Apple’s decision. Maybe there’s more than a question of copyright at stake here after all.