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Correction: In the Sept. 15 issue, “Behind RIAA’s Subpoena Splurge” incorrectly stated that music company BMG planned to stop deducting recoupable “marketing” expenses from recording artist royalties and that it planned to increase the royalty rates to artists for digital downloads. Rather, BMG overhauled its royalty accounting process by eliminating certain standard deductions (e.g., packaging, standard free goods, and new technology), which traditionally had been used in calculating artist royalties. Additionally, instead of basing royalties on the record’s suggested retail list price, less the standard deductions, BMG now bases them on a record’s wholesale price, without making those deductions. The policy also applies to online revenues, which are no longer subject to such deductions and are calculated based on the artist’s album rate rather than the lower singles royalty rate. According to Jim Cooperman, acting co-general counsel of BMG, the changes were implemented to create a more transparent and simplified accounting process. When the Recording Industry Association of America sent Verizon Internet Services Inc. a subpoena last year seeking the identity of a subscriber who may have illegally downloaded music online, Verizon didn’t just say no. The Internet service provider complained loudly and in public that the request was an unprecedented assault on digital privacy. Verizon Associate General Counsel and Vice President Sarah Deutsch then cobbled together a coalition of other ISPs and privacy and consumer advocates to battle the powerful Washington, D.C.-based lobbying group’s request. The subpoenas “are not going to solve any of [the RIAA's] problems,” says Jason Schultz, attorney for the digital rights group the Electronic Frontier Foundation. “It’s a publicity stunt.” Naturally, the RIAA and the music industry it represents sing a different tune. “The problem of piracy is staggering,” says Jim Cooperman, acting co-general counsel of BMG, one of the recording industry’s “Big Five” labels. “People feel they don’t have to buy the music anymore because they’re stealing it.” Despite all the sound and fury, the subpoenas were ruled valid this spring. Emboldened, the RIAA sent shock waves through campuses and computer dens across the nation this summer as it filed a blitz of subpoenas at other ISPs to name names of illegal online music downloaders. The industry has tried other ways of snaring digital pirates but, since its victory over Napster two years ago, it hasn’t been as successful. Last spring it lost the first round of litigation against the leading software companies — or peer-to-peer (P2P) networks — behind online music “sharing.” The ISP subpoenas and a granted expedited appeal in the P2P cases are the latest twists in an increasingly bitter litigation and public relations war. The stark numbers show the business’s plight: What was a $40 billion music industry in 2000 shriveled to $26 billion in 2002. The industry blames illegal downloads, estimated at more than 2.6 billion a month, for most of the damage. A third of the nation’s record stores have closed in the past few years, too; including 107 Musicland stores, while the chain Wherehouse Entertainment Inc., filed for Chapter 11 protection, and Tower Records faces bankruptcy if it cannot find a buyer. Observers say, however, that the recording business needs to accept that the Internet, as a distribution vehicle for music, is here to stay. Indeed, the industry has started to make some concessions, including striking licensing deals with Apple Computer Inc.’s iTunes Music Store to sell music online. And that’s just the beginning. Over the long term, “the revenues will come from Webcasting, satellite performance royalties [live Web and television concerts], and deals with Apple and Microsoft for digital distribution,” says Walter McDonough, general counsel of Future of Music, a D.C.-based nonprofit group that helps record companies and recording artists address digital issues. Industry in-house lawyers, of course, will play a significant role in creating these newfangled arrangements. “What we as lawyers at a record company would do was fairly stable for a long time,” says Susan Hilderley, director of business and legal affairs, Interscope and Geffen music division, at Universal Music Group. “With all of the new technology, we all had a lot of learning to do.” While the industry figures out how to win back the music-buying public, it’s also been in full attack mode on the litigation front. And if it seems like the Big Five sing in harmony when it comes to lawsuits, it’s because they coordinate their battles through the RIAA. The powerful industry group acts as a clearinghouse for both music business advocacy and legal action, and performs such mundane tasks as certifying sales figures for gold and platinum albums. ON THE OFFENSIVE But aggressive litigation right now is a top priority. Matt Oppenheim, senior vice president for business and legal affairs at the RIAA, says that he and the litigation chiefs at the record labels discuss strategy at least once a week via conference calls. And he and industry GCs confer frequently as well. Adds Wade Leak, BMG vice president for legal and business affairs: “No decisions [at the RIAA] are made without the companies’ input,” including the consent of senior management over potential protracted and costly court battles. The group has had some success. The RIAA and the labels went on the offensive as soon as online music file sharing became popular. They won an early victory in 2001 by shutting down the seminal music-sharing service Napster. The site was an easy target because Napster physically maintained the computer servers where illegal music files, typically in high-fidelity, compressed, download-friendly MP3 format, were stored. (With P2P networks, the files are stored on individual user computers; special software lets consumers “see” the files and download them onto their own hard drives.) The industry was hoping to repeat its Napster victory when it set its sights on the companies that make P2P software. In October 2001, 28 of the leading entertainment companies (including movie studios) sued the Nevis, West Indies-based Grokster Ltd., Woodland Hills, Calif.-based StreamCast Networks Inc. (the company that makes the Morpheus file-sharing software), and Sharman Networks, which makes KaZaA, a rival file-sharing program, for encouraging copyright infringement by creating software that allows users to download copyrighted material for free. U.S. District Judge Stephen Wilson of Los Angeles ruled in April in favor of StreamCast and Grokster. “Defendants distribute and support software, the users of which can and do choose to employ it for both lawful and unlawful ends,” Wilson wrote in his opinion. (The Dutch company that makes KaZaA received a “no liability” ruling from a court in the Netherlands.) Yet the case is far from over; Oppenheim points out that the U.S. Court of Appeals for the 9th Circuit granted an expedited appeal in July, which, he says, means there’s a good chance that the RIAA will prevail. Grokster President Wayne Rosso, who calls what the RIAA is doing “genocidal litigation,” agrees that the case likely will go further. “It has Supremes written all over it,” he says. With the battle against the software companies at a temporary stalemate, the music industry decided to go after the illegal downloaders themselves. But they faced a logistical problem: How could the RIAA identify the culprits, most of whom use colorful screen names when they log on to the P2P networks? The 1998 Digital Millennium Copyright Act appeared to contain a streamlined subpoena procedure that would help the RIAA track down alleged offenders. Instead of filing a lawsuit and obtaining a judge’s approval for a subpoena, the RIAA believed that it could merely fill out forms at any court in a jurisdiction where the ISPs have subscribers. The RIAA would allege copyright infringement, and the court clerk would send subpoenas to the ISPs demanding that they turn over information about their customers. Oppenheim says the group sent out 100 subpoenas as a test to various ISPs around the country and all but one complied: Verizon Internet Services, a subsidiary of Verizon Communications Inc. The ISP refused to meet the RIAA’s demand that it unmask a subscriber who had allegedly used KaZaA software to illegally download music. Verizon’s lawyers were outraged. “If you want to go after users, you should go through the proper legal process, where the users get notice that someone is seeking their identity and have a right to defend themselves,” says Verizon’s Deutsch. Oppenheim says that he and record company GCs sought the subpoenas only after they asked Verizon to remove copyrighted material from its network; the ISP refused, saying that the content wasn’t on its servers, but on its subscribers’ PCs. Oppenheim notes, too, that Verizon and other ISPs hype their broadband Internet services by boasting about their short download times for music, images, and other large digital files. “We just sent Verizon a subpoena,” says Oppenheim. “They’ve blown it up into being the Pentagon Papers.” The subpoenas galvanized the ISP industry, and created a powerful enemy for the music business. In a motion for summary judgment to the U.S. District Court for the District of Columbia, 45 organizations — from the American Civil Liberties Union to the National Coalition Against Domestic Violence, which says this subpoena process could allow abusive husbands to track down their battered wives — signed an amicus brief warning that a ruling in the RIAA’s favor could dangerously erode Internet users’ privacy protections and due process rights. In April, Judge John Bates ruled that the subpoena was valid. Verizon has appealed, and Deutsch and her colleagues are asking Congress to amend the Digital Millennium Copyright Act. Buoyed by its success, the RIAA isn’t waiting for the outcome of those efforts. In June, RIAA President Cary Sherman announced that the group would search out individuals illegally distributing music online; the first batch of subpoenas were filed in Washington, where the RIAA is based. The litigation against online pirates shows no sign of ending, and while industry GCs are closely involved with the RIAA’s efforts, in-house lawyers at the Big Five are also looking for other ways to resolve these issues. One tack is to develop relationships with artists that take into account the new digital era. Under traditional contracts, the music company gives an artist an advance. Most of that sum goes toward expensive recording studio time. The music company shoulders manufacturing and marketing costs, and then, hopefully, fans snap up CDs, and the business “deducts” the advance and marketing costs from the album’s profits. But with such services as Apple’s iTunes Music Store and the recently announced BuyMusic.com, says McDonough of Future of Music, “if you are going into a nonphysical universe, what’s the point of having deductions?” McDonough adds that music companies and musicians will soon share publishing, live fees, movie licensing, and other revenue, instead of relying mainly on CD sales. In fact, Cooperman says that BMG is ending its usual practice of deducting marketing and other expenses from CD sales revenue, and instead will try to work out alternative deals with its acts. BMG will also increase the royalty rates paid to artists from digital downloads. Still, McDonough is skeptical that music GCs can change with the times. “Unfortunately, I don’t think that the in-house lawyers for the labels are used to doing these sorts of deals,” he says. “It brings up all sorts of issues, like creating joint ventures with people that never existed before. They need to figure out how they can lower the revenues based on physical distribution and expand the percentage based on nonphysical distribution and licensing. That’s the only way out for them.” But Universal’s Hilderley says that she and her in-house peers are already adapting, and won’t be singing their swan song anytime soon: “We have talented, creative people who take artists with potential and turn them into something polished and ready to sell millions of records. While the models may change, I don’t think we’re going anywhere.” Daphne Eviatar is a reporter at Corporate Counsel, an American Lawyer Media magazine. Corporate Counsel Reporter Eriq Gardner contributed to this article, which first appeared in the September issue.

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