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Internet phone service has got a lot of people talking. In the past year, a growing number of consumers have embraced Voice-over-Internet-Protocol, a technology that eliminates hefty long-distance telephone bills by letting individuals make calls directly over the Internet. The buzz over VoIP has spread from Sand Hill Road’s venture capital shops to the power brokers in Washington, D.C. And veterans of the Internet’s last major shakeup of the business world, file-sharing, have joined the effort to popularize Internet phone service. Streamcast Networks Inc., the company which owns Morpheus, and the founders of Kazaa — authors of controversial software that has been the subject of litigation brought by the music industry — are among the dozens of companies looking to cash in on VoIP. Like the file-sharing companies before them, though, VoIP companies face an uncertain legal future. The cloudy rules governing Internet phone calls, and the dramatic cost savings, have raised eyebrows among competitors and regulators. Once again in the nascent Internet industry, a strong legal team could prove as important as a good business plan. “I’ve joked around here that although our core business model is to develop and promote a P2P [peer-to-peer] application and a general communications application, our secondary business model seems to be employing lawyers,” says Matthew Neco, the general counsel and vice president of business affairs at Streamcast. Neco took over as GC last year, shortly after the company relocated from Nashville to Los Angeles. Despite its well-known name, Streamcast is still very much a startup company, with a total staff of seven. The legal function plays a prominent role in the operation: Neco is one of two management executives listed on the company’s Web site, alongside Chief Executive Officer Michael Weiss. Streamcast’s business still revolves around Morpheus, the popular file-sharing software application. But the company is dipping its toes into the VoIP waters by offering Internet phone features. Last month, the company inked a partnership agreement with i2 Telecom International Inc. to develop a special pay-by-the-minute Internet phone product. While VoIP is still in its infancy, many believe it could ultimately reshape the telephone industry. One report by financial services company UBS AG’s global equity research division likened the potential impact of Internet phone calls to the music downloading frenzy. “We believe VoIP technology has the potential to do to wireline carriers what file- sharing is doing to the recording industry,” the report states. At this point, most of the legal disagreements about Internet phone calls are being played out in the regulatory arena rather than in litigation. But the stakes are just as high. “The new services that need a favorable Internet regulatory environment, their life or death depends on the kinds of decisions that are made by the [Federal Communications Commission],” says Steven Wildman, director of Michigan State University’s Quello Center for Telecommunication Management and Law, which recently hosted a forum on VoIP. In February, the FCC formed a committee to seek public comment and craft a policy on the emerging VoIP phenomenon. Among the key points of contention are the interconnection fees which telephone carriers pay each other to route calls through their respective networks. Many VoIP companies maintain that they don’t need to pay these fees, since they are Internet services not bound by standard phone company regulations. Nor do the upstart phone companies necessarily contribute to the government’s $6 billion universal access fund, which is used to subsidize phone service in rural and low-income areas. Not surprisingly, the phone companies that own the local networks view such exemptions as an unfair competitive advantage. SBC Communications Inc., the nation’s second-largest local phone company, calls for VoIP to remain free of regulation in a petition it filed with the FCC last month. But the company also contends that under the existing regulations, IP services which use exchange facilities on a public switched telephone network must pay access charges. For file-sharing veterans like Streamcast and Skype, thorny legal hazards are a natural part of the business terrain. So far, the legal implications of Streamcast’s foray into Internet phone calls have been limited to routine transactional work, such as the i2 deal. Much more pressing is the music industry’s courtroom campaign to put Streamcast out of business. Streamcast is a defendant in two major file-sharing lawsuits: Metro-Goldwyn-Mayer Studios Inc. v Grokster Ltd., 01-8541, in Los Angeles district court, and EMI Christian Music v. Streamcast Networks, 03-CV-484, in a Nashville district court. Each suit seeks millions of dollars in damages. A WAIT-AND-SEE APPROACH Among the 10 outside counsel that work for Streamcast in various capacities, the company’s primary trial force consists of former Brobeck, Phleger & Harrison partner Charles Baker, now at Texas firm Munsch Hardt Kopf & Harr, and the Electronic Frontier Foundation. Neco recognizes the potential for legal wrangling in VoIP. “I have very little doubt that yes, the entrenched players are interested in this, and in protecting their turf,” says Neco. But he’s taking a wait-and-see approach rather than leading the charge into the regulatory fray. As the FCC rulemaking process gets rolling, says Neco, “we’ll have adequate time to get involved in commenting upon it or participating in it if we decide that that’s our role, or if we decide that that’s a role for the third-party vendors” that Streamcast works with. Less clear is the strategy of Skype, one of the most popular Internet phone services, with nearly 3 million customers. Launched by Kazaa creators Janus Friis and Niklas Zennstrom in August 2003, Skype is based in Luxembourg and has collected some $19 million in funding from a handful of venture capital firms. Like the executives at Streamcast, Skype’s management is well-versed in the litigious side of business, with Kazaa listed as a defendant in several suits. But it’s unclear what kind of legal capabilities Skype has assembled as it takes on the established phone companies or how integral the legal function is to the overall operation. Zennstrom is represented by Beverly Hills attorney Jeffrey Gersh for U.S. legal matters relating to the Kazaa litigation. Gersh declined to comment on whether he’s involved with Skype. A company representative said Skype could not participate in this story but would like the opportunity to introduce its legal team at some point in the coming months. “Skype is currently cheered by the public comments from the FCC and expects its ultimate decision making will significantly influence the growth and innovation of the VoIP industry in the U.S.,” the representative wrote in an e-mail. The regulatory uncertainty surrounding Internet phone calls has already prompted some VoIP companies to mobilize their legal resources. Roderick Coy, a partner at Michigan’s Clark Hill who specializes in telecommunications regulation, represents a newly formed consortium of VoIP companies in regulatory proceedings throughout the Midwest. “You have regulators and legislators sort of beginning to hear about this now even though it has been coming along for several years, and struggling with the idea of, �Well, is this really a telephone service or not?’” says Coy. Internet phone services in which one computer user calls another individual’s computer (similar to an Internet instant messaging program) are exempt from regulation, according to an FCC ruling released earlier this year. But some VoIP services allow an individual using a computer to reach another individual on their regular telephone. This is where the principles of regulation, and of local phone network access charges, get messier. “The regulatory environment right now for who has to pay for termination or origination of VoIP calls is very muddy,” says Russell Blau, a partner at Washington, D.C.’s Swidler Berlin Shereff Friedman. Last year, Blau represented Vonage, a New Jersey-based VoIP company, in one of the first legal challenges to the new communications trend. Vonage filed an appeal in Minnesota district court after the state’s Public Utilities Commission ordered the company to comply with local telephone regulations. Drawing a distinction between basic telecommunications services, which provide telephone service, and enhanced “information” services, which piggyback on the telecommunications network, U.S. District Judge Michael Davis found that Vonage was not bound by traditional phone company regulations. “Vonage uses telecommunications services, rather than provides them,” wrote Judge Davis. “VoIP services necessarily are information services, and state regulation over VoIP services is not permissible because of the recognizable congressional intent to leave the Internet and information services largely unregulated,” he ruled. While the court order was a big victory for VoIP providers, the ground rules could change completely once the FCC crafts its new policy on Internet phone calls. FCC Chairman Michael Powell has repeatedly stressed his commitment to leaving the Internet unregulated. But the commission’s announcement of the IP rulemaking process notes that certain mechanisms for implementing important social objectives like universal access “may change as communications migrate to Internet-enabled services.” Meanwhile, law enforcement officials are angling to ensure that their wiretap powers won’t be diminished as more people make phone calls over the Internet. The FCC has established a separate committee to address that specific concern. The real fun may not start until after the FCC unveils its VoIP policy. Whatever the FCC decides, say some attorneys, it may well face a court challenge. “After the order comes out and we see what it says,” notes Blau, “anything can happen.”

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