A $1.6 billion Spotify lawsuit is based on a law made for player pianos

 theverge.com  3/14/2018 4:28:38 PM   Sarah Jeong

Spotify is finally gearing up to go public, and the company’s February 28th filing with the SEC offers a detailed look at its finances. More than a decade after Spotify’s launch in 2006, the world’s leading music streaming service is still struggling to turn a profit, reporting a net loss of nearly $1.5 billion last year. Meanwhile, the company has some weird lawsuits hanging over its head, the most eye-popping being the $1.6 billion lawsuit filed by Wixen Publishing, a music publishing company that includes the likes of Tom Petty, The Doors, and Rage Against the Machine.

So, what happened here? Did Spotify really fail to pay artists to the tune of a billion dollars all the while losing money? Is digital streaming just a black hole that sucks up money and spits it out into the cold vacuum of space?

The answer is complicated. The amount of money that songwriters are making through streaming services like Spotify is oddly low, but the Wixen lawsuit itself exists in a bizarre universe of convoluted legal provisions that have very little bearing to fairness, common sense, or even how the technology actually works. And as Spotify’s IPO filing notes in its section on risk factors, the company is dependent on third-party licenses, which makes its business model especially vulnerable to any hiccups in the bureaucracy of music licensing.

Spotify is being sued by Wixen because of mechanical licenses — a legal regime that was created in reaction to the dire threat to the music industry posed by player pianos. Yes, the automated pianos with the rolls of paper with punch holes in them.

But that’s not actually the weird part. The weird part is that Spotify is fundamentally being sued for literal paperwork: Wixen says Spotify is legally required to notify songwriters in writing that they’re in the Spotify catalog — a fact that escapes probably zero songwriters today. A paper notice requirement made sense in the age of player pianos when songwriters could hardly be expected to keep track of every player piano roll in the country. It makes no sense in the age of Spotify, Pandora, and Apple Music. The question of what would be fair to pay artists is a contentious one, but the story of Wixen v. Spotify is not so much about paying the artists. It’s really a story about how, in a time when services, labels, and artists have never been better poised to work under a centralized, automated system for licenses and royalties, everyone keeps punching themselves in the face instead.

When player pianos became popular at the turn of the century, they posed a threat to the music industry. Before recorded music existed, songwriters made their money by selling sheet music, but the manufacturers of piano rolls that played their songs didn’t pay them a dime. The songwriters claimed that the piano rolls were equivalent to sheet music and that they were entitled to royalties. The manufacturers disagreed.

In 1908, the Supreme Court ruled that player piano companies were not required to pay royalties to songwriters, and piano rolls didn’t fit the definition of sheet music. Outraged, the songwriters went to Congress, and the next year, “mechanical licenses” were created as part of the Copyright Act of 1909 to provide royalties to songwriters. As music technology evolved, mechanical licenses did, too, following the shift from player pianos to physical records and finally to digital downloads and certain kinds of streaming (delightfully labeled “digital phonorecord deliveries” in legal jargon).

It’s not clear what the word “mechanical” actually means. It might be the player pianos that inspired the law or it might be a reference to how the license works: it’s what the law calls a compulsory license. It works automatically: a player piano roll company or a streaming service doesn’t have to negotiate rates with individual songwriters, they just have to follow the rules that are set by the Copyright Royalty Board every five years.

Unfortunately, nothing is ever that simple in copyright law, and when it comes to music copyright, it’s especially convoluted. This is because as the technology around music has evolved over time, Congress and other legislative bodies around the world have chosen to tack on all kinds of little fixes to keep the whole thing going. There isn’t one copyright in one song — it’s four or five or six or really, a potentially unknowable number of rights scattered across the whole work.

Because Cyndi Lauper’s famous “Girls Just Want to Have Fun” was originally written by Robert Hazard, two different people own the rights in the sound recording versus the composition.

Right off the bat, a song is split into two different kinds of copyright: the composition and the sound recording. Composers have been writing songs for centuries — that part is pretty straightforward and well-settled — but the technology of recording music is a pretty recent innovation. So, copyright for sound recordings was only added to US copyright law in 1976.

Sometimes rights in composition and rights in sound recording belong to the same person. If you write and record your own music, you own all the rights. But often in the world of commercial music, multiple people are co-authors for the composition and sound recording, with one or two overlapping creators. For the sake of simplicity, let’s assume that all of these people are adequately represented by various agents, have signed all the right contracts, and are actually on speaking terms with each other.

Now, we can move on to the part that will make you want to blow your brains out.

So there are the rights in composition and the rights in sound recording, but after that, each of these components is subdivided into even more rights.

In 2018, there are a bajillion ways to listen to a song. Maybe you’re still using FM radio, maybe you prefer SiriusXM, maybe you’re a Spotify adherent, maybe you buy things through the iTunes store, or maybe you’re a hipster who only listens to records. Every one of these things has to license all the rights to songs in a completely different way.

FM radio and SiriusXM are treated completely differently from streaming services like Spotify, and even more bizarrely, they’re treated differently from each other. FM radio is considered a “public performance,” and it doesn’t pay royalties to the artists who record the songs, just the songwriters. Royalties for public performances of compositions are compulsory and are collected by a handful of organizations called performance royalty organizations (PRO). There are basically three big players in this field — BMI, ASCAP, and SESAC — which then redistribute the royalties to their member artists according to some mysterious formula. Theoretically, this is efficient and good for artists who can’t be bothered to chase down royalties, but it’s a little cartel-like since the PROs are actually private entities. And, well, they’ve been under an antitrust consent decree for decades, so someone at some point agreed with me that it seemed pretty cartel-like.

Does it make any sense for FM radio to pay songwriters but not the recording artists listeners actually know? No, but let’s move on.

Similar to the BMI / ASCAP / SESAC arrangement, internet and satellite radio pay sound recording royalties to a government-endorsed nonprofit called SoundExchange that calculates how much every artist is owed and automatically sends it to them.

Remember Pandora as it used to be? How you couldn’t just play any song you wanted? All of those weird restrictions, like the limited number of skips? That had to do with the licensing regime Pandora fell under. Pandora threw in all of those restrictions so it could qualify as internet radio, and therefore only deal with a couple of middlemen that then dealt with individual artists.

Spotify is in a different place altogether because it allows you to play the exact song or album you want to, at any given time. Spotify can’t just use BMI or SoundExchange as an easy clearinghouse for rights. It has to get licenses for both rights in recording and rights in composition from everyone.

The extremely wild thing to take away here is that internet radio and satellite radio are treated completely differently from a streaming service like Spotify. They might all seem like streaming services to you, but legally they’re totally different.

When it comes to sound recordings, Spotify has to negotiate with individual labels and artists. But when it comes to the rights in composition, it pays mechanicals (the compulsory, automatically prenegotiated rates mentioned earlier). Rates are currently set at 9.1 cents per composition or 1.75 cents per minute, whichever is longer.

Record companies pay mechanicals to songwriters. So every time a CD gets pressed with Cyndi Lauper’s classic “Girls Just Wanna Have Fun,” songwriter Robert Hazard receives that mechanical royalty. The recording industry has been dealing with mechanical licenses forever and is theoretically familiar with the ins and outs of locating composers and making sure they get their compulsory licensing fees.

Perhaps for that reason, the iTunes store doesn’t pay mechanicals directly: instead, Apple pays record companies, which are then supposed to pay the songwriters. You can think of iTunes as a sort of extension of the record industry — another layer of distribution that branches right off the labels.

How licensing works for iTunes downloads.

But Spotify took a completely different route. Instead of foisting the work off onto the record labels, Spotify is on the hook for making sure songwriters get their mechanicals. There’s a good reason why, of course: the iTunes store and Spotify work in very different ways.

How licensing works for Spotify.

Consider this: once you buy a CD, you have the CD. Once you buy a track from iTunes, you have the file. The various licenses, including the mechanical license, are bought and paid for, and you own something.

When you listen to music through Spotify, you don’t own the song, even though you might be able to listen to it at any time. The moment Jay Z yanks Watch the Throne from Spotify, you just don’t have it anymore. That 9.1 cent fee per composition makes sense when you’re pressing a single CD, but it doesn’t have any meaningful application to on-demand streaming.

So when it comes to mechanical licenses, streaming services like Spotify fall under a completely different set of fees set by something called the Copyright Royalty Board, which is part of the Library of Congress.

As of this year, services like Spotify are facing a formula that is changing every year from now until 2022. In 2018, they’ll be paying 11.4 percent of revenue or 22.0 percent of total content cost, whichever is greater. This keeps ticking up over the course of five years, at which point the Copyright Royalty Board will issue a new ruling.

  • In 2019, 12.3 percent of revenue or 23.1 percent of total content cost
  • In 2020, 13.3 percent of revenue or 24.1 percent of total content cost
  • In 2021, 14.2 percent of revenue or 25.2 percent of total content cost
  • In 2022, 15.1 percent of revenue or 26.2 percent of total content cost

Every five years, a bunch of judges decides the fair rate for all songwriters and set fees for various scenarios. It’s not just that streaming services have to follow a certain rate. If your service offers “conditional downloads,” you get another rate and you get treated differently based on whether you’re supported by subscriptions or ads. And if you thought “9.1 cents per composition or, if a composition is longer than 5 minutes, 1.75 cents per minute” sounded complicated, streaming services have to abide by a set of formulas often calculated as percentages of revenue. For the time period that Wixen is suing over, Spotify would have owed the songwriters something like “10.5% of revenue minus PRO payments,” depending on which formula got applied.

So what Spotify owes to songwriters is set by regulation that’s negotiated every five years in front of a panel of administrative judges. And that means Spotify knows exactly how much it’s supposed to pay to music publishers. And that money is being paid... somewhere. We’re not sure. The publishers aren’t sure. In fact, Spotify might not be sure.

That’s where the Wixen lawsuit comes in.

Just like BMI and ASCAP are more or less the only game in town for compulsory licenses for recording artists, the Harry Fox Agency (HFA) is more or less the place you go to get licenses from songwriters. If there’s something like a phone book for all the songwriters in the country, it’s HFA. And if the composer isn’t represented by HFA, HFA is supposed to go out and find them so they can get their money.

This is the most baffling part of the Wixen lawsuit. Wixen claims that “Spotify knew that HFA did not possess the infrastructure to obtain the required mechanical licenses and Spotify knew it lacked these licenses.”

It’s ironic: HFA is pretty much the agency for the job, and on top of that, HFA was founded by the National Music Publishers Association (NMPA) — a trade organization that represents songwriters’ interests — back in 1927. But it’s not untrue that HFA’s efficiency is somewhat questionable. Every one of these big clearinghouses for music rights — like BMI and ASCAP — is like that. After Paul McCartney signed up with a company called Kobalt to administer his rights, his lawyer told The New York Times that McCartney had suddenly seen a 25 percent increase in how much money was collected.

Legally speaking, the lawsuit isn’t about whether Spotify is supposed to pay “10.5% of revenue minus PRO payments” and whether it was willing to do so. It’s about whether it sent along a piece of paper to a songwriter’s last known address letting them know that they were going get paid. And because they supposedly didn’t, Wixen is asking for $150,000 in statutory damages per song. That’s an expensive piece of missing paper — totaled up, it’s why the lawsuit is for $1.6 billion.

The law does allow Spotify to file its notice of intent with the Copyright Office if it can’t find the rights holder, and it’s not clear from the lawsuit whether that happened and whether that was supposed to be HFA’s job. (Spotify did not return requests for comment.) It’s possible that something was filed at the Copyright Office and notice still never made its way to the songwriters. (About 45 million notices of intent have been filed at the Copyright Office since 2016 when the process first became available.)

It’s almost like this whole thing could be automated and it isn’t because we can’t have nice things.

The Wixen lawsuit isn’t the first of its kind. It’s a breakaway lawsuit after a 2017 class action settlement with Spotify where $43.4 million was set aside to compensate songwriters who didn’t receive royalties. And that suit came in the aftermath of Spotify’s $30 million settlement with the National Music Publishers Association (NMPA) in 2016.

The $43.4 million fund from the 2017 settlement, Wixen claims, is simply not enough. A similar lawsuit filed in August 2017 also objected to the $43.4 million settlement, calling it an “empty gesture that encourages infringement and is entirely insufficient to remedy years of illegal activity.”

The headache around mechanical licensing didn’t start with tech companies. In 2009, the NMPA and RIAA reached a settlement over mechanical licenses that record companies had not paid to songwriters — likely for the same bureaucratic reasons that Spotify is currently struggling with. The irony there is that the three biggest members of both the NMPA and the RIAA are the same companies: Sony, Warner, and Universal. The fight over mechanical licensing is the left hand and the right hand slapping each other, forever.  

Why are there three different kinds of clearinghouses while other rights are still negotiated on a case-by-case basis? And we’re just talking about music here — we’re not talking about books, movies, short video clips, or photography. Music is just one slice of copyright law, and that slice is an Escher-esque hellscape of percentages and if-then conditionals.

Centralized clearinghouses like SoundExchange, ASCAP, and HFA (to some extent) are what are known as “collection societies.” In other countries, particularly in Europe, collection societies are much more popular and cover many different kinds of industries. In general, the trend in other countries is to group music rights together into one collection society, rather than split them up into several different ones divided by type of copyright and type of distribution.

And yes, there are some horror stories out of these systems — waste, inefficiency, and bureaucratic corruption. But no one can look at the US hybrid free market / collective system and say, in good faith, that it’s all working out. In the end, artists just want to make music and get a check at the end of the quarter while someone else in a suit does the work of chasing down royalties from 20 different places.

In 2018, streaming companies know with precision how many people are listening to what song. Databases of artists and how much they’re being owed are being updated regularly. And yet, in this unprecedented age of information and automation, it’s only become more difficult and more complicated to get money to the people who are owed it. Everywhere else the digital revolution is supposed to be streamlining old processes; when it comes to music, the logistics have only gotten more convoluted.

The paradox has to do with the unique position of music copyright. More than any other kind of copyright, music copyright law has suffered at the hands of technological change. With every new innovation — from player pianos to cassette players to internet radio — legislators have tacked on some new patch to “fix” music copyright, creating an increasingly untenable monstrosity of flapping bits held together with staples and Scotch tape. And while this mess is barely understandable by the average consumer, it pops out in one fairly obtrusive way: music streaming is dominated by a handful of giants because only a giant can deal with the legal mess. Anyone can open a record store (although good luck getting any foot traffic), but if you want to launch a streaming service, you’d need billions of dollars and lots of lawyers to fend off lawsuits like Wixen v. Spotify.

Part of the Wixen lawsuit has to do with the introduction of the introduction of the Music Modernization Act by Rep. Doug Collins (R-GA) earlier this year. One of the things the MMA would do is create a Mechanical Licensing Collective, a collection society that acts as the official middleman for mechanical licenses for digital services — like SoundExchange, but for mechanicals. Another thing it does is it allows the Copyright Royalty Board to set different mechanical rates for different songs based on market value. Instead of the same flat fee for every song, more “valuable” songs can charge higher mechanicals than others.

The MMA does something else: it prevents lawsuits like Wixen v. Spotify. If a streaming service sets aside the money it’s trying to allocate to a songwriter it can’t find, it can’t be sued later on for not finding the songwriter.

And for once in the history of the world, a proposed bill has met with the approval of the record labels and the tech companies. The MMA has the support of the RIAA, the National Music Publishers Association, the various performance royalties organizations, and the Digital Music Association, a trade organization that represents Spotify, YouTube, Amazon, Napster, and others. Both Spotify and Pandora have directly lauded the bill as well.

That’s how much this state of affairs sucks: the RIAA and Napster have managed to agree on something.

The bill has now been introduced in both the House and the Senate. The music industry — with all its various stakeholders, who are far more accustomed to suing each other than presenting a unified front — are hoping that Congress will push the button and turn the unholy disaster of music licensing into something slightly less unholy and somewhat less disastrous. But less controversial causes have failed to pass muster in the last year. Only time will tell.

In the meantime, we have Wixen vs. Spotify.

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