Spotify’s $100 Million Problem
Billboard magazine estimates that Spotify and other streaming services have as much as $100 million dollars in unpaid songwriter royalties and documents provided to us confirm that Spotify had more than $140 million in “unpaid fees to copyright owners” at the end of 2014.  While these kind of “unmatched” and unpaid balances are a long standing problem throughout the music business,  Spotify’s unpaid royalties are different because it appears to be the result of not having licenses for these songs.  If true this means Spotify broke the law. As I reported last week this appears to be the case with a large portion of my own song catalogue being unlicensed by Spotify. Victory records also reported that its entire song catalogue was unlicensed by Spotify and Spotify subsequently yanked their entire catalogue.  Here is Spotify’s head of global communications and policy seemingly admitting this in an email to The Wall Street Journal:

“We want to pay every penny, but we need to know who(sic) to pay,” Spotify spokesman Jonathan Prince said in an email.

If Spotify does not “know who(sic) to pay” that means they have never bothered to license the songs.  You see in order to be fully licensed Spotify would have to enter into a direct licensing agreement with every songwriters’ publishing company or exercise the federal compulsory license which also requires notifying the songwriters’ publishing company 30 days in advance of use of the song.  In advance! Not after the song accrued royalties.   The reason the law is written this way is it forces the streaming service to gather contact information from songwriters and publishers in advance so they “know who to pay” and don’t accrue unpaid royalties.   This is explicitly and precisely the intent of the law and why  the register of copyrights Marybeth Peters recommended keeping in place this licensing requirement in her strangely prescient 2004 statement to House Judiciary Committee:

“The problems might be only deferred rather than avoided because the licensee would still have to identify and locate the copyright owner in order to pay royalties to the proper person…”

Is this a Crime?

I am not an attorney, but it is clear that at the very least using unlicensed songs is copyright infringement.  The NMPA has stated that up to 25% of the royalties are not making it from streaming services to songwriters.  As noted above the only way this happens is if you have a large pool of unlicensed songs at the streaming services.  This would seem to qualify this as mass copyright infringement and my understanding is this is potentially a RICO predicate.  Spotify may have also run afoul of many other state and federal laws in the process.  As I noted last week virtually every state has unclaimed property laws that could apply to this situation. Certainly NY State AG office has forced companies holding unpaid royalties (including major record labels) to pay these out under abandoned property laws. There is also the matter of Spotify’s fiduciary responsibilities to investors.  The $100 million question in this case is this:

Has Spotify disclosed to it’s investors in a timely manner that it has a large pool of unlicensed songs and unpaid royalties?

This by law should be disclosed  in their financial statements to investors.  First the actual amount of unpaid royalties  should appear in financial statement as a current liability since these royalties are immediately payable. Second since Spotify is now aware it may be distributing a large pool of unlicensed songs, it is also aware that there is the potential for large court awarded damages or private settlements. In other words there is high likely hood of pending lawsuit or settlement.  Billboard reports that Spotify is already in settlement talks with the NMPA.  Has Spotify disclosed this to investors?

I’m not an expert on corporate accounting but if it’s true that the accrued unpaid and unmatched royalties are now $100 million, that didn’t just start last quarter.  It seems likely to me that this is a material issue that someone knew about before Spotify filed their 2014 financial statements.  Did they disclose this then?  For more on the importance of reporting contingent liabilities see  Motley Fool’s simplified explanation of GAAP rules on contingent liabilities here.

Certainly before Spotify files for an IPO or goes into another round of fundraising the unlicensed songs must be fully disclosed to the public.  (Why doesn’t Spotify set up a wikileaks type searchable database so songwriters can search for their songs.  The major labels were required years ago to do something similar by New York Attorney General).

It should be noted that civil and criminal charges may also apply to not just Spotify and it’s officers  but also to its public accounting firm Ernst and Young that audited and then certified financial statements to investors.  In the Enron collapse investors sued Enron’s audit CPA firm Arthur Andersen.  As a result Arthur Andersen lost their CPA license and went out of business.   And yes the possibly of third party liability also  applies to The Harry Fox Agency which appears to have been hired by Spotify to license songs and distribute royalties. But (for the moment) chasing HFA is a red herring, because  ultimately it is Spotify’s legal responsibility that those licenses are obtained and royalties are paid.

Finally as Spotify is a global firm with headquarters  in Luxembourg, any accounting irregularities, or failure to disclose contingent liabilities as described could trigger legal action in the EU or member countries. And certainly EU laws governing financial disclosure are much tougher than US laws.

Should DOJ, FTC, Congress, NY State and EU Investigate. 

Yes, Yes, Yes, Yes and Yes.  Why?

The DOJ, FTC, NY State and EU have all launched investigations into anti-competitive practices by Apple music and the major record labels/publishers.  Our sources tell us that in three of those cases the complainant was Spotify.  The “temporary” 70 year old  DOJ anti-competitive consent decrees that severely limit songwriters ability to negotiate also benefits Spotify.  So clearly the DOJ, FTC, NY State and EU believe that anti-competitive practices in the digital music business warrant investigation.  So I ask this:

What could possibly be more anti-competitive than one market dominant streaming service (Spotify) operating with the advantage of a large pool of unlicensed songs while its competitor (Apple) seems to license them all?

I realize that what I’m saying also applies to YouTube.  But we all know why YouTube/Google will never be properly investigated by the executive branch. Here, here, here, here, here and here.   That’s why people go to EU to get justice on Google.  The question is this: does Spotify enjoy the same level of protection?

It certainly appears that way.

The above timeline suggests Spotify began conducting “lawfare” against Apple and major labels shortly after it hired former Obama and Hillary Clinton aide Jonathan Prince.  (Prince is connected enough to get a 90 minute meeting with Denis McDonough White House Chief of Staff at 4:00 pm on a Friday afternoon-see White House visitors log below.) Each of these investigations appears designed to preserve the free tier of Spotify’s streaming service which has come under scrutiny by artist and labels for meager payouts.  Labels, performers and songwriters object to the free tier because it pays 1/7th  per spin when compared to the $9.99 a month subscription tier.

Although the free tier makes less money per user than the subscription tier, a Spotify IPO is likely to value the service on the number of users, not revenue.   Thus CEO Daniel Ek and Spotify’s Silicon Valley VC backers are highly incentivized to build a bigger money losing company through free streaming than a smaller company through higher sustainable subscription revenue.

 

 

But ultimately this anti-trust/unfair competition push by Spotify is a head scratcher. Spotify’s rumored complaints seem absurd*:

1. The dominant streaming service Spotify (50%+ global market share) is complaining that a smaller higher priced competitor (Apple Music) somehow has an unfair advantage?
2. It is anti-competitive for record labels and performers to favor subscription services like Apple that pay a higher fee? In essence Spotify demands government agencies repeal capitalism.
3. Apple has payment information on over 200 million consumers because it sells things.  Spotify does not because it decided to mostly provide its product for free, an email address or FaceBook account is all it requires.   Governments should step in to protect a shitty business model?

In other words Spotify is saying:

“In order to save competition we have to destroy competition”

Now if the government absolutely insists it wants to get involved in the digital music business,  they need to do it for the right reasons. The right reasons are things like protection of property rights,  unlawful activity and market failures.  When it is credibly reported that a music streaming services is: operating with perhaps 25% of revenues to songwriters going unpaid; entire catalogues of songs are unlicensed;  holding $100 million in unpaid royalties; and may not have not properly disclosed material financial concerns to investors? It is time to investigate.

Besides, turnabout is fair play

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*We really should know the nature of these complaints.  It’s absurd that it is a secret.  I have been researching a related matter at University of Georgia and I submitted a FOIA request to the FTC and FOIL request to the NY State AG office on certain details of this investigation but the requests were denied.  I plan to appeal the decisions as there is no reason to not release this information as it appears the main complainant (Spotify) has clearly been running its mouth to reporters.  Ergo, it is clearly not a secret!  The release of this information would only enhance the public understanding of the operation of government institutions which is the purpose of these laws. Further open government is foundational to a properly functioning democracy otherwise citizens begin to doubt the fairness of the system. Just saying.