Category: ESG

On the Internet, “Partners” Don’t Hear You Scream: Spotify CEO Makes a $350M “Bundle” While Sticking Songwriters with an ESG “Bundle” of Crap

Here’s a quote for the ages:

MICHAEL BURRY

One of the hallmarks of mania is the rapid rise and complexity 
of the rates of fraud. And did you know they’re going up?

The Big Short, screenplay by Charles Randolph and Adam McKay,
based on the book by Michael Lewis

We have often said that if screwups were Easter eggs, Spotify CEO Daniel Ek would be the Easter bunny, hop hop hopping from one to the next. That’s is not consistent with his press agent’s pagan iconography, but it sure seems true to many people.

This week was no different. Mr. Ek cashed out hundreds of millions in Spotify stock while screwing songwriters hard with a lawless interpretation of the songwriter compulsory license. That interpretation is so far off the mark that he surely must know exactly what he is doing. It’s yet another manifestation of Spotify’s sudden obsession with finding profits after a decade of “get big fast.”

The Bunny’s Bundle

Let’s look under the hood at the part they don’t tell you much about. Mr. Ek evidently has what’s called a “10b5-1 agreement” in place with Spotify allowing staggered sales of incremental tranches of the common stock. Those sales have to be announced publicly which Spotify complied with (we think). And we’ll say it again for the hundredth time, stock is where the real money is at this stage of Spotify’s evolution, not revenue.

As a founder of Spotify, Mr. Ek holds founders shares plus whatever stock awards he has been granted by the board he controls through his supervoting stock that we’ve discussed with you many times. These 10b5-1 agreements are a common technique for insiders, especially founders, who hold at least 10% of the company’s shares, to cash out and get the real money through selling their stock.

A 10b5-1 agreement establishes predetermined trading instructions for company stock (usually a sale so not trading the shares) consistent with SEC rules under Section 10b5 of the Securities and Exchange Act of 1934 covering when the insider can sell. Why does this exist? The rule was established in 2000 to protect Silicon Valley insiders from insider trading lawsuits. Yep, you caught it–it’s yet another safe harbor for the special people. Presumably Mr. Ek’s personal agreement is similar if not identical to the safe harbor terms because that’s why the terms are there.

As MusicBusinessWorldWide reported, Mr. Ek recently sold $118.8 million in shares of Spotify at roughly the same time that he likely knew Spotify was planning to change the way his company paid songwriters on streaming mechanicals, or as it’s also known “material nonpublic information”.

As Tim Ingham notes in MusicBusinessWorldwide, Mr. Ek has had a few recent sales under his 10b5-1 agreement: “Across these four transactions (today’s included), Ek has cashed out approximately $340.5 million in Spotify shares since last summer.” Rough justice, but I would place a small wager that Ek has cashed out in personal wealth all or close to all of the money that Spotify has paid to songwriters (through their publishers) for the same period. In this sense, he is no different than the usual disproportionately compensated CEOs at say Google or Raytheon. 

Stock buybacks artificially increase share price. Now why might Spotify want to juice its own stock price?

Spotify Shoves a “Bundled” Rate on Songwriters

Spotify’s argument (that may have caused a jump in share price) claims that its recent audiobook offering made Spotify subscriptions into a “bundle” for purposes of the statutory mechanical rate. (While likely paying an undiscounted royalty to the books.) 

That would be the same bundled rate that was heavily negotiated in the 2021-22 “Phonorecords IV” proceeding at the Copyright Royalty Board at great expense to all concerned, not to mention torturing the Copyright Royalty Judges. These Phonorecords IV rates are in effect for five years, but the next negotiation for new rates is coming soon (called Phonorecords V or PR V for short). We’ll get to the royalty bundle but let’s talk about the cash bundle first.

You Didn’t Build That

Don’t get it wrong, we don’t begrudge Mr. Ek the opportunity to be a billionaire. We don’t at all. But we do begrudge him the opportunity to do it when the government is his “partner” so they can together put a boot on the necks of songwriters. This is how it is with statutory mechanical royalties; he benefits from various other safe harbors, has had his lobbyists rewrite Section 115 to avoid litigation in a potentially unconstitutional reach back safe harbor, and he hired the lawyer at the Copyright Office who largely wrote the rules that he’s currently bending. Yes, we do begrudge him that stuff.

And here’s the other effrontery. When Daniel Ek pulls down $340.5 million as a routine matter, we really don’t want to hear any poor mouthing about how Spotify cannot make a profit because of the royalty payments it makes to artists and songwriters. (Or these days, doesn’t make to some artists.) This is, again, why revenue share calculations are just the wrong way to look at the value conferred by featured and nonfeatured artists and songwriters on the Spotify juggernaut. That’s also the point Chris made in some detail in the paper he co-wrote with Professor Claudio Feijoo for WIPO that came up in Spain, Hungary, France, Uruguay and other countries.

Spotify pays a percentage of revenue on what is essentially a market share basis. Market share royalties allows the population of recordings to increase faster than the artificially suppressed revenue, while excluding songwriters from participating in the increases in market value reflected in the share price. That guarantees royalties will decline over time. Nothing new here, see the economist Thomas Malthus, workhouses and Charles Dickens‘ Oliver Twist.

The market share method forces songwriters to take a share of revenue from someone who purposely suppressed (and effectively subsidized) their subscription pricing for years and years and years. (See Robert Spencer’s Get Big Fast.). It would be a safe bet that the reason they subsidized the subscription price was to boost the share price by telling a growth story to Wall Street bankers (looking at you, Goldman Sachs) and retail traders because the subsidized subscription price increased subscribers.

Just a guess. 

The Royalty Bundle

Now about this bundled subscription issue. One of the fundamental points that gets missed in the statutory mechanical licensing scheme is the compulsory license itself. The fact that songwriters have a compulsory license forced on them for one of their primary sources of income is a HUGE concession. We think the music services like Spotify have lost perspective on just how good they’ve got it and how big a concession it is.

The government has forced songwriters to make this concession since 1909. That’s right–for over 100 years. A century.

A decision that seemed reasonable 100 years ago really doesn’t seem reasonable at all today in a networked world. So start there as opposed to the trope that streaming platforms are doing us a favor by paying us at all, Daniel Ek saved the music business, and all the other iconographic claptrap.

Has anyone seen them in the same room at the same time?

The problem with the Spotify move to bundled subscriptions is that it can happen in the middle of a rate period and at least on the surface has the look of a colorable argument to reduce royalty payments. If you asked songwriters what they thought the rule was, to the extent they had focused on it at all after being bombarded with self-congratulatory hoorah, they probably thought that the deal wasn’t “change rates without renegotiating or at least coming back and asking.”

And they wouldn’t be wrong about that, because it is reasonable to ask that any changes get run by your, you know, “partner.” Maybe that’s where it all goes wrong. Because it is probably a big mistake to think of these people as your “partner” if by “partner” you mean someone who treats you ethically and politely, reasonably and in good faith like a true fiduciary. 

They are not your partner. Don’t normalize that word.

A Compulsory License is a Rent Seeker’s Presidential Suite

But let’s also point out that what is happening with the bundle pricing is a prime example of the brittleness of the compulsory licensing system which is itself like a motel in the desolate and frozen Cyber Pass with a light blinking “Vacancy: Rent Seekers Wanted” surrounded by the bones of empires lost. Unlike the physical mechanical rate which is a fixed penny rate per transaction, the streaming mechanical is a cross between a Rube Goldberg machine and a self-licking ice cream cone. 

The Spotify debacle is just the kind of IED that was bound to explode eventually when you have this level of complexity camouflaging traps for the unwary written into law. And the “written into law” part is what makes the compulsory license process so insidious. When the roadside bomb goes off, it doesn’t just hit the uparmored people before the Copyright Royalty Board–it creams everyone.

David and friends tried to make this point to the Copyright Royalty Judges in Phonorecords IV. They were not confused by the royalty calculations–they understood them all too well. They were worried about fraud hiding in the calculations the same way Michael Burry was worried about fraud in The Big Short. Except there’s no default swaps for songwriters like Burry used to deal with fraud in subprime mortgage bonds. 

Here’s how the Judges responded to David, you decide if they are condescending or if the songwriters were prescient knowing what we know now:

While some songwriters or copyright owners may be confused by the royalties or statements of account, the price discriminatory structure and the associated levels of rates in settlement do not appear gratuitous, but rather designed, after negotiations, to establish a structure that may expand the revenues and royalties to the benefit of copyright owners and music services alike, while also protecting copyright owners from potential revenue diminution. This approach and the resulting rate setting formula is not unreasonable. Indeed, when the market itself is complex, it is unsurprising that the regulatory provisions would resemble the complex terms in a commercial agreement negotiated in such a setting.

PR IV Final Rule at 80452 https://app.crb.gov/document/download/27410

It must be said that there never has been a “commercial agreement negotiated in such a setting” that wasn’t constrained by the compulsory license. It’s unclear what the Judges even mean. But if what the Judges mean is that the compulsory license approximates what would happen in a free market where the songwriters ran free and good men didn’t die like dogs, the compulsory license is nothing like a free market deal.

If the Judges are going to allow services to change their business model in midstream but essentially keep their music offering the same while offloading the cost of their audiobook royalties onto songwriters through a discount in the statutory rate, then there should be some downside protection. Better yet, they should have to come back and renegotiate or songwriters should get another bite at the apple.

Unfortunately, there are neither, which almost guarantees another acrimonious, scorched earth lawyer fest in PR V coming soon to a charnel house near you.

Eject, Eject!

This is really disappointing because it was so avoidable if for no other reason. It’s a great time for someone…ahem…to step forward and head off the foreseeable collision on the billable time highway. The Judges surely know that the rate calculation is a farce

But the Judges are dealing with people negotiating the statutory license who have made too much money negotiating it to ever give it up willingly although a donnybrook is brewing. This inevitable dust up means other work will suffer at the CRB. It must be said in fairness that the Judges seem to find it hard enough to get to the work they’ve committed to according to a recent SoundExchange filing in a different case (SDARS III remand from 2020).  

That’s not uncharitable–I’m merely noting that when dozens of lawyers in the mechanical royalty proceedings engage in what many of us feel are absurd discovery excesses. When there are stupid lawyer tricks at the CRB, they are–frankly–distracting the Judges from doing their job by making them focus on, well, bollocks. We’ll come back to this issue in future. The dozens and hundreds of lawyers putting children through college at the CRB–need to take a breath and realize that judicial resources at the CRB are a zero sum game. This behavior isn’t fair to the Judges and it’s definitely not fair to the real parties in interest–the songwriters.

Tell the Horse to Open Wider

A compulsory license in stagflationary times is an incredibly valuable gift, and when you not only look the gift horse in the mouth but ask that it open wide so you can check the molars, don’t be surprised if one day it kicks you.

A version of this post first appeared on MusicTech.Solutions

by Trichordist Editor

Spotify’s ESG fail: Governance

This is the third of a three part post on Spotify’s failure to qualify as an “ESG” stock. 

[This is an extension of Spotify’s ESG Fail: Environment and Spotify’s ESG Fail: Social. “ESG” is a Wall Street acronym often attributed to Larry Finkat Blackrock that designates a company as suitable for socially conscious investing based on its “Environmental, Social and Governance” business practices. See the Upright Net Impact data model on Spotify’s sustainability score. As of this writing, the last update of Spotify’s Net Impact score was before the Neil Young scandal.]

Spotify has one big governance problem that permeates its governance like a putrid miasma in the abattoir: “Dual-class stock” sometimes referred to as “supervoting” stock. If you’ve never heard the term, buckle up. I wrote an extensive post on this subject for the New York Daily News that you may find interesting.

Dual class stock allows the holders of those shares–invariably the founders of the public company when it was a private company–to control all votes and control all board seats. Frequently this is accomplished by giving the founders a special class of stock that provides 10 votes for every share or something along those lines. The intention is to give the founders dead hand control over their startup in a kind of corporate reproductive right so that no one can interfere with their vision as envoys of innovation sent by the Gods of the Transhuman Singularity. You know, because technology.

Google was one of the first Silicon Valley startups to adopt this capitalization structure and it is consistent with the Silicon Valley venture capital investor belief in infitilism and the Peter Pan syndrome so that the little children may guide us. The problem is that supervoting stock is forever, well after the founders are bald and porky despite their at-home beach volleyball courts and warmed bidets.

Spotify, Facebook and Google each have a problem with “dual class” stock capitalizations.  Because regulators allow these companies to operate with this structure favoring insiders, the already concentrated streaming music industry is largely controlled by Daniel Ek, Sergey Brin, Larry Page and Mark Zuckerberg.  (While Amazon and Apple lack the dual class stock structure, Jeff Bezos has an outsized influence over both streaming and physical carriers.  Apple’s influence is far more muted given their refusal to implement payola-driven algorithmic enterprise playlist placement for selection and rotation of music and their concentration on music playback hardware.)

The voting power of Ek, Brin, Page and Zuckerberg in their respective companies makes shareholder votes candidates for the least suspenseful events in commercial history.  However, based on market share, Spotify essentially controls the music streaming business.  Let’s consider some of the  implications for competition of this disfavored capitalization technique.

Commissioner Robert Jackson, formerly of the U.S. Securities and Exchange Commission, summed up the problem:

“[D]ual class” voting typically involves capitalization structures that contain two or more classes of shares—one of which has significantly more voting power than the other. That’s distinct from the more common single-class structure, which gives shareholders equal equity and voting power. In a dual-class structure, public shareholders receive shares with one vote per share, while insiders receive shares that empower them with multiple votes. And some firms [Snap, Inc. and Google Class B shares] have recently issued shares that give ordinary public investors no vote at all.

For most of the modern history of American equity markets, the New York Stock Exchange did not list companies with dual-class voting. That’s because the Exchange’s commitment to corporate democracy and accountability dates back to before the Great Depression. But in the midst of the takeover battles of the 1980s, corporate insiders “who saw their firms as being vulnerable to takeovers began lobbying [the exchanges] to liberalize their rules on shareholder voting rights.”  Facing pressure from corporate management and fellow exchanges, the NYSE reversed course, and today permits firms to go public with structures that were once prohibited.

Spotify is the dominant streaming firm and the voting power of Spotify stockholders is concentrated in two men:  Daniel Ek and Martin Lorentzon.  Transitively, those two men literally control the music streaming sector through their voting shares, are extending their horizontal reach into the rapidly consolidating podcasting business and aspire soon to enter the audiobooks vertical.  Where do they get the money is a question on every artists lips after hearing the Spotify poormouthing and seeing their royalty statements.

The effects of that control may be subtle; for example, Spotify engages in multi-billion dollar stock buybacks and debt offerings, but has yet makes ever more spectacular losses while refusing to exercise pricing power.  

So yes, Spotify is starting to look like the kind of Potemkin Village that investment bankers love because they see oodles of the one thing that matters: Fees.

On the political side, let’s see what the company’s campaign contributions tell us:

Spotify has also made a habit out of hiring away government regulators like Regan Smith, the former General Counsel and Associate Register of the US Copyright Office who joined Spotify as head of US public policy (a euphemism for bag person) after drafting all of the regulations for the Mechanical Licensing Collective;

Whether this is enough to trip Spotify up on the abuse of political contributions I don’t know, but the revolving door part certainly does call into question Spotify’s ethics.

It does seem that these are the kinds of facts that should be taken into account when determining Spotify’s ESG score. At this point, it looks like Spotify is an ESG fail–which may require divesting by some of the over 600 mutual funds that hold shares.

by thetrichordist

Spotify’s ESG Fail: Social

By Chris Castle

[This post first appeared on MusicTechSolutions.]

Investopedia ESG criteria

[This post is Part 2 of a three part post on Spotify’s ESG Fail, and is an extension of Spotify’s ESG Fail: Environment. “ESG” is a Wall Street acronym often attributed to Larry Fink at Blackrock that designates a company as suitable for socially conscious investing based on its “Environmental, Social and Governance” business practices. See the Upright Net Impact data model on Spotify’s sustainability score. As of this writing, the last update of Spotify’s Net Impact score was before the Neil Young scandal.]

I started to write this post in the pre-Neil Young era and I almost feel like I could stop with the title. But there’s a lot more to it, so let’s look at the many ways Spotify is a fail on the Social part of ESG.

Before Spotify’s Joe Rogan problem, Spotify had both an ethical supply chain problem and a “fair wage” problem on the music side of its business, which for this post we will limit to fair compensation to its ultimate vendors being artists and songwriters. In fact, Spotify is an example to music-tech entrepreneurs of how not to conduct their business.

Treatment of Songwriters

On the songwriter side of the house, let’s not fall into the mudslinging that is going on over the appeal by Spotify (among others) of the Copyright Royalty Board’s ruling in the mechanical royalty rate setting proceeding known as Phonorecords III. Yes, it’s true that streaming screws songwriters even worse that artists, but not only because Spotify exercised its right of appeal of the Phonorecords III case that was pending during the extensive negotiations of Title I of the Music Modernization Act. (Title I is the whole debacle of the Mechanical Licensing Collective scam and the retroactive copyright infringement safe harbor currently being litigated on Constitutional grounds.)

The main reason that Spotify had the right to appeal available to it after passing the MMA was because the negotiators of Title I didn’t get all of the services to give up their appeal right (called a “waiver”) as a condition of getting the substantial giveaways in the MMA. A waiver would have been entirely appropriate given all the goodies that songwriters gave away in the MMA. When did Noah build the Ark?  Before the rain. The negotiators might have gotten that message if they had opened the negotiations to a broader group, but they didn’t so now they’ve got the hot potato no matter how much whinging they do.

Having said that, you will notice that Apple took pity on this egregious oversight and did not appeal the Phonorecords III ruling. You don’t always have to take advantage of your vendor’s negotiating failures, particularly when you are printing money and when being generous would help your vendor keep providing songs. And Mom always told me not to mock the afflicted. Plus it’s good business–take Walmart as an example. Walmart drives a hard bargain, but they leave the vendor enough margin to keep making goods, otherwise the vendor will go under soon or run a business solely to service debt only to go under later. And realize that the decision to be generous is pretty much entirely up to Walmart. Spotify could do the same.

Is being cheap unethical? Is leveraging stupidity unethical? Is trying to recover the costs of the MLC by heavily litigating streaming mechanicals unethical (or unexpected)? Maybe. A great man once said failing to be generous is the most expensive mistake you’ll ever make. So yes, I do think it is unethical although that’s a debatable point. Spotify has not made themselves many friends by taking that course. But what is not debatable is Spotify’s unethical treatment of artists.

Treatment of Artists

The entire streaming royalty model confirms what I call “Ek’s Law” which is related to “Moore’s Law”. Instead of chip speed doubling every 18 months in Moore’s Law, royalties are cut in half every 18 months with Ek’s Law. This reduction over time is an inherent part of the algebra of the streaming business model as I’ve discussed in detail in Arithmetic on the Internet as well as the study I co-authored with Dr. Claudio Feijoo for the World Intellectual Property Organization. These writings have caused a good deal of discussion along with the work of Sharky Laguana about the “Big Pool” or what’s come to be called the “market centric” royalty model.

Dissatisfaction with the market centric model has led to a discussion of the “user-centric” model as an alternative so that fans don’t pay for music they don’t listen to. But it’s also possible that there is no solution to the streaming model because everybody whose getting rich (essentially all Spotify employees and owners of big catalogs) has no intention of changing anything voluntarily. 

It would be easy to say “fair is where we end up” and write off Ek’s Law as just a function of the free market. But the market centric model was designed to reward a small number of artists and big catalog owners without letting consumers know what was happening to the money they thought they spent to support the music they loved. As Glenn Peoples wrote last year (Fare Play: Could SoundCloud’s User-Centric Streaming Payouts Catch On?, 

When Spotify first negotiated its initial licensing deals with labels in the late 2000s, both sides focused more on how much money the service would take in than the best way to divide it. The idea they settled on, which divides artist payouts based on the overall popularity of recordings, regardless of how they map to individuals’ listening habits, was ‘the simplest system to put together at the time,’ recalls Thomas Hesse, a former Sony Music executive who was involved in those conversations.

In other words, the market centric model was designed behind closed doors and then presented to the world’s artists and musicians as a take it or leave it with an overhyped helping of FOMO.

As we wrote in the WIPO study, the market centric model excludes nonfeatured musicians altogether. These studio musicians and vocalists are cut out of the Spotify streaming riches made off their backs except in two countries and then only because their unions fought like dogs to enforce national laws that require streaming platforms to pay nonfeatured performers.

The other Spotify problem is its global dominance and imposition of largely Anglo-American repertoire in other countries. The company does this for one big reason–they tell a growth story to Wall Street to juice their stock price. In fact, Daniel Ek just did this last week on his Groundhog Day earnings call with stock analysts. For example he said:

The number one thing that we’re stretched for at the moment is more inventory. And that’s why you see us introducing things such as fan and other things. And then long-term with a little bit more horizon, it’s obviously international.

Both user-centric and market-centric are focused on allocating a theoretical revenue “pie” which is so tiny for any one artist (or songwriter) who is not in the top 1 or 5 percent this week that it’s obvious the entire model is bankrupt until it includes the value that makes Daniel Ek into a digital munitions investor–the stock.

Debt and Stock Buybacks

Spotify has taken on substantial levels of debt for a company that makes a profit so infrequently you can say Spotify is unprofitable–which it is on a fully diluted basis in any event. According to its most recent balance sheet, Spotify owes approximately $1.3 billion in long term–secured–debt. 

You might ask how a company that has never made a profit qualifies to borrow $1.3 billion and you’d have a point there. But understand this: If Spotify should ever go bankrupt, which in their case would probably be a reorganization bankruptcy, those lenders are going to stand in the secured creditors line and they will get paid in full or nearly in full well before Spotify meets any of its obligations to artists, songwriters, labels and music publishers, aka unsecured creditors.

Did Title I of the Music Modernization Act take care of this exposure for songwriters who are forced to license but have virtually no recourse if the licensee fails to pay and goes bankrupt? Apparently not–but then the lobbyists would say if they’d insisted on actual protection and reform there would have been no bill (pka no bonus). 

Right. Because “modernization” (whatever that means).

But to our question here–is it ethical for a company that is totally dependent on creator output to be able to take on debt that pushes the royalties owed to those creators to the back of the bankruptcy lines? I think the answer is no.

Spotify has also engaged in a practice that has become increasingly popular in the era of zero interest rates (or lower bound rates anyway) and quantitative easing: stock buy backs.

Stock buy backs were illegal until the Securities and Exchange Commission changed the law in 1982 with the safe harbor Rule 10b-18. (A prime example of unelected bureaucrats creating major changes in the economy, but that’s a story for another day.) 

Stock buy backs are when a company uses the shareholders money to buy outstanding shares of their company and reduce the number of shares trading (aka “the float”). Stock buy backs can be accomplished a few ways such as through a tender offer (a public announcement that the company will buy back x shares at $y for z period of time); open market purchases on the exchange; or buying the shares through direct negotiations, usually with holders of larger blocks of stock. 

Vox’s Matt Yglesias sums it up nicely:

A stock buyback is basically a secondary offering in reverse — instead of selling new shares of stock to the public to put more cash on the corporate balance sheet, a cash-rich company expends some of its own funds on buying shares of stock from the public.

Why do companies buy back their own stock? To juice their financials by artificially increasing earnings per share.

Spotify has announced two different repurchase programs since going public according to their annual report for 12/31/21:

Share Repurchase Program On August 20, 2021, [Spotify] announced that the board of directors [controlled by Daniel Ek] had approved a program to repurchase up to $1.0 billion of the Company’s ordinary shares. Repurchases of up to 10,000,000 of the Company’s ordinary shares were authorized at the Company’s general meeting of shareholders on April 21, 2021. The repurchase program will expire on April 21, 2026. The timing and actual number of shares repurchased depends on a variety of factors, including price, general business and market conditions, and alternative investment opportunities. The repurchase program is executed consistent with the Company’s capital allocation strategy of prioritizing investment to grow the business over the long term. The repurchase program does not obligate the Company to acquire any particular amount of ordinary shares, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion. The Company uses current cash and cash equivalents and the cash flow it generates from operations to fund the share repurchase program.

The authorization of the previous share repurchase program, announced on November 5, 2018, expired on April 21, 2021. The total aggregate amount of repurchased shares under that program was 4,366,427 for a total of approximately $572 million.

Is it ethical to take a billion dollars and buy back shares to juice the stock price while fighting over royalties every chance they get and crying poor? I think not. 

I think there’s clearly a legitimate question of whether Spotify fails on the environmental and social prongs of ESG. In Part 3 we will consider “governance.”

by thetrichordist