The Trichordist

[Editor Charlie sez: a royalty “audit” is a right of the song owner to look inside the books and records of the party paying royalties to confirm that all royalties were paid and that all royalties were paid correctly, usually during a specified period of time. This usually results in the song owner discovering an underpayment that would have gone unpaid without the audit.]

By Chris Castle

It is commonplace for artists to conduct a royalty examination of their record company, sometimes called an “audit.” Until the Music Modernization Act, the statutory license did not permit songwriters to audit users of the statutory license. The Harry Fox Agency “standard” license for physical records had two principal features that differed from the straight statutory license: quarterly accounting and an audit right. When streaming became popular, the services both refused to comply with the statutory regulations and also refused to allow anyone to audit because the statutory regulations they failed to comply with did not permit an audit. I brought this absurdity to the attention of the Copyright Office in 2011.

After much hoopla, the lobbyists wrote an audit right for copyright owners into the Music Modernization Act. However, rather than permitting copyright owners to audit music users as is long standing common practice on the record side, the lobbyists decided to allow copyright owners to audit the Mechanical Licensing Collective. At the expense of the copyright owner, of course, no matter how many mistakes the copyright owner discovered or how big the underpayment. This is consistent with the desire of services to distance themselves from those pesky songwriters by inserting the MLC in between the services and their ultimate vendors, the songwriters and copyright owners. The services can be audited by the MLC (whose salaries are paid by the services), but that hasn’t happened yet to my knowledge.

But the MLC has received what I believe is its first audit notice that was just published by the Copyright Office after receiving it on November 9. First up is Bridgeport Music, Inc. for the period January 1, 2021, through December 31, 2023. January 1, 2021 was the “license availability date” or the date that the MLC began accounting for royalties under the MMA’s blanket license.

Why Audit Now?

Bridgeport’s audit is wise. There are no doubt millions if not billions of streams to be verified. The MLC’s systems are largely untested, compared to other music users such as record companies that have been audited hundreds, if not thousands of times depending on how long they are operating. Competent royalty examiners will look under the hood and find out whether it’s even possible to render reasonably accurate accounting statements given the MLC’s systems. Maybe it’s all fine, but maybe it’s not. The wisdom of Bridgeport’s two year audit window is that two years is long enough to have a chance at a recovery but it’s not so long that you are drowned in data and susceptible to taking shortcuts. 

In other words, why wait around?

Auditing the Black Box

A big difference between the audit rules the lobbyists wrote into the MMA and other audits is that the MLC audit is based on payments, not statements. The relevant language in the statute makes this very clear (17 USC §115(d)(3)(L):

A copyright owner entitled to receive payments of royalties for covered activities from the mechanical licensing collective may, individually or with other copyright owners, conduct an audit of the mechanical licensing collective to verify the accuracy of royalty payments by the mechanical licensing collective to such copyright owner…The qualified auditor shall determine the accuracy of royalty payments, including whether an underpayment or overpayment of royalties was made by the mechanical licensing collective to each auditing copyright owner.

Royalty payments would include a share of black box royalties distributed to copyright owners. It seems reasonable that on audit a copyright owner could verify how this share was arrived at and whatever calculations would be necessary to calculate those payments, or maybe the absence of such payments that should have been made. Determining what is not paid that should have been paid is an important part of any royalty verification examination.

Systems Transparency

Information too confidential to be detected cannot be corrected.  It is important to remember that copyright owner audits of the MLC will be the first time an independent third party has had a look at the accounting systems and functional technology of The MLC. If those audits reveal functional defects in the MLC’s systems or technology that affects any output of The MLC, i.e., not just the royalties being audited, it seems to me that those defects should be disclosed to the public. Audit settlements should not be used as hush money payments to keep embarrassing revelations from being publicly disclosed.

Unsurprisingly, The MLC lobbied to have broadly confidential treatment of all audits. Realize that there may well be confidential financial information disclosed as part of any audit that both copyright owners and The MLC will want to keep secret. There is no reason to keep secrets about The MLC’s systems. To take an extreme example, if on audit the auditors discovered that The MLC’s systems added 2 plus 2 and got 5, that is a fact that others have a legitimate interest in having disclosed to include the Copyright Office itself that is about to launch a 5 year review of The MLC for redesignation. Indeed, auditors may discover systemic flaws that could arguably require The MLC to recalculate many if not all statements or at least explain why they should not. (Note that a royalty auditor is required to deliver a copy of the auditor’s final report to The MLC for review even before giving it to their client. This puts The MLC on notice of any systemic flaws in The MLC’s systems found by the auditor and gives it the opportunity to correct any factual errors.)

I think that systemic flaws found by an auditor should be disclosed publicly after taking care to redact any confidential financial information. This will allow both the Copyright Office and MLC members to fix any discovered flaws.

The “Qualified Auditor” Typo

It is important to realize that there is no good reason why a C.P.A. must conduct the audit; this is another drafting glitch in the MMA that requires both The MLC’s audited financial statements and royalty compliance examinations be conducted by a C.P.A, defined as a “qualified auditor” (17 USC § 115(e)(25)). It’s easy to understand why audited financials prepared according to GAAP should be opined by a C.P.A. but it is ludicrous that a C.P.A. should be required to conduct a royalty exam for royalties that have nothing to do with GAAP and never have. 

To be frank, I doubt seriously whether anyone involved in drafting the MMA had ever personally conducted or managed a royalty verification examination. That assessment is based on the fact that royalty verification examinations are one of the most critical parts of the royalty payment process and is the least discussed subject in the lengthy MMA; at the time, the lobbyists did not represent songwriters and tried very hard to keep songwriters inside the writer room and outside of the drafting room as you can tell from The MLC, Inc.’s board composition; and that the legislative history (at 20) has one tautological statement about copyright owner audits: ”Subparagraph L sets forth the verification and audit process for copyright owners to audit the collective, although parties may agree on alternate procedures.” Well no kidding, smart people. We’ll take some context if you got it.

As Warner Music Group’s Ron Wilcox testified to the Copyright Royalty Judges, “Because royalty audits require extensive technical and industry-specific expertise, in WMG’s experience a CPA certification is not generally a requirement for conducting such audits. To my knowledge, some of the. most experienced and knowledgeable royalty auditors in the music industry are not CPAs.” (Testimony of Ron Wilcox, In re Determination of Royalty Rates and Terms for Ephemeral Recording and Digital Performance of Sound Recordings (Web IV), Copyright Royalty Judges, Docket No. 14-CRB-0001-WR (Oct. 6, 2014) at 15.). 

I would add to Ron’s assessment that the need for “extensive technical and industry-specific expertise” has grown exponentially since he made the statement in 2014 due to the complexity and numerosity of streaming. I’m sure Ron would agree if he had a chance to revisit his remarks. But inside the beltway of the Imperial City, it ain’t that way and you can tell by reading their laws handed down by the descendants of Marcus Licinius Crassus. All accountants are CPAs, all accounting is according to GAAP, all the women are strong, all the men are good-looking, and all the children are above average and go to Sidwell Friends. In the words of London jazzman and club owner Ronnie Scott to an unresponsive audience, “And now, back to sleep.”

The “qualified auditor” defined term should be limited to the MLC’s financials and removed from the audit clauses. This was a point I made to Senate staff during the drafting of MMA, but was told that while they, too, agreed it was stupid, it’s what the parties wanted (i.e., what the lobbyists wanted). And you know how that can be. So now we sweep up behind the elephants in the circus of life. But then, I’m just a country lawyer from Texas, what do I know.

All praise to Bridgeport for stepping up.

This post first appeared on MusicTech.Solutions