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Rock & Rolled

The music labels are All Shook Up by Online File Sharing. Is It Too Late For Them To Adapt?

January 2004

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A year ago my wife visited our local Wherehouse store in San Clemente. It was closed, and soon after the chain filed for Chapter 11. Total industry music sales are down from $40 billion in 2000 to $30 billion in 2002. In part that is because huge amounts of music are available for free on the Internet. Why pay for something that you can get for free?

Unfortunately for content businesses, the genie is out of the bottle. In the digital age, near-perfect copies of songs can be made by computers almost instantly and then distributed in unlimited quantities on the Internet. Cary Sherman, president of the Recording Industry Association of America (RIAA), finally admitted the obvious to the BBC in January 2003: Pirated music on the Internet is here to stay. Nearly half of 12-to-22-year-olds downloaded music in July 2003 alone. Unauthorized music is so pervasive that my 11-year-old son was shocked when I told him that burning CDs of whatever he wanted would be illegal.

The music labels, worried about their public image, were initially reluctant to sue to prevent music from being downloaded from the Internet. Now the gloves are off. The labels sued Hummer Winblad Venture Partners, Napster's financiers. Music publishers, for their part, sued Bertelsmann, a German record label that tried to transform Napster into a legitimate, paying subscription service. That's pretty much like trying to lick the crumbs off the plate after the cookies are gone. Despite the lawsuits, the availability of unauthorized music on the Internet continues to grow.

In April 2003 the federal district court in Los Angeles found that two prominent websites, StreamCast Networks and Grokster, did not contribute to copyright infringement by distributing software that enables users to swap content. (MGM Studios, Inc. v. Grokster, Ltd., 259 F. Supp. 2d 1029.) Since some of the content is in the public domain, the software has substantial noninfringing uses. And unlike the old Napster, content was not transferred directly through the sites or with the defendants' contemporaneous knowledge or assistance. Also, without control over users' infringement, the companies could not be liable vicariously. The court decided the case correctly, but in the long run its decision is irrelevant. Though the law lags behind technology, in this case technology is rendering the law superfluous.

There is no public-policy consensus about what, if anything, should be done. To some extent the conflict arises out of the U.S. Constitution's competing utilitarian and natural law philosophies. The copyright clause's utilitarian purpose is to promote content, whereas the First Amendment reflects the natural law imperative of free speech. Article 1, section 8, of the Constitution states that Congress shall have the power to "promote the Progress and Science of useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries." The Founders intended to spur the creation of new works by giving authors a copyright monopoly for a limited time. They had watched quality content dry up after their 18th-century French contemporaries ended copyright protection.

Now the creators of music, books, magazines, software, and movies must try to adapt. To protect their copyrights in the digital age, today's content creators are using many tactics at once-none of which is a panacea. The following are some of their efforts.

Ethics: The RIAA has tried in vain to convince the cybernauts that copying is wrong. However, making a moral argument based on a utilitarian scheme is a hard sell. In the short run, there is no doubt that the greatest good for the greatest number of people is unlimited free music. The RIAA could buy up every TV advertising spot for a month and it would not matter. The consequences of its failure are dramatic: 50 percent of music downloaders say they now buy fewer CDs.

Business Methods: Each new technology so far has resulted in new revenue streams for copyright owners. The invention of television, videocassette recorders, and then
digital video disk (DVD) players has only added to Hollywood's total movie revenues. But after watching Napster unlock Pandora's box, the movie studios realized that increases in bandwidth could soon mean their extinction. Without secure copyrights, studios would be left with only a trickle of money from product placements and third-party tie-in promotions. Already, physical control of new releases has been considerably tightened. Except for the Oscar derby, the studios will no longer send reviewers advance copies of new releases.

Since it's too late to prevent music from being pirated off the Internet, record labels are experimenting with new business models such as metering and monthly subscriptions. In April 2003 Apple launched its iTunes Music Store, which permits Macintosh-based listeners to download a song for 99 cents. Six months later Napster relaunched, with legitimate music licenses and the same business model as Apple's. The music labels hope that low sales prices for songs from unbundled CDs eventually will stimulate enough transactions to offset multibillion-dollar revenue declines. In the first four months of operation, the Apple Store claimed $10 million in sales and hopes to sell $100 million in downloads in the first year of operation. In October, Apple added a Windows-compatible service; a month later Microsoft, Wal-Mart, and Sony announced plans to launch competing services. The days are numbered for selling CDs in little jewel boxes for $16.95.

Content owners now are pinning their hopes on embedded digital rights management (DRM) devices that control how, when, and under what circumstances content can be used. Apple's iTunes, for instance, limits the number of computers that a song can be copied to. Try to make more copies than the license allows, and the DRM software stops you.

The DRM future, though, also promises legitimate viral distribution and creative bargains for consumers. For example, Britney Spears could sell a downloadable new song for a set price. The terms might require that after the song is listened to a set number of times, a Pepsi commercial would play before the song could be listened to again. Other terms might state that the song could be emailed to another user if the first user accepted a Pepsi screen saver on his or her cell phone, or that a user could get a credit to download a second song after five friends downloaded the screen saver. The imagination's the limit.

Critics of DRM worry that the equitable protections of fair use will be abridged. You may no longer be permitted to pass along an ebook download as you would a paperback. In addition, digital encryption could protect content indefinitely, arguably violating the constitutional restriction that copyrights last only for "limited times." That danger was raised by plaintiffs in 321 Studios v. Metro-Goldwyn-Mayer Studios, Inc., filed April 22, 2002. (No. 3:02CV1955.) We will also see more time limits on the consumption of content-the Disney Company, for instance, plans to sell DVDs that "rust" and become unreadable just 48 hours after opening the package.

Civil Litigation: In September 2003 the RIAA responded to the Grokster decision by suing 261 alleged individual file sharers. Since then the RIAA has filed dozens of additional suits, but no one believes litigation will completely stop the digital erosion of the analog music market. At best, the lawsuits may reduce song swapping at the margins, much as policing by the Business Software Alliance has reduced the unauthorized use of computer software.

Part of the RIAA's problem is that the available remedies are of little value against ordinary infringers. Few potential defendants have the financial resources to pay a judgment reflecting actual damages for broadly distributing content. As for injunctions, it has been a maxim for hundreds of years that the law should not do useless acts. No court wants to look impotent by entering an injunction that as a practical matter cannot be fully enforced.

Criminal Complaints: Organized crime has learned that trafficking in software and other content has higher margins than narcotics and is much less violent. Two years ago the Department of Justice established multidisciplinary teams of attorneys, FBI gumshoes, and technologists to attack piracy. Dubbed Computer Hacking and Intellectual Property (CHIP) units, their meager resources force them to harpoon whales while the ocean teems with minnows. But even the whales swim quickly and are able to adjust operations to avoid would-be Ahabs. To fool U.S. Customs agents, for instance, counterfeiters are now shipping goods through several countries before attempting a U.S. entry. Once here, efforts to cover their tracks continue. In Orange County digital pirates in Little Saigon now outsource operations throughout the United States. And offshore, there is little that Disney can do about an Iranian-based website that allows customers to download free movies.

Commercial pirates have learned that U.S. Attorneys are reluctant to undertake actions spanning multiple jurisdictions. Why? Because of the inherent turf issues over control, resources, and credit, plus an institutional bias towards quantity rather than quality. Taking years putting together a complex case is not the way to win a promotion. In addition, simpler cases are easier to try and win, and some of the piracy schemes are quite complicated.

Legislation: Hollywood has helped launch sweeping legislation to attack piracy on all fronts. In 2002 it supported the Consumer Broadband and Digital Television Promotion Act (S. 2048), which would have required all digital-device manufacturers to install a filter to prevent the playing of pirated works. When works are digitized, a unique digital fingerprint or tag can be added that is undetectable to users but can block unauthorized playback. The bill, however, was defeated by manufacturers that wanted to stimulate demand for computers and other digital devices.

A second bill, the Peer-to-Peer Piracy Prevention Act (H.R. 5211), would amend the Copyright Act to permit private hacking by authorizing copyright holders to break into computer networks and servers that they believe store pirated content. The RIAA had tried and failed to include similar language in the USA Patriot Act of 2001. But H.R. 5211 died in committee.

Hollywood's latest hopes are pinned on the Author, Consumer, and Computer Owner Protection and Security Act (H.R. 2752), sponsored by Rep. John Conyers Jr. (D-Mich.) and Rep. Howard Berman (D-Calif.). The bill would make uploading a single unauthorized digital content file a felony with a potential fine of $250,000 a file, plus jail time. At this point, however, those remedies are too draconian to win broad congressional support.

Government Regulation: On November 4, 2003, the Federal Communications Commission (FCC) adopted a rule requiring TV manufacturers to sell sets with encryption capability. By July 1, 2005, new sets must be able to recognize a digital "broadcast flag" inserted by broadcasters on selected programs. Flagged programs would then be received by digital television sets but cannot be redistributed to PCs. The FCC rule is based largely on a proposal by the Motion Picture Association of America to prepare for all-digital TV.

Self Help: Some content owners are trying to frustrate infringers by seeding the Internet with fakes or poor-quality copies of songs. Others urge copyright holders to send automated computer programs called "bots" or "spiders" to seek out and attack unauthorized copies. Such measures potentially run afoul of computer trespass and anti-hacking statutes and could expose content owners to civil and criminal liability. Bots, however, are being used to track the availability of pirated content: BayTSP Corporation uses them to count the number of copies of pirated movies available on the Internet.

Technical Protection: Inevitably, the last line of defense will become the only line of defense. Nonlinear encryption methods are all but unbreakable. Everything on the Internet is migrating to a wireless environment. With wireless broadband, personal digital assistants will have the bandwidth needed to handle real-time streaming of content protected with secure encryption. And even perfect technology isn't foolproof: Before content is played, the electronic locks must be taken off so that a consumer can see and hear it. At that point, it's possible to rerecord the content free of restrictions.

To date, workable content defenses have been relatively simple. Recognizing that limited-security systems can be broken, Congress enacted the Digital Millennium Copyright Act (DMCA) in 1998. (17 U.S.C. ยง 512.) Among other things, the DMCA makes it a crime to circumvent copy-protection measures. Content owners have used it to prevent techies who discover security holes from publicly revealing the information. In one case, a 16-year-old published a computer program to unscramble the DVD industry's Content Scramble System. A third party published the program and was enjoined under the statute from further publication. First Amendment purists were outraged and argued that suppressing speech that identifies security flaws would only make security problems worse in the long run.

Politically, however, the DMCA fractured the usual divide between conservatives and liberals. Traditional conservatives and property-rights advocates contend the law provides the economic incentives to authors that are crucial to stimulating core political speech. Libertarians and progressives believe that unfettered distribution of information is the best way to check concentrations of power. Those views coincide with the views of civil libertarians, who say the DMCA's anticircumvention provision to limit speech is effectively an unconstitutional prior restraint. Hollywood liberals-who supported broad First Amendment protections in the past for sexed-up movies-now argue uncomfortably against an expansive reading.

The DMCA also split the content community, since some copyright holders are threatened by the Internet more than others. Newspapers are relatively immune to piracy because the content's value expires quickly and most readers enjoy the feel and crinkle of real paper. Reading ebooks does not yet provide the resolution and touch to be a viable substitute for the real thing. Business software publishers have lucrative ancillary services of installation, customization, and ongoing maintenance. Over time, their revenue streams will shift from up-front license fees to metered-use fees. Publishers of mass-market software, however, do not enjoy multiple revenue streams and face a more problematic future.

Without the enjoyment associated with a transmitting medium such as paper, or the technical support that software requires, the record labels face the prospect of continued decline. Their future young customers are busy burning CDs with pirated copyrighted songs. But having crossed the Rubicon in September, the RIAA was unwilling to march on Rome. Its first round of lawsuits were filed before first sending a demand letter, with some DMCA subpoenas listing as few as five downloaded songs. After much public criticism, the association announced an amnesty program, relatively low settlement amounts, and a threshold of distributing 1,000 copyrighted files for targeting pirates.

The Internet is turning the record labels into irrelevant middlemen. Eventually they must play a different role, focusing instead on marketing talent and distributing content through DRM arrangements. But though technology may reduce production costs, the collapse in consumer revenue has meant far less money to develop new talent. In the past few months, one label has announced massive job cuts, another has cut the price of CDs to as low as $10, and Sony Music Entertainment has signed a letter of intent to merge with Bertelsmann AG's BMG. Consolidating, cost cutting, and price cuts will all be deployed to try to manage the transition to digital delivery of content.

For the consumers of music, the future promises content tailored to individual tastes, delivered seamlessly by intelligent digital agents. Transaction time for finding new content will approach zero. Your alarm clock will wake you with a song from a personal play list. If you wish, sensors will recognize you in the shower and continue playing your favorites from a home audio system, and so on to the car and office.

Intelligent software agents, with preapproved authority, will purchase new songs from your favorite artists. They will search play lists of others with similar tastes. The agent will then deliver overlooked content to you with a high probability that you will enjoy it. Popular artists may capture greater revenue by conducting reverse auctions for new content. Everyone who wants to hear a new song the first day of release will pay a premium. Each day afterwards the price will drop, with your software agent ready to pounce when the price reaches an acceptable predetermined level.

Creators face a difficult future. The Framers sought to balance temporary and limited monopolies for content providers with the free flow of information to the public. Preserving that balance may now rely on some of the security measures proposed to protect the creators' contracts. Permitting providers to hack into private computers is beyond the pale, as is forcing consumers to buy computers that can read only approved content. But we may have to embrace such practices as disabling pirated software by means of automatic time-outs and those self-destructing DVDs planned by the Disney Company. We will have to permit creators to bottle up their content in tight little boxes bound up by technology and contract-or risk having everything and nothing for free.

R. Scott Feldmann is a partner with the Irvine office of Crowell & Moring LLP. He currently represents publishers and software companies; his former firm represented StreamCast Networks.


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