What They'll Never Tell You About the Music Business

by Peter M Thall

  PIRACY

  Bootlegging, or copying an artist’s logo, trademarks, and trade name, and selling merchandise without authorization, is as old as show business itself. Ordinarily, merchandisers will have mechanisms (and lawyers) in place to keep piracy to a minimum—especially during tours. The days of bootleg merchandisers setting up shop in the parking lots of rock-and-roll arenas are pretty much over, but the days of bootleggers are not. Different genres of music invite different styles of stealing, and it is important that the merchandiser be skilled at stopping these thieves in advance if possible. In recent years, courts have become educated in the ways of this unauthorized underworld and have been willing, in many instances, to grant temporary restraining orders, in advance, against the John Does, the as-yet-unidentified thieves. Enjoining behavior before the person has his or her day in court is generally anathema to all courts (and a remarkable remedy in a democracy when you think about it), but in bootlegging cases US courts have come to embrace this procedure as the only way to stop the piracy of artists’ merchandise by people who would otherwise simply disappear in their vans never to be identified and never to be caught.

  Of course, taking any formal legal action requires a coordinated effort, and there is considerable cost involved. Who pays for this? Who is responsible for initiating actions to prevent the sale of unauthorized merchandise? Are these costs cross-collateralized against the retail side? The language in the contract should answer all of these questions.

  Bootlegging will occur wherever there is a vacuum. In the retail area, bootlegged merchandise runs rampant where the subject of the piracy doesn’t see to it that the retail shelves are filled with legitimate merchandise. Doing so actually minimizes the risk that illegal products will appear. In the course of selecting a merchandiser, the artist should determine whether the merchandiser is effective in distributing product to the retail side. (If Internet sales are going to be part of the deal, is the merchandiser adept at ensuring that its website is placed up front on a search engine?) At the time the basic merchandise agreement is being considered, artists’ representatives should raise the issue of the efficacy and the reputation of the merchandiser in pursuing bootleggers and in filling up distribution channels in response to demand for the artists’ products.

  AUDITS

  I would like to mention briefly the issue of audits and general examinations of the books and records of merchandisers. I cannot think of another situation in which the ability to check books and records on a regular basis is more appropriate. Most dealings for merchandise on the road are in cash, the road personnel of merchandise companies are often picked up for temporary duty and are not known (or bonded), and merchandising income is derived from many sources and in many locations outside of the centers of the music business. These unique characteristics of the tour merchandise business leave open a lot of room for carelessness, let alone abuse and downright stealing. The tour accountant, who, it goes without saying, should have a familiarity with merchandising operations in general, needs access at all times to the books and records of the venue and the merchandiser so that these monies can be monitored on a daily basis. Remember, we are not just talking about the artist losing some money; we have also seen that there are considerable consequences to the artist in the event that guarantees are not met. Even when all of the provisions of an agreement have been honored, sloppy accounting can have the same effect as a material breach of the performance-guarantee provisions of the agreement.

  12 • AUDITS

  Truth or Consequences

  Money doesn’t talk. It swears.

  —BOB DYLAN, “IT’S ALRIGHT, MA (I’M ONLY BLEEDING)”

  After all the negotiating is over, the career has slowed down or stopped, and the records have run their course, when the action is all in the past, the shining knight finally appears—ready to bring sense out of chaos, truth out of lies, rationality out of illogic, money out of nowhere. Who is this hero? The accountant! This may seem an unlikely role for this often-disparaged professional whose salient personality traits are supposed to be passivity, cordiality, and conservatism. But the accountant may be the only person who has the understanding and experience to turn failure into success, to turn short-term earnings into long-term security. In football, success or failure starts with the quarterback. In the record business, success or failure at the beginning may well depend on how good the lawyer and manager are, but in the end, it surely rests with the accountant.

  EXAMINING THE AUDIT

  Useful and effective audits do not have to wait until the end of an artist’s career to be conducted. In fact, as we saw in chapter 4, the longer one waits, the more likely a person who wishes to audit another will be shut out. Except as otherwise indicated in this chapter, when using the term audit, I am referring to audits of record companies by artists or producers. In brief, an audit is an examination by an expert of the financial books and records of a company that has agreed to make periodic payments—in particular, royalty payments—to another person: the artist or producer, or, as you will see later, the songwriter.

  When most of us hear the word audit we think of the government breaking down the door, or a fancy accounting firm certifying the financial statements of a public company. But in this chapter, I am not referring to audits that actually “certify” whether statements are correct; indeed, this will never occur because in the end compromise is the name of the game in the music business, leaving precision in the dust. In my experience, record company or music publishing statements have never been certified as accurate. The only purpose of an audit—an examination of books and records—is to determine if there can be raised a convincing argument on behalf of the auditor’s client that there are any significant underreportings or underpayments by the party that is supposed to write the check.

  The parties in whose interest an audit is customarily performed are:

  • The artist who audits the record company.

  • The producer who audits the record company. This audit may have to piggyback on the artist’s audit because the record company may limit the producer’s access to the record company records rather than open them up to multiple audits of essentially the same data.

  • The publisher who audits the record company either directly or through the efforts of its agent, most often the Harry Fox Agency, Inc.

  • The writer who audits the publishing company.

  • The writer’s own publishing company that audits the writer’s administrating publishers or subpublishers.

  When the Artist Audits the Record Company

  After the record has been produced and released, and the costs of and returns on its active life are in, the auditor enters the game to determine if the record company has accounted for and paid the artist what the artist was entitled to pursuant to his or her agreement with the record company. Record company audits will examine issues such as free goods, returns, mathematical calculations of statements (do you remember your multiplication tables?) and cut-outs. (Cut-outs are records taken out of inventory because of their totally poor sales history and, essentially, given away for a pittance and marked accordingly so that they cannot reappear as a “return” at the other end of the record company’s distribution system.)

  Interestingly, the accountant within the record company whose job it is to defend the company’s interpretations of the contract and its practices does not ordinarily report to the chief financial officer of the company, but rather to an operations executive, or even to the head of legal or business affairs. Why is this? Because the audit is looked upon as just another deal to negotiate, to settle, to compromise. It is the end game of the process of identifying and signing the artist, selling the artist’s recordings, and turning them into “catalogue.” The audit is expected, it is anticipated, and in a way it is welcomed, because for the first time, the open questions—crucial questions as to accuracy in payment calculations—will be closed for all time. Closure, both for the record company and the artist
, is a good thing. And when the record company has to make a settlement as a result of the audit procedure, it is not just a vindication or victory for the artist; through settlement, the record company closes a chapter in which it has often miscoded charges, miscalculated royalties, and distorted the intention of the parties as reflected in the written contract.

  In fact, record companies often view audits as a group—they review the annual audit picture and balance the costs of defending the onslaught of the artist’s (or publishing company’s) auditors. If an artist is important and handled by an important auditor, there may be a generous settlement. If not, probably not. In effect, audits are a profit center.

  Even when the record company pays up, it may be just so the artist and the artist’s auditor will go away. Rarely, if ever, will the record company provide a statement that indicates with any specificity how much they erred or in what categories. Audit settlements do not ordinarily specify the rationale behind them. Even when the particulars of a settlement are quantified by category, companies are unlikely to change their practices in the future, or even admit to the errors of the past. Their goal is to get the auditor out of the building and close a chapter in the life of the artist and record company. A cash settlement is a small price indeed to pay for that.

  When Is an Escalation an Opportunity?

  Often recording contracts provide for escalating royalties once a record reaches a particular sales threshold. Sometimes, these royalty provisions provide for retroactive adjustment upward. Depending on the contract’s definitions of “sales” and “net sales,” the upward adjustment might well apply even though the sales threshold is not net of free goods. In other words, for royalty payment purposes, record companies will calculate net sales, after free goods are excluded. But for royalty calculation purposes, they may have inadvertently defined the sales threshold in terms of sales, rather than net sales. On a greatest-hits recording on which the royalty rate is increased retroactively on older tracks as a result of the achievement of a certain amount of sales, this distinction can amount to hundreds of thousands of dollars gained—or lost. Furthermore, the contractual definitions of records and phonorecords may allow the record company to increase royalties only on vinyl or CD versions of record sales, but not on, say, downloads.

  When a Publishing Company Audits the Record Company

  A publishing company’s audit of a record company most often is pursued by the Harry Fox Agency, Inc., which represents about 80% of all publishers in the United States, and, through its affiliated mechanical rights societies around the world, most publishers based outside of the United States as well. Two issues that are unique to audits initiated by publishing companies are (1) unmatched lists and (2) controlled compositions.

  Unmatched Lists The term unmatched lists (also referred to as suspense lists) refers to data collected, more or less efficiently (often less), by the record company with respect to musical compositions on which mechanical royalties are payable but where the party entitled to the royalties is not identified. Even if the record company knows whom to pay, it may not pay because it has no executed license agreement from the publisher or from the publisher’s agent (again, usually the Harry Fox Agency). The careless and haphazard way that unidentified compositions are listed and accounted for by record companies is legendary in the music industry, and if an auditor does not know where to look, the income will be lost for the audit period. Remember, once a period has been the subject of a resolved audit, that period is, absent outright fraud, closed for all time, and is no longer subject to question. Further, you may be sure there is nobody at the record company who is pointing the auditor in the right direction. If the auditor is not plugged in to the idiosyncratic ways in which record companies hide—or misplace—royalty-generating events and income, the audit’s effectiveness will be lessened accordingly.

  Controlled Compositions Controlled compositions are dealt with at some length in the next chapter. Suffice it to say at this point that controlled composition clauses are often “custom” negotiated for each artist, and a full and complete comprehension of the particular clause at issue is essential if an auditor is to be able to verify the accuracy of accounting statements from the record company. Some countries—in particular, Canada—have established certain floors on controlled-composition clauses that will have the effect of overriding some of the clauses now written into contracts. Sophisticated thinkers are at work here, and the auditor will have to muster all of his or her insights and experience just to keep up with them.

  Auditing Copublishers and Subpublishers

  Copublishing agreements are between two entities that agree to share ownership of the copyrights to a given body of compositions as well as the compensation due to the owners of the copyrights. The term subpublisher refers to a foreign publisher who represents the interests of a US publisher. In either case, the companies involved are often multinational corporations.

  THE FLOW OF MONEY

  We will see in chapter 13 how multinational companies or companies whose rights are themselves represented overseas by subpublishers have different views as to what “receipts” are and whether they should pay royalties on those receipts or the royalties should be paid “at source.” The multinationals (and I am using this term intentionally, because these companies are not set up and have never been set up to be “global” in the sense that they create one concerted worldwide effort to exploit artists and their copyrights) move their money around so facilely that it is a wonder that even the home office knows where it is.

  Sometimes, in fact, the home office doesn’t. Until PolyGram Music Publishing was sold to Universal Music, it had its headquarters in Baarn, the Netherlands. Yet its home office was in London. When you made a deal with the US affiliate, it was impossible to figure out who would possess the books and records of US sales, or of the foreign sales. What’s more, PolyGram counted its money in Dutch guilders!

  Money is exchanged and moved back and forth faster than it is at the World Series of Poker—and with much more success. Like good poker players, these companies keep their information close to the vest—so close, in fact, that it becomes prohibitive to try to follow it without the aid of the CIA (which, hopefully, has other things on its agenda).

  Moving money from country to country—paying, receiving credits for, and simply getting the benefit of international tax treaties (as to which, be assured, these multinationals are expert)—will befuddle even the most astute auditors. How much more baffling the money chase became with respect to PolyGram Music statements when this company was finally absorbed into another multinational—the Universal Music Group—in 1999. And that was before Universal (owned predominantly by Seagrams of Canada, but partly by Matsushita of Japan) was sold to Vivendi (of France) and before a consortium of investors in 2011–2012 purchased EMI Music Publishing and Universal Music group purchased EMI’s record assets. See what I mean?

  There is an inherent disadvantage in dealing with a multinational publishing company in that the Harry Fox Agency—previously owned and run by the American National Music Publishers Association, and since 2015 by SESAC, theoretically the songwriters’ last chance for an honest count—does not always audit the affiliated record companies. For example, Harry Fox does not audit the major record companies on behalf of their publishers that license their sister record companies directly, bypassing the Fox agency entirely. The publishing companies will tell you that they conduct internal audits by their own in-house people, but these are easily tinkered with so that the combined company can produce a profit-and-loss picture that says what the company wants it to say. This is an obvious impediment to achieving an accurate “count,” and more importantly, as will be seen later, it will reduce the chances that an efficient and conscientious audit will be able to correct registration errors, whose correction, ironically, would benefit both the original publisher and its administrating publisher.

  This disparity among music publishers and the lack of vigor with w
hich some pursue audit rights can be a serious handicap, and, while it should not discourage songwriters or their self-owned publishing companies from entering into administration or copublishing arrangements with a multinational, it would be appropriate to address this issue at the time the contract is negotiated rather than after earnings that might otherwise have been uncovered by a more zealous publisher have been lost forever.

  ACCESS TO REGISTRATION INFORMATION

  It is important for auditors to have access to copies of the foreign societies’ accountings to their publisher members—whether these publishers obtain rights of representation directly, for example, in the case of music indigenous to their territory, or through a worldwide or regional administrator. No foreign society will allow a US (original) publisher to audit them directly; but each country’s societies operate differently, and depending on the copyright owner’s negotiating leverage, it is at least within the range of possibility to obtain access for the auditor to so much additional data that the success of the audit process will be geometrically more promising.

  Occasionally, the impediment established by foreign societies can be overcome by the original publisher when it becomes a member of the foreign rights society itself or when it establishes in the foreign country an affiliate company that becomes a member of the foreign rights society. This avenue is not widely taken for a variety of good reasons—not the least of which is figuring out what to do with the foreign entity (if one is created) once it is established. For once the original publisher has created a new tax entity in a foreign country, it may find that there are tax consequences beyond the publisher’s original expectations both in that country and in the United States. Even the possibility of dissolving the entity can have severe tax implications.