Publishers Not Getting The Upside?

I want to bring to your attention something that could be (or probably already is) problematic in Section 115 and the related regulations for the calculation of the amounts owed to publishers for certain streaming royalties. In short, the concept of a royalty pool for publisher payments that is defined to take into account all cash and non-cash consideration given to record labels (referred to as the applicable consideration in the regulations and known as “total content costs” (“TCC”)) appears to accomplish nothing for music publishers – despite the perception that it would when TCC was negotiated and announced a few years ago.

Look closely at the definitions in Section 115 for streaming and the related applicable consideration definitions. For publishers, wasn’t the intent that there would be a royalty pool that would include all the various forms of consideration—cash and non-cash items such as stock shares given to record labels (hence “Total Content Cost”)? With the references to GAAP in the way the regulations calculate TCC as we read them it appears that if cash and non-cash items given to labels are not expensed under GAAP by the streaming service, those items are not required to be included in the calculation of the royalty pool for publishers. If you are a streaming service you are probably not going to elect to expense under GAAP what was given to record labels if it means you can exclude amounts from the TCC. Excluding non-cash items from TCC has no impact on the labels – but direct impact on publishers.

Here is a story from Billboard in 2012 that outlines the intent of “total content costs”. The article states:

“The use of a total content cost will allow music publishers to potentially partake in whatever upside occurs when music labels negotiate in a free market how much they charge to supply their music to digital music service providers.”

“Also, if a major comes up with a creative deal that includes an equity stake in a digital music service provider or a guaranteed allotment of advertising, those items are assigned a value and included when figuring total content cost, which allows music publishers to participate in such deals.”

What the TCC was meant to accomplish may not actually work in practice.

This brings up two important points:

1. Why is GAAP referenced in the regulations at all as it relates to TCC? The answer is probably that most people think that if you throw GAAP in to a provision that it means certain standards and principles will be applied when it comes to royalty calculations and audits. However, GAAP is not always applicable and can lead to unintended outcomes – and for Section 115 streaming royalties it appears that the reference to GAAP completely undermines the intent of the provision.

2. Audits. As you know, there is no audit right under Section 115 licenses. So, you cannot check to see what is actually included in the publisher royalty pool.

This may be one of the reasons behind why U.S. publishers feel that royalty payments from music subscriptions services seem so low – that’s because publishers are probably not getting paid from a royalty pool that they thought was clearly defined to include certain cash and non-cash consideration paid by streaming services to labels.

On a related note, Michael Simon of HFA announced at the AIMP meeting on October 15, 2015 in Los Angeles that HFA is conducting an audit of a subscription service client of theirs to confirm the accuracy of reporting that HFA prepares on their behalf. Does this mean that HFA is effectively auditing themselves and their client as it relates to the accuracy of the statements that HFA prepares? Am I missing something? If true, this is like asking the fox (no pun intended) to do an after action report for the assault on the chicken coop. Chickens? There were no chickens.

If HFA is both (1) performing an audit of their subscription service client and (2) they may have insights from the accounting statements that they prepare for their client, they should be in a better position to know than anyone outside their client what’s being included and excluded from the publisher royalty pool. (It appears that this HFA audit is one that would not be available under the current version of Section 115 which does not permit audits of statutory licenses—and sheds light on the need to provide an audit right to everyone.) Michael Simon indicated from the AIMP dais that the audit is underway, so hopefully soon HFA can let music publishers know from their audit if their client is excluding amounts from the TCC that most publishers thought would be included.

How much in royalties have publishers already missed out on? With revenue from streaming music services predicted to be the dominant source for the music industry in the future I would suggest getting this potential TCC GAAP requirement issue sorted right now.

Keith Bernstein
CEO, Royalty Review Council
November 4, 2015