Mar 30, 2014 · 9 minutes

Earlier this month, a huge development took place in the music tech world that has massive implications for the future of the music industry: A US District Court in New York handed down a ruling stating that the royalty rate Pandora pays the music licensing group ASCAP will remain at 1.85 percent of Pandora's revenue. Pandora argued that the rate should only be 1.7 percent (which is what radio broadcasters pay) while ASCAP argued that the rate should gradually increase to 3 percent. Mathematically speaking, this is a win for Pandora which, despite its massive popularity, has struggled to sustain profitability and likely can't afford to pay a higher rate.

Does this mean the fight between licensing groups and Pandora is over, with the music streaming service reigning victorious? Judging by the heated atmosphere at last week's Music Business Association law conference, the battle has just begun.

In a panel covering the ASCAP ruling, Kenneth Steinthal, who represented Pandora in an earlier ASCAP case, butted heads against Stuart Rosen, senior vice president and general counsel of BMI, a performance rights organization that licenses music much like ASCAP does. The often testy discussion provided a valuable window into the chaotic state of the music industry, where each stakeholder, from tech companies to record labels to artists, is struggling for a piece of a revenue pie that's been cut in half since 2000.

The disagreement centered around whether music publishers like Sony or Universal should continue to license songs played on Pandora through ASCAP and BMI, where court-mandated rates apply, or if they should be allowed to negotiate directly with the streaming services on the open market. It was actually the lawyers representing BMI who argued publishers should be allowed direct negotiation, leaving ASCAP and BMI to only handle royalty payments for non-digital distributions. That may sound counter-intuitive, but some allege the reason ASCAP was happy to let big publishers go directly to Pandora was that it would drive the market royalty rate up, which ASCAP could then use as a benchmark when petitioning the courts to raise the rate. Steinthal and other Pandora supporters called foul on what they perceived to be anti-competitive practices, and the courts agreed.

Despite many differences of opinion, the one thing all the panelists agreed on is that the current state of music licensing is a mess, with Steinthal calling it a "ball of confusion" and Lisa Buckley, an intellectual property lawyer siding with BMI, saying "it's a chaotic and confusing situation to deal with."

The arguments on both sides can sound equally chaotic and confusing on first glance, so before we unravel them, let's talk about why ASCAP and BMI exist in the first place.

What purpose do ASCAP and BMI serve?

ASCAP and BMI, known as "performance rights organizations" or PROs, were founded in the first half of the 20th century to help record labels and artists collect royalties on "public performances" of their work. As the advent of radio began to eat into revenue from concerts and recordings, artists needed a way to collect royalties without calling up every radio station in the country that might be playing their music. ASCAP and BMI stepped in to collect and distribute these radio royalties, as well as royalties for music played in bars and restaurants. These outlets pay ASCAP and BMI for a license to play songs from each organization's repertoire and that fee is split between the PRO and the publisher (usually the record label or one of its parent companies), which then pays a chunk to the performing artist.

In the digital age, do we still need ASCAP and BMI?

For the purpose of collecting royalties from local radio stations and bars, yes. The process of monitoring and collecting fees from these establishments spread all over the country is no less cumbersome than in the pre-digital age and requires big organizations devoted to that purpose. But more and more, users' listening habits have migrated over to large, consolidated networks like Pandora which can be dealt with more directly. Sure, smaller labels with less extensive catalogs (and thus less negotiating leverage) may still want to go through the PROs for all their licensing and distributions, but big publishers with huge repertoires of beloved bands might benefit from negotiating royalty rates directly with Pandora, while letting ASCAP and BMI handle the local radio stations and bars.

This is at the heart of the issue: Publishers want to "partially withdraw" from BMI and ASCAP so they can negotiate rates with Pandora directly that are not subject to court-mandated rates, while still using BMI and ASCAP to license for bars and local radio stations.

So what's wrong with that? Isn't that in the spirit of capitalism?

Not according to Steinthal and others who represent digital radio services.

Let's step back for a moment: In the 1940s, the Department of Justice wanted a way to keep ASCAP from driving prices up or engaging in other monopolistic activities. So under the Sherman Anti-Trust Act, it created what's known as a "consent decree" requiring ASCAP and later BMI to charge fair rates to radio stations and other licensees. The "fair rate" is decided by what the courts call a "hypothetical free market." That's the whole reason courts are involved at all in setting Pandora's rates.

But why a "hypothetical" free market? If publishers negotiated directly with Pandora, wouldn't that create a "real" free market?

Not necessarily, said Steinthal. "Every economist agrees on the hallmarks of a competitive market: There has to be a level set of information. Buyer and seller must have equivalent information sets going into a negotiation."

He says that wasn't the case when Sony negotiated royalty rates directly with Pandora, and Judge Denise Cote agreed in her ruling. She writes:

ASCAP refused to provide Pandora with the list of Sony works without Sony’s consent, which Sony refused to give. Without that list, Pandora’s options were stark. It could shut down its service, infringe Sony’s rights, or execute an agreement with Sony on Sony’s terms."
Sony also leaked the terms of the deal it eventually struck despite signing a confidentiality agreement with Pandora. These are hardly the "hallmarks of a competitive market."

Because of the anti-competitive atmosphere facilitated by partial withdrawals, the courts disallowed them. But Buckley, one of the lawyers on BMI's side, sees partial withdrawals differently. She says that allowing publishers to license performance rights through ASCAP and BMI for bars and local radio stations while striking separate direct deals with Pandora is fair and in the spirit of the consent decree handed down over fifty years ago by the DOJ.

The purpose of the consent decree, she says, is to "disaggregate monopolistic power over the licensing of music. The consent decree was not intended to restrict a copyright owner's ability to enter into a direct license with a user." Under that rationale, the partial withdrawal of licensing rights from ASCAP and BMI is lawful and fair.

She also said that using ASCAP or BMI to license music for some purposes but not all is not unprecedented, For example, licensing of songs used in Broadway plays is outside of a PRO's purview.

BMI's Rosen agrees: "Ken (Steinthal) says BMI is a monopoly. So won't marketplace rates be better?"

But wait: Why would ASCAP and BMI want publishers to withdraw some of their licenses?

If you ask Steinthal, it's a scheme between publishers and PROs to artificially jack up the rates Pandora pays.

"This is part of a plan. Major publishers basically announced they were going to pull out, try to get outside the context of the consent decree and not be subject to court scrutiny, get new rates, then ASCAP would take that rate and use it as a benchmark."

In other words, he alleges that ASCAP's intent was to let publishers withdraw their digital licensing rights so they can negotiate new deals on the free market where the court's rates don't apply -- deals that, as Steinthal noted, were not made fairly. Then ASCAP can say to the rate court, "Look! This is what the real rate should be. How do we know? It's been tested on the free market!" Finally, after getting the new court-mandated rates, it could let publishers back in.

As we saw in the decision, the courts didn't fall for ASCAP's scheme, keeping Pandora's royalty rates the same. Judge Cote alludes to this collusion by pointing to an email from ASCAP Chairman Paul Williams (yes, the Paul Williams who wrote "The Rainbow Connection") that outlines the plan clear-as-day:

My job is to make this transition as smoothly as possible in the board room . . . to assuage the fears of the writers who may see this as an ASCAP death knoll . . . . [W]e are in fact giving [the major publishers] the right to negotiate. The end result being that they will set a higher market price which will give us bargaining power in rate court.

Not surprisingly, BMI's Rosen denies that publishers and PROs are trying to pull a fast one on the industry. In BMI's defense, its policy is that publishers who leave BMI must wait a whole year before being let back in, unlike ASCAP where publishers can come and go as they please.

So what happens next?

To recap, the courts kept Pandora's rate the same and disallowed partial withdrawals, meaning that publishers must either license music through ASCAP or BMI for all purposes, digital or otherwise, or not at all. And because of the difficulty of collecting non-digital royalties, many of the publishers have come back to ASCAP and BMI.

But the fight's not over. "My future is on the Acela every day visiting the DOJ," says Rosen, who would like to see the consent decree modified so that partial withdrawals are allowed. "We think partial withdrawal has to be a part of any future system."

Steinthal is okay with that in theory but says there need to be protections to avoid collusion between publishers and PROs. Direct deals between Internet radio stations and publishers must be fair, with both parties having access to the same information (which wasn't the case between Sony and Pandora). Also, he says, publishers shouldn't be allowed to partially withdrawal from a PRO, test the waters on the market, then immediately come back as a way to jack up rates.

For all parties to come to an agreement, there needs to be dialogue (even if it's a bit heated) between those representing PROs, publishers, and Pandora, like what we saw at this conference. But striking an agreement may be easier said than done. Despite arriving from all different sides of the debate, each stakeholder involved is driven by the same thing: cash. Pandora doesn't want to be gouged on royalty rates. Its survival may depend on it. Record companies, faced with revenues that have only recently stopped plummeting, need any advantage they can get in setting these rates. BMI and ASCAP, sensing that many publishers may no longer need their services, want to milk as much money from licensing for the publishers that do decide to stay.

Meanwhile in the middle are the people producing all this content: The artists, who struggle to live off meager royalty payments even as each middle-man in the distribution and licensing process claims to be working in their best interests.

[Illustration by Hallie Bateman]