What the Pandora Lawsuit Means for SiriusXM and Spotify

Record labels want a little "R-E-S-P-E-C-T" from Pandora (NYSE: P  )  when it comes to songs recorded before 1972.

A number of major record labels are suing the Internet radio company for copyright infringement for using songs recorded before 1972 without paying license fees, according to the Associated Press.

The suing labels -- which include divisions of Sony  (NYSE: SNE  ) , Warner  (UNKNOWN: WMG.DL  ) , and Universal Music Group -- are arguing that while songs including Aretha Franklin's Respect and the Beatles' Hey Jude are not covered by federal copyright law, they have been protected in common law by states including New York, AP reported. The lawsuit, filed in New York state court, says that artists and labels have been deprived of tens of millions of dollars every year by services including (but not limited to) Pandora.

The labels also sued satellite radio company Sirius XM (NASDAQ: SIRI  ) last year in a similar case.

Pandora released a statement to AP that it is confident in its legal position and looks forward to a quick resolution of this matter.

A look at the SiriusXM lawsuit

Audio recordings didn't begin falling under federal copyright protection until Feb. 15, 1972. That fact has led to confusion as to whether royalties are owed for use of music from a wide range of artists including Bob Dylan, Elvis Presley, and James Brown by services including SiriusXM and Pandora.

The SiriusXM case, filed in California, has not been heard yet but the satellite company has stated that "there is no state law that requires SiriusXM (or any of the hundreds of thousands of other U.S. businesses that publicly perform music) to pay license fees for pre-1972 recordings," Hollywood Reporter wrote.

The judge in the case could find that SiriusXM owes an enormous amount of back royalties. Or the judge could find the company at fault but not impose a stiff penalty because by waiting decades to sue, the record labels created the environment in which the satellite company improperly used the music. The resolution of the suit could impact companies beyond SiriusXM, including Pandora as well as restaurants, bars, and any other business using the pre-1972 music without paying royalties.

It's also important to note that the SiriusXM case is in California while the Pandora case was filed in New York and judges from the two states could have different opinions. That could create a legal mess and a slew of lawsuits across the country.

Sirius spells out its royalty policy on its website:

Music royalty rights were established by Congress and are the product of the Copyright Act. Unlike terrestrial radio, SiriusXM is required to pay copyright music royalties to recording artists, musicians, and recording labels that hold copyrights in sound recordings (the actual recording of a work) that were fixed after 1972. Like terrestrial radio, SiriusXM must also pay music publishers who hold copyrights in musical compositions (or the lyrics and music) through their collective organizations such as ASCAP and BMI. The U.S. Music Royalty Fee offsets royalties payable by SiriusXM to composers, publishers, recording artists, musicians, and record labels that hold copyrights in musical works and sound recordings.

The company acknowledges on its website that the U.S. Music Royalty Fee is currently 12.5% of the subscription price of plans that include musical performances. That equates to $1.87 on the company's base $14.99/month subscription package, according to the FAQ on the SiriusXM website.

The company paid $677 million in royalties and revenue share in 2013 up from $551 in 2012.

Why this matters to SiriusXM and Pandora, but not Spotify

Pandora and SiriusXM rely on the compulsory licensing provisions of federal copyright law. Basically that means the record labels can't forbid any service from using its copyrighted material as long as they meet the federally mandated payment for said use. Spotify and other on-demand services are not likely to be affected by either lawsuit as in most cases they make deals directly with music publishers and do not fall under the compulsory licensing rules.

Terrestrial radio broadcasters pay royalties only to music publishers, which control songwriting copyrights; digital services must also pay for use of recordings, according to The New York Times.

How big is the royalty market?

Pandora pays performance royalties (for the performers of the music) and publishing royalties (for the writers/owners of the music). The company, according to its website, pays statutory performance royalties to SoundExchange, as well as publishing royalties to ASCAP, SESAC, and BMI.

In March a federal judge concluded that Pandora is more like regular radio than other music services, including Apple's  (NASDAQ: AAPL  ) iTunes Radio and Spotify.

In her decision U.S. District Judge Denise Cote concluded that Pandora should continue paying a royalty rate of 1.85% of its annual revenues, and that the 3% music publishers had sought was not "reasonable," GigaOm reported. The judge also pointed out that while Pandora falls under a lot of criticism for its royalty payments the company pays more than its competitors.

"Broadcast radio pays no royalties for terrestrial broadcasts of sound recordings; satellite radio pays 9% of revenue for satellite transmission of sound recordings; and Pandora paid 55.9% of its revenue for Internet transmission of sound recordings in 2012," she wrote.

In June of 2013 Pandora founder Tim Westergren acknowledged in a blog post that the company paid over $250 million in royalties in 2012. 

"The total is huge and growing but the per spin number is small," he wrote.

In 2013 the company spent $343 million on what it called "content acquisition costs" (royalties, mostly), about half of its $638 million in revenue. 

Overall the number is not huge compared to other businesses but to many of the artists affected (or their estates) it's a question of being paid for their work first and foremost, with the rate of that compensation secondary.

SiriusXM and Pandora should pay (to a point)

No artist should not be compensated for his or her work due to a technicality in copyright law. However the judges rule in these two cases both companies should take steps to make sure that payments are made for pre-1972 music under the same provisions that post-1972 songs are being paid for. 

It's also important that a deal be reached that makes sense for artists, labels, and Pandora, SiriusXM, and whatever companies will develop in the space down the road. Artists may long for a return to the days when only their record label (and maybe their management) could cheat them out of royalties, but those days aren't coming back. Physical music sales and downloads are declining to the point that it's possible the entire notion of owning music disappears. Forcing Pandora and SiriusXM to compensate all artists regardless of when they recorded their songs makes sense, but pushing them to pay so much their services become bad business propositions does not.

Whether they like them or not artists need Pandora, SiriusXM, and the other modern music services to distribute their music. The system is clearly not perfect and needs refinement, which these lawsuits could begin to provide. Coming up with a fair system for artist compensation is critical to maintaining a pipeline of artists creating new music. 

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