In the last week, copyright audits have been in the news. Several broadcasting publications noted the recent announcements by the Copyright Royalty Board that SoundExchange has decided to audit several companies that pay it royalties, including webcasters (including Pandora and a number of broadcasters in connection with their webcast operations), business establishments services (those who provide music for stores and other businesses – DMX and Muzak) and music services provided by cable and satellite video providers (e.g. DMX and MusicChoice).  It was also just announced in the Federal Register that the sports leagues plan to audit a number of MVPDs to determine if the MVPDs have been accurately paying the royalties owed the sports league for the sports programming on TV stations carried on certain satellite and cable systems.  What are these audits, and why are they being announced by publication in the Federal Register?

When media companies buy a piece of equipment, or a building in which to house their operations, they usually know in advance how much their purchase is going to cost, and in the vast majority of cases, they get a bill specifying the price.  Even the purchase of some programming is easily quantifiable – either as a fixed fee per month, or some barter arrangement or other set fee.

But, in many other licensing transactions, the fees are not as easily quantifiable.  For certain movie packages or other syndicated video programming, the number of times that a program is played is not necessarily clear in advance.  For music, it is even more complicated, as a digital music service never knows how much music it is going to use when it enters into a licensing agreement.  In the case of programming carried by an MVPD on a distant signal basis pursuant to the compulsory copyright licenses under Sections 110 and 119 of the Copyright Act, the MVPD in advance won’t know how many subscribers it will have or exactly what programming the stations that it carries will program.  So in all of these cases, the user of the copyrighted material does not get a bill.  Instead, the user has to tell the “seller” of the rights (or its representative) how much they owe.  Because the buyer is reporting how much they think that they owe, the rights organizations usually have the right, by contract or by law, to audit the user to decide if the user paid the right amount.

Audit rights are standard in music licensing agreements.  They appear in agreements between record companies and performers, and in agreements between on-demand music services and music labels.  The agreements with ASCAP, BMI and SESAC (the performing rights organizations, or PROs), who get paid for the public performance of musical compositions also have audit rights.  And they are standard in other kinds of licensing agreements where the usage of the copyrighted material is not known in advance.  If audit rights are standard in all of these agreements, why is it that the SoundExchange and MVPD audits are being published in the Federal Register?

What is different SoundExchange and the sports leagues are collecting royalties paid under statutory licenses, where they must by law provide their copyrighted material to services that transmit that material to the public.  Under these statutory licenses, the government sets the fees to be paid by the services, and the services must account for those fees and pay them as required by the governmentally established licenses.  The services must also operate under rules set by the government.  As all of these transactions are governed not by contracts but instead by government-set laws and rules, the process becomes more public, in that the rules require that the audits be announced in a Federal Register publication, and that the audits be conducted in a certain way.

The nature of the payment determines the questions that will be asked in the audit.  For SoundExchange, the questions tend to center on counting the “performances” (one song as played to one listener), as fees are usually paid on a per-performance basis.  The auditors there will want to look at your server records, to see if you have accurately reported on the number of performances of sound recordings.  Questions can get very technical, arguing over questions inherent in the nature of the streaming and record-keeping process.  Issues can arise over questions of whether very short connections were ever heard by a listener, or whether disconnections and rapid reconnections from the same IP address during the same song were from the same listener or not.  Details on these matters were addressed in filings in the recent CRB webcasting proceeding, but the CRB rules released in December are largely unchanged.  The audit must be conducted by an independent CPA.

For the MVPD audits, the Copyright Office itself adopted the rules for the audits which are far more detailed than the rules adopted by the CRB for music services.  The audit is to be conducted by a CPA selected by the MVPD out of a choice of 3 independent CPAs suggested by the copyright holder who requests the audit.  The auditor and the party requesting the audit cannot communicate during the audit with the copyright holder.  And the initial audit is limited to only 10% of an MSO’s systems, and a system can only be audited once a year.  If a substantial discrepancy is found, then the audit can be expanded to a larger sample of the MSO’s systems.

Auditors looks at a variety of issues reported on an MVPD’s Statement. Questions include the number of channels that the MVPD devoted to the rebroadcast of over-the-air TV stations, the number of subscribers to each of the cable systems, the amounts paid by those subscribers for the tier of service that contained the broadcast stations, and similar issues.  Auditors are not permitted to opine on legal questions as to whether a system has properly carried a station as a local or distant signal.

As the royalties subject to these audits are paid differently, the remedies in the event of a finding of an underpayment are expressed differently.  In both cases, after the auditor completed its report, it must offer the copyright user a chance to respond to the audit, and the auditor must use the response to correct any errors.  For a SoundExchange audit, after any corrections are made, the audit is delivered to SoundExchange, which then decides what’s next.  The audit results are not filed with the CRB.  For an audit of an MVPD, after getting a response from the MVPD, the copyright owner can itself provide comments on the report.  As MVPD payments are not made to a private collective, but instead to the government, the audit report is then filed with the Copyright Office, and the MVPD is supposed to make any necessary catch up payments discovered by the audit promptly.

A common theme in audits is that, if significant underpayment is found, there are penalties.  For SoundExchange, in addition to late fees, the cost of the audit can be transferred to the licensee if royalties were underpaid by more than 10%.  In the audits of MVPDs, the copyright holders pay the fees unless the underpayment was between 5 and 10%, in which case the fees are split.  If the underpayment exceeds 10%, the MVPD pays for the audit.

SoundExchange each year conducts a number of audits, usually announced at the beginning of the year.  See, for instance, our articles here and here about past audits.

These audits can be technical and time consuming.  If you get an audit letter, call an expert who has dealt with audits before.  While, in some cases, you could seemingly respond to what is requested on your own, experts may have tips about what to provide or how to provide it, which may save money in the long run.  As disputes come up, you’ll want to talk to people who have been through an audit before to see how the process is likely to be resolved.

In any case, audits can be a time-consuming and potentially costly affair. So know the requirements of every copyright license, whether negotiated or statutory, and carefully keep your records so, if your name is picked to have your payments reviewed, you’ll be ready to address any question that might come up.