State Senate to Examine Music Firms

The state Senate has widened its probe of music industry accounting practices and is investigating whether major record companies defrauded artists out of royalties through undisclosed licensing deals with record clubs and video channels.

The Senate Rules Committee in Sacramento issued subpoenas late last week seeking documents from artists’ lawyers and managers to substantiate the allegations, which first came to light at a hearing last month called by Sen. Martha Escutia (D-Whittier) and Sen. Kevin Murray (D-Culver City) to examine accounting practices in the music industry.

During the July 23 hearing, artist representatives accused the world’s five largest music companies of collecting millions of dollars annually from licensing deals with record clubs and video channels never shared with artists. Attorneys also alleged that companies employ fraudulent accounting formulas to bilk artists out of earnings on music sold overseas.

“We want to find out how these deals are structured and whether artists are getting shortchanged,� Murray said in an interview. “We’re also interested in determining whether companies are cheating artists by using unfair tactics in the accounting of foreign royalties.�

Escutia and Murray have scheduled a second hearing on the matter Sept. 24 in Sacramento.

The accounting issue is the latest wrinkle in an ongoing debate over artists’ rights in the recording industry. Performers and musicians have complained to lawmakers that music companies use unfair contracts that bind them longer than other California workers and use accounting tricks that reduce their wages and health-care and pension benefits.

The Recording Industry Assn. of America, a Washington trade group that represents the nation’s five biggest music companies, declined to comment on the allegations, except to say that artists are paid in accordance with their contracts. Record executives privately say labels do not cheat artists on music sold overseas nor do they profit from covert licensing arrangements at artists’ expense.

Entertainment attorney Don Engel, who has sued labels on behalf of Luther Vandross, Meatloaf, Don Henley and the Dixie Chicks, told lawmakers last month that companies routinely cheat artists out of royalties.

In an interview, Engel spelled out what he characterized as a series of schemes perpetrated on artists by the music industry.

Music Video Costs

Record companies, he said, purport that music videos are promotional tools to help generate sales of CDs. Artists are contractually required to reimburse companies for at least half of the cost of each promotional video before they receive a royalty check.

But the music giants enter into agreements with video channels under which the music companies receive millions of dollars in payments and other benefits, such as free advertising, that are not disclosed to artists, Engel said.

MTV, one of the biggest video channels, could not be reached for comment.

Artist managers and lawyers say music companies should be required to book such licensing fees and barter arrangements as income, and that they should be required to share that money with the artists whose videos undergird the agreements. Otherwise, the companies should stop requiring artists to reimburse them for video costs, attorneys say.

“Accountants in other businesses have a very simple term for this kind of scheme,� Engel said. “They call it double-dipping.�

Record companies disagree, saying such licensing fees are not required to be shared with artists. They say attorneys who negotiate contracts for artists are aware that cable video channels pay licensing fees to record companies for the global rights to a vast catalog of videos. Companies say fees from music video channels are not profits, but are used to help defray investments in video production for artists, many of whose recordings do not return a profit.

Record Club Pacts

State lawmakers also intend to review alleged pacts between music companies and record clubs.

Record clubs were created to sell records to consumers through mail order in rural areas at substantially reduced rates. The clubs, owned by the same entertainment conglomerates that own several of the music companies, manufacture and distribute CDs independently of the record labels. Before the emergence of national distribution outlets such as Wal-Mart and Amazon.com, clubs were considered a viable outlet for sparking sales.

Based on that premise, labels long ago inserted clauses in recording contracts that require artists to accept drastically reduced royalty rates for music sold through clubs. The contracts also permitted clubs to give away many promotional CDs--recordings for which artists get paid no money at all.

Artists complain that club sales cannibalize retail sales, since clubs sometimes sell millions of CDs by some acts. Plus, artists say, it is difficult to determine how many CDs are manufactured by the clubs when they audit a label’s books. As a result, many artists earn nothing or very little on CDs sold through clubs.

Music corporations, on the other hand, pocket millions each year from licensing fees from the clubs. Engel alleges that the companies keep club royalty fees artificially low and said he has seen documents indicating that the five music giants earn nearly $50 million collectively per year from club fees that are never shared with artists.

Record companies contend artists are paid fair royalty rates established under their contracts. In the music business, a company’s most valuable assets are the master recordings it has acquired over the years. Companies say club deals typically hinge on the licensing of a company’s entire catalog and are not tied to any particular work or artist. It is for that reason, companies maintain, that club licensing fees are not shared with individual acts.

Foreign Royalty Rates

The third accounting area that state lawmakers intend to examine involves the tabulation of foreign royalties.

Engel and other attorneys maintain that music corporations use accounting tricks to reduce payments of foreign royalties by as much as half. Attorneys say the practice has been going on for decades and started back in the days when companies cut licensing deals in foreign territories with third parties, such as independent firms that manufactured and distributed the product for a fee overseas.

Years ago, companies inserted clauses in contracts allowing them to deduct those distribution fees from artist royalties. Since then, most music labels have been swallowed up by global entertainment conglomerates, which gobbled up many of the foreign distributors. Still, the artists say, music labels have failed to make any adjustments in foreign royalty rates. In recent lawsuits brought by artists, companies have refused to disclose the nature of those manufacturing and distribution agreements overseas.

Artists’ attorneys say companies also collude with the same foreign distributors to establish fictitious retail prices designed to reduce artist royalty rates overseas. In some territories, they deduct a manufacturing tax. And in others, they deduct a value added tax, even though they receive credits for such taxes. Attorneys say some companies also deduct a packaging charge based on the fictitious retail price before computing the artist royalties.

Using these and other tactics, companies routinely misrepresent the money owed to artists on sales of music overseas, attorneys say. They say some artists have discovered in audits that they were paid about half of what they earned. And though most contracts grant audit rights to artists, companies refuse to turn over manufacturing records, copies of agreements with foreign distributors or to disclose the convoluted formulas used to determine foreign royalty rates.

Companies have said they pay fair royalties on music sold abroad. Companies also say it is impossible to generalize about how overseas royalties are computed.

“The music industry’s current accounting system is sorely lacking in transparency,� says Greg Hessinger, the national executive director of the American Federation of Television and Radio Artists union, who testified before the state Senate Judiciary Committee in July. “And until the labels recognize that artists have an inherent right to be given a clear accounting of what they are owed, people will continue to have the perception that they are being cheated.�