One monopoly sues another — for antitrust violations!  Is this a great country or what?  The Swami weighs in.

In some confrontations, it’s tough to say who to root for. Godzilla vs. Mothra, for instance. Or Duke vs. UNC. Or Liverpool vs. Manchester City.   (For the record, I’m going with (1) Godzilla, (2) UNC and (3) a draw with a number of red cards and several non-career threatening injuries thrown in for good measure.)

And now we have SiriusXM vs. SoundExchange.

SiriusXM – the monopolistic satellite radio provider that many radio broadcasters view as an archenemy – has sued SoundExchange – the monopolistic digital music licensing agency that many radio broadcasters view as an archenemy. SiriusXM’s claim is that SoundExchange (along with a co-defendant, the American Association of Independent Music (A2IM)) has engaged in antitrust violations and tortious interference with prospective economic advantage.

(The notion that SiriusXM, an entity created by the merger of the only two satellite radio providers, would complain that somebody else is violating the antitrust laws is rich with irony. But I digress.)

It’s still way too early for me, the Swami, to try to predict how this suit might eventually end up. But I don’t think it’s too early to imagine who the overall winners and losers might be as this litigation plays out. We’ll get to that in a minute.

Before then, some background on SiriusXM v. SoundExchange.

First, why might folks not like SiriusXM and SoundExchange?

SiriusXM is the spawn of Sirius and XM Radio, the two original satellite radio operators. When they merged to form SiriusXM, many felt the FCC too readily acceded to their promises to refrain from anticompetitive business practices, promises that, also to many, rang hollow and seemed to lack conviction.

And SoundExchange has long been viewed as less than sympathetic, particularly because of the arduous recordkeeping and reporting requirements it imposes on webcasters. And then there are the seemingly ever-increasing royalties it sucks out of webcasters and the less than transparent manner in which it appears to run its business. (On a personal note, I don’t think SoundExchange deserves a bad reputation. I’ve found many of the folks there to be more than helpful and willing to work with broadcasters making a good faith effort to comply with the requirements of the statutory copyright license.)

Second, about that lawsuit.

Webcasters are required to pay copyright royalties for music they transmit. The “easy” way to do that is to send the money to SoundExchange, which serves as the agent of the copyright holders (much like ASCAP, BMI and SESAC do on the broadcast side). The royalty rates SoundExchange charges are set by the Copyright Royalty Board (CRB) periodically.

But motivated parties can sidestep SoundExchange by going straight to the copyright holders to negotiate separate licenses for each piece of music to be transmitted. That approach can be very advantageous. Direct deals can lead to more favorable royalty rates than would be available through the CRB ratemaking process. In its most recent rate ruling, the CRB ordered SiriusXM to pay 8% of gross revenues, and in the next CRB go-round SoundExchange is reportedly ready to ask for an increase up to 13%; by contrast, direct licensing could have tied down a royalty rate in the 5%-7% range.

Being able to negotiate a bunch of direct deals at a substantially lower rate could also be useful in future CRB ratemakings. Such lower rate deals would provide empirical proof of what the actual market for webcasting rights would bear, the standard the CRB is supposed to use in setting rates.  A significant rate reduction across the board through CRB ratemaking would be huge for SiriusXM, which reportedly spent $200 million in royalties in 2011.

Furthermore, direct licensing has practical benefits. The two sides can agree on their own reporting procedures (broadcasters always complain that the standard CRB-mandated, SoundExchange-enforced paperwork regimen is too onerous). They can waive various stringent conditions (such as limitations on the number of songs from one artist within a given time period). Economies of scale can be created across multiple platforms that also allow for better marketing (think interactivity and social media, for example).

A primary downside of direct licensing: it tends to be less convenient to achieve, requiring lots of leg work followed by lots of separate, possibly difficult, negotiations which may or may not result in deals. 

Apparently, SiriusXM tried its best to enter into direct licenses. It says it entered into 80 of them, but claims to have been shut out of many, many more.  Figuring that its lack of success was not just a matter of bad luck, SiriusXM filed suit in the U.S. District Court for the Southern District of New York. It alleged that SoundExchange and A2IM ,“acting in concert with one another and with their individual recording company members, have erected an industry-wide conspiracy to boycott and tortiously interfere with Sirius XM’s efforts to secure through the workings of a competitive market copyright rights critical to the conduct of its business.”

Specifically, SiriusXM claims that SoundExchange, A2IM and others coerced record companies not to do business directly with SiriusXM. The coercion supposedly involved “implicit and explicit threats to enforce compliance” as well as efforts to “misle[a]d record companies as to their economic interests and even encourage[ ] some record companies to terminate license agreements they had already concluded with SiriusXM”. 

According to SiriusXM, a conspiracy involving SoundExchange, A2IM and others was designed to ensure that webcasting royalties would have to be set by CRB decision, and that the CRB decision would have to be based on essentially speculative testimony. No direct licenses, no negotiated settlement and no real evidence of what actual market participants actually want.  

In filing its lawsuit, SiriusXM did not need to prove its case in its entirety. Rather, it just needed to advance enough factual claims that, if proven at trial, would establish its entitlement to the relief it’s seeking. In its complaint, SiriusXM refers to various communications from the defendants – mailings to their members, public statements, etc. – all allegedly designed to spread the word loud and clear that

direct licensing is harmful to the Defendant’s scheme to establish and maintain super-competitive royalty rates. Hold the line and don’t sign up [for direct licensing with SiriusXM].

And sure enough, SiriusXM quotes a bunch of such communications, all of which seem to support its claims. (Here’s a link to a copy of SiriusXM’s complaint, so you can see for yourself what it’s alleging.)

SiriusXM also alleges that several artists and music labels refused to enter into licenses with SiriusXM because those artists and labels were supposedly scared that (a) SoundExchange would reduce the royalties to which they were entitled and (b) they would end up as pariahs in the music industry, blackballed from board memberships or other leadership positions.

Whether or not SiriusXM will be able to prove all its allegations to the satisfaction of a trier of fact in a court of law remains to be seen. 

Still, we can speculate about how all this might affect some key players not directly involved in the suit.

First, those we’ll call “winners”: 

Broadcasters. Broadcasters don’t have a dog in this fight, per se. In fact, that’s the beauty of this lawsuit from the broadcasters’ perspective.   If SiriusXM wins, broadcasters will reap the benefits without any effort. 

What benefits? The possible dismantling of SoundExchange, or the imposition of some limiting consent decree against SoundExchange, or the forced introduction of a competitor receiving agent.  A SiriusXM win would certainly help establish actual market values that would serve as a “willing buyer/willing seller” standard in future SiriusXM ratemaking proceedings. Although such numbers would technically have no direct bearing on the broadcasters’ next CRB ratemaking proceeding (i.e., Webcasting IV, due to begin in 2014 to set rates for 2016-2020), those numbers would provide important concrete data – possibly the only such data – regarding the value of a digitally transmitted sound recording. Moving further out toward the edges, there’s also the simple hope that a SiriusXM victory might embolden more smaller, so-called “independent” labels to license their copyrighted material directly to radio stations as well as SiriusXM. 

This would be especially important if the broadcasters’ own worst case scenario – enactment of the Performance Rights Act – were to occur. We’ve thankfully heard little about this legislation for a couple of years, but imagine if (a) it were too pass and (b) SoundExchange were given the right to administer those royalties as well. Broadcasters would then be in virtually the same position SiriusXM is in right now: paying royalties on two fronts and completely bound by the rules and procedures set by the CRB and SoundExchange. In this scenario, any relaxation of the SoundExchange grip that SiriusXM might achieve through its lawsuit would ultimately benefit broadcasters. 

SiriusXM. If nothing else, SiriusXM gets some street cred from the broadcasters?  SiriusXM is taking up this fight with SoundExchange on its own. By contrast, when broadcasters took on SoundExchange and the Webcasting II decision, they did so en masse, with the bulk of the broadcasting industry marching in lock step.

But more than that, SiriusXM made the right play. Not necessarily the winning play – we won’t know that for a while – but the right play. Litigation is expensive, but not as expensive as the $200 million in royalties that SiriusXM claims to have paid last year. Add in the fact that a victory would not only reduce that expense, but also afford SiriusXM more flexibility in future negotiations and the ability to innovate.  

And even if it loses, SiriusXM is likely to be able to add a few more direct licenses to the 80 it already has (out of 500 or so that it sought). That should give it a little more bargaining power in future ratemaking proceedings by fully demonstrating the value of a sound recording under the “willing buyer/willing seller” standard applicable to satellite radio.  And regardless of whether that pans out, well, as one commentator (The Motley Fool) put it: “SiriusXM is part of a legal complaint where it really doesn’t have much to lose beyond legal fees. If its complaint doesn’t hold up, SiriusXM is back to where it is now.  If it has merit, SiriusXM should be able to strike better licensing terms with labels that value the promotional power of being broadcast to the provider’s 21.9 million subscribers.”

Smaller Independent Recording Artists.   Unlike major artists represented by major labels, these artists are more likely to be at the mercy of the bigger players. SiriusXM’s lawsuit, successful or not, is likely to give these artists and their labels a more prominent voice. There’s also a little leverage that might lead to a chance to work out the deals they really want, deals that aren’t just about money but about creating future opportunities for themselves.

Royalty Logic. You’ve probably never heard of this company. It’s the scrappy underdog to SoundExchange, a wannabe designated receiving agent that has repeatedly been turned away by the CRB. Much like BMI got its start after ASCAP encountered legal troubles, could Royalty Logic position itself as the answer to SoundExchange’s anti-competitive behavior – a ready-made competitor?

And now the “losers”:

SoundExchange. SoundExchange may well win this lawsuit, but I doubt that will happen quickly or inexpensively. At a minimum, I predict that the lawsuit will survive a motion to dismiss. To be sure, the evidence alleged by SiriusXM in support of the alleged conspiracy is largely circumstantial. But the Federal Rules of Civil Procedure say that a court, when considering a motion to dismiss, must view all factual claims in SiriusXM’s favor. I think there’s enough in SiriusXM’s complaint to get it past a motion to dismiss and into the discovery phase. Once it gets that far, any number of possible resolutions would be available, most favorable (at least in some ways) to SiriusXM and unfavorable to SoundExchange. 

Furthermore, where SiriusXM has little to lose because its situation can’t get worse, SoundExchange has everything to lose, because its situation can’t get much better than it is right now, at least in terms of market share. 

The CRB. The CRB is a bigger part of the practical problems here than it is the solution to those problems. From allowing SoundExchange to exist without competition to siding with SoundExchange on virtually every contested fact in the 2007 Webcasting II decision (and many other ratemaking proceedings), the CRB may have created the environment that allowed questionable, if not illegal, activity to flourish. It’s legal authority and constitutionality has already been questioned. This might be enough to rethink the entire regime. 

We won’t know how the litigation will shake out for some time But the ultimate result in the case may be beside the point. The mere initiation of the case may represent an early tremor signaling the onset of a seismic event, an event that would likely, one way or another, fundamentally affect all the players. Check back here for updates.