phonorecords III
While the Mechanical Licensing Collective’s announcement last month about the “final final” Phonorecords III Copyright Royalty Board rate determination adjustment seemed to imply songwriters and publishers were due another roughly $400 million to, sources say the number likely overstates the coming financial windfall.
After a more than two year wait that included an appeal process, a remand, a new partial rate trial, and then the time to recalculate and resubmit adjusted play reports, sources say that number may correctly assess how much more money was earned and reported due to the CRB determination covering 2018 through 2022 — but it also likely includes payments that have already been made.
Within the total adjustment, about $250 million in net extra mechanical royalties will be paid out thanks to the adjustment, with practically all of that coming from the 2021-2022 period. Those royalties will be paid out beginning in May by the Mechanical Licensing Collective, the agency created by the Music Modernization Act to collect and disburse mechanical royalties from on-demand digital streaming services. This means adjusted monies paid out by the MLC will probably begin reaching songwriters from their publishers in the following quarter.
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The rest of the roughly $400 million adjustment comes from performance royalties. But sources at the U.S. performance rights organizations say they are surprised by the MLC’s claim that another $138 million has been discovered in the resubmitted play reports required by the final rate determination.
The MLC may be the best positioned to understand this, though. Because the mechanical rate formula calls for the digital service providers to report how much they paid in performance royalties each month — or estimate how much they will pay — the MLC has insight into how much was reported collectively for mechanical and performance royalties for the period of 2018-2022 before the rate determination was finalized. It also has insight into how much performance royalties totaled after the play reports were resubmitted with the adjustments due to that final determination. The final determination happened in August 2023, eight months after the 2018-2022 term ended, with the resubmitted reports due Feb. 9, 2024.
In contrast, the PROs themselves only know what they each individually have been paid, and each digital service only knows what they individually have paid out to each PRO. Neither of those sides can see the whole performance revenue pool like the MLC can, unless they share information with competitors, which is unlikely but possible. Consequently, sources at PROs and digital services say they are surprised and puzzled by the MLC’s announcement that more performance royalties were found due to the adjusted reports. Others say the MLC’s announcement has caused consternation between songwriters and PROs. One source at a PRO suggests that the MLC including performance royalties in its report was a “marketing mishap.”
PRO sources insist that whatever performance royalties came in have largely already been paid out, and they don’t expect any new windfalls. And sources at the digital services say that, from what they can tell, the streamers have already paid out all the performance royalties that were due and they don’t expect to be making further payments.
Meanwhile, sources at PROs say the MLC’s announcement has caused significant confusion, leading songwriters to inquire about when they will get additional payouts for performance and why they were not made aware of this sooner.
Even if the performance royalties have already been paid, many executives in the music industry are speculating about what caused such a significant increase. The all-in mechanical formula that was determined by the CRB in Phonorecords III, by itself, doesn’t do anything to change performance royalties, which are typically decided by private negotiations between PROs and streaming services.
It’s possible digital services made mistakes when they reported the monthly performance royalties the first time around. The MLC could also have made a mistake either when it added up all the interim royalties paid while parties were awaiting a final determination or when it subsequently adjusted performance royalties for the period.
Alternatively, some of the PROs could have negotiated deals that tie their performance rates to the statutory mechanical rate. That would mean when digital services reverted to paying a lower mechanical rate while the 2018-2022 rate was still being determined, they wound up paying lower performance royalty rates, too — which later increased after the final CRB rate determination. But while some PRO sources concede that they try to negotiate for at least 50% of the statutory rate as a floor, they also say they don’t have any deal triggers specifically tied to the mechanicalrate.
Another theory is that one or two of the PROs might have been operating under an interim royalty rate with one or more streaming services while working through negotiations, which hypothetically weren’t finalized until recently. If those performance royalty rates have now been decided, the adjustments could be reflected in this total reported number. But several sources say they aren’t aware of any instances where this has happened.
It isn’t unusual for there to be streaming royalty adjustments after the fact, even without a new subsequent “final final” rate determination, sources point out. As it is, streaming services will sometimes need to make estimates on reporting monthly performance and mechanical royalty payments and then later adjust if necessary once the period has closed. At that time, the new payment would be made and the expense adjustment would be reported to the MLC — not two years later, sources say.
Performance and mechanical royalties have a see-saw effect where an increase in one will result in a decrease in the other. That’s because the formula for calculating the mechanical rate includes a first step in the formula that initially acts as a cap for an all-in publishing royalty pool that combines the two. This has publishers worried. If the services have already fulfilled all of their performance payments and the PROs have paid out all the received performance royalties, then how can the services now claim that $138 million as an additional deduction in the resubmitted reports? By claiming additional performance payouts, that would likely reduce the potential mechanical royalty payouts on the resubmitted report.
Aside from whether more money is coming, how these publishing royalties are paid — as performance or mechanicals — matters to publishers and songwriters.
For example, if that newfound $138 million in performance royalties needed to be paid out, it would likely mean that only about $120 million to $125 million of it would flow to songwriters and publishers because of the PROs’ overhead expenses.
If, instead, that $138 million was mechanical royalties, the songwriters and publishers would get all of that because the MLC has no overhead expense deduction since digital services finance the operation. But, instead of it getting paid out separately and directly split between publishers and songwriters, these royalties are paid to publishers, who then distribute royalties to their writers, but usually after recouping. So, the difference in where the payment comes through matters significantly to songwriters and publishers.
Overall, this adjustment seems to weigh more favorably for the mechanical royalty pool. Previously, during the interim period, the $2.77 billion in total publishing royalty payouts from digital services were weighted 50.93% to mechanical and 49.07% to performance. But after adjustments, including subtracting a slight overpayment in mechanicals for the years of 2018-2019, the $3.16 billion in total publishing royalties paid out by digital services to the PROs and the MLC works out to 52.63% paid in mechanical and 47.37% to performance, or nearly a two-percentage point increase for the former.
Eventually, when the MLC digs into the resubmissions and compares them to the earlier monthly play reports, it will likely be able to discern if the additional $138 million is coming across the board from all services or if a specific service or two accumulated the bulk of the new reported performance royalties. But if that doesn’t solve the mystery, another process is beginning that could bring in an answer. Last month, the MLC served notice on some 50 digital services that it is performing audits on them. If all else fails, that should bring some clarity to the mystery.
Rarely does an accounting issue move markets and surprise people throughout the music business. But that’s what happened Monday when Hipgnosis Songs Fund, the publicly traded investment trust backed by the catalogs of such artists as Neil Young and Stevie Nicks, announced it will cancel a planned quarterly dividend payment to shareholders.
According to Hipgnosis Songs Fund’s board of directors, the decision was the result of the company’s independent valuation expert, Citrin Cooperman, reducing its expectations of “industry-wide” retroactive payments from the Copyright Royalty Board’s Phonorecords III (a.k.a. CRB III) ruling that increased the royalties music publishers receive from on-demand music streaming services for the years 2018 to 2022. Billboard estimated that the music industry would gain over $250 million in total, and another industry expert recently told Billboard they estimated the industry-wide retroactive payment will approach $400 million.
Hipgnosis’ adjustment was substantial: down roughly 54% from $21.7 million to $9.9 million. Meanwhile, Billboard continues to stand by its previous estimate and no other publishers or rights funds that spoke for this story have had to decrease their projections.
“Frankly, I’m shocked… I really do not understand this,” says one music publishing executive.
Multiple sources say there have been no new updates regarding CRB III in recent weeks that would cause a publisher to cut their expectations for accruals by more than half, and it must be an accounting error unique to Hipgnosis and Citrin Cooperman. “None of the data points have changed,” explains another publishing executive. “The ruling is what it is, so they must’ve made a mistake here.” Citrin Cooperman did not respond to Billboard’s request for comment.
The fallout Monday was immediate: With the sudden change in expected retroactive royalties, Hipgnosis Songs Fund was forced to cancel a dividend payment to not risk violating the debt covenants for its $700 million revolving credit facility. That dividend — 1.3125 pence per ordinary share — was announced on Sept. 21 and was to have a payment date of Oct. 27. The company’s share price dropped 10% on Monday’s news. Dividends are an integral component to the fund’s strategy of providing investors with stable returns from proven, successful music catalogs. Since its initial public offering in July 2018 through March, Hipgnosis Songs Fund had declared dividends of 21.6 pence per share, according to the latest annual report.
While the retroactive CRB III payments would be less than Hipgnosis Songs Fund expected and impacted a dividend payment this quarter, the resulting cash crunch likely won’t happen until 2024. Streaming royalties due for the period 2018 to 2020 will be paid directly to rights holders, with everything after that flowing through the Music Licensing Collective with a Feb. 9, 2024, deadline. Most of the adjustment will come from the 2021-2022 royalties owed to the MLC, according to sources. Considering the time it will take the MLC process the distributions, publishers probably won’t receive this tranche of royalties until the spring 2024.
In August, the Copyright Royalty Board stated its final determination for how songwriters and publishers would be paid for the period of 2018-2022. These rates were hotly contested between the music business and streaming services over the past six years. Though rates were nearly finalized in 2018, some streamers remanded it back to the CRB in 2019 in hopes of getting more favorable terms. In the meantime, the streaming services paid songwriters and publishers under the guidelines set by the previous period, Phonorecords II, which was lower than what was ultimately set for 2018-2022.
Ever since, the music business has been preparing for when the 2018-2022 rates would finally be settled, and streaming services would have to undergo a massive recalibration of what they had previously paid out. When the judges released their final determination in mid-August, it proved that these streaming rates overall would lead to more money for publishers and songwriters.
Other publicly traded publishing companies have also announced the amounts of their expected adjustments ahead of receiving the money. Universal Music Group-owned Universal Music Publishing Group, one of the world’s largest music publishers, expects to book a catch-up adjustment of nearly 30 million euros in the third quarter of 2023 related to Phonorecords III, UMG said in its July 26 earnings call. Warner Music Group, which often ranks as the third largest publisher, according to Billboard’s Publishers Quarterly, recognized a benefit of $20 million — less than the amount of Hipgnosis Songs Fund’s initial estimate — in the quarter ended Sept. 30, 2022, resulting from the CRB’s ruling July 1, 2022, ruling.
Reservoir Media accrued less than $3 million in royalties in the third and fourth quarters of calendar 2022 related to the CRB III decision, says CEO Golnar Khosrowshahi. Reservoir Media doesn’t expect to adjust the size of the CRB III adjustment. “We continue to believe our estimates are accurate,” says Khosrowshahi. “We’ve applied an appropriate level of conservatism in recording that revenue.”
The amount of the expected windfall appears to have received a great deal of consideration inside Hipgnosis Songs Fund. According to Hipgnosis Songs Fund’s latest annual report, the company compared the Phonorecords III accrual estimates to estimates provided by the independent valuer — Citron Cooperman — as well as the fair-value appraiser for the City National Bank-led revolving credit facility. The 182-page report mentions the term “CRB III” 49 times and includes lengthy discussions of the company’s regulatory environment and how the CRB III determination raised the headline royalty rate due to music publishers by 44% from 10.5% to 15.1%.
CRB III will give publishers less than a 44% rate increase, though. The amount owed to music publishers is a complicated formula that includes minimum per-subscriber fees and percentage-of-revenue calculations. Publishers typically received above the headline rate from streaming services from 2018 to 2022, meaning extra amounts owed retroactively will be less than they would otherwise. Sources tell Billboard the effective rate for some streaming services was in the range of 12% to 13% of service revenue rather than 10.5%.
Hipgnosis did not respond to Billboard’s request for comment.
The Copyright Royalty Board’s final determination for royalty rates for making and distributing phonorecords for the 2018-2022 term (aka Phonorecords III) were published by the Federal Register late last week, following a legal review — and close check for typos — by the office of Register of Copyrights Shira Perlmutter.
The majority of the rates determination is no surprise. Since the official remand by an Appeals Court in October 2020 — which followed a March 2019 appeal by digital services of the CRB’s February 2019 rates determination for the 2018-2022 term — the CRB judges had been wrestling with different aspects of the complicated mechanical rate formula cited by the appeal courts, with various aspects of the rates determination coming out in dribs and drabs over the last eight months.
As is already known, the CRB judges stayed with the escalating rate structure for the all-in percentage of revenue prong, which covers both mechanical and performance royalties, for on-demand streaming for the 2018-2022 period.
(The 21% of total content cost is for performance royalties are determined by a separate process but whatever was agreed to be paid to ASCAP, BMI and the other performance royalty organization is subtracted from the all-in bucket in one step of the process to determine one of the mechanical rates bucket.)
That rate structure escalated from 10.5% in the prior five-year term of 2013-2017 to 11.2% in 2018, 12.3% in 2019, 13.4% in 2020; 14.2% in 2021, and 15.1% in 2022. But in moving to the other all-in prong — the total cost of content prong, i.e. what the services pay the record labels — the CRB judges re-installed the ceiling, which prevents publishers and songwriters from automatically being rewarded when labels and artists negotiations higher rates from the services; and the judges abandoned the earlier escalating rate structure from its initial 2019 determination for the total cost of content prong, which similarly rose in annual increments from 21% of what’s paid to labels to 26.1% over the five year term. Instead, the judges stuck with 21% of total content cost for the full five-year term — the same percentage it had been in the previous five years.
(This article mainly uses the percentages from what’s known as the stand-alone portable streaming model, i.e. the main on-demand streaming vehicle, which at Spotify is known as the paid subscriber tier. The ad-supported rate is 22% of what’s paid to labels.)
In other moves, the CRB stuck with 9.1 cents per song for physical and downloads and 24 cents per ringtone for Phonorecord III. In Phonorecords IV, for 2023-2027, the royalty rate for ringtones would remain the same but the per song rate will earn 12 cents per track or 2.31 cents per minute of playing time or fraction thereof, whichever amount is larger for physical products and permanent downloads. Also, that rate will be subject to an annual cost-of-living adjustment.
Before an Appeals Court remanded a significant part of the CRB rate determination for 2018-2022 back to the CRB, digital streaming services were adhering to the structure of the initial determination which means that for some 33 months the formula applied the higher rates for the total cost of content prong without a ceiling. As such, industry sources speculate that some digital services overpaid during that period — and Billboard estimates that they might have over paid by $50 million.
But after the remand most services reverted back to the 2013-2017 rates of which used the headline rate of 10.5% of revenue, and consequently most industry financial sources suggest that the service underpaid from October 2020 through December 2022. Consequently, Billboard estimates that digital services collectively might owe $200 million to $250 million for the latter period. Looking at the two period, with the earlier one 2018-2020 partially offsetting the later period of 2021-2022, that could mean a $200 million windfall for publishers and songwriters.
Now that this has all been settled, the Mechanical Licensing Collective—working with required updated information from the digital services—has six months from the Aug. 10 date to make adjustments in what has been paid and what may still be owed from 2021 and 2022, the two years the MLC has been in operation. It will also have to rectify any under or over payments for unclaimed and unpaid royalties from the earlier periods before it began operations— a responsibility it was handed as part of the Music Modernization Act.
But besides the unpaid royalties, any needed adjustments to the rest of the payments made to publishers and songwriters during the 2018-2020 period will be handled by the digital services, likely with the help of their third party vendors, i.e. Music Reports Inc and the Harry Fox Agency.
The Phonorecords IV rate determination for 2023-2027 preceded the final determination for Phonorecords III, as it was published in the Federal Register on Dec. 16, 2022.
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