The major labels' use of "most favored nation" (MFN) clauses in deals with download and subscription retailers are receiving increased industry scrutiny in the wake of New York State Attorney General

The major labels’ use of “most favored nation” (MFN) clauses in deals with download and subscription retailers are receiving increased industry scrutiny in the wake of New York State Attorney General Eliot Spitzer’s probe into digital music pricing.

Digital music service operators are privately complaining that the clauses, which dictate that a label cannot receive pricing terms worse than its competition, are a tool for defacto collusion by the record companies. Multiple digital retail executives polled by Billboard point to MFNs as one likely focus of the Spitzer investigation. Spitzer’s office declined comment.

In some cases, the clause allows labels to audit the terms of deals the retailers have with other record companies in order to ensure that they are receiving the best pricing terms possible, digital retail sources say.

Buzz about MFNs began swirling after venture capitalist Sean Ryan, a former Listen.com and RealNetworks executive who ran the Rhapsody subscription service, raised the issue in a recent post on his blog.

“I used to refer to it as the ‘Lazy Business Development’ clause since it effectively saves labels from actually negotiating the terms - they just claim MFN and do an audit once a year if they think a competitor is getting better terms,” Ryan said.

Ryan claims that the MFN issue is a bigger anti-trust issue than questions about the labels’ download wholesale prices, which all fall within a few cents of each other. Ryan says there isn't really a need for the labels to collude on pricing, because MFNs ensure wholesale parity. Digital retailers familiar with the situation say that the clauses are most prominently used by the labels in subscription licensing deals, where wholesale rates aren’t as strongly defined.

Spitzer’s investigation into digital music pricing comes as the major labels are set to begin renegotiating their licensing agreements with Apple Computer. The majors are said to be looking to move to a variable pricing scheme in which hit tracks would be priced above 99 cents, and other tracks could be priced lower.

At least one unnamed digital service operator has been subpoenaed so far, and executives at virtually every retailer say they expect to be contacted by Spitzer’s office. Warner Music Group, EMI, Sony BMG and Universal Music Group all reportedly have been issued subpoenas as part of the inquiry.

Label sources maintain the investigation is off the mark.

“He’s really got it totally wrong,” says one major label exec who was directly involved with the licensing negotiations for digital services like iTunes, Napster and Rhapsody. “That it’s a monolithic price is totally false. I know (different labels) charge different prices.”

This isn’t the first time a government agency has looked into digital music pricing practices. In 2001, the U.S. Department of Justice initiated a two-year investigation in the matter. No anti-trust charges were ever filed. The case was dropped in 2003.

Additional reporting by Antony Bruno in Los Angeles.

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