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Sony’s Equity Stake in Spotify Challenged in Lawsuit Claiming Artists Are Robbed

In a big development that will bring new examination into whether recording artists are properly benefiting from the rise of streamed music, Sony Music's dealings with Spotify are now being…

If Spotify ever goes public, it could raise north of $10 billion from investors eager to be a part of a company that has attracted more than 75 million subscribers, including more than 20 million who pay for the premium version. Standing to benefit from such a liquidity event are recording companies including Sony, Warner and Universal, which reportedly own as much as a 20 percent stake in the Sweden-based streaming giant. However, even before anything like that happens, there will be legal examination into whether the labels have decided to enrich themselves at the expense of their recording artists.

On June 15, American Idol-affiliated 19 Recordings sought permission to file an amended complaint under seal in an ongoing lawsuit with Sony Music. A redacted copy, obtained by The Hollywood Reporter after the parties discussed what was to remain private, details allegations that many insiders have long anticipated ever since word of Sony’s equity stake in Spotify (more than five percent) began circulating five years ago.

Sony is now being sued for self-dealing on the allegation that its equity position is harming 19 artists like Kelly Clarkson and Carrie Underwood. The lawsuit asserts that Sony negotiated the stake, and is also taking advertising income from Spotify, in lieu of demanding fair-market royalty rates from the streaming company. An additional claim for breach of good faith and fair dealing essentially frames what’s happened in the recording business as a diversion of money that would otherwise be going to artists.

And the legal examination could spread.

“Each of the major record labels also own an interest in Spotify,” states the amended complaint. “On information and belief, those other record labels have engaged in the same self-dealing as Sony with respect to the diversion of payments to them, and the below market streaming royalty rates to artists. Together, and individually, Sony and the other major record labels therefore have significant power to exert control over Spotify in order to not only dictate how revenue will be paid, but wrongfully and in bad faith divert money from royalties that must be shared to other forms of revenue that they can keep for themselves.”

The charges reflect how the music industry has changed over the years after facing mortality in the form of dwindling record sales. At the turn of the century, the recording giants filed lawsuits against Napster and other file-sharing services in an effort to stem the tide of those getting music for free. The RIAA later attempted to go after individual pirates, but turning the clock back to the time when fans were buying physical products was impossible. And so, the ever-shrinking pool of record giants have gotten what they can from Apple’s iTunes store and when downloads ebbed, began having skin in the streaming game with equity stakes. If Dr. Dre and Jimmy Iovine could become near billionaires by selling Beats to Apple, what fortunes awaited the record labels once Spotify was sold or went public?

Having equity in Spotify might be smart, but if the money doesn’t trickle down from labels to profit participants, is it legal? The amended suit states that Sony has motive in making Spotify a more valuable company by giving it favorable royalty arrangement. By doing so, Sony’s own investment position is bigger, and any cash-outs won’t have to be shared with artists.

19, founded by Idol creator Simon Fuller and controlled by the show’s owner, Core Media Group (which is now part of a joint venture between 21st Century Fox and Apollo Global Management), originally filed suit in February 2014, and among the plaintiff’s claims was that streaming music was being treated as “sales” or “distributions” rather than as “broadcasts” or “transmissions.” The latter classification requires an even split of income with artists. The former —treating streams like units sold at a record store —  allows Sony to fork over a substantially lesser amount of money to artists. The lawsuit alleges that Sony picks the accounting treatment most in its favor.

Sony’s deal with streaming upstarts is causing a closer look in more than one way. It’s not just about self-dealing. It’s also about what Sony is allegedly hiding.

One month ago, The Verge published a copy of Sony’s agreement with Spotify, and before it was taken down after Sony claimed a copyright violation over the posting, it was noted that Sony got a big advance and free ad space from Spotify besides a guaranteed minimum of $0.00225 per stream royalty rate on its free service. (Spotify says its average “per stream” payout to rights holders is between $0.006 and $0.0084, which includes money for both publishing and sound recording licensing.) In the aftermath, Sony issued a statement noting that it “shares with its recording artists all unallocated income from advances, non-recoupable payments and minimum revenue guarantees.” Sony didn’t directly mention advertising credits and spoke nothing about any money that would come from selling its equity stake in Spotify. And as for the stream rates, Sony’s competitors are said to be paying more, though the exact difference is redacted from the publicly available complaint.

The streaming agreements that Sony has signed is labeled “not a legitimate business model” in the lawsuit that seeks more than $20 million from compensatory damages, the cost of audits, interest and more.

Richard Busch (perhaps best known for representing Marvin Gaye’s family in the “Blurred Lines” lawsuit) is representing 19 have been fighting in recent weeks to get Sony to come forward with the streaming agreements because they wanted to see whether streams were being discussed “transmissions.” According to the lawsuit, they were. Sony allegedly tried to “mislead 19’s auditors with highly redacted portions of the [streaming] agreements to allegedly support their mischaracterization of the services’ exploitations.”

But the lawsuit now means even more because it’s the first case to test whether the record industry establishment and tech industry vanguard are in cahoots at the expense of the creatives. The issue might be important beyond the music realm too. For example, for the past few years, top television showrunners have been engaged in backroom talks over whether they’ve seen proper profit participation from Hulu, owned by a few of the big studios.

19’s lawsuit only pertains to it Sony, though given how recording artists at large may be implicated, class action suits could follow. Statute of limitations and a potential race among plaintiffs’ lawyers to share in the spoils of damages could also prompt more lawsuits to come sooner rather than later.