Hollywood movie studios are notorious for under-representing profits. On August 30, Napoleon Pictures filed a lawsuit against Fox Searchlight for $10 million in undisclosed profits derived from the hit indie Napoleon Dynamite. The plaintiff claims that the studio failed to pay them the full amount of home video royalties owed and also overstated deductions.

At the Sundance Film Festival in 2004, the breakout comedy had its choice of several distributors. One of the reasons that the producers chose Fox Searchlight was because of the high royalty payments that were promised. Napoleon Pictures also alleges breach of contract and negligent misrepresentation.

With stories such as this often surfacing in the press, one may ask ‘how do studios get away with this? Some of the reasons are that plaintiffs require time and money to bring a lawsuit. Many younger artists may also be deterred by the public exposure and the possibility of earning a bad reputation.

Three legal verdicts handed down last year favored producers over studios. The first verdict was handed down by a unanimous jury in 2007 and affirmed by a California Court of Appeal last May. It concerned profit distributions by Warner Bros Entertainment Inc to a producer (Ladd) for the movies Police Academy, Chariots of Fire, and Blade Runner. The total amount awarded to Ladd was a whopping $97 million.

To bring a profit participation case against a studio, artists commence the process by requesting an audit of the studio’s books. The artist will need to hire a professional studio auditing firm and work through their concerns with studio reps.

The term ‘net profit’ is defined in Generally Accepted Accounting Standards (‘GAAP’). In addition to GAAP, Financial Accounting Standards Bulletin 53 (‘FASB 53′) discusses when income from the exploitation of a motion picture is to be recognized as earned and when the cost of producing and distributing a motion picture is recognized as incurred.

What is surprising is that the reports to net-profit participants by studios do not follow GAAP or FASB 53. Instead, the reported net profit follows a complex document that explains the accounting methodology employed by the studio.

This document will often appear as a schedule to the participant’s employment agreement containing the studio’s Standard Profit Definition (‘SPD’). The accounting provisions which are contained in the studio SPDs make it difficult, if not mathematically impossible, in many cases, for net profits to ever be derived.
GAAP is based on the accrual method of accounting. The accrual method provides that revenue is recognized when it’s derived and expenses are recognized when they are incurred. In an SPD, revenue is recognized when cash is received (which can take an inordinate amount of time, if ever) and expenses are recognized when they are incurred. This mismatching of revenue and expenses will delay, possibly forever, the reporting of profits.

Lawyers representing net profit participants can challenge SPDs for breach of contract; unconscionability of the SPD; and breach of fiduciary duty (amongst other remedies).

I am resolving. I will no longer listen to a CD, or even a song, twice in a row. I think the reason that I listen to music on repeat is that it costs so much money – it is too much of an investment. Also, I don’t like thinking about an artist making something because they think that I will like the finished product, and not because they look at the market and determine that a certain “sound” sells. By listening over and over, I was trying to get the most bang for my buck before having to make a second investment on a second album. But now that is over, and the bucks won’t have to bang anymore.

I know, I know. I could always download music without the consent of the rights holder. I could find the newest Lil Wayne song and get it in a few seconds. But downloading is also an investment. Not an investment of money of course, but an investment of risk. Given the jury verdict in a recent file-sharing case, this can be quite risky, and therefore quite an investment. Therefore, investment is still a hurdle when downloading music without the consent of the rights holder.

In addition to the practical hurdle of investing in risk, I also see a problem with the incentives provided to many commercial musicians. That incentive is to make money – often a lot of money. The thought process of these musicians might go something like this: “I need to make an album that will sell. What will my listening audience like? I should try to make my album include music that they will like. To achieve this, I should see what is currently selling and emulate it.” Thus, the final product contains music that the artist thinks listeners will like, not necessarily music that the artist likes. I am more likely to enjoy music that the artist enjoyed making, rather than music that the artist made for pecuniary reasons.

Enter free music. When I say free, I mean truly free and not the music that some people label as “free” because it is available online. It sounds too good to be true, but some musicians have been releasing music for free. A lot of artists have been releasing their art for free – not just music. Musicians such as Radiohead, NIN, Girl Talk, Sage Francis, DJ Jester, Danger Mouse, and others, have released their music either for free or for a purchase price which can be determined by the downloader. Movies are also released for free online. Such films as Loose Change, Steal this Film, and others are available for free. Not to mention all of the user-created content for free viewing available on YOUTUBE. The software has been released for free for some time now; think of the free and open-source movements.

Free music does not present problems of risk or misaligned incentives. Instead, the artist makes music he loves, for the sole reason that he or she loves it, and not because of a monetary incentive. Some of them may ask downloaders to pay what they see fit, but $O is an option. So why not listen to this music instead? There is plenty of it, and there is no reason to listen to the same album over and over to get a bang for the buck when there is no buck.

France has certainly upped the ante in the battle against pirated copyrighted material. A new law bans internet access for violators. Apparently, after your third violation (just warnings for the first two), a third-party agency intervenes between the violator and the internet access provider, and, as a punishment, you lose internet access for up to a year. The best part – is you’re still required to pay for that internet non-access.

Although I could never, ever, see this happen in the United States, it’s an interesting idea. With that being said, I have a few (okay, many) issues with this “solution.” Aside from the seemingly impossible task of enforcing this law – I think we’re talking millions, not thousands of violators – is this the right solution? The government would be sticking its thumb in a cracked dam and hoping that no other leaks sprout. This law would address the problem, but at what cost? What other leaks would start to sprout?

I have a First Amendment issue with limiting communication. After all, are not email, web programs (Facebook, Twitter), blogging, etc., valuable means to communicate? Isn’t open communication something we cherish in America? It’s not like you didn’t pay your cell phone bill, so they’re shutting off your phone. They’re shutting off your cell phone because you uploaded a copyrighted picture somebody sent to you.

I also have a problem with the warning system. France essentially permits two illegal downloads (or, to be precise, getting caught for two illegal downloads), but draws a line in the sand over the third violation. Sure, line drawing is necessary for all laws, but why not incorporate a fine or something for the first two violations if you’re serious about enforcement? When you give violators slack, they’ll take it.

There is also an over-broadness issue if the internet access is cut off for the entire household. Say the violator is your fourteen-year-old son and the family shares one computer. Do we punish minors? Moreover, if he violates the rule three times, is the entire family stuck? Say mom needs the computer for a work project or daughter needs to research for homework? You’re punishing an entire household for one person’s crime. This isn’t exactly the American way. If the internet access is only cut off from one user, you’re just egging on the violator to hop on the net under a sibling’s or parent’s login. Oh, and what if someone steals or borrows or whatever your computer and violates the law? Once you get your computer back (or even if you have to buy a new one) you might have to sit out an entire year from having internet access.

Finally, there are so many loopholes in this law that it’s practically impotent. Why not just burn a cd of copyrighted material instead of downloading it? Why not watch the copyrighted material on someone’s computer who is only at strike 1 or hasn’t gotten caught yet? Why not access copyrighted material on an unblocked public computer (i.e. library, public school, etc. that does not have a firewall)? Exactly how much invasion of privacy are we willing to approach to accurately enforce this?

While I certainly appreciate that there is a problem, I just don’t see how the ends justify the means here. When America wanted to cut off the (free) Napsters of the world, Congress went after (surprise!) the (free) Napsters of the world. Spend resources on the sources flooding all of the copyrighted material onto the internet so you don’t need to worry about setting up a shotty dam.