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INTERNATIONAL COPYRIGHT PIRACY: A GROWING PROBLEM WITH LINKS TO ORGANIZED

CRIME AND TERRORISM

HEARING

BEFORE THE

SUBCOMMITTEE ON COURTS, THE INTERNET,

AND INTELLECTUAL PROPERTY

OF THE

COMMITTEE ON THE JUDICIARY

HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

MARCH 13, 2003

Serial No. 9

Printed for the use of the Committee on the Judiciary

(

Available via the World Wide Web: http://www.house.gov/judiciary

(II)

COMMITTEE ON THE JUDICIARY

F. JAMES SENSENBRENNER, JR., Wisconsin, Chairman

HENRY J. HYDE, Illinois

HOWARD COBLE, North Carolina

LAMAR SMITH, Texas

ELTON GALLEGLY, California

BOB GOODLATTE, Virginia

STEVE CHABOT, Ohio

WILLIAM L. JENKINS, Tennessee

CHRIS CANNON, Utah

SPENCER BACHUS, Alabama

JOHN N. HOSTETTLER, Indiana

MARK GREEN, Wisconsin

RIC KELLER, Florida

MELISSA A. HART, Pennsylvania

JEFF FLAKE, Arizona

MIKE PENCE, Indiana

J. RANDY FORBES, Virginia

STEVE KING, Iowa

JOHN R. CARTER, Texas

TOM FEENEY, Florida

MARSHA BLACKBURN, Tennessee

JOHN CONYERS, JR., Michigan

HOWARD L. BERMAN, California

RICK BOUCHER, Virginia

JERROLD NADLER, New York

ROBERT C. SCOTT, Virginia

MELVIN L. WATT, North Carolina

ZOE LOFGREN, California

SHEILA JACKSON LEE, Texas

MAXINE WATERS, California

MARTIN T. MEEHAN, Massachusetts

WILLIAM D. DELAHUNT, Massachusetts

ROBERT WEXLER, Florida

TAMMY BALDWIN, Wisconsin

ANTHONY D. WEINER, New York

ADAM B. SCHIFF, California

LINDA T. SA ́ NCHEZ, California

PHILIP G. KIKO, Chief of Staff-General Counsel

PERRY H. APELBAUM, Minority Chief Counsel

SUBCOMMITTEE ON COURTS, THE INTERNET, AND INTELLECTUAL PROPERTY

LAMAR SMITH, Texas, Chairman

HENRY J. HYDE, Illinois

ELTON GALLEGLY, California

BOB GOODLATTE, Virginia

WILLIAM L. JENKINS, Tennessee

SPENCER BACHUS, Alabama

MARK GREEN, Wisconsin

RIC KELLER, Florida

MELISSA A. HART, Pennsylvania

MIKE PENCE, Indiana

J. RANDY FORBES, Virginia

JOHN R. CARTER, Texas

HOWARD L. BERMAN, California

JOHN CONYERS, JR., Michigan

RICK BOUCHER, Virginia

ZOE LOFGREN, California

MAXINE WATERS, California

MARTIN T. MEEHAN, Massachusetts

WILLIAM D. DELAHUNT, Massachusetts

ROBERT WEXLER, Florida

TAMMY BALDWIN, Wisconsin

ANTHONY D. WEINER, New York

BLAINE MERRITT, Chief Counsel

DEBRA ROSE, Counsel

MELISSA L. MCDONALD, Full Committee Counsel

ALEC FRENCH, Minority Counsel

(III)

C O N T E N T S

MARCH 13, 2003

OPENING STATEMENT

Page

The Honorable Lamar Smith, a Representative in Congress From the State

of Texas, and Chairman, Subcommittee on Courts, the Internet, and Intellectual Property .................................................................................................... 1

The Honorable Howard L. Berman, a Representative in Congress From the

State of California, and Ranking Member, Subcommittee on Courts, the

Internet, and Intellectual Property .................................................................... 2

WITNESSES

Mr. John G. Malcolm, Deputy Assistant Attorney General, Criminal Division,

United States Department of Justice

Oral Testimony ..................................................................................................... 5

Prepared Statement ............................................................................................. 7

Mr. Rich LaMagna, Senior Manager—Worldwide Investigations, Microsoft

Oral Testimony ..................................................................................................... 17

Prepared Statement ............................................................................................. 18

The Honorable Jack Valenti, President and Chief Executive Officer, Motion

Picture Association of America (MPAA)

Oral Testimony ..................................................................................................... 23

Prepared Statement ............................................................................................. 24

Ms. Joan Borsten Vidov, President, Films By Jove, Inc.

Oral Testimony ..................................................................................................... 33

Prepared Statement ............................................................................................. 35

APPENDIX

STATEMENTS SUBMITTED FOR THE HEARING RECORD

Prepared Statement of the Honorable Howard Berman, a Representative

in Congress From the State of California .......................................................... 83

Prepared Statement of the Honorable Bob Goodlatte, a Representative in

Congress From the State of Virginia .................................................................. 84

Prepared Statement of the Honorable Martin T. Meehan, a Representative

in Congress From the State of Massachusetts .................................................. 85

Prepared Statement of the Honorable John Conyers, Jr., a Representative

in Congress From the State of Michigan ........................................................... 85

Prepared Statement of the Honorable Robert Wexler, a Representative in

Congress From the State of Florida ................................................................... 86

Prepared Statement of Mr. Gary R. Johnson, President, Chairman and CEO

of Sawyers Research Products, Inc. .................................................................... 87

Prepared Statement of Mr. Michael Newcity, Deputy Director, Center for

Slavic, Eurasian, and East European Studies ................................................... 93

Prepared Statement of Mr. Timothy P. Trainer, President, The International

AntiCounterfeiting Coalition ............................................................................... 100

(1)

INTERNATIONAL COPYRIGHT PIRACY:

A GROWING PROBLEM WITH LINKS TO

ORGANIZED CRIME AND TERRORISM

THURSDAY, MARCH 13, 2003

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON COURTS, THE INTERNET,

AND INTELLECTUAL PROPERTY,

COMMITTEE ON THE JUDICIARY,

Washington, DC.

The Subcommittee met, pursuant to call, at 9:10 a.m., in Room

2141, Rayburn House Office Building, Hon. Lamar Smith [Chairman of the Subcommittee] presiding.

Mr. SMITH. The Subcommittee on Courts, the Internet, and Intellectual Property will come to order.

I’m going to recognize myself and the Ranking Member for opening statements, and we’ll certainly put the opening statements of

all other Members, without objection, into the record. And after

that, we’ll move immediately to our witnesses and look forward to

hearing their testimony.

Today, the Subcommittee will conduct its second hearing on

copyright piracy. The first hearing addressed peer-to-peer copyright

infringement on university campuses. The Subcommittee now will

examine the extent of international copyright piracy and whether

there are links between this activity and organized crime and terrorism.

The rise of the Internet and new digital media has changed the

way that the public enjoys entertainment products, including music

and movies. One of the advantages of digital formats, such as CDs

and DVDs, is that they offer extremely high-quality reproduction of

audio and video. A major disadvantage is that digital formats make

the works very susceptible to piracy. Since every digital copy offers

a perfect reproduction, these works are easily copied and distributed over the Internet on a global basis.

Last year, American copyright-based industries suffered more than $9 billion worth of piracy-related losses in 56 countries. Half

of those losses affected the music industry. In fact, there was one

pirated music product for every three sold worldwide.

In 2000, the annual seizure of pirated discs for the Motion Picture Association was 1.9 billion units. By the close of 2002, it was

up to 6.1 billion units. In just 2 years, the annual piracy rate had

increased five times.

In some places, such as Asia and parts of the former Soviet

Union, pirated software accounts for nearly 90 percent of the softVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
2

ware used. At the close of 2002, for example, seizures of pirated

Microsoft products alone exceeded $1.7 billion.

The copyright industries drive the engine of the American economy. Exports and foreign sales of U.S. copyrighted products total

$100 billion, which helps the national balance of trade. Copyrighted

works are a result of American creativity. When properly commercialized, these works lead to jobs, profits, and a more enjoyable

quality of life for us all.

There is good reason why the Founders embraced the concept of

intellectual property protection. They realized that if creators cannot gain from their creations, they will not bother to create. And

actors and writers and composers and singers cannot gain if their

work is stolen. Would any other American industry be able to sustain its operations for long if a third of its sales were lost to theft?

A recent article in Time Europe noted that an average drug deal- er pays $47,000 for a kilo of cocaine with an estimated street value

of $94,000, which yields 100 percent profit. For the same $47,000

investment, a pirate could buy or produce 1,500 pirated copies of

Microsoft’s Office 2000 professional software and resell it for a profit of 900 percent.

In other words, the overhead for pirating copyrighted material

relative to other illegal economic activities is minimal, the profits

are exceptional, and the relative risk level of attracting the attention of law enforcement officials is low. Well, low risk and high

profit is how criminals view piracy.

In the end, it really doesn’t matter whether the pirates are individuals or crime organizations. One thing is clear. Their activity is

rising, and it must be addressed.

That concludes my opening statement, and now I’ll recognize the

Ranking Member, Mr. Berman of California, for his.

Mr. BERMAN. Well, thank you, Mr. Chairman. And I want to

commend you for putting together the third week, the third

straight fine hearing, and I appreciate your scheduling this and organizing it.

And I particularly want to thank you for inviting Joan Borsten

Vidov to testify. She’s a constituent of mine, and she’s been a friend

for a very long time, a very long time. She brings a valuable perspective to the hearing, that of an American entrepreneur whose

business has been dramatically impacted by a foreign government’s

sustained campaign to steal her rights to intellectual property.

Because we usually hear about copyright piracy from large corporations or celebrities, we often lose sight of the impact that piracy has on individual American entrepreneurs or copyright owners.

While Internet—international hard goods piracy may seem a dull

subject to some, it is a critical issue to U.S. copyright holders. The

aggregate hard good piracy losses suffered by U.S. copyright industries in foreign nations are pretty astounding. You’ve mentioned

some of the figures. You talked about 56 countries. I have an estimate that it probably equals $20–$22 billion annually worldwide,

not including Internet piracy.

Individual foreign countries—China, $1.85 billion; $770 million

in Brazil; $800 million in Italy; $757 million in Taiwan; and $756

million in the Russian Federation. Another interesting statistic—93

3

percent of business software sold in China, 47 percent of music sold

in Taiwan, 80 percent of movies sold in the Russian Federation

were pirated.

In 2001, 99 percent of entertainment software sold in Brazil was

pirated, while, in 2002, 55 percent of entertainment software sold

in Italy was pirated.

As piracy percentages climb in a particular nation, it becomes increasingly difficult for U.S. copyright owners to establish a legitimate market. In some cases, as with entertainment software in

Brazil, U.S. copyright owners have had to abandon the market entirely. They simply can’t justify the expense of maintaining a presence in a nation where the demand for their copyrighted works is

almost entirely met by vastly cheaper pirated versions.

The piracy-related inability of U.S. copyright owners to access a

legitimate market in many foreign countries results in real harm

to the U.S. economy. The core copyright industries make a tremendous contribution to the U.S. economy, accounting for more than 5

percent of the U.S. gross domestic product. That’s more than the

deficit will be in about 5 or 6 years. [Laughter.]

Mr. BERMAN. How much greater would the contributions to the

U.S. economy be if U.S. copyright owners could access foreign markets otherwise dominated by pirate product? Our Microsoft witness

will speak to some real numbers, but I do want to remark on his

estimate that in 2008, software piracy will cost the U.S. $1.6 billion

in lost tax revenue.

These numbers and percentages can seem dry, and their sheer

size sometimes begs skepticism. And that’s why Joan’s presence

today, I think, is so important. Her personal story of intellectual

property theft by the Russian government provides a context to

these numbers, just as she provides a face for U.S. victims of international copyright piracy.

I don’t want to steal her thunder, but I want to highlight a couple of the issues that I think her particular situation represents.

In Joan’s case, the theft of her intellectual property rights is not

some private syndicate operating in distant shadows within a foreign government, but it is the foreign government itself—the Russian Federation government.

Through the establishment of dummy corporations, fraudulent license transfers, and illegal pressuring of Russian courts, the Russian Federation government has attempted to deprive Joan of her

valid license to copyrights for a library of Soviet era animation.

Where a foreign government is itself stealing intellectual property from a U.S. citizen, it is particularly appropriate for the U.S.

Government to demand that the foreign government stop the theft.

Conversely, it would be entirely inappropriate for the U.S. to grant

any special trade privileges, such as WTO accession or GSP benefits, to a foreign nation whose government is stealing intellectual

property from a U.S. citizen.

I know your particular focus, Mr. Chairman, is on the links between organized crime, terrorism, and this international piracy. In

that regard, I wish to note that intellectual property theft by a government represents the very essence of organized crime.

In any nation, there is typically no bigger organization than its

government and no greater power. Thus, when the government

4

steals intellectual property, it is engaging in organized crime of the

highest magnitude.

I thank you again, Mr. Chairman, for scheduling the hearing and

yield back.

[The prepared statement of Mr. Berman follows in the Appendix]

Mr. SMITH. Thank you, Mr. Berman.

Let me introduce our witnesses today. Our first witness is the

Honorable John G. Malcolm, currently a deputy assistant attorney

general in the Criminal Division of the Department of Justice,

where his duties include overseeing the Computer Crime and Intellectual Property Section, the Child Exploitation and Obscenity Section as well, the Domestic Security Section, and the Office of Special Investigations.

An honors graduate of Columbia College and Harvard Law

School, Mr. Malcolm served as a law clerk to judges on both the

United States District Court for the Northern District of Georgia

and the 11th Circuit Court of Appeals.

Our next witness is Rich LaMagna, who is the senior manager

of worldwide investigations at Microsoft, where he manages global

anti-piracy investigations. In this capacity, he provides policy and

operational guidance to members of the Microsoft worldwide anticounterfeiting team.

Mr. LaMagna received his B.A. from Gettysburg College in 1970

and a master’s of arts in liberal studies from Georgetown University in 1996. He is a graduate of the Foreign Services Institute in

Chinese and French studies and is fluent in Cantonese, Mandarin,

and French.

Our next witness is Jack Valenti, who is president and chief executive officer of the Motion Picture Association of America. Born

in Houston, Texas, Mr. Valenti became a highly decorated serviceman while serving in the Army Air Corps in World War II. In

1952, he co-founded the advertising political consulting agency of

Weekley & Valenti.

He is perhaps best known, however, for his service as a special

assistant to President Johnson from 1963 to 1966. On June 1,

1966, Mr. Valenti resigned his White House post to assume the

helm at MPAA. He has a B.A. from the University of Houston and

an MBA from Harvard.

Our last witness is Joan Borsten Vidov, who is president of Films

by Jove, Inc., a California-based film production and distribution

company, which acquired in 1992 worldwide rights to most of the

award-winning animation library of Moscow’s Soyuzmultfilm Studio.

Ms. Borsten received her B.A. in comparative literature from the

University of California at Berkeley and her M.S. in bilingual education at USC.

Welcome to you all. Without objection, your entire written testimony will be made a part of the record. I would ask you all to try

to keep your comments within the 5 minutes allotted. But we very

much look forward to hearing from you all today.

And Mr. Malcolm, we’ll begin with you.

5

STATEMENT OF JOHN G. MALCOLM, DEPUTY ASSISTANT ATTORNEY GENERAL, CRIMINAL DIVISION, UNITED STATES

DEPARTMENT OF JUSTICE

Mr. MALCOLM. Thank you, Mr. Chairman. I’ll try to abide by the

time limits you set.

Mr. SMITH. Turn on your mike. Is it—— Mr. MALCOLM. There we go. Okay.

Mr. Chairman, Members of this Committee, thank you for inviting me to testify today. I am pleased to offer the Justice Department’s views on the links among organized crime, terrorism, and

intellectual property piracy.

The focus of this hearing is extremely important, and I commend

you, Mr. Chairman, for your attention to this issue. At the outset,

I would like to take this opportunity to acknowledge your considerable and consistent support of law enforcement during your distinguished tenure as Chairman of this Committee. You’ve played a

vital role in many cybersecurity issues, and the department is, indeed, grateful for your support.

The strong enforcement of intellectual property laws is a priority

for the Department of Justice, and with the assistance of this Subcommittee, we will continue to wage an aggressive battle against

piracy in the months and years ahead.

As you know, Mr. Chairman, with Congress’s generous support,

Attorney General Ashcroft has established 13 Computer Hacking

and Intellectual Property (or CHIP) units across the Nation. These

specialized units, which are comprised of dedicated Federal prosecutors whose primary focus is on prosecuting high-tech crimes, including intellectual property crimes, help the Justice Department

to keep pace with the rapidly changing face of high-tech crime.

The establishment of these specialized units ensures that individuals who misuse technology to further criminal activity will not

find a safe haven in the United States.

Congress also allocated resources that have allowed the department to significantly increase the size of the Criminal Division’s

Computer Crime and Intellectual Property Section, or CCIPS, as

it’s more commonly known.

Intellectual property protection is one of CCIPS’s core responsibilities. CCIPS now has a deputy chief whose sole responsibility

is to oversee and manage 10 attorneys within the section who are

dedicated to IP enforcement. These attorneys are developing a focused and aggressive long-term plan to combat the growing threat

of piracy.

As my written testimony outlines, Mr. Chairman, the Justice Department has achieved many significant victories as of late against

IP pirates. One of those cases is Operation Buccaneer. To date,

over 20 convictions have been attained in this ongoing investigation of online international piracy groups. The sentences in these

cases have been the longest ever imposed for online piracy, ranging

from 33 to 46 months imprisonment.

Just yesterday, CCIPS, working with the CHIP unit in the eastern district of Virginia under the able stewardship of U.S. attorney

Paul McNulty, indicted Hew Raymond Griffiths, a leader in some

of the most well-known online piracy groups around the world.

Griffiths, whose screen name was Bandido, directed the actions of

6

many of the defendants I mentioned before who have already been

convicted and sentenced.

Over the course of the past 2 years, while Operation Buccaneer

systematically dismantled the criminal organizations he managed

and incarcerated many of the people he supervised, Mr. Griffiths

remained in Australia, seemingly beyond the reach of U.S. law enforcement. However, the department will seek to extradite Mr.

Griffiths for criminal prosecution.

The decision to extradite Griffiths for his role in intellectual

copyright piracy should send a strong signal around the world. For

too long, people engaged in piracy have believed that if they were

outside the borders of the United States, they could violate our intellectual property laws with impunity. They’re wrong.

This indictment and the extradition sends a clear and unequivocal message to everybody involved in illegal piracy that, regardless

of where you are, the Justice Department will find you, investigate

you, arrest you, prosecute you, and incarcerate you.

In the battle against piracy, international cooperation is essential, and Operation Buccaneer has been precedent setting in this

regard. Indeed, U.S. law enforcement continues to support its counterparts in the United Kingdom, Sweden, Finland, and Norway,

who are investigating individuals in those countries in connection

with this ongoing operation. Our commitment to strong intellectual

property rights enforcement will not stop at our borders.

Mr. Chairman, piracy today is big business—a worldwide, multibillion dollar illicit economy, which robs legitimate industries and

creators of income, while driving up the costs to consumers. Not

surprisingly, criminal organizations are playing a more prominent

and dangerous role in piracy around the globe.

My written testimony describes two different, yet equally troubling types of criminal organized activity that are emerging globally—organized online piracy groups, such as the one run by Mr.

Griffiths, and traditional organized crime syndicates operating primarily from Asia to Eastern Europe.

While it’s true that online piracy or warez groups do not fit

squarely within the definition of organized crime used by the department, they are nonetheless responsible for placing a massive

number of pirated movies, music, games, and software into circulation each year and represent a significant and growing threat to intellectual property rights around the globe. They specialize in being

the first to release new pirated software to the warez community

for unauthorized and unlimited reproduction and distribution.

These online groups are extremely security conscious, often utilizing the latest technology to hide their illegal operations. Like legitimate companies, top-tier warez groups have clear hierarchies

and divisions of labor. Rank and position within warez groups are

based on a variety of factors, including special skills, length and

quality of service to the group, and reputation within the warez

scene.

A typical group—which consists of people all around the world

who may know each other only by their screen names—will consist

of one or two leaders, two or three high-level individuals known as

council, 12 to 15 staff members, and a general membership comprising anywhere from 20 to 80 individuals.

7

The more work somebody does for the group, the higher within

the organization that person will move, and the greater access that

person will have to pirated material.

What’s surprising to many, Mr. Chairman, is that online piracy

groups typically don’t engage in piracy for monetary gain. That

having been said, it would be a grave mistake to dismiss their conduct as harmless or unimportant.

On the contrary, most of the pirated movies, music, games, and

software available on the Internet come from these high-level

warez groups. And further, they are the source for much of the pirated products which filter their way down to less sophisticated,

but more widely used distribution mechanisms, such as peer-topeer networks.

While the pirates who steal and distribute software do not profit

monetarily, the consequences to the victim companies are just as

dire as if they did. For many victim companies, particularly smaller

companies whose livelihood depends upon the success of only one

or two products, irreversible damage occurs the moment the pirated digital copy hits the Internet.

Among emerging concerns is the fact that traditional organized

crime syndicates appear to be playing a dominant role in the production and distribution of certain types of hard goods piracy, such

as optical disks. This problem seems particularly prevalent in Asia

and parts of the former Soviet Union. Unlike warez groups, the

goal of these organized crime groups is to make as much money as

they possibly can.

Highly organized criminal syndicates pose special challenges for

law enforcement because they have significant resources to devote

to their illegal operations, thereby increasing the scope and sophistication of their activity. They control international distribution

channels, which allow them to move massive quantities of pirated

goods, as well as any other illicit goods, throughout the world.

These groups will not hesitate to threaten or injure those who attempt to interfere with their operations. Throughout Asia, organized crime groups operate assembly lines and factories that generate literally millions of pirated optical discs. These groups pirate

a full range of products, ranging from music to software to movies

to video games. Anything that can be reproduced onto an optical

disk and sold around the globe is available.

Mr. SMITH. Mr. Malcolm, we’re 71⁄2 minutes into your testimony,

and I’m only half way through your written statement. I’m getting

concerned.

Mr. MALCOLM. I apologize. Actually, I only had two more paragraphs, but I’ll be happy to yield and would be happy to answer

your questions.

[The prepared statement of Mr. Malcolm follows:]

PREPARED STATEMENT OF JOHN G. MALCOLM

Mr. Chairman and Members of the Subcommittee:

Thank you for inviting me to testify before you today. This is an extremely important topic, and I commend you, Mr. Chairman, for holding this hearing. This hearing and the others recently held by the Subcommittee are providing the American

public with an important look at the growing threat of intellectual property (IP)

crime, which chiefly includes copyright piracy, trademark counterfeiting, and theft

of trade secrets. Today I am pleased to offer the views of the Department of Justice

on the links among organized crime, terrorism and intellectual property piracy.

8

THE DEPARTMENT OF JUSTICES ANTI-PIRACY PROGRAM

The enforcement of this nation’s criminal laws protecting intellectual property is

a priority at the Department of Justice. Since the beginning of his tenure, Attorney

General Ashcroft has worked diligently to ensure that the prosecutorial resources

needed to address intellectual property crime are in place. Shortly after becoming

the Attorney General, he used additional resources provided by Congress to establish or expand Computer Hacking and Intellectual Property (or CHIP) Units in ten

U.S. Attorney’s Offices across the nation. These specialized units consist of dedicated federal prosecutors whose primary focus is on prosecuting high tech crimes,

including IP crimes. Subsequently, the Attorney General established three additional CHIP units, and used additional funding to bolster the cyber and IP prosecutive resources in a number of other jurisdictions. The CHIP units ensure that the

Department of Justice has a ready supply of prosecutors to pursue IP cases. The

expertise of the various CHIP Units helps the Justice Department to keep pace with

the changing face of high-tech crime. Rapid advances in technology bring new challenges to the investigators and prosecutors who handle these cases, and the establishment of these specialized units ensures that the individuals who misuse technology to further their criminal activity will not find a safe haven in the United

States.

The CHIP Units complement the already existing network of Computer and Telecommunications Coordinators (CTCs) that serve in every United States Attorney’s

Office. The CTCs regularly receive specialized training in the investigation and

prosecution of high-tech crimes, including intellectual property crimes. Many of the

94 U.S. Attorneys Offices have two or more CTCs to help meet the growing demand

for trained high-tech prosecutors.

Working hand-in-glove with the CHIP Units and the CTC network is the Criminal

Divisions Computer Crime and Intellectual Property Section, also known as CCIPS,

which I supervise. Created as a Unit in 1991 by then-Assistant Attorney General

Robert Mueller and elevated to a Section in the Criminal Division in 1996, CCIPS

is a highly specialized team of over thirty-five lawyers who focus exclusively on computer and intellectual property crime. CCIPS attorneys prosecute cybercrime and intellectual property cases; advise and train local, state, and federal prosecutors and

investigators in network attacks, computer search and seizure, and IP law; coordinate international enforcement and outreach efforts to combat intellectual property

and computer crime worldwide; and comment upon and propose legislation. For example, CCIPS attorneys worked with Congress, including Members of this Committee, in 1997 to improve IP enforcement through the legislative amendments

made by the ‘‘No Electronic Theft’’ (NET) Act. Those amendments extended federal

criminal copyright law to unlawful large-scale reproduction and distribution of copyrighted works even when the thieves do not make a profit. In 1999, CCIPS prosecutors obtained the first convictions after trial under the Economic Espionage Act of

1996, a criminal statute that protects trade secrets. CCIPS also worked with the

U.S. Sentencing Commission in 2001 to amend the sentencing guidelines to provide

substantial sentences for copyright infringement.

With the deeply appreciated support of Congress, we have significantly increased

the size of the Computer Crime and Intellectual Property Section in the past eighteen months, which is allowing us to devote additional resources to address piracy

both here and abroad. Intellectual property protection is an important part of my

portfolio, and a core responsibility of CCIPS. Moreover, for the first time, CCIPS has

a Deputy Chief whose sole responsibility is to oversee and manage the attorneys in

the Section dedicated to IP enforcement. At present, there are ten CCIPS attorneys

working full-time on the IP program. The attorneys of CCIPS are developing a focused and aggressive long-term plan to combat the growing threat of piracy. They

are developing and implementing the Departments overall anti-piracy strategy, assisting AUSAs in the prosecution of intellectual property crimes, and reaching out

to international counterparts to ensure a more effective world-wide response to intellectual property theft. Working in concert, CCIPS, the CTC Network, and the

CHIP Units create a formidable, multi-pronged approach to prosecuting intellectual

property crimes. We are already beginning to see the positive results of their efforts.

SIGNIFICANT PROSECUTORIAL ACCOMPLISHMENTS:

In the past few years we have achieved many significant prosecutorial victories

against IP pirates. I would like to take just a few minutes to highlight some of our

most recent accomplishments.

9

Operation Buccaneer:

The Computer Crime and Intellectual Property Section, working with the CHIP

Unit for the Eastern District of Virginia and the United States Customs Service,

continues to investigate and prosecute a massive international copyright piracy conspiracy code-named ‘‘Operation Buccaneer.’’ This undercover investigation culminated in the simultaneous execution of more than 70 searches worldwide in December 2001, including searches in Australia, Finland, Sweden, Norway, and the

United Kingdom. It was the largest Internet software piracy investigation and prosecution ever undertaken, and the first to reach across international borders to

achieve coordinated enforcement action against domestic and foreign targets. The

investigation targeted multiple top-tier, highly organized and sophisticated international piracy or ‘‘warez’’ groups that specialized in ‘‘cracking’’ the copyright protection on software, movie, game and music titles and distributing tens of thousands

of those titles over the Internet. I will discuss their organized criminal operations

in more detail shortly.

As a result of Operation Buccaneer, as of today, twenty U.S. defendants have been

convicted of felony copyright offenses, sixteen of those in the Eastern District of Virginia. Nine defendants have received prison sentences of between 33 to 46 months,

the longest sentences ever imposed for Internet copyright piracy. Six defendants are

awaiting trial in the United Kingdom, and I can assure you with virtual certainty

that more prosecutions will be brought in the U.S. as this investigation progresses.

In both its scope and outcome, Operation Buccaneer is the most significant Internet

piracy case ever brought, and it has sent a strong deterrent message which continues to resonate throughout the copyright piracy community.

United States v. Mynaf:

On February 13, 2003, a California man, Mohsin Mynaf was sentenced in the

Eastern District of California to 24 months in federal prison for multiple violations

relating to copyright, including Digital Millennium Copyright Act violations, criminal copyright infringement, and trafficking in counterfeit labels. Mynaf operated a

videocassette reproduction center which produced counterfeit movie videocassettes,

which he would then sell at various locations throughout California. In addition to

24 months in federal prison, Mynaf must also pay in excess of $200,000 in restitution. Three other individuals have also been convicted of aiding and abetting Mynaf

in his illegal activity and are awaiting sentencing. This case was successfully prosecuted by a CTC in the U.S. Attorneys Office in Sacramento, California.

Operation Decrypt:

On February 11, 2003, in the Central District of California, as part of a year-long

investigation known as Operation Decrypt, 17 individuals were indicted for their

roles in developing sophisticated software and hardware used to steal satellite television signals. One of the individuals has already pled guilty and admitted to being

responsible for nearly $15 million in losses to the victim companies. An additional

nine defendants have also agreed to plead guilty to various crimes as a result of

their involvement. The defendants in these cases used online chat rooms to exchange information and techniques on how to defeat the sophisticated security protections utilized by satellite entertainment companies. In October of 2002, search

warrants were executed in seven states as part of this operation. Operation Decrypt

is being prosecuted by an attorney with the CHIP Unit for the Central District of

California, located in Los Angeles.

United States v. Ke Pei Ma, et. al:

On February 26, 2003, in a joint operation between federal and local law enforcement in New York City, four arrests were made and six people were charged (two

remain fugitives) in conjunction with an investigation of the illegal distribution of

Symantec and Microsoft software. At the time of the arrests, over $9 million worth

of counterfeit software was seized from distribution centers in the New York area.

The defendants are believed to have distributed thousands of copies of counterfeit

software and received an estimated $15 million over two years in return for the pirated products. In a single two-month period, the defendants received nearly $2 million dollars as a result of their illegal activity. This case was prosecuted by attorneys in the CHIP Unit in the Eastern District of New York.

United States v. Rocci:

Beginning on February 25, 2003, the Computer Crime and Intellectual Property

Section, working with the CHIP Unit for the Eastern District of Virginia, engaged

in a ground-breaking and highly-successful public education effort as part of a conviction originally obtained in December of 2002. In December, David Rocci of Virginia, pled guilty to conspiring with others to traffic in illegal circumvention devices

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in violation of the Digital Millennium Copyright Act. Rocci was the owner and operator of the most prominent publicly-accessible web site on the Internet dedicated to

providing information about the ‘‘warez’’ scene and copyright infringement,

www.iSONEWS.com. Rocci used his web site as the exclusive medium to conduct

the illegal sale of circumvention devices known as ‘‘mod chips,’’ which defeat security protections in the Microsoft Xbox and allow unlimited play of pirated games on

the gaming console. As a condition of his guilty plea, Rocci transferred his domain

name and website to the United States. Upon taking control of the domain name

late last month, the United States replaced iSONEWS.com with a new web page

providing information about U.S. v. Rocci, as well as a general anti-piracy message

outlining the potential criminal consequences for engaging in illegal piracy. (A copy

of the website is attached to this testimony.) This case marks the first time that

the United States has assumed control of an active domain name in an intellectual

property case. In the first three days, the new law enforcement site received over

238,000 hits from Internet users worldwide. As of March 11, the two week mark,

the site received over 550,000 hits. The Department feels a strong sense of responsibility to educate the public about the need to respect intellectual property rights and

will look for additional opportunities like this to build upon successful prosecutions

of those who willfully violate those rights.

Mr. Chairman, as you can see, the Department of Justice is actively pursuing intellectual property criminals engaged in a wide array of illegal activity, and we are

doing so using all of the various statutes at our disposal. Our efforts are beginning

to pay off, and we are having success in our battle with global piracy. But we are

not resting on our laurels and are aware that there is much work to be done. We

remain committed to this effort and will build on our success by continuing to prosecute piracy aggressively.

ORGANIZED CRIMINAL ACTIVITY AND PIRACY:

As a result of cases such as those I have just mentioned, law enforcement today

has a deeper and more sophisticated understanding of piracy than it has ever had

before. Piracy is a continually evolving crime. Traditionally, piracy operations were

small, often run by individuals or a loose collection of people trying to make a quick

buck in what has been perceived to be a fairly ‘‘risk-free’’ criminal enterprise. However, in recent years, that has changed. Piracy is now big business: a world-wide,

multi-billion dollar illicit economy which robs legitimate industries and creators of

income, while driving up costs for consumers.

It is against this backdrop that criminal organizations are playing a more prominent—and dangerous—role in piracy around the globe. Organized criminal activity,

in many forms, is clearly a factor in global piracy today. Today, I will talk about

two different, yet equally troubling, types of organized criminal activity that are

emerging globally: organized on-line piracy groups and traditional organized crime

syndicates operating from Asia or Eastern Europe.

ORGANIZED ON-LINE PIRACY GROUPS:

One aspect of piracy—practically non-existent as recently as twenty years ago—

is online or Internet piracy. The Internet has changed the landscape of intellectual

property crimes in many ways. Piracy over the Internet poses significant challenges

for law enforcement. It is harder to detect than traditional means of piracy, and it

costs the pirates virtually nothing to operate, while generating countless perfect digital copies of music, movies, software and games in just a fraction of the time it

would take to generate the copies manually. Even when we successfully remove the

source of digital piracy, any copies previously distributed remain on the Internet

and can spawn a whole new generation of pirated products with little more than

a few strokes on a keyboard.

As mentioned, until recently, on-line piracy was believed to be high-return, lowrisk endeavor by many in the piracy community. Now, however, through a number

of high-profile enforcement actions, the Department is making it clear to members

of the online piracy community that their activities may have dire consequences for

them. In addition to Operation Buccaneer, attorneys from the Department, along

with the Federal Bureau of Investigation, have effectively prosecuted online pirates

in other cases, such as the ‘‘Pirates with Attitude’’ and ‘‘Fastlane’’ prosecutions in

Illinois, and two ongoing prosecutions, ‘‘Operation Bandwidth’’ in Nevada and ‘‘Operation Digital Piratez’’ in New Hampshire. We are committed to continuing to disrupt the online piracy community. The word is out: the Department of Justice will

pursue online pirates and will put them in jail.

The Department has learned a great deal about the online piracy community.

First and foremost, it is dominated by a handful of highly structured, security conVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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scious groups which exist solely to engage in piracy online. These organized criminal

groups are frequently referred to as ‘‘warez’’ groups. While warez groups are a relatively new phenomenon, they are responsible for placing a massive number of pirated movies, music, games and software into circulation each year, and represent

a significant and growing threat to intellectual property rights around the globe.

The leading international warez groups compete against each other to attain a

reputation as the fastest, highest quality, free providers of pirated computer software, including utility and application software, PC and console games, and movies.

These groups specialize in being the first to release new pirated software to the

warez community for unauthorized reproduction and distribution. The groups prosecuted as part of Operation Buccaneer were among the most notorious organized online piracy groups in the warez scene.

These criminal organizations are extremely security conscious, utilizing state-ofthe-art technology to attempt to shield their illegal activity from victim companies

and from law enforcement. They are also highly organized, structured to maximize

their manpower and technological know-how to fully and efficiently support their illegal activity.

Like legitimate companies, ‘‘top-tier’’ warez groups have clear hierarchies and divisions of labor. Rank and position within warez groups are based on a variety of

factors, including special skills, length and quality of service to the group, and reputation within the warez scene. A typical group—which can consist of people all

over the world who may know each other only through their screen names—will

consist of one or possibly two leaders, two or three high level individuals known as

‘‘Council,’’ twelve to fifteen Staff members, and a general Membership comprising

anywhere from twenty to eighty individuals. The Leader has ultimate authority over

all aspects of the group and its activities. Council members are primarily responsible for the group’s day-to-day operations, including preparation of new releases,

recruitment, and security issues. Staff members are typically the most active individuals in preparing a group’s new releases for distribution, or in maintaining the

group’s ‘‘File Transfer Protocol’’ (FTP) sites from which the pirated software is distributed. Finally, the general Members contribute to the group in a variety of ways,

including acting as occasional suppliers of new software, hosting the groups FTP

servers, or providing hardware (e.g., laptops, hard drives, routers, other computer

equipment) to other group members for use in their warez activities. The more work

someone does for the group, the higher up the organization that person will move,

and the greater the access that person will have to pirated products.

While there are countless similarities, two factors distinguish warez groups from

traditional organized crime syndicates. First, warez groups conduct their illegal operations in the cyber world as opposed to the physical world. Second, and perhaps

most startling, warez groups typically do not engage in piracy for monetary gain.

In fact, in some quarters of the warez scene, pirates who engage in ‘‘for profit’’ operations are held in contempt and criticized.

Despite the fact that warez groups typically do not profit directly, it would be a

grave mistake to dismiss their conduct as harmless or unimportant. On the contrary, warez groups pose a growing and significant threat to intellectual property

rights holders around the world. It is generally agreed that most of the pirated movies, music, games and software available on the Internet come from these high-level

warez groups. Further, they are the source for much of the pirated products which

filter their way down to less sophisticated, but more widely used, distribution mechanisms such as peer-to-peer networks. For example, a warez group dedicated to

music piracy will obtain unauthorized advance copies of songs and albums and distribute those advance copies to the warez scene. Within days, or frequently within

just a few hours, the warez music release filters down to public ‘‘Internet Relay

Chat’’ (IRC) channels and peer-to-peer networks—often weeks before its commercial

release date. The availability of MP3 files on the Internet in advance of legitimate

CD’s being made publicly available results in a direct injury to the artists and to

the recording industry.

While the pirates who steal and distribute copyrighted works do not profit monetarily, the consequences to the victim company are just as dire as if they did. For

many victim companies, particularly smaller companies whose livelihood depends

upon the success of only one or two products, irreversible damage occurs the moment the pirated digital copy hits the Internet.

Any consideration of organized crime and IP must include top-level warez release

groups. While we recognize that our efforts must address all aspects of online and

hard-good piracy, including the pursuit of those involved in the lower tiers of the

Internet distribution chain, the Department will continue to devote significant resources to pursuing warez groups.

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TRADITIONAL ORGANIZED CRIME AND INTELLECTUAL PROPERTY.

Another emerging concern is the fact that traditional organized crime syndicates

appear to be playing a dominant role in the production and distribution of certain

types of hard goods piracy, such as optical disks. This problem seems particularly

prevalent in Asia and parts of the former Soviet Union. Unlike warez groups, the

goal of these organized crime groups is to make as much money as they can.

The continued emergence of organized crime poses substantial challenges for law

enforcement. Highly organized criminal syndicates frequently have significant resources to devote to their illegal operations, thus increasing the scope and sophistication of their criminal activity. Further, by nature, these syndicates control international distribution channels which allow them to move massive quantities of pirated goods, as well as other illicit goods, throughout the world.

As one might expect, these groups do not hesitate to threaten or injure those who

attempt to interfere with their illegal operations. Industry representatives in Asia

report that they have been threatened and their property has been vandalized by

members of these syndicates when their anti-piracy efforts strike too near the illegal

operation. Government officials have also been threatened. These criminal syndicates are a formidable foe, but one that must be dealt with to truly attack the

problem of intellectual property theft.

Throughout Asia, organized crime groups operate assembly lines and factories

that generate literally millions of pirated optical discs. These groups pirate a full

range of products ranging from music to software to movies to video games. Anything that can be reproduced onto an optical disk and sold around the globe is available. There is also anecdotal evidence that syndicates are moving their production

operations onto boats sitting in international waters to avoid law enforcement.

Recently, an attorney from the Computer Crime and Intellectual Property Section

visited Kuala Lumpur, Malaysia to conduct law enforcement training for Malaysian

prosecutors and agents. According to Malaysian officials with whom he spoke, many,

if not most, of the optical disk production facilities in Malaysia are owned and operated by organized crime syndicates, specifically very wealthy and powerful criminal

gangs or ‘‘triads’’ from Taiwan which control a significant number of facilities not

just in Malaysia but across Asia generally.

The reach of organized crime appears to extend beyond the production of optical

disks into the distribution chain. While in Malaysia, that same CCIPS attorney visited an open air market, similar to ones found in large cities around the world,

which offered a myriad of pirated products. While touring the market, our attorney

learned that many vendors offer their goods on tables covered in brightly colored

cloths which indicate that vendors affiliation with a specific criminal syndicate. One

vendor may use a red cloth to show his affiliation with one criminal gang, while

his neighbor offers his wares on a blue cloth signifying his affiliation with another

criminal gang.

Of course, this problem is not limited to Malaysia, but occurs in other parts of

the world such as in parts of the former Soviet Union. Additionally, many organized

piracy groups from Asia use South America, most notably Paraguay, as a transshipment point for pirated products. Industry groups have reported that organized

crime from Taiwan and other parts of the world control much of the distribution

of optical disks into Latin America through Ciudad del Este.

It is also true that the pirated goods produced by organized crime syndicates enter

into and are distributed throughout the United States. There is ample evidence, for

example, that Taiwanese triad members import into the United States massive

amounts of counterfeit software and other counterfeit products, such as ‘‘remarked’’

computer chips. The reach of these organized crime operations is undeniably global

in scope.

Of course, developing more and better intelligence about these organized crime

groups and their operations is just the first step in what will be a long and potentially difficult process of targeting this type of activity. Because most of these syndicates operate outside the United States, we must rely on foreign governments for

much of the enforcement efforts in this area. The importance of international cooperation cannot be overstated. If a government lacks the will or the expertise to

enforce IP laws, organized crime will continue to proliferate with impunity. Even

in countries that have the will and expertise to fight back, a lack of investigative

resources, inadequate laws, a judicial system that will not impose serious sentences,

or corruption can grind IP enforcement to a halt.

The Department of Justice is committed to being a constructive part of the United

States government’s international IP outreach efforts. In particular, we are focusing

our resources on those foreign nations which face surmountable difficulties in the

investigation and prosecution of IP crimes. We are pleased to be working with other

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United States agencies, such as the Patent and Trademark Office, the State Department and the U.S. Trade Representative, to ensure that foreign nations are committed to building sound and lasting IP enforcement regimes.

The Justice Department will continue to work closely with investigative agencies,

especially the Federal Bureau of Investigations and the United States Customs

Service, to develop additional intelligence sources and information in order to enhance our ability to respond to the growing threat of organized crime from Asia and

other parts of the world. This is a serious and emerging threat that victimizes

American rights holders, costs companies hundreds of millions of dollars, and damages our nation’s economy. There is no easy solution. The task at hand requires a

concerted effort on the part of industry, government and law enforcement. The Department stands ready to do its part.

TERRORISM AND PIRACY

Finally, Mr. Chairman, I want to close by briefly discussing terrorism. Earlier I

noted that organized crime syndicates are frequently engaged in many types of illicit enterprises, including supporting terrorist activities. On this point, I want to

be crystal clear. Stopping terrorism is the single highest priority of the Department

of Justice. We are constantly examining possible links between traditional crimes

and terrorism, and we will continue to do so. All components of the Justice Department, including CCIPS, the Counterterrorism Section, and the Organized Crime and

Racketeering Section, will do everything within their power to make sure that intellectual property piracy does not become a vehicle for financing or supporting acts

of terror.

CONCLUSION

On behalf of the Department of Justice, I want to thank you again for inviting

me to testify today. We thank you for your support over the years and reaffirm our

commitment to continuing to work with Congress to address the significant problem

of piracy. I will be happy to answer any questions that you might have.

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Mr. SMITH. Okay. Thank you, Mr. Malcolm.

Mr. LaMagna.

STATEMENT OF RICH LAMAGNA, SENIOR MANAGER—

WORLDWIDE INVESTIGATIONS, MICROSOFT

Mr. LAMAGNA. Mr. Chairman and Members of the Subcommittee, thank you for the opportunity to testify on this important topic. Let me assure you it will not be in Cantonese or Mandarin. [Laughter.]

Mr. LAMAGNA. My testimony will focus on software counterfeiting, the manufacture and sale of pirated CD-ROMs and physical

components. This sophisticated form of piracy is dominated by organized criminal enterprises that produce billions of dollars in

counterfeit software.

For most of its history, the software industry has battled against

piracy. Despite these efforts, software piracy remains a serious

problem throughout the world, accounting for one quarter of the

software used in the United States and 40 percent of the software

used worldwide. In some regions, piracy rates approach 90 percent.

Our industry loses almost $11 billion each year from software

counterfeiting and other forms of piracy. Annual seizures of counterfeit Microsoft products exceed $1.7 billion. Over the next 5

years, software piracy will cost the U.S. economy more than

175,000 jobs and $1.6 billion in tax revenues.

Software counterfeiters go to great lengths to make pirated software look genuine in an effort to deceive the consumer and maximize illicit profits. Here is an example of counterfeit Office ’97.

Even the most sophisticated consumer would have great difficulty

in distinguishing it from the genuine product.

Software counterfeiters use state-of-the-art technology to manufacture counterfeit CD-ROMs, components, and packaging. For

many years, Microsoft has worked to outpace counterfeiters by developing physical security features that help consumers and law

enforcement agencies distinguish legitimate software from sophisticated counterfeits.

For example, Microsoft’s certificate of authenticity incorporates

several proprietary technologies, including special inks and micro

text. Because these physical security features are increasingly difficult to reproduce, counterfeiters are now combining pirated CDROMs and packaging with genuine security features obtained

through theft or fraud.

More than 500,000 genuine certificates have been stolen in the

U.S. and Europe recently. The stolen certificates are sold to counterfeiters through a variety of distribution channels.

Currently, Federal law does not prohibit trafficking in genuine

physical security features. This loophole discourages law enforcement from investigating and prosecuting persons who facilitate

counterfeiting by trafficking in genuine physical security features.

Mr. Chairman, we look forward to working with you and the

Subcommittee to address this matter. Having spent much of my career fighting drug traffickers, I am struck by the similarities between the illegal drug trade and counterfeiting, which is equally

profitable but involves much less risk.

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Like drug trafficking, software counterfeiting operations consist

of global networks of well-financed and sophisticated criminal enterprises. In the United States, Microsoft and other intellectual

property owners have worked closely with Congress and Federal

authorities to ensure that counterfeiting laws, enforcement, and

penalties keep pace with counterfeiting crimes.

In addition, Microsoft’s investigative team has worked closely

with Federal and local law enforcement to bring about several important counterfeiting seizures, particularly in California, a major

distribution center for counterfeit software.

In late 2001, the U.S. Customs Service, aided by a State and

local task force and Microsoft investigators, seized $100 million in

counterfeit software, Microsoft and other products—the largest seizure in software history.

Working closely with Taiwan authorities, Customs uncovered a

major international counterfeiting network, financed by criminal

enterprises in Asia. This raid demonstrates the critical importance

of close multilateral cooperation between industry and law enforcement.

Unfortunately, few foreign law enforcement agencies share a

strong commitment to anti-counterfeiting enforcement. As a result,

the foreign criminals that finance and control worldwide counterfeiting operations are rarely prosecuted or punished.

All governments must recognize that software counterfeiting is a

serious crime that demands the same level of commitment and cooperation that we bring to other global organized crime activities.

We encourage the Federal Government to send a clear message to

foreign authorities that software counterfeiting is a major crime

priority that demands tough penalties, a sustained commitment of

resources, and multilateral cooperation among government agencies and industry.

Thank you.

[The prepared statement of Mr. LaMagna follows:]

PREPARED STATEMENT OF RICHARD C. LAMAGNA

Mr. Chairman, members of the Subcommittee, thank you for the opportunity to

testify on this important topic. My name is Rich LaMagna, and I am Senior Manager of Worldwide Anti-Piracy Investigations at Microsoft Corporation. I joined

Microsoft in 1999 after a 28-year career as a Special Agent with the DEA and the

FBI investigating international drug trafficking organizations. My testimony this

morning will focus on software counterfeiting—the illegal manufacture and sale of

pirate CD-ROMs, packaging, and other physical components. This particularly sophisticated form of piracy is increasingly dominated by international organized

crime groups that produce billions of dollars in counterfeit software each year.

I. THE SCOPE AND IMPACT OF SOFTWARE COUNTERFEITING

A. Economic Contribution of the Commercial Software Industry

Over the past 25 years, computer software has fundamentally reshaped every

facet of our lives and helped secure this country’s economic leadership. By the late

1990s, the software industry employed more than 800,000 U.S. workers with aggregate wages of $55.6 billion. By the year 2008, the software industry is expected to

employ more than 1.3 million workers in the United States alone.

Annually, the software industry contributes more than $28 billion in tax revenues

to federal and state governments, benefiting a host of national and community programs. This tax contribution is expected to reach $50 billion by the year 2008. Also

significant is the industry’s contribution to the U.S. balance of payments. While the

U.S. trade deficit reached new record highs in 2000, the U.S. software industry genVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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erated a trade surplus of more than $20 billion. The software industry’s growing

trade surplus means more jobs and tax revenues for the U.S. economy.

The success of the U.S. software industry is due in large part to this country’s historical commitment to strong intellectual property protection. It is no coincidence

that the United States—the world’s leading advocate for intellectual property

rights—is also home to the world’s largest software industry. The software industry’s continued growth and economic contributions are directly dependent on our

ability as an industry and a nation to eliminate software theft.

B. Economic Impact of Software Piracy and Counterfeiting

For almost fifteen years, the software industry has battled against software theft,

recognizing that widespread piracy threatens the very existence of our industry. Despite these efforts, software piracy remains a serious problem throughout the world,

accounting for one-quarter of the software used in the United States, and 40 percent

of the software used worldwide. In parts of Asia and the former Soviet Republic,

piracy rates approach 90 percent, virtually eliminating sales of legitimate software.

The software industry loses almost $11 billion each year from counterfeiting and

other forms of software piracy. Annual seizures of counterfeit Microsoft products exceed $1.7 billion. These revenue losses directly translate into lost jobs and opportunities for the U.S. economy. By the late 1990’s, software piracy had cost the U.S.

economy more than 109,000 jobs and almost 1 billion in tax revenues; by 2008, piracy-related losses will nearly double, accounting for 175,000 lost jobs and $1.6 billion in lost tax revenues.

II. TRENDS IN SOFTWARE COUNTERFEITING OPERATIONS

Unlike the cheap fakes sold on street corners, counterfeit software is typically

marketed as genuine product to unsuspecting consumers who would never knowingly purchase illegal products. To create the look of genuine packaged software,

counterfeiters use state-of-the-art technology to create near-perfect copies of Microsoft CD-ROMs, packaging, documentation and other components. Because counterfeiters bear none of the R&D, marketing or support costs that determine the price

of legitimate software, these criminal operations are able to reap enormous profits

from the sale of counterfeits.

A. Trafficking in Physical Anti-counterfeiting Features

For many years, Microsoft has worked to outpace counterfeiting technology by developing physical product features that help consumers and law enforcement agencies distinguish legitimate software from sophisticated counterfeits, much in the

same way the US Government authenticates its paper currency. For example,

Microsoft packaging has for many years included a certificate of authenticity

(‘‘COA’’) that incorporates special inks, holograms and micro-text. Microsoft has invested several millions of dollars to develop an edge-to-edge hologram that covers

the entire surface of the CD-ROM. (Examples of these features are included in Attachment to this testimony.) The edge-to-edge hologram involves a highly sophisticated, proprietary technology that is etched into recent versions of Microsoft Office.

Because these physical anti-counterfeiting features are increasingly difficult to reproduce, counterfeiters are now combining pirate CD-ROMs and packaging with

genuine components obtained through theft or fraud. In recent years, more than 100

robberies of authorized replicators in the US and Europe have netted 540,000 Microsoft COAs with an estimated value of $50 million. According to our sources, genuine

COAs, end user manuals, end user license agreements and other physical components are in high demand among counterfeiters because they significantly increase

the marketability and selling price of counterfeit software.

So far, counterfeiters have found it impossible to replicate the edge-to-edge technology. As an alternative, they have developed holographic stickers that, when attached to the CD-ROM, closely resemble the look of the edge-to-edge hologram. Recent versions of these fake stickers found in Asia are of such high quality, few consumers would be able to detect the counterfeit.

B. Proposed Clarification to Federal Anti-counterfeiting Law

Currently, federal law prohibits trafficking in counterfeit software and ‘‘counterfeit labels,’’ but does not provide adequate civil and criminal remedies to combat the

sale of genuine physical components or the combination of stolen components with

counterfeit CD-ROMs and packaging. Moreover, it is unclear whether prohibitions

against counterfeit labels would cover counterfeit edge-to-edge holograms or COAs.

This loophole in existing federal law makes it very difficult for prosecutors to target

those criminals who clearly facilitate counterfeit sales by trafficking in genuine or

counterfeit physical anti-counterfeiting features.

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Mr. Chairman, we thank you for your leadership last year in introducing a clarification to federal anti-counterfeiting law that would close this loophole. We look forward to the opportunity to work with you and the Subcommittee to address this

matter.

III. INVOLVEMENT OF ORGANIZED CRIME

The production and distribution of high quality counterfeit software require a

high level of planning, funding and organization; and access to replicating equipment, raw materials, packaging, shipping facilities, and money laundering avenues.

Because of the enormous opportunities for profits and the low risk of prosecution

or significant punishment, software counterfeiting has become part of an intricate

web of international organized crime. Although crime groups based in Asia produce

the largest quantity of sophisticated counterfeits, manufacturing and distribution

centers exist throughout the world. In fact, California is a major entry and assembly

point for counterfeit software CD-ROMs and components.

The federal government explicitly acknowledged the growing involvement of organized crime when it created a new ‘‘Intellectual Property Rights Initiative’’ in 1999

to strengthen enforcement against intellectual property crime. At a congressional

hearing, former Customs Commissioner Ray Kelly stated that—

Our investigations have shown that organized criminal groups are heavily involved in trademark counterfeiting and copyright piracy. They often use the proceeds obtained from these illicit activities to finance other, more violent crimes.

These groups have operated with relative impunity. They have little fear of being

caught—for good reason. If apprehended, they face minimal punishment. We

must make them pay a heavier price.

Global counterfeiting flourishes because counterfeiters face little risk of prosecution or meaningful punishment. In the United States, Microsoft and other intellectual property owners have worked closely with Congress and Federal authorities to

ensure that counterfeiting laws, enforcement, and penalties keep pace with counterfeiting crimes. In recent years, these efforts have led to important reforms, including

improved sentencing guidelines for intellectual property crime, increased appropriations for IP-related law enforcement activities, and the creation of the FBI Cyber

Division.

In addition, Microsoft invests millions of dollars each year to assist law enforcement in investigating criminal counterfeiting operations. Microsoft’s worldwide antipiracy team consists of more than 100 attorneys, forensic experts, and in-house and

outside investigators, who work closely with law enforcement agencies in this country and throughout the world to investigate and prosecute international networks

of criminal counterfeiters. In the United States, Microsoft’s investigative team has

worked closely with Federal and local law enforcement to bring about important

counterfeiting seizures, a number of which involved organized crime:

• In February 2000, the FBI and LA Sheriff’s Office led 12 raids against suspected criminal counterfeiters, resulting in the arrest of 12 individuals. Law

enforcement officials seized several thousand counterfeit copies of Microsoft

software, worth more than $5 million. The persons arrested were part of a

well-organized international counterfeiting operation, with ties to organized

crime groups based in Asia.

• In November 2001, the LA Sheriff’s office, aided by U.S. Customs, the Secret

Service and Microsoft investigators, executed the most significant raid and

seizure of Microsoft software and components in U.S. history, with an estimated retail value of $100 million. The raid interrupted a major counterfeit

software distribution pipeline that moved containers of counterfeit software

and other illegal components from Taiwan through the Port of Los Angeles.

Taiwan authorities later confirmed that the counterfeiting operation was financed by criminal groups based in Asia.

• In April 2002, the FBI and several other federal and local law enforcement

agencies dismantled a highly organized international counterfeiting ring, with

assembly and distribution arms in Northern California, Washington and Oregon and direct ties to Asia-based criminal groups. The undercover investigation, known as ‘‘Operation Cyberstorm,’’ led to the arrest of 27 individuals

and the seizure of approximately $10 million in counterfeit software and components. The counterfeiters were also involved in money laundering and credit card fraud.

These cases demonstrate the critical importance of close, multilateral cooperation

between industry and law enforcement. For example, in the 2001 raid described

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above, Taiwan authorities worked closely with US law enforcement and Microsoft

to investigate and prosecute the leaders of the operation based in Asia. Unfortunately, few foreign law enforcement agencies share this commitment to anti-counterfeiting enforcement; and, as a result, the foreign criminals that finance and control

worldwide counterfeiting operations are rarely prosecuted or punished.

In closing, we face a daunting challenge. How can we successfully fight a wellfinanced, global network of counterfeiting rings, when the criminals who control

these operations bear little risk of prosecution and meaningful punishment outside

the United States? Clearly, we cannot succeed, until all governments recognize that

software counterfeiting is a serious crime that demands the same level of enforcement and cooperation that we bring to other global organized crime activities. We

encourage Federal law enforcement agencies to join together in sending a clear, unified, and unequivocal message to foreign authorities that software counterfeiting is

a major crime priority that demands tough penalties, a sustained commitment of

law enforcement resources, and multilateral cooperation among national authorities

and industry.

Thank you.

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Mr. SMITH. Thank you, Mr. LaMagna.

Mr. Valenti.

STATEMENT OF JACK VALENTI, PRESIDENT AND CHIEF EXECUTIVE OFFICER, MOTION PICTURE ASSOCIATION OF AMERICA (MPAA)

Mr. VALENTI. Thank you, Mr. Chairman, Mr. Berman, and Members of the Committee.

Before I begin, I want to introduce a gifted young independent

filmmaker from Britain, whose blockbuster film, ‘‘Bend It Like

Beckham,’’ is proving very popular in Europe. But, alas, it’s been

hijacked all over the world, and here it is avalanching this country.

And guess what? Her film doesn’t come out yet in the United

States for another week.

Ms. Gurinder Chadha. Stand up. I want them to see you.

Because in the words of Peter Finch in the movie ‘‘Network,’’

she’s mad as hell, and she’s not going to take it anymore. [Laughter.]

Mr. SMITH. Thank you for being here.

Mr. VALENTI. Let me do my little show and tell. Hope you can

see the screen over there. Beginning in 1998, Mr. Chairman, we

had zero seizures of counterfeit DVDs in this country. And now,

you can see in the year 2002 over 7 million.

Now here is a major trading and piracy. A major motion picture

was released in the United States November the 22nd last year.

Two days before, in a press screening, it was camcorded and then

ran like a wire through all of Asia and Malaysia, Indonesia, Thailand, Beijing, Hong Kong, and so forth. And by the time this picture opened, it had been stolen all over the world.

The major centers of DVD counterfeit production are Malaysia,

Thailand, Taiwan, China, Philippines, and now Russia. Now here’s

a map of Russia. There are about 26 pirate factories in Russia, and

guess what? Six of them are on land owned by the Russian government.

They’re now beginning—it moved over and avalanched Central

and Eastern Europe and now are invading the European Union,

which is the largest international market for our movie.

This next slide shows you how ingenious these dudes are all over

the world. These are criminal elements. A raid of a DVD factory

revealed an underground tunnel, where a meter-wide little electric

car transported the counterfeit DVDs from their factories into a

house several hundred yards away.

Our surveillance team thought it was mighty strange that no

material was being shipped out of the factory until we did a raid.

The enforcement team broke through the roof and then rappelled

down in the place before they could destroy the evidence and found

this underground tunnel.

As you can see in this next slide how ingenious they are and how

much money they spend to do this because it’s much more profitable being in the pirating business today than in the drug trade.

Much less risk, as Mr. Malcolm and this Microsoft executive pointed out. You can make a lot more money with a lot less risk than

being in drugs.

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Next slide is a—this is very ingenious. This is a submersible

barge. It’s a submarine barge. It has no propulsion. Fishing boats—

when it gets underwater, fishing boats tow it. And if somebody

wants to raid the fishing boat, they immediately cut the line to the

submersible barge and then locate it by GPS positioning. So they

can go back later and pick it up.

This next slide shows you what’s in that damned barge—174,000

counterfeit DVDs were found when we made this raid. They have

very ingenious methods of smuggling. Shipping containers, cars

with hidden compartments, stacks of DVDs in bags of asphalt, concealed cavities in stacks of cardboard. You name it, they do it.

Now this looks like an innocent—next slide is an innocent, pristine, pure little blank DVD. But guess what, you pull back the

cover, and underneath, you have a pirated DVD. The DVDs go

from—they’re using DHL and FedEx. And by the way, both of

those express services have been cooperating fully with us.

We found in one raid that we found 418 parcels, and you can believe this, and we had 10,000 pirated DVDs in there. Now these

DVDs will go all over the world, but mainly to Australia, the Middle East, Europe, and the United States. And that’s pretty much

all over the world.

And finally, piracy and guns go hand in hand. This is an organized crime enterprise, Mr. Chairman. This is a sniper rifle, M–16,

heavy weapons, as well as cocaine was there. Wherever we go, we

find this connection.

The Customs Service, in their bulletin of November 2, 2002, said

there was a definite connection between organized crime and terrorists. This is where the connection is. A lot of terrorists are being

funded by this illegal merchandise.

I think Attorney General Malcolm has been absolutely wonderful

and sturdy in making sure that in this country we are really on

top of these and making it clear that this is going to be a high-risk,

low-reward business. But, alas, that’s not so abroad.

I hope these remarks charm you greatly, but I think I’ll stop at

this point. Thank you, sir.

[The prepared statement of Mr. Valenti follows:]

PREPARED STATEMENT OF JACK VALENTI

America’s crown jewels—its intellectual property—are being looted. Organized,

violent, international criminal groups are getting rich from the high gain/low risk

business of stealing America’s copyrighted works. We don’t know to what end the

profits from these criminal enterprises are put. US industry alone will never have

the tools to penetrate these groups or to trace the nefarious paths to which those

profits are put. For these reasons it is entirely suitable and necessary that the Subcommittee on Courts, the Internet and Intellectual Property of the House of Representative’s Committee on the Judiciary hold this hearing and illuminate the nature of the problems and the effect on the copyright industries (consisting of movies,

TV programs, home videos, books, music, computer games and software).

THE ECONOMIC WORTH OF THE COPYRIGHT INDUSTRIES

The copyright industries were responsible in 2001 for some five percent of the

GDP of the nation. Over the past quarter century, these industries’ share of GDP

grew more than twice as fast as the remainder of the economy. They earn more

international revenues than automobiles and auto parts, more than aircraft, more

than agriculture. The copyright industries are creating new jobs at three times the

rate of the rest of the economy. The movie industry alone has a surplus balance of

trade with every single country in the world. No other American industry can make

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that statement. And all this comes at a time when the U.S. is suffering from some

$400 billion in trade deficits.

DIGITAL PIRACY: THE DELIVERY DREAM, THE PIRACY NIGHTMARE

It would be a serious mistake to take our past successes for granted. While piracy

has been a sad fact illuminating our lives since the blossoming of the home video

entertainment business a quarter century ago, the forms of digital piracy we now

face raise serious, new challenges that we need your help in addressing.

I must admit, with all appropriate modesty, that we had become fairly good at

combating the old forms of analog video tape piracy. With the help of our government and international trade agreements, such as the World Trade Organization’s Agreement on Trade Related Intellectual Property, most countries have adopted

modern copyright laws. We had been seeing declining loss rates in many of the traditional centers of piracy. Despite our successes, we were losing close to $3 billion

dollars a year.

And then the world changed. Digital technologies, which offer so much in terms

of enhanced clarity of image and sound, and exciting new ways to deliver high quality entertainment directly to people’s homes, also gave birth to serious new forms

of piracy.

By now, I presume that all of you have heard of our concerns about Internet piracy—and I assure you, that dialogue will continue. The mysterious magic of being

able, with a simple click of a mouse, to send a full-length movie hurtling with the

speed of light to any part of the planet, is a marketing dream and an anti-piracy

nightmare. Ask the music industry how Internet piracy can devastate an industry’s bottom line. As computer modem speeds accelerate and broadband access spreads

across the United States and around the world, more people are gaining the ability

to download full length motion pictures quickly. The threat to the motion picture

industry from Internet piracy is growing.

Internet piracy is not the only digital threat we face. Today, I’d like to focus on

another form of digital piracy—widespread piracy of optical discs—CDs, Video CDs,

DVDs, and recordable versions like CD-Rs and DVD-Rs. The piracy of DVDs and

other optical media products is dominated by organized crime and increasingly

threatens our international markets, which account for 40 percent of revenues

earned by the filmed entertainment industry. Indeed, all industries that rely on intellectual property protection, including the music and video game industries, are

facing huge losses from optical disc piracy, especially in international markets.

Microsoft products are another favorite target for the pirates.

The motion picture industry seized over 7 million pirate DVDs worldwide last

year. DVD piracy didn’t exist for our industry as recently as 1999.

‘‘DIE ANOTHER DAY:’’ AN EXAMPLE OF PIRATES IN ACTION

The damage from pirated DVDs is enormous. DVD piracy erodes our home video

revenues, but also corrodes revenues from our international theatrical business. Pirate DVDs often enter the market months before the release of legitimate DVDs— often before a movie is released into the theaters. Let me give you just one example.

MGM’s latest James Bond film, Die Another Day, was released theatrically in major

cinemas in the United States on November 22. The first pirate copy, camcorded

from a press screening in the United States, showed up in pirated DVD format in

Malaysia on November 21. By the 28th, only six days after its US theatrical release,

every major market in Asia was already infected with pirate copies of Die Another

Day. In Taiwan, theatrical release wasn’t scheduled until February 1 to coincide

with Chinese New Years holidays—normally a big period for cinema sales in that

part of the world. The pirates had nine full weeks to sell our products in pirated

form before the film was legitimately released in theaters.

A SNAPSHOT OF OPTICAL DISC PIRACY AROUND THE WORLD

The problem of large-scale pirate optical disc production began in China in the

mid-90s. When China cut off the export of piratical discs in the late 1990s, the pirates packed up their equipment and relocated to more hospitable areas where enforcement was lax or absent. Now we are seeing major problems with DVD production in Malaysia, Thailand, Taiwan, Philippines, and Indonesia. Pakistan, Bangladesh, Ukraine, and elsewhere in Central Europe are host to factories replicating

pirate copies of music CDs. The music industry’s problems today are always a danger sign for us, since pirates often start with music and then move on to movies,

video games and other products.

In the past year, we have also witnessed a major surge of large-scale factory production of DVDs in Russia. Today there are at least 26 optical plants in Russia, inVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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cluding at least five that specialize in the production of DVDs. The number and

overall capacity of these plants has more than doubled in the past two years. Nine

of these plants are located on property owned by the Russian Government.

Pirate DVDs have devastated the local market in Russia. Pirate DVDs have so

saturated the Russian market that the pirates have resorted to selling them on the

streets by the kilo. Pirate DVDs are sold everywhere—at street markets, in kiosks,

in retail stores and over the Internet.

Those 26 plants in Russia currently have capacity to replicate about 300 million

DVDs and CDs a year; legitimate demand in Russia is approximately 18 million

units. This excess capacity points to the fact that the Russian pirates are targeting

export markets—OUR export markets. Piracy in Russia poses a major threat to revenues across Europe. In 2002 MPA’s anti-piracy operations seized pirate Russian

DVDs in markets across Central and Eastern Europe. In July a raid at a retail market in Poland turned up over 4000 copies of pirate discs from Russia. Those discs

contained 15 different language tracks—from Finnish and Swedish to Greek and

Turkish, Dutch, Danish, to Indian and Arabic. If bold actions aren’t taken quickly

to shut down this piracy, American sales of copyrighted works to Western Europe— our most lucrative market in the world—will be demolished by these pirated imports from Russia. The time to act is now before these criminals further build out

their distribution networks and alliances throughout Central and Western Europe.

Even before large-scale factory production has been brought under control, we are

now seeing the rapid growth of local burning of movies and other forms of copyrighted content onto blank recordable media—CD-Rs and DVD-Rs. This kind of piracy is more dispersed geographically, since the piracy takes place in medium to

small ‘‘labs’’ with banks of CD burners, but is often still highly organized. The retail

markets in Taiwan are filled with this kind of pirate product; not coincidentally,

Taiwan is one of the world’s largest producers and exporters of blank optical discs,

fueling this problem around the world.

THE ORGANIZED CRIME CONNECTION

Several U.S. government agencies are bringing attention to the link between organized crime and copyright piracy. The Federal Bureau of Investigation’s website

home page states the following:

‘‘Unlike criminals who engage in other types of criminal activity, those who commit IP crimes can not easily be categorized. Counterfeiters, software pirates, and

trade secret thieves are as different as the intellectual property they counterfeit,

steal, and sell. In general, software pirates have an acute interest in computers

and by extension, the Internet. Many counterfeiters hail from foreign countries,

such as South Korea, Vietnam, or Russia. They are frequently organized in a

loosely knit network of importers and distributors who use connections in China,

Southeast Asia, or Latin America to have their counterfeit and imitation products made inexpensively by grossly underpaid laborers. There is also strong evidence that organized criminal groups have moved into IP crime and that they

are using the profits generated from these crimes to facilitate other illegal activities. There are a number of reasons for the dramatic increase in IP crime in recent years. First, many forms of IP can be produced with minimal start-up costs

making IP crimes accessible to large numbers of people; second international enforcement of IP laws is virtually nonexistent; and finally, domestic enforcement

of IP laws has been inadequate and consequently the level of deterrence has been

inadequate.’’

The link between piracy and organized crime has been widely accepted by the European Commission, which recently organized a forum to address the prevention of

organized crime and included a discussion of piracy and counterfeiting. Interpol has

also acknowledged the link with organized crime and established the Interpol Intellectual Property Crime Action Group. Many national enforcement authorities, from

the United Kingdom to Australia have recognized that piracy and organized crime

go hand in hand.

The Secretary of State for Northern Ireland, the Rt. Hon. Dr. John REID, last

year announced the Serious & Organised Crime Threat Assessment & Strategy. He

identified as immediate priority areas of criminality: (1) Armed Robbery; (2) Counterfeit Goods—Intellectual Property Crime; (3) Tobacco and fuel smuggling; and (4)

Drug Dealing.

CASE EXAMPLES OF ORGANIZED CRIME

Pirate factories go to great lengths to conceal and harden their operations. One

raid in October 2001, near Bangkok, revealed an underground tunnel linking a facVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
27

tory to a residential house. Pirate products were moved out of the factory on a

meter-wide, specially installed electric rail system that ended under the kitchen

sink of a near-by home. The products were trucked away from the back of the house,

effectively hiding the movement of pirated goods out of the factory.

The pirates employ sophisticated security systems, such as hardened front doors

and surveillance cameras, to delay entry by enforcement officials into the factories.

These security devices give the pirates the 10–15 minutes they need to destroy the

evidence of their crimes in vats of acid kept specifically for this purpose. Local police

have been forced to adopt equally sophisticated responses. In the raid on a factory

in Thailand the police, accompanied by our anti-piracy enforcement team, broke

through the roof of the factory and rappelled down ropes in order to maintain the

element of surprise.

SOPHISTICATED SMUGGLING

The pirates also use highly sophisticated smuggling methods. Macau Marine Police, working with Hong Kong Customs, intercepted two submerged, un-powered,

purpose-built ‘‘submarines’’ in two, separate raids in April and May 1999. These

submarines were towed behind fishing boats and had ballast and compressed air

tanks that enabled the sub to be raised and lowered. If enforcement officials intercepted the fishing vessel, the tow line could be cut, the barge’s location marked with

GPS positioning, and later recovered when the coast was clear. In these cases, however, the authorities, relying on sophisticated intelligence, knew what they were

looking for and were able to recover 174,000 pirate optical discs in one seizure and

73,000 in the second. These cases demonstrate the scale and level of sophistication

that criminal syndicates employ to evade detection. Traditionally, such methods

have been reserved for the smuggling of drugs and other contraband, including firearms.

Pirates use other ingenious methods to smuggle their products. The International

Federation of the Phonographic Industries, in a raid with Polish Customs last year,

intercepted a car suspected of transporting pirate CDs from Russia. When the authorities removed the car’s fender, they found a hidden compartment full of pirated

CDs. MPA has found hidden compartments in shipping containers, stacks of DVDs

concealed in bags of asphalt, and ingenious concealed cavities in what appeared to

be stacks of flattened cardboard boxes.

Sometimes the pirates try to ship pirated products by disguising them as legal

products. A law enforcement official in Australia thought he had a shipment of

blank DVDs—until he pealed back the label on one of the copies—and uncovered

a shipment of pirated copies of the film ‘‘Ali.’’

With the cooperation of major express mail delivery services, we have made

progress in cutting down the shipment of pirated DVDs from Malaysia. In a major

raid last July in Penang, Malaysia, we discovered 418 separate parcels containing

about 10,000 pirate DVDS destined for Australia, the Middle East, Europe and even

the United States.

VIOLENCE AND INTIMIDATION

Pirates also employ violence and intimidation. A raid on a street market in Malaysia last summer turned into a riot. A vehicle driven by the pirates rammed the

van transporting the Malaysian enforcement officials and MPA’s anti-piracy investigators to the raid. Bat wielding pirates attacked the enforcement team. Only after

the Malaysian enforcement officials fired their weapons into the air did the crowd

disperse.

Pirates have directly threatened Government leaders. Last year, the President of

the Municipal Council in a city in Malaysia received a personal death threat along

with a threat that his daughter would be raped if the crackdown on illegal VCD

traders continued. The Minister of Domestic Trade and Consumer Affairs in Malaysia also received a personal death threat.

In the Netherlands two years ago, our local program helped smash a sophisticated

and violent criminal organization that was distributing compilation pirate optical

discs under the HiteXplosion and MovieBox labels. The discs contained monthly

compilations of interactive games, movies and music. Two of the pirates had organized the torture of two associates for under-reporting their sales of pirated CDs

and DVDs. The two were subsequently sentenced to four and a half year prison

terms on charges of extortion and accessory to kidnapping and attempted assault.

In the UK, there is increasing evidence that Chinese crime gangs control much

of the pirate DVD business in London and the South East. Illegal immigrants have,

it appears, been pressed into selling pirate DVDs by Chinese human traffickers

(known as Snakeheads) to pay off family debts to the gangs.

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GOVERNMENTS NOTE LINKS TO TERRORISM

Mr. Chairman, let me commend to your attention an article by Kathleen Millar

in the November 2002 issue of U.S. Customs Today entitled ‘‘Financing Terror: Profits from Counterfeit Goods Pay for Attacks.’’ With your permission, I would like to

enter this article into the record. The article outlines the ‘‘close connections between

transnational crime and terrorism.’’ It states that the participants at the 1st International Conference on IPR hosted by Interpol in Lyon, France in 2001 ‘‘all agreed

the evidence was indisputable: a lucrative trafficking in counterfeit and pirate products—music, movies, seed patents, software, tee-shirts, Nikes, knock-off CDs and

‘fake drugs’ accounts for much of the money the international terrorist network depends on to feed its operations.’’ The article concludes that ‘‘The new link between

commercial-scale piracy and counterfeiting has redirected public attention in 2002,

and law enforcement agencies like Customs and Interpol are going after the organized crime syndicates in charge of what was too often viewed as a ‘victimless

crime.’ September 11 changed the way Americans look at the world. It also changed

the way American law enforcement looks at Intellectual Property crimes.’’

The Police Service of Northern Ireland’s (PSNI) Anti-Counterfeiting and Racketeering Unit also reports that paramilitary organizations in Northern Ireland regard

counterfeiting as their preferred fund-raising option. According to the PSNI, these

paramilitary groups last year made specific threats against officers involved in antipiracy raids at Newtownards Market after PSNI officers had seized over £50,000

worth of counterfeit goods, including DVDs.

AN APPEAL FOR ASSISTANCE

To deal with this kind of organized crime, MPAA and our fellow copyright associations, need the help of governments—both here and abroad. It is simply not possible

for a private sector organization to penetrate this kind of organized, criminal endeavor without the help of governments. Governments need to dedicate the same

kinds of legal tools to fighting piracy that they bring to other kinds of organized

crime: money laundering statutes, surveillance techniques, and organized crime

laws.

We also need your help to let foreign government officials whom you meet here

or when you are abroad, know that inaction is not an option in the fight against

piracy. The continued vitality of the copyright industries, one of America’s signature

industries, is at stake.

We need our enforcement agencies to help train and work with foreign enforcement agencies to stem the flow of piracy across borders.

We also need the continued assistance of all the agencies that make up the ‘‘country team’’ at American embassies abroad. Ambassadors and their staff from State

and Commerce have done outstanding jobs in offices from Moscow to Taipei in helping press for better laws and better enforcement. They help deliver the message that

failure to address these high levels of crime has consequences for our bilateral relationships. The traditional enforcement agencies—Customs and legal attaches—are

also playing an important role in some countries in engaging their counterparts in

dialogue, in improving coordination among enforcement agencies around the world,

and in training foreign law enforcement in all aspects of fighting organized crime—

including copyright theft.

Recently negotiated trade agreements are playing a crucial role in raising the

standards of copyright law and enforcement around the world. The Office of the US

Trade Representative has done an excellent job in the newly negotiated FTAs with

Chile and Singapore incorporating provisions that raise the standards for copyright

protection to the level of US laws and help provide the tools we need to combat this

menace. The agreements also help open markets—and the more open the market,

the less the incentive for piracy. I hope I can encourage you to support these Free

Trade Agreements when they come before Congress later this year.

ENTERTAINMENT INDUSTRY COALITION FOR FREE TRADE

I’m pleased to announce that in recognition and support of the value of trade

agreements in helping to move our international agenda forward, we will be launching at noon today an Entertainment Industry Coalition for Free Trade. This coalition brings together a wide range of entertainment industries and associations—

films, music, entertainment software, theater owners, and television programmers.

We hope that many of you can join us at noon today as we launch this Coalition

whose main objective is to spread the word that trade matters to our industries.

29

IN CONCLUSION

Large, violent, highly organized criminal groups are getting rich from the theft

of America’s copyrighted products. Only when governments around the world effectively bring to bear the full powers of the state against these criminals can we expect to make progress. Only when industry and governments join forces to fight

these organized groups will we succeed in protecting one of the jewels in America’s

trade crown. A singular truth exists in the movie industry: ‘‘If you can’t protect

what you own, you don’t own anything.’’

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Mr. SMITH. Thank you, Mr. Valenti.

Ms. Vidov.

STATEMENT OF JOAN BORSTEN VIDOV, PRESIDENT, FILMS BY

JOVE, INC.

Ms. VIDOV. Chairman Smith, Congressman Berman, and other

distinguished Members of the Subcommittee, I want to thank you

for the invitation to appear here today.

I am president of a U.S. small business which has encountered

extraordinary difficulties as licensee of Russian intellectual property. I am here to describe these difficulties because our experience

illuminates the links between copyright piracy in Russia and organized crime.

As my testimony will show, the organization behind Russian

copyright piracy is the government itself, directed at the highest

level by the Ministry of Culture. What fits the definition of organized crime more than a foreign government conspiring to steal the

property of a small U.S. business? That is the worst kind of organized crime by the most powerful possible organization.

Eleven years ago, my company signed a contract with Russia’s

premier animation studio, Soyuzmultfilm, to restore and market a

large library of over 100—or 1,000 animated films produced during

the Soviet era. We invested millions of dollars to acquire, repair,

restore, and distribute these works.

Together with our partner, Mikhail Baryshnikov, we made the

animation accessible for the first time to a greater worldwide audience by creating dubbed version with actors such as Charlton

Heston in English, Catherine Deneuve in French, and Julio Iglesias

in Spanish.

Seven years after we signed our contract, when our investment

was showing a profit, officials of the Russian Ministry of Culture

began a campaign to retroactively void our contract. In ’99, they set

up in Moscow a dummy corporation with the same name as our

contracting partner and claimed that their new company was the

true copyright holder back in 1992.

Thus began a protracted series of suits and countersuits in the

Russian courts between the animation studio that had licensed the

rights to us and the Ministry of Culture. During this period, Films

by Jove suffered financial losses because the ministry prohibited

the Russian State Film Archive from supplying us with films for

which we had the rights.

After our Russian licenser won a series of decisions and appeals

against the Ministry of Culture, the ministry resorted to manipulating the courts. The chief justice of the Russian commercial court

was instructed at an ex parte meeting to ‘‘protect State interests.’’

As a result, all lower court rulings that had gone against the ministry were vacated.

Films by Jove successfully defended its copyright in the U.S.

courts. In August 2001, the U.S. Federal court for the Eastern District of New York held that Films by Jove had licensed the rights

to the animation library from the proper rights holder. The dummy

corporation was a party to the case and agreed to be bound by the

judge’s ruling.

34

Despite this, the Ministry of Culture has been flouting the U.S.

decision for more than a year. For example, ministry officials have

been sending letters via Russian embassies to broadcasters with

whom we are negotiating, informing them—falsely—that only licenses issued by the dummy corporation are legitimate and implying that my company does not have the right to contract out the

animation.

Ministry employees have been showing up at international sales

expos, announcing that we are pirates and thieves and trying to

sell our own product. In Japan and Korea, our distributors have

been terrorized by a Soviet expatriate acting on instructions from

the ministry and insisting that all royalties be paid to him instead

of to us.

Most recently, the Ministry of Culture tried to make arrangements to have the American Film Institute screen the same animated films that were the subject of the Federal court decision.

Fortunately, the AFI discovered in time that the ministry did not

hold rights to these works.

The Ministry of Culture’s campaign against my company has not

been stopped by the intervention of U.S. Government officials. You,

Congressman Berman, together with Congressmen Weldon and

Waxman, sent two letters to the deputy prime minister in charge

of the Ministry of Culture. In November, the U.S. ambassador to

Russia, Alexander Vershbow, met personally with the minister of

culture about our case.

The U.S. trade representative, the Commerce Department, the

staff at the U.S. embassy in Moscow have repeatedly raised this

matter with the minister of economic development and trade. What

is the motivation between this relentless harassment that has damaged my company’s reputation, deceived our trading partners, and

interfered with our international sales?

We believe that part of the answer is that the ministry aims to

establish a government monopoly that will funnel money directly

into the pockets of top ministry officials from two major cash

streams—revenues from the sale of Soviet era films, including animation, and Russian box office receipts from American movies that

bring in hundreds of millions of dollars.

The Ministry of Culture has already created the new organization that will consolidate this monopoly. It is called Roskinoprokat,

or the Russian film distribution. One of its publicly stated goals is

to control imports of U.S. blockbusters, and it plans to open—I’ve

got that much more.

Mr. SMITH. Okay.

Ms. VIDOV. And it plans to open offices in Los Angeles this summer. Roskinoprokat is a monolithic throwback to a Soviet-style

command economy, and it is difficult to reconcile with Russia’s

claims to be a modern market economy.

I’d like to close my testimony by reminding you that the attempted theft of intellectual property by the Russian government

officials is not limited to film, music, and software. For example,

my colleague, Gary Johnson, who is here with us today, has submitted testimony about the company he heads, Sawyer Research

Product.

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Like Films by Jove, his company’s success caught the eye of a

Russian official—in his case, a local governor—who again, on the

basis of ‘‘state interests,’’ obtained Russian court rulings that

stripped Gary’s company of its physical plant, equipment, and

trade secrets.

Proprietary blueprints developed by another small firm, American Capital Systems, are in danger of being exploited without compensation because the company refused to pay a bribe demanded

by an official of the Russian Ministry of Finance. Congressman

Weiner, who represents ACS, is submitting testimony in connection

with that case.

And in closing, I want to thank the Subcommittee for giving me

the opportunity to testify today. I’ll be happy to answer any of your

questions.

[The prepared statement of Ms. Vidov follows:]

PREPARED STATEMENT OF JOAN P. BORSTEN VIDOV

Chairman Smith, Congressman Berman and other distinguished members of the

subcommittee, I want to thank you for the invitation to appear before the Subcommittee today. I come to you as president of a small business that invested in

Russia and is in danger of having its investment expropriated without compensation. I also come to you as the representative of a group of small businesses who

have suffered a similar fate in Russia.

As a victim of Russia’s weak enforcement of intellectual property rights, I come

to you with a warning that Russia’s disrespect for IP rights is on the increase due

to the difference between stated policy and what certain government officials unofficially condone in practice. Even as Russia moves toward membership in the WTO,

systematic copyright violations and collusion between government officials and pirates both continue unabated.

Finally, I come to you as a victim of a breakdown of separation of powers between

Russia’s executive and judicial branches: from the highest federal courts to the

smallest regional courts, judges make ill-founded rulings when government officials

often with private agendas exert pressure on courts in the name of ‘‘protection of

state interests.’’

So as you can see, I have a number of issues to discuss, but here at the outset

let me make clear that my comments do not purport to make any linkage between

piracy and organized crime and terrorism. Others more qualified may speak directly

to those precise issues, but the purpose of my testimony today is to outline my experience with intellectual property rights violations in Russia. To demonstrate why

this matters to the U.S. Congress, I would like to highlight the following points and

the impact they have on our bilateral commercial relationship:

I. IPR violations in Russia hurt U.S. investors

II. The use of ‘‘state interests’’ and illegal ex-parte meetings hinder legitimate judicial reform efforts in Russia

III. Russia disregards U.S. and international arbitration court decisions

IV. The U.S. government must play an important role in addressing Russian IPR

violations in the United States

In my conclusion, I will present several recommendations to Congress on steps

that can be taken to address these issues.

I. IPR VIOLATIONS IN RUSSIA HURT U.S. INVESTORS

The International Intellectual Property Alliance (IIPA) 2003 report on Russia

cites losses to U.S. copyright holders of $1 billion a year, making Russia one of the

worst violators of U.S. intellectual property rights.

The majority of my testimony will be dedicated to IPR violations in the entertainment industry (e.g., films, CDs, videocassettes, DVDs, electronic games, etc.). But

there is another, equally important area impacted by IPR violations—technology

transfer. I would like to share an example with you. My colleague, Gary Johnson,

is President of Sawyer Research Products. (Gary is in the audience today, has submitted separate testimony for the record, and is happy to answer any questions.)

Sawyer is a global leader in the business and technology of single crystal piezoVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00039 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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electric materials, especially quartz, which is second only to the production of silicon

in the ranking of crystal materials used in electronics.

In 1994, Sawyer became a shareholder of Quartz Glass Plant in the Vladimir region of Russia. The plant’s success, in large measure the result of utilizing Sawyer’s world-class technology in a neglected facility in the heart of Russia, caught the eye

of the local governor who waved the ‘‘protection of state interests’’ flag. Shortly following a court decision favorable to their ends, private parties closely linked to the

local administration deployed a private security force to block Sawyer from its own

plant, despite the fact that Sawyer had not exhausted the appeals process and litigation continued. Sawyer technology now is available to a nearby plant still under

state ownership, as well as to the private parties continuing to occupy the object

of Sawyer’s investment.

The Sawyer example highlights the devastating impact IPR violations have on

U.S. small businesses investing in Russia. I would like to emphasize this point, because, unlike our larger counterparts, SMEs do not have the financial or human resources necessary to devote to the extensive legal proceedings resulting from IPR

violations in Russia.

Films By Jove case

Now I would like to provide my personal experience with IPR/copyright violations

in Russia.

I have been an executive in the U.S. motion picture industry for over 15 years,

and am currently president and co-owner of the Los Angeles-based film production

and distribution company, Films By Jove. Eleven years ago, in May 1992, we signed

a contract with Russia’s leading animation studio to restore and market a large

body of Soviet-era animated films. For your background, during the Soviet era, this

type of animation had been sold for peanuts, by the kilo, or just given as a bonus

to companies buying a large package of Soviet feature films.

Today the Russian animation we distribute can be seen in theaters and on television all over the world, and is available on videocassettes and DVD in thousands

of retail outlets in North America, South America, Europe, and Asia. Together with

our partner Mikhail Baryshnikov, we gave the old animation new cachet by revoicing it in English with actors such as Jessica Lange, Martin Sheen and Charlton

Heston. We revoiced in French with actors like Catherine Deneuve, and in Spanish

with Julio Iglesias. Together with the prestigious art book publisher Harry N.

Abrams, we published the only book of Russian fairy tales currently in print in the

United States, handsomely illustrated with cells from the animation.

We are proud to have contributed to the safeguarding and promotion of Russia’s

rich artistic heritage. We accomplished this by investing millions of dollars to acquire, repair, restore, and distribute these films, making them accessible for the

first time to the general public outside the former USSR. The Soviets had freely

‘‘borrowed’’ Western literature and music to make some of the best animated films—

a bad habit that did not end after the USSR signed its first intellectual property

convention in 1973. So we also had to plead and cajole representatives of these writers and musicians to license us the rights necessary to keep these films alive.

In 1999, seven years after we licensed the animation library, when the investment

in restoring the animated films first showed a profit for the Russian animation studio and for my company, the Russian State Film Committee (later absorbed into the

Ministry of Culture) commenced a legal and political campaign to retroactively void

our contract. This effort began when the State Film Committee set up in Moscow

a shell corporation with the same name as the Russian studio from which we had

licensed the animation rights. Ministry of Culture officials claimed that this new

company, established in 1999, was the true copyright holder back in 1992, instead

of the entity with whom we had contracted. Hence, they claimed, our contract was

void retroactively.

Thus began a protracted series of suits and countersuits, decisions and appeals

in Russian courts between the animation studio that had licensed the rights to us

and the Ministry of Culture. During this period, Films By Jove suffered financial

losses because the Ministry of Culture prohibited the Russian State Film Archives

from supplying us with films for which we had the rights. Such interference with

our normal business operations became part of an organized campaign to deny our

property rights.

Throughout this time, Ministry of Culture officials significantly damaged my company’s interests by sending letters via Russian embassies to broadcasters with

whom we were negotiating—informing them, falsely, that only licenses issued by the

dummy corporation were legitimate and implying that Films By Jove could not

therefore contract out the rights. These misleading statements have deceived our

trade partners, interfered with our commercial activities, and caused us serious fiVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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nancial losses due to damage to our reputation and lost sales. Furthermore, the letters from the Ministry blatantly misrepresent the fact that Films By Jove has successfully defended its copyright in the U.S. courts. The studio with which Films by

Jove contracted in 1992 was also successful in the Russian court system, only to

have the decisions overturned in the name of ‘‘state interests.’’

The unrelenting and organized efforts by Russian government officials to annul

the contractual rights of Films By Jove, and to destroy our investment, have already

come to the attention of the U.S. Congress. In 2002, two letters concerning our case

were sent to Russian government officials jointly signed by Congressman Berman,

Congressman Waxman and Congressman Weldon, including the following points:

1. Officials of the Russian government ‘‘appear to have inappropriately influenced the decisions of the Russian courts in violation of the constitutional

separation of powers between the two branches of government’’;

2. Such efforts directly harm the long-term investment of Films By Jove; and

3. The Ministry of Culture does not appear to be committed to safeguarding the

rights of American investors, contrary to President Putin’s repeated statements pledging that investors will be guaranteed a level playing field, adherence to the rule of law, an independent judiciary, and no government interference in private commercial contracts.

In response, Congressmen Berman, Waxman and Weldon received a letter from

the Russian Ambassador to the U.S. questioning the reference to Films By Jove as

an investor. Apparently the Russians destroyed evidence of our wire transfers and

payments to the studio (assuming U.S. banks do not keep records) because, according to the Russian Ambassador, the Russian company received no payments from

the U.S. party to the contract.

In addition to the assistance we received from the U.S. Congress regarding our

case, U.S. Ambassador to Russia Alexander Vershbow and the staff at the U.S. Embassy have also raised our case repeatedly with the Minister of Economic Development and Trade. Ambassador Vershbow met personally with the Minister of Culture

last November and explained that we are ready to conduct negotiations aimed at

reaching an amicable and transparent solution based on the rule of law.

In spite of repeated assurances that our concerns would be addressed, a new fullscale campaign was mounted at an international television sales expo in France last

fall to advise all buyers that we were ‘‘pirates’’ and ‘‘thieves,’’ that all new contracts

had to be signed with them, and that any contracts previously signed with our company were null and void. The state-studio’s brochures specifically advertised the titles we legally acquired, paid for, and into which we invested significant amounts

of money for restoration and revoicing in order to make them sellable to international broadcasters.

To address this situation, we had recourse to a French court decision that we had

won in 1996 against Sovexportfilm, another state-owned Russian company that we

caught pirating in the early 1990s (it too enjoys Ministry of Culture support). On

the basis of that decision, a French magistrate ordered his bailiff to shut down the

Russian sales booth at Cannes in order to gather evidence about the shell company’s

commercial activities that violated our intellectual property rights. The director of

the shell company and his deputy both told the French bailiff that they worked for

the Russian Ministry of Culture.

The Russian Ministry of Culture is now in the process of liquidating the studio

with which we signed our agreement, showing no concern at all for the livelihoods

and pensions of the 300 shareholders, most long-term employees of the animation

studio.

IPR violations and expropriation—to what end?

It appears that part of the impetus for these copyright violations is the Ministry’s

goal to establish a Soviet-type structure to funnel profits directly into the pockets

of the film industry’s leadership. Currently, a state-owned entity, ‘‘Roskinoprokat,’’

is seeking to control all phases of the Russian feature film industry, from buying

Kodak stock, to duplicating films for video and DVD, to producing Russian films,

dubbing others into Russian, and controlling all cinema houses in Russia. All of the

film studios have had to become state companies. Most have already had their libraries of films made during the USSR extracted from the production arms.

This desire to control all is what led the Ministry of Culture to destroy the successor of the studio with which we signed our contract. The expropriation of our

property rights under this contract was another well-orchestrated step toward concentrating in the same hands all of the animation rights.

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You will hear more about Roskinoprokat in the coming years because, as they

openly state in interview after interview in Russia, the biggest plum is rights to distribute U.S. studio films, which generate the biggest profits in Russia. More than

100 modern movie theatres operate in Russia today, a number expected to triple in

the next five years, with revenues predicted to reach $100 million. Post-Soviet Russian films constitute only about 3 percent of the screen repertory and average

$200,000 at the box office. By contrast, American movies have proven to be very

popular and very lucrative, grossing an average of $2.8 million at the Russian box

office.

The Minister of Culture and his Deputy have made clear that their goal is to consolidate everything into one big government-owned company. Roskinoprokat recently announced plans to open offices in Los Angeles this summer and is already

hiring staff. One of their associates told me earlier this week that they believe it

is only a ‘‘matter of time’’ before the major studios ‘‘succumb.’’ The result will surely

be a nightmare even worse than Sovexportfilm’s monopoly on importing foreign

films into the Soviet Union.

II. THE USE OF ‘‘STATE INTERESTS’’ AND ILLEGAL EX-PARTE MEETINGS HINDER

LEGITIMATE JUDICIAL REFORM EFFORTS IN RUSSIA

The importance of ‘‘state interests’’ in the application of law and administrative

process in Russia raises critical separation of powers issues. In the Soviet tradition,

courts and administrative powers, including enforcement agencies, pursue a mission

related to state interests. They do not follow the Western norms of fair adjudication

of law according to the facts and transparent procedures to implement rulings and

otherwise conduct administrative process. In the Russian environment, state prosecutors operating under control of the executive branch define ‘‘state interests’’ in

many judicial proceedings. Their very presence in a case frequently creates outcomes consistent with their objectives, rather than with the law and facts.

We unfortunately have experienced the illegitimate use of ex-parte meetings in

court decisions. At the same time that the Russian Ministry of Culture was challenging our copyright in U.S. court, it was continuing in Russian courts to challenge

the legitimacy of the animation studio that had contracted with us. After six rulings

against the Ministry of Culture in the Russian courts, Ministry officials invited the

Chief Justice of the Supreme Arbitrazh (or Commercial) Court to send a representative to a secret but well-documented ‘‘consultation’’ at the offices of Deputy Prime

Minister Matviyenko. The purpose of the meeting was to secure for the new government-owned studio rights that belonged by law to the studio with which we signed

our contract. No one from our side was invited of course, and such ex-parte meetings

are against the law.

Attending the meeting on behalf of the government was Minister of Culture

Shvidkoy, two of his deputy ministers, a Ministry of Culture lawyer, a representative of the State Property Ministry, two representatives of the State Prosecutor’s Office, the director of the Russian patent bureau Rospatent, representatives of the

Presidential Administration, director of the state-owned studio, and the chairman

of Roskinoprokat.

This ex-parte meeting resulted in one cassation court decision and one Supreme

Arbitrazh (Commercial) Court decision that together vacated all lower court rulings

that had previously been decided against the Ministry of Culture. The effect of these

decisions was that the properly registered successor of the company from which we

gained our license was de-registered. It should be noted that in his declaration to

the U.S. Federal Court, which I have submitted for the record, the respected Russian jurist Sergei Pashin concluded that the Supreme Arbitrazh Court decision was

clearly inconsistent with both Soviet and Russian law and prior decisions made by

the same court about the same matter, and that it had all of the markings of what

is known in Russia as a ‘‘state ordered decision.’’

III. RUSSIA DISREGARDS U.S. AND INTERNATIONAL ARBITRATION COURT DECISIONS

One of our contractual obligations was to defend the Russian studio’s copyright

against pirates in our distribution territory, which included the United States. In

August 2000, while we were engaged in a lawsuit against a convicted felon for copyright violation in the U.S. Federal Court for the Eastern District of New York, the

shell corporation set up by the Russian Ministry of Culture joined the suit as a third

party on the side of the felon. Their objective in joining the suit against us in U.S.

court was to attempt to gain a ruling that Films By Jove was not the legitimate

copyright holder of the animation. The Ministry was thus tenacious in its organized

campaign to undermine my company’s rights, and we were unexpectedly burdened

with enormous legal expenses in the effort to defend ourselves.

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As it turned out, the Russian Ministry of Culture allied itself with the losing

party in the U.S. district court: Films By Jove won the case. The felon with whom

the Ministry had allied itself was arrested in December 2000 and subsequently

pleaded guilty to pirating the intellectual property of the Motion Picture Association

of America and the Recording Industry of America using master tapes and optical

cassettes illegally manufactured in Russia. The Ministry’s support for this convicted

felon has never wavered.

On a related note, I also want to strongly urge the U.S. government and members

of the international community to address Russia’s failure to observe the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

As several of my small business colleagues will tell you, Russian bailiffs do not enforce foreign arbitral decisions, even when ordered to do so by the Russian Supreme

Court. I would be happy to provide examples of these cases if you so desire.

IV. THE U.S. GOVERNMENT MUST PLAY AN IMPORTANT ROLE IN ADDRESSING RUSSIAN

IPR VIOLATIONS IN THE UNITED STATES

Russian IPR violations not only impact our business in Russia, they affect our

business in the U.S. and in other countries. The losses I referenced earlier from the

IIPA report on Russia do not include the massive additional losses caused by the

import into the U.S., Germany and Israel—all countries with major populations of

wealthy Russian immigrants—of illegally manufactured videos CDs, DVDs and software.

In the U.S., our government plays an important role in addressing IPR violations.

For example, in December 2000 when the FBI arrested a Brighton Beach video pirate for piracy of the MPAA and RIA—the same one we sued in U.S. Federal

Court—they confiscated truckloads of master cassettes and CDs imported from Russia. Unfortunately the pirate’s arrest only resulted in a momentary lull in the violations of Russian and U.S. intellectual property by the Russian e ́migre ́ community—

and for that we have to look to our own legal system.

The pirate, Joseph Berov, opened his bootleg video business while on federal probation for importing Russian women into the U.S. for the purpose of indentured servitude. Yet two years after his arrest by the FBI and one year after he pleaded

guilty, Mr. Berov has yet to be sentenced by the U.S. Federal Court for the Eastern

District of New York. In the interim, he has opened two new superstores and resumed importing illegal video CDs from Russia. The message to his partners at the

Ministry of Culture and the local e ́migre ́ community is that ‘‘crime pays.’’

Other examples of Russian IPR violations in the U.S. include the Ministry of Culture’s attempt last week to present the American Film Institute (AFI) with an animation program that violates both our license and the August 2001 U.S. Federal

Court decision that we won. The same program included feature film rights that

were legally licensed to legitimate U.S. distributors by the very Russian studios the

Ministry agrees are the legal copyright holders. The AFI was vigilant and thus

averted a major scandal. Two years ago, the American Cinematheque was less vigilant, and, with the Ministry of Culture, organized a tour of films without the consent of the legitimate producer (Mosfilm) of the films. The copyright holder was not

consulted, not paid, and not even acknowledged.

Conclusion

I would like to close my testimony today by offering the following recommendations to the U.S. government, in order to address IPR violations in Russia:

• To continue to hold hearings such as this to raise awareness of IPR violations.

In particular, these hearings should examine critical points of influence and

leverage to curb Russian copyright violations. They should investigate the official role of Russian government agencies in IP piracy. They should consider

why the state company Roskinoprokat, a self-proclaimed ‘‘child’’ of the Ministry of Culture, is being allowed to open an office in the U.S. and conduct

commercial activity; and whether Roskinoprokat will be protected by the

same sovereign immunity afforded the Ministry.

• To work with your colleagues in the U.S. Executive Branch (State Department, Commerce Department, USTR, etc.) to identify appropriate costs that

could be imposed on Russia as a result of the disregard for the rule of law

(treaty violations, expropriation cases, etc.);

• To support U.S. funding for rule-of-law initiatives in Russia, especially in the

area of enforcement; and,

• To work with your counterparts in the Russian Congress (‘‘Duma’’) to get a

commitment to resolving these violations and disputes.

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I want to thank the Subcommittee for giving me the opportunity to testify today,

and I will be happy to answer any of your questions.

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Mr. SMITH. Thank you, Ms. Vidov.

I just want to say to you that those bells did not indicate your

time was up. That was just to indicate that we’re going into session

in 15 minutes. So don’t take that too personally.

Ms. VIDOV. Thank you.

Mr. SMITH. Before I begin my questions, I just want to thank the

Members who are present for their attendance. This Subcommittee

consistently has the best attendance of any Subcommittee I’ve been

associated with, and I just appreciate the Members taking the time

to come and being interested in the subject matter as well.

Mr. Malcolm, let me direct my first comment, not question, toward you and just say that I appreciate the progress the DepartVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00069 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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ment of Justice is making. You mentioned dozens of prosecutions

and convictions. My only hope is that they will increase.

Certainly, the problem is increasing, and I hope that your activity and effort and determination will increase proportionately. And

so, I wish you well in that regard.

Mr. MALCOLM. Thank you.

Mr. SMITH. I wanted to ask you a question, and this goes to a

statement you made on page 15 of your prepared remarks.

You say that organized crime syndicates are frequently engaged

in many types of illicit enterprises, including supporting terrorist

activities. What would be some examples of that? Or how serious

is that connection between the piracy and the terrorist activities?

Mr. MALCOLM. Well, it’s difficult for me to give you a precise

number of specific examples. Let me say, Mr. Chairman, that it

would surprise me greatly if the number were not large, as Mr. Valenti has stated. This is an easy enterprise in which to enter. The

barriers to entry are very small. The profits are huge.

There are worldwide distribution networks, and one can make

perfect digital copies in a matter of moments and distribute them

throughout the world with a few clicks of a mouse. And the dollars

are very large, and these illicit organizations are looking to raise

money, as much money as they can, as quietly as they can, and as

quickly as they can.

Now that having been said, CCIPS works very closely with our

international partners on all manners of Internet theft and piracy,

hard goods in general, and the Counterterrorism Section, of course,

is actively involved in looking at the distribution of any commodity,

including pirated goods, that would aid and support terrorist organizations.

Mr. SMITH. Okay. Thank you, Mr. Malcolm.

Mr. Valenti, on page 3 of your testimony, you have a nice turn

of phrase that I want to read, but I want to ask you a question

after that.

You say, ‘‘The mysterious magic of being able with a simple click

of a mouse to send a full-length movie hurtling with the speed of

light to any part of the planet is a marketing dream and an antipiracy nightmare.’’

And that is certainly true. I know you’ve been asked this question many times before, but it still might be enlightening for all of

us to hear your response, and that is we know the increasing problem of international piracy and domestic piracy. And yet, we continue to set box office records.

Why is that, and what’s your concern about the future? And is

there—in other words, you can see if we’re setting box office

records, why is there such a great concern?

Mr. VALENTI. We did set box office records in 2002, the largest

box office in the history of the movie industry, and more people

went to the movies since 1957.

That’s to the theaters, which is the right way to see a movie. It’s

an extraordinary experience. With unknown companions of a single

night and having in a darkened theater this movie explode on you,

and you just—you just think it’s wonderful.

However, only 2 out of 10 movies ever get their money back from

theatrical exhibition. They must go to other venues—to premium

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cable, to television, to basic cable, and to international. Because

last year, I might add, while we had all-time box office records, the

average cost of the 225 movies made by the seven major studios,

the average cost to make and market a U.S. movie was $90 million.

Now, I realize with the deficits and everything else, that may not

seem much. But to us, that’s serious money, to quote Senator Dirksen.

And I think it’s a serious problem because if you have your movie

abducted, kidnapped, and then sent all over the world while it’s in

theatrical exhibition, you then set into decay and kind of send it

into atrophy, which, by the way, I’ve been looking for a way to use

that word ‘‘atrophy’’ for a long time. [Laughter.]

Mr. VALENTI. Thank you for letting me do it. It is sucking the

blood out of our business in the future.

Now I have to tell you that I am an optimist. I truly believe, I

truly believe and am confident that in time we will find the technological means and other means, including the help of the Congress,

to put a stop to this piracy or at least bring it down to tolerable

levels where we can sturdily protect our movies.

But, as I said, if we just depended on box office revenues, this

movie industry would be in a state of anemia.

Mr. SMITH. Thank you, Mr. Valenti.

One other question. You mentioned in your prepared remarks,

but not your oral testimony that today you will be launching an entertainment industry coalition for free trade. What do you hope to

accomplish with that?

Mr. VALENTI. Well, I’m a great believer in open trade with all

countries. There is a kind of a theory that abounds in a lot of foreign countries. They believe that if they can barrier, exile, shrink,

or otherwise restrict the American movie from coming into their

country that their own movie industry will spring like Athena from

the forehead of Zeus and prosper mightily. Of course, it’s a defunct

mythology that doesn’t work, but it is still there.

Over 40 percent of all the revenues that fortify the American film

industry come from international revenues, come from international sources. So that open trade, keeping the lines of communication and trade open between countries is very important to us.

And Ambassador Zoellick, the U.S. trade representative, will be

a part of that launching, as will be a number of senators and congressmen. I think it’s a very, very important coalition that we’re

building.

Mr. SMITH. Okay. Thank you, Mr. Valenti.

Mr. LaMagna, you mentioned that you feel that Federal law does

not provide adequate civil and criminal remedies to combat trafficking in genuine physical components or in the combining of stolen components with counterfeit CD-ROMs and packaging. The

loophole in existing Federal law makes it very difficult for prosecutors to target those persons who clearly facilitate counterfeit sales.

I’d like for you to be more specific as to where we have the loopholes in the law, and I’d also like Mr. Malcolm to respond to your

assertion that we really don’t have the legal tools that we need and

tell us why not.

Mr. LAMAGNA. Thank you, Mr. Chairman. What we have in our

business, sir, are people who intentionally traffic in components.

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And by that, I mean certificates of authenticity, manuals, end-user

license agreements. These are the components that go into a software package which essentially authenticate the software.

These people knowingly traffic in genuine components because

they know, frankly, that they can’t be arrested, they can’t be prosecuted for that. There is a brisk million-dollar business around the

world in the trafficking of these components. As a matter of fact,

we have noticed that we have experienced a sharp increase in the

number of thefts of these components around the world.

For example, a simple certificate of authenticity will sell for approximately $50 on the market. We had a theft in California a couple of years ago of 80,000 certificates out of a facility. These people

are trafficking in these components because they know nothing will

happen to them. They are selling them to people who combine

them with counterfeit software and then sell that either over the

Internet or through their distribution channels.

Mr. SMITH. Okay. Mr. Malcolm, are laws sufficient, or do we

need additional laws to help you prosecute these individuals?

Mr. MALCOLM. Well, Mr. Chairman, we are—as you can imagine,

we have ongoing dialogue with Microsoft on all manner of issues,

and we have certainly discussed this matter with Microsoft. We

have an open door.

We are exploring with them the scope of this problem and looking to Microsoft to provide us with some specific examples of cases

where the laws are inadequate. We’re in the process of having

those discussions and evaluating the issue, and we’re not recommending anything one way or the other at this stage. However, we

remain open to being persuaded that there are loopholes that need

redressing by Congress.

Mr. SMITH. Okay. Thank you, Mr. Malcolm.

My time is up, Ms. Vidov. But I have a hunch Mr. Berman is

going to cover the subjects that I wanted to ask you about as well.

So, Mr. Berman, the gentleman from California, is recognized for

his questions.

Mr. BERMAN. Well, thank you very much, Mr. Chairman.

Well, first, Mr. Valenti, you introduced the director of ‘‘Bend It

Like Beckham’’ and who I had the chance to meet yesterday. A

very interesting story of the impacts of piracy, particularly on college campuses in the context of an independent producer who is—

ability to get the financing for her next film will very much depend

on the efficacy of interest in this movie. And so, again, a different

face.

But her story regarding the piracy and the college campuses reminds me of the hearing that the Chairman called 2 weeks ago on

peer-to-peer systems, and there the context was mostly about

music.

But I know you’ve been going to college campuses recently, went

to Duke and, I think, either to George Washington or Georgetown

just recently to talk about this. In terms of independent films and

film-making, not music, I’m curious the students’ reaction and just

your sense of how they’re reacting to the message that you’re delivering to them.

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Mr. VALENTI. Matter of fact, I was at all of those universities,

and Tuesday, I was at Stanford. And I’m on a little crusade, and

I do have personal interaction with these students after I speak.

What I have been trying to tell them is that no free nation can

lay claim to greatness unless it’s constructed a platform from which

springs, I think, a moral compact. Which I think in a speech I delivered at Duke I laid out, saying this is all part of what William

Faulkner called the old verities—duty, service, honor, integrity,

pity, pride, compassion, sacrifice.

And I said to these students, if you treat these words casually,

if you think that only the rubes and the rabble and the unlearned

and the unsophisticated are the only ones who honor and observe

them, then you’re going to witness the slow undoing of the great

secret of America.

Now, none of these kids would go into a Blockbuster store and

walk out with a furtive glance with a DVD under their jacket. They

wouldn’t do that because they know they would get caught, and

disciplinary action will come—humiliation and embarrassment, besides being a crime.

Yet these same students will go on the Internet at file-swapping

sites and put a DVD in their digital jacket with total impunity and

feeling guiltless. They have—I told them they’re practicing a kind

of sophistry in which they are trying to say, well, maybe it’s a kind

of stealing, but everybody else does it, and besides, music and movies cost too much.

There is a sense of decay there, but the good news is that I found

that there is a silent majority operating on campuses. The students

come up to me after I have these one-on-one open forums, and

they’ll say, ‘‘Well, I didn’t speak up, Mr. Valenti, but I couldn’t

agree with you more. We know it’s wrong. We know it’s a crime,

and we ought not do it.’’ And I believe that as universities begin to organize and construct

codes of conduct, where the students understand with great clarity

what the rules of the game are—that you get caught one time,

maybe you get a slap on the wrist. The second time, some schools

are taking away your computer privileges. Third time, you may be

subject to disciplinary action.

I think once those codes of conduct are in place so everybody understands what the problems are and make this a high-risk, not

high-reward kind of an enterprise, then I think these young kids

are going to understand that it is not only morally wrong, they’re

stealing.

Mr. BERMAN. Thank you.

Ms. Vidov, the—you mentioned your horror story and what the

conduct of the Russian ministry and their allies have done to your

investment and your legal rights. You mentioned another case.

But how widespread, from your investigation and work on this,

do you think this problem is, and from that, do you draw any—do

you have any conclusions regarding the Russian investment environment and how the U.S. should handle its Russian trade relations as we deal with growing Russian interest in joining WTO?

Ms. VIDOV. I think that the big companies are quite different

from the small and medium enterprises. And I think that the small

and medium enterprises are sitting ducks if they invest in Russia.

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If they haven’t already come under attack, then it could happen to

them any day.

There are about 25 small and medium businesses on the ambassador’s short list of what as far as I can tell as a former investigative reporter, I don’t think there were more than 50 small businesses that ever invested in Russia. And each and every one of

them have pretty much the same story that we’re telling.

We happen to be in intellectual property, but you’re going to hear

the same story from the guy who cashed out his pension to open

a sport salmon fishing retreat on the Kola River, or Gary’s company, you know, which invested $8 million in a plant in the middle

of Russia that—I hope I don’t get it wrong—grows artificial quartz,

to a company that invested in grain silos in the Far East.

In every single case, it’s the same. And I don’t know what can

be done to stop the Russians other than make it clear to the Russians that we’re not going to send investors in if the situation

doesn’t improve.

We’ve gotten to the point where I mean virtually everyone, large

and small, who invested in Russia, their lawyers said to them, oh,

you know, Russia’s a signatory to the UN Convention on Enforcement of Foreign Arbitration Awards. So everyone put in, oh, you

can arbitrate in Sweden, or we’re going to arbitrate in London.

The only problem is when the American companies go, and for

the small ones it’s considerable expense, and win those cases, they

can’t get them enforced. It doesn’t matter that Russia’s a signatory.

The man I told you about from the Kola River project, the salmon fishing? He actually got a decision from the Russian supreme

court that said because we’re signatories to this convention, we

have to enforce. And now, they’ve taken him to court 80 times to

avoid paying him.

Mr. SMITH. Thank you, Mr. Berman.

The gentleman from Virginia, Mr. Goodlatte, is recognized for his

questions.

Mr. GOODLATTE. Thank you, Mr. Chairman. I very much appreciate your holding this hearing on an issue that, as you know, you

and I have both been involved in promoting for several years now.

Mr. Valenti, I want to commend you for how you have helped the

Members of this Committee and others visualize the true extent of

this problem. This is not just a matter of somebody making a few

copies in their basement and going out on a street corner and selling it.

This is a big, big industry, and it is linked to other aspects of

organized crime and to other misuses of funds, including terrorist

activities. And it’s a multi-billion dollar industry, and we’ve seen

it all around the world.

Chairman Smith and I were in Moscow a year ago, the charge’—

you’ll be interested in this, Mr. LaMagna. The charge’ at the U.S.

embassy, the second in charge, came over to our hotel to brief us.

He stopped a block from the hotel on his way in and bought a copy

of the business version of Microsoft Windows, which costs hundreds

of dollars in the U.S., for $2.70.

And I still have that copy, by the way. If you’d like it, I’ll be

happy to surrender it. [Laughter.]

71

Mr. GOODLATTE. It’s not usable on any system that I know of. It

is nonetheless an example of the nature of this problem, which is

huge.

It’s not just in other countries. There was a huge raid on Canal

Street in New York City last year, where millions and millions of

dollars of counterfeit goods were seized. And all those little stalls

there in New York City are not just little independent operations

either.

The report showed that the underground area around Canal

Street was honeycombed with storage facilities and hideouts and so

on for this very sophisticated operation, which has the face of a little guy with a little operation.

I was in Spain, in Madrid, a few weeks ago. On the sidewalks

all over Madrid are little blankets with maybe a hundred DVDs or

CDs. When they see somebody coming, they can grab that blanket,

wrap it up, and be running down the street in an instant. But

there are millions of them all over the city. So the problem is truly

astonishing.

Now, one thing I want to say to Jack Valenti is that I think a

lot of these countries are getting it—not only from the standpoint

of their obligation to combat this kind of piracy, this kind of crime

in their country, but also from the standpoint that this really

hinders their ability to be able to develop intellectual property in

their country.

The Russians, in particular, a wonderful country of tremendous

scientific and creative abilities of many of their people, but there’s

no way to develop a significant software industry or creative arts

industry. If they do not protect our intellectual property rights in

their country, they’re certainly not going to also be able to develop

their own legitimate business where people can be rewarded for

their creativity.

So my question to you, Mr. Malcolm, is what kind of efforts does

the Justice Department have in coordinating these efforts around

the world? And do you have a project to try to get countries to pass

legislation? I know the Russian Duma, for example, is meeting

today, as we speak, on this very issue.

What kind of coordinating efforts does the Justice Department

have to not only encourage the enforcement of the law, but the encouragement of the adoption of this ethic by passing laws creating

greater protections for our intellectual property and their own in

countries around the world?

Mr. MALCOLM. Certainly, Congressman. Obviously, beyond the

Justice Department, State, USTR and PTO are all involved in this

effort as well, since it’s a diplomatic effort in addition to a law enforcement effort.

On the law enforcement front, CCIPS, and other representatives

of the Justice Department are actively involved with law enforcement all around the world, and with respect to Operation Buccaneer, for instance, we have had effective coordination with the

Australians, the British, the Swedes and the Finns.

Last year, representatives from CCIPS met with over 30 representatives from nations around the world in various face-to-face

meetings here and abroad to discuss legislative efforts, law enforcement training and different techniques in how we would be able to

72

work well together. There are even more trips planned for this

year, including, for instance, this summer a 2-week training and

discussion session scheduled for China, where you know this is a

particular problem.

So we’re actively involved in engaging in 24–7 contacts with our

counterparts around the world in stressing the need for effective IP

enforcement.

Mr. VALENTI. Mr. Chairman, may I amplify what Mr.

Goodlatte——

Mr. SMITH. Yes, I’m sure he’d be happy for you to do that.

Mr. VALENTI. I think, Congressman Goodlatte, you really hit

something when you’re talking about your visits or your importuning foreign countries.

I think codels in their visits around the world can be a superior

method of striking a real chord with these foreign countries. And

I know that Congressman Wexler, Chairman of the Congressional

Taiwan Caucus, has been singularly effective in meeting face-toface with Taiwanese and telling them what is right and what is

wrong.

I know that other codels have gone all over the world, and we

know about it to try to work with them and brief them. But I suggest, Mr. Chairman, that’s one of the great instruments in favor of

doing something worthy in this field, and that is the codel itself.

It has a marked influence on these foreign officials.

Mr. SMITH. Okay. Thank you, Mr. Goodlatte.

Mr. GOODLATTE. Mr. Chairman, if I might, I have an opening

statement I’d like to submit for the record.

Mr. SMITH. Okay. Without objection, that complete opening statement would be made a part of the record.

[The prepared statement of Mr. Goodlatte follows in the Appendix]

Mr. GOODLATTE. Thank you, Mr. Chairman.

Mr. SMITH. Thank you, Mr. Valenti, for your good point. We’ll

take more codels with that in mind. [Laughter.]

Mr. SMITH. The gentleman from Massachusetts, Mr. Meehan, is

recognized for his questions.

Mr. MEEHAN. Thank you, Mr. Chairman. I, too, would like to

submit my opening statement for the record.

Mr. Valenti, I keep hearing that the entertainment industry is

suffering greatly as a result of digital piracy. However, in 2002,

Hollywood obviously set a box office record with movie theaters

selling over $1.5 billion in tickets, $9.5 billion worth of revenue.

This may seem to some people to be contradictory, and I was

wondering if you could clarify that issue.

Mr. VALENTI. I mentioned earlier on a similar question, Mr. Congressman, that only 2 out of 10 movies ever get their money back

from theatrical exhibition. It is mandatory to retrieve their investment to move through the other venues—HBO, premium cable, airlines, hotels, basic cable, network, and international. We have to do

that.

And if this movie is stolen early in the journey of that movie to

all of these other venues, it, without any question, decreases the

value of that movie. Now, remember, in America, unlike most counVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00076 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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tries, all movies are made with private risk capital. Either you borrow money from a bank or you get investors to put money in it.

And if down the road in ’04, ’05, and ’06, it begins to look like

that we’re in a state of decay, some of that private risk capital is

going to go other investment opportunities. So it is very important

for us to begin now to stop this before it becomes a flood tide.

Mr. MEEHAN. It’s my opinion that publicizing the individuals

caught engaging in copyright infringement of any kind is—can be

a great deterrence. What is the industry doing along these lines?

In other words, are you working in conjunction with Government

agencies in this process? Do you see for a need to reform in this

area? And if so, what would you propose?

Mr. VALENTI. I think in the area of analog piracy and DVD counterfeiting—I’m not talking Internet piracy now—the Justice Department has been marvelously cooperative. The FBI has lifted the

level of importance of intellectual property theft to its large priority. U.S. attorneys are on the alert.

Of course, now with terrorism on the rise, a lot of the resources

of the FBI and U.S. attorneys are being directed other places. But

I cannot tell you how grateful I am for what the Justice Department, other agencies are doing.

Our problems in this area are largely foreign. And for example,

in Australia recently, just last March, a big raid found 35,000 counterfeit DVDs brought in by two Malaysian nationals. They arrested

them, tried them, sentenced them. A very light sentence and a fine.

And guess what? They deported them. They never served any

time in jail, and they never paid their fine. So the Malaysians probably say, ‘‘Hey, this is a terrific business we’re in. Let’s do it

again.’’ And that sort of thing is endemic and pandemic around the

world.

Mr. MEEHAN. Ms. Borsten, you highlighted in your testimony in

great detail your company’s particular experience with the Russian

government. Do you believe that your experience is unique, or do

you feel that there is a general problem that exists for the United

States companies trying to protect their property rights in Russia?

Ms. VIDOV. Well, as I said in a previous question, I just don’t

think Russia is ready for American investment. It’s certainly not

ready for small and medium companies, and as you know, they’re

the backbone of our country, and they’re going to have to be the

economic backbone of Russia if it’s going to become a viable market

economy.

And they—the Russians, I mean, they need to understand—the

same thing happens every time. If you’re successful—and that’s the

key. It’s not that as a small, medium company, you go in and you

take the normal risks. But then the problem in Russia is you become a success and you’re targeted by some government minister

or governor who says, ‘‘Gee, you know, I want that for myself.’’

And they manipulate the courts to get it from you, but they don’t

take what you establish—what they do—and continue it. Instead,

they divide it up, and they sell off the assets and pocket it. So the

people that you created jobs for, now they’re out of work. The revenue streams that you created that were coming into Russia,

they’re gone.

74

So a lot of work needs to be done, and the Russians need to be— we shouldn’t be—we shouldn’t be out there cheerleading and saying, you know, go to Russia, is my opinion, and invest because an

investor has not very good chance to actually see the results of his

investment.

Mr. MEEHAN. And it’s interesting because we’ve tried to put a lot

of attention into helping them set up a judicial system, helping

them set up some kind of a financial system. But it sounds to me

that you have drawn general conclusions about Russian investment, the environment.

And are there any conclusions between the United States-Russia

trade relations from your perspective that you would draw here?

Ms. VIDOV. I think—I know that there are budget cuts. But I

think that as much money as possible has to be put into rule of

law aid that we can give them and, you know, sending judges over

and sending delegations. And I mean, I think that the people themselves want to do the right thing.

And really, one of the things that happened in our case was that

the reason that we know as much as we do about all of these ex

parte meetings is that there were people in the involved ministries

who were outraged at what happened and came and delivered to

us the documents because they knew that it was wrong.

So I think a lot of Russians want it to be that way. But somehow,

it’s just not happening.

Mr. MEEHAN. Yes, we’re sending a lot of people over there, but

maybe we just need to do a better job or send more and maybe

have it more structured.

Thank you, Mr. Chairman.

[The prepared statement of Mr. Meehan follows in the Appendix]

Mr. SMITH. Thank you, Mr. Meehan.

The gentleman from Virginia, Mr. Forbes, is recognized for his

questions.

Mr. FORBES. Thank you, Mr. Chairman. And thank all of you for

being here today.

Certainly, I think that we’re all very concerned about this. One

of the big problems is that we’re losing a lot of money that we could

be utilizing in other places. Secondly, a lot of the money is going

to the wrong people and used for wrong purposes.

But I think one of the things that’s useful is just this education

process and getting these statistics out. Unfortunately, I don’t

think a lot of people see the correlation between some of the piracy

issues and some of the things that are taking place.

One of the things that hit me is that we see the television ads

by the Office of National Drug Control Policy, where all those ads

convey a message that, you know, every time this action takes

place, look at who you’re really helping. And it would be good if we

could see some of those ads along this line, too, because I think a

lot of our public doesn’t really realize it.

The second thing, I think it’s important that we begin to perhaps

look at some of these issues and some of our trade agreements and

perhaps how we’re enforcing those trade agreements. I think that

could be a significant help for us.

The final thing, though, that I have a question about. Mr. Valenti, you talked about the 40 percent figure for our motion picVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00078 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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tures and that we needed to make another 40 percent in other

venues other than theatrical exhibitions—for example, internationally.

What percentage of that statistic is made up internationally? Do

you have a feel for that?

Mr. VALENTI. Of the total revenues to the American film industry, Mr. Forbes, around 40 percent of those total revenues in movies, television, home video, pay-per-view come from international

markets.

Mr. FORBES. Oh, so about 40 percent is international markets.

Mr. VALENTI. And 60 percent domestic.

Mr. FORBES. Of that 40 percent, we talked about the codels,

which I think certainly are always good opportunities. Is there any

dialogue that goes on between the motion picture industry and

some of the foreign countries in terms of wanting to get their support for enforcement of some of these laws and provisions there?

Mr. VALENTI. Yes, Mr. Forbes. As a matter of fact, the Motion

Picture Association is a global enterprise. We have offices in Brussels and in New Delhi and in Rio and Toronto. We have offices in

Singapore and Beijing. So every day, we are at work moving

around the world, talking and meeting with officials.

I myself spend a good deal of my time on airplanes going to Europe, Latin America, Asia, and meeting with foreign ministers,

prime ministers, ministers of culture, et cetera, trying to persuade

them that it is in their long-term interest that they do things to

curtail piracy.

Indeed, one of the things that’s drawing together in a seamless

web of unity are the creative communities of the world, usually antagonistic to us because that we have so much of the marketplace.

But now they’re with us, joined at hip and thigh, because they realize that pirates, criminal pirates are equal opportunity thieves.

They steal everything that they believe has a marketplace.

And therefore, we’re finding a great deal of support from the actors, writers, directors, producers—the people who do films in these

foreign countries, which is very helpful.

Mr. FORBES. And we talked about the Russian problem, obviously, that exists there. But this 40 percent figure that we’re looking at, can you give us a basic idea of where you tend to see your

biggest losses internationally in this area?

Mr. VALENTI. Yes. The biggest losses are in Russia, China, Malaysia, Thailand, and other places like that. Russia is totally out

of control at this time. I think your comments were absolutely authenticated by what we find over there.

As a matter of fact, I am at this moment in contact with our ambassador in Russia and with the Russian officials. I believe that I’m

going to have an appointment sometime in late April, early May

with the Russian prime minister that Mr. Putin, the president, has

put in charge of this piracy situation. And I intend to confront him

and talk about this.

He’s agreed to the appointment. So I would assume they would

have some kind of rebuttal to the grievances that I will put before

him.

Mr. FORBES. And it’s always good to look at the areas that we

have a concern like Russia. But where would you say would be the

76

best models that we could look at as far as countries that have

been supportive of the motion picture industry perhaps or basically

protection against these kind of issues?

Mr. VALENTI. Mostly in Western Europe. I think they do a very

good job. Their laws are pretty sturdy, and there is—but you can

have a great copyright law, Mr. Forbes, that’s just absolutely exquisite in all of the things that we want to do, but there has to be

a political will, a political resolve to enforce those laws.

And unhappily, some countries’ officials of the government are

involved in the piracy operations, which does make it a little bit

difficult for them then to enforce the copyright laws.

We have some problems in Brazil at this time. We hope to alleviate our problems in Mexico. I think President Fox has been very

forthright in trying to help us on this and his attorney general as

well. We’re making some progress there.

But it is in Asia is where most of this is going on, and I include

Russia there. As I said, Russia is making this a great export business. They do about 300 million, maybe, DVD counterfeit copies.

They only consume about 18 million of them in Russia.

So what do you do with the other 200-plus million? You export

it. It’s part of your export trade.

Mr. LAMAGNA. Mr. Chairman, may I comment on that, please?

Mr. SMITH. Even though the gentleman from Virginia’s time has

expired, yes, please go on and comment.

Mr. LAMAGNA. I’d just briefly like to say that we do have some

models in the Federal Government and a history.

My background is drug enforcement for 28 years, DEA and FBI.

And I saw where we, over the years, have built the capability, the

institution building, international agreements to get governments

to adopt regimes for enforcement, the 1988 Vienna convention on

drugs.

And I think we have—we have some models here for training, for

information sharing, for cooperation, for free trade incentives. And

I see parallels between the drug industry and organized crime and

the pirating in software. And I think we could look back on those

models to see what we’ve done because they’ve been very, very successful over the years in certain countries.

Mr. SMITH. Okay. Thank you, Mr. Forbes.

The gentleman from Florida and Chairman of the Taiwan Caucus, Mr. Wexler, is recognized for his questions. [Laughter.]

Mr. WEXLER. Thank you very much, Mr. Chairman. And I, too,

want to thank you for calling this hearing to highlight the extraordinary connections, disastrous connections between international

copyright infringement and organized crime.

I can’t help but sit here and wonder, and I’m sure most Members

of this Committee and people involved in this community have had

these discussions with many parents who don’t yet fully understand the ramifications of what it is to steal a movie or to pirate

a song.

If more American parents understood the connection between the

pirating of intellectual property and organized crime, I think there

would be a much more effective public relations response in our

own country to better appreciate the disastrous ramifications of

what is occurring.

77

And I think Mr. Forbes, very rightfully so, brought up the commercial with respect to drugs, whereas I think most Americans at

this point appreciate the connection between the purchase of an illegal drug and organized crime and the profits related thereto.

If most Americans understood the facts as Mr. Valenti presented

them this morning that the profits from the stealing and pirating

of intellectual property are greater than the profits to organized

crime of the illicit sale of drugs, I think there would be an incredibly more effective response even within our own country.

And having watched Mr. Valenti’s presentation, in some degree

of jest, I wonder whether the Motion Picture Association would

turn its attention toward Iraq, and we probably could find the mobile chemical weapon laboratories if your intelligence seems as

good as it appears to be this morning.

I would like to address two questions to Mr. Malcolm, if I could.

And I say this with the preface that your presentation this morning

I think is an exceptionally detailed commitment by the Department

of Justice in outlining what the problem is.

But what I would like to inquire is, understanding what the

problem is, what is the level of the intensity in terms of the action

of the Department of Justice in responding to the problem that is

at hand?

So I would respectfully ask could you elaborate on what the Department of Justice’s role is, in your view, and will be in terms of

actually combating the actual piracy abroad? What programs are in

place that will focus the attention of the Department of Justice on

the piracy abroad?

And it would seem to me that while this goes beyond the Department of Justice, that there needs to be a concerted effort, not just

by the Department of Justice, but by the Commerce Department,

by the trade representative to the point where any American official, whether it be a Member of Congress or potentially even more

important, a member of the executive branch, when they meet with

officials of those offending countries that this issue be highlighted

to the point where all of the tools of American commercial interests

and other interests will be tied to the issue of piracy.

So I would ask if you could elaborate on what actually the Department of Justice is doing. And in that same light, in talking to

some of our own officials here at home, I think a number of us last

fall wrote a letter asking what was the effort that was being conducted with respect to the preparation of prosecutors in our own

country to better understand how to prosecute peer-to-peer piracy?

As I understand it, that’s not something that most lawyers learn

in law school. And if you could define for us either here today or

in writing, if that’s more appropriate, what is occurring in the Department of Justice to better prepare prosecutors to actually be in

a position to prosecute?

Mr. MALCOLM. Congressman, thank you for that question. With

respect to your side comment about the need for our trade representatives and Commerce Department to be actively involved in

this effort, I applaud that statement and agree with it.

With respect to what the Department of Justice is doing, let me

say that in the year and a half that I’ve been in this job, and I was

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a Federal prosecutor in Atlanta for 7 years, so I’m familiar with the

prosecutorial process, this has been a personal priority with me.

I’ve had an open door, for instance, with the MPAA. I’ve met

with Mr. Valenti. I’ve met with representatives of the RIAA and

the intellectual property community.

We have established 13, as I stated, CHIP units, which are growing. Which have prosecutors who are dedicated to computer crimes,

a significant portion of those resources are devoted to IP crimes.

The Computer Crime and Intellectual Property Section has

roughly doubled, with the assistance of Congress through the resources that were given, since the time that I have been there, and

they are using some of those resources to engage in extensive training, both here and abroad.

Every U.S. Attorneys Office has a Computer and Telecommunications coordinator, or CTC. I should say every office has at least

one, in many cases two or three. This is a huge problem. It is a

global problem.

Through some of the activities that I’ve talked about, such as Operation Buccaneer—there are others, Operation Bandwidth, Digital

Piratez—we are trying to cut off the heads of some very large

snakes that are involved in putting out this material to be pirated

and to cost our economy and to raise huge dollars for nefarious people.

That having been said, there are a lot of snakes out there, including some big ones that we still have to tackle. However, despite

the resource crunch from the war on terrorism, at least at the Department of Justice as it comes to intellectual property crime, we

have had an unprecedented level of increase in activity during the

past year and a half that I’ve been there.

Mr. SMITH. Good question. Thank you, Mr. Wexler.

My colleague from Texas, Mr. Carter, is recognized for his questions.

Mr. CARTER. Mr. Malcolm, tell me what’s the—on the peer-topeer problem that we have, under what statutes would you prosecute someone peer-to-peer, and what kind of punishment range

would that carry with it, should there be a conviction?

Mr. MALCOLM. Thank you, Representative Carter. I’m sorry that

I had forgotten to mention peer-to-peer in response to Mr. Wexler’s

question. Let me be clear with respect to peer-to-peer what it is

that we are talking about.

There are the operators and designers of peer-to-peer networks,

and there are those who use peer-to-peer networks for the purposes

of copyright infringement. And I want to distinguish between the

two because one thing the department is very sensitive to is to the

notion of not wanting to stifle technology and its developments on

the Internet.

Peer-to-peer, any type of a system can be used for good purposes

or nefarious purposes. It can be used to transmit noncopyrighted

material for academic research, personal, you know, fair use, what

have you. It can, of course, be used and is being used for rampant

infringement.

So with respect to the people who design and operate peer-topeer networks, we remain open to evaluating evidence that is preVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00082 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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sented to us that it is being designed for the purpose of facilitating

copyright infringement and we’d consider an appropriate case.

With respect to those people who use peer-to-peer networks or,

for that matter, any other mechanism to engage in copyright infringement, we will prosecute them. We can prosecute them under

the criminal copyright laws, which generally carry up to 5 years.

Felonies, we can prosecute them under the net act, which is a 3-

year felony. They have different elements that are involved, and

one would need to evaluate based on the specific facts of the case

presented.

Mr. CARTER. Just starting there, I’ve been in the punishment

business now for about 20 years. I happen to feel punishment is

a deterrence to crime. I think when we publicize in the drug industry that we’re busting users and we’re busting mules and we’re

busting pushers that it slows down the traffic in drugs.

And I think that it would be a good idea to go out and actually

bust a couple of these college kids. And you know, if you want to

see college kids duck and run, you let them read in the paper that

somebody got about a 33-month sentence in the Federal penitentiary for downloading copyrighted material, and I think we might

slow at least that traffic down quite a bit.

The other thing I’m curious about is on this international piracy,

you know, we’re hearing about it here. But you don’t read about

it in the newspaper. It’s not publicized. Are you getting convictions

in that area, and are the sentences appropriate?

Mr. MALCOLM. Congressman, with respect to international piracy, it does get some press. In certain cases, for instance, Operation Buccaneer, which has been an international effort, I believe

has gotten a fair amount of press. As I said earlier with Mr.

Griffiths’s indictment and our seeking extradition of him from Australia, that was just announced yesterday. It’s my understanding

that that’s been reported in the media.

And if I may just briefly comment on your comment about university settings and publicizing what it is that we do. One is that

I agree that universities should not somehow be off limits, and the

people who use those systems to engage in copyright infringement.

With respect to Operation Buccaneer, for instance, seven universities were searched in connection with that operation. And the

systems administrator, for instance, at MIT for the economics department was targeted and convicted.

With respect to advertising our efforts, I would note attached to

my written testimony is a Web page. In connection with the Digital

Millennium Copyright Act plea recently, an individual named

David Rocci surrendered his Web page called ISONEWS.com. It

was very popular in the warez community.

We took it over, published a deterrence message. And within 2

weeks, there were over 550,000 hits. So that’s people who would

otherwise be interested in piracy who will see that site and will

have a very clear message as to the consequences of engaging in

that activity.

Mr. CARTER. Thank you.

Mr. Valenti, nobody that I know of in the entire world communicates with the American people and the people of the entire

80

world better than the motion picture industry. And I probably

learned—and I’ve been a trial judge for 20 years.

And I probably learned more about the international drug industry from the movie ‘‘Traffic’’ than anybody else. And I think the

whole country did.

Why don’t you all start making movies about this is international

crime? You know, this would be a subject of a lot of good movies,

and actually people would start realizing when they’re stealing

these things that they’re participating in international crime.

Mr. VALENTI. Well, first, Judge, I want you to know anybody that

comes from Texas can’t be all bad. I want you to know that.

[Laughter.]

Mr. VALENTI. So, secondly, do you have an agent, by the way?

[Laughter.]

Mr. VALENTI. Because before we talk about this, I think that’s a

darned good idea. Frankly, I hadn’t thought about it. That’s something we ought to do. But as a matter of fact, I am going to suggest

that to some of my writer friends out in Hollywood.

One of the things you said, though, captured my interest about

how to deal with this university piracy. My lawyer who is here,

Troy Dow, went on KaZaA, which is one of these notorious fileswapping sites. And at the bottom of the screen on KaZaA, they

tell you with great candor how many people are on KaZaA at that

precise moment, how many files they are invading, and how many

bits of information they’re trading.

Last week, when he went on KaZaA, there were 4.19 million people on KaZaA at that precise moment. They were trading 550 million files—550 million files—with 5 quadrillion bits of information.

A quadrillion is one million billion, which is too many zeroes for

me to contemplate. But that’s the kind of activity 24 hours a day.

The reason why—I think one reason why the university is taking

a serious interest in codes of conduct, they’re having to spend millions of dollars in increasing the bandwidth of their state-of-the-art,

large pipe, high-velocity broadband networks. It’s sagging under

the weight of all these student activities.

Now, they’re not going up there to do a paper on Nietzsche or

Herodotus. They’re going up there to trade files mainly in movies.

And as a result, the universities are having to do something about

it.

One story to show you how bad this is. I’m not going to name

the university. It’s one of the most prestigious universities in this

country. Last year, their broadband access system was so

bombarded with student activity, particularly in a file-swapping

site called Gnutella, they actually set up a separate server for

Gnutella so that anybody who wanted to go on Gnutella would not

go on the university system, they’d go to this special server.

And the campus daily that one of my people, Rich Taylor, who’s

here, found it on the Internet. The campus daily has an editorial,

Mr. Chairman, Mr. Carter. It said, ‘‘We certainly thank the university for this new file server. It’s going to make it a lot faster and

easier for us to upload and download.’’ The next paragraph says, ‘‘However, the university has a conundrum here in the way of a moral issue here because they’re saying

it’s okay for us to take something that doesn’t belong to us.’’

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Well, I fired off a fiery letter to the president of that university.

You know the idea. A letter that says ‘‘harsh words to follow,’’ that

sort of thing. [Laughter.]

Mr. VALENTI. And within 10 days, they took the server down.

But that’s what’s going on because these universities are being

overburdened with this kind of activity. And one of the problems

is, as you point out and we all know, it’s low risk. Nobody does

anything about it.

Mr. CARTER. That’s right. And one final question, if I may, Mr.

Chairman.

Mr. SMITH. The gentleman is recognized for another question.

Mr. CARTER. Mr. Valenti, you talked about the other countries

that help in enforcement. What—if you were going to say the three

best countries that help with enforcing these laws overseas, where

would they be? What would they be?

Mr. VALENTI. Our anti-piracy experts, and we do have an antipiracy division that operates in over 41 countries in the world.

Lately, Macau, Hong Kong are two places where we’re getting pretty good help. I think that Mr. Malcolm may confirm some of that.

I think the UK is very good because they are putting big sentences. They busted one notorious pirate and gave him, I think,

about 10 to 15 years in the slammer, which does tend to make your

eyes smart a little bit and makes you think you might want to go

in another business.

I think those are the—the European Union has just passed a

copyright directive, which we think is pretty good. They have an

enforcement directive that now is trying to be implemented. So I

think they’re trying to do what they can to make sure that they

can try to find a way to conquer this, this terrible thing.

Mr. CARTER. Thank you.

Mr. SMITH. Thank you, Mr. Carter. And thank you all for your

testimony today.

It seems to me that we’ve had a nice confluence of enlightening

testimony, perceptive questioning from many Members, and instructive answers as well, all of which is going to help this Subcommittee.

It also seems to me quite obvious that the problem is growing

worse, and we are not doing enough to reduce the problem. And I’m

not sure enforcement alone will do it. It’s going to take the cooperation of foreign governments, some of which may or may not be inclined to help us. We’ve heard specifically about Russia.

But in any case, we’re going to have to do a lot more, whether

it’s intergovernment treaties or cooperation or leverage or whether

it’s enforcement on our side by the DOJ or others. Regardless, it’s

a problem that should not be overlooked and needs to be addressed.

And I just realized that we on this Committee, I think, are pretty

much unanimous in wanting to stop that problem from becoming

worse and, in fact, try to reduce the problem and reduce the impact

on real people. Now that’s something that oftentimes goes overlooked.

We talk in sort of thematic general, almost idealistic terms about

organizations and so forth. But we’re really talking about real people, whether it be musicians or artists or actors or recorders, anybody else. It is those individuals who are being hurt. It’s their liveVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00085 Fmt 6633 Sfmt 6601 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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lihoods that are being lost, and we certainly want to address that

in the future.

So I thank you again for being here today and thank you again

for your testimony. We’ll no doubt see you again at some point in

the future.

[Whereupon, at 10:39 a.m., the Subcommittee was adjourned.]

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A P P E N D I X

STATEMENTS SUBMITTED FOR THE HEARING RECORD

PREPARED STATEMENT OF THE HONORABLE HOWARD L. BERMAN, A REPRESENTATIVE

IN CONGRESS FROM THE STATE OF CALIFORNIA

Mr. Chairman,

I commend you for putting together another fine hearing.

I want to particularly thank you for inviting Joan Borsten to testify. Joan is a

constituent and a good friend from way back. She brings a valuable perspective to

this hearing: that of an American entrepreneur whose business has been dramatically impacted by a foreign government’s sustained campaign to steal her rights to

intellectual property. Because we usually hear about copyright piracy from large

corporations or wealthy celebrities, we often lose sight of the impact that piracy has

on individual American entrepreneurs or copyright owners.

While international hard-goods piracy may seem a dull subject to some, it is a

critical issue to U.S. copyright holders. The aggregate hard-good piracy losses suffered by U.S. copyright industries in foreign nations are pretty astounding. According to the International Intellectual Property Alliance, or IIPA, ‘‘losses due to piracy

of U.S. copyrighted materials around the world are estimated to reach $20–$22 billion annually (not including internet piracy.)’’

Even more astounding are the piracy numbers for individual foreign nations. In

2002, the U.S. motion picture, recording, music, software, and book publishing industries collectively suffered piracy losses of $1.85 billion in China; $800 million in

Italy; $771 million in Brazil; $757 million in Taiwan; and $756 million in the Russian Federation.

The percentage of pirated goods in these five nations provides another disturbing

measure of the severity of the problem. In 2002, 93% of business software sold in

China, 47% of music sold in Taiwan, and 80% of movies sold in the Russian Federation were pirated. In 2001, 99% of entertainment software sold in Brazil was pirated; while in 2002, 55% of entertainment software sold in Italy was pirated.

As piracy percentages climb in a particular nation, it becomes increasingly difficult for U.S. copyright owners to establish a legitimate market. In some cases, as

with entertainment software in Brazil, U.S. copyright owners have had to abandon

the market entirely. U.S. copyright owners simply cannot justify the expense of

maintaining a presence in a nation where the demand for their copyrighted works

is almost entirely met by vastly cheaper, pirated versions.

The piracy-related inability of U.S. copyright owners to access a legitimate market

in many foreign countries results in real harm to the U.S. economy. The core copyright industries make a tremendous contribution to the U.S. economy—accounting

for more than 5% of U.S. GDP, 3.5% of total U.S. employment, and $89 billion in

foreign sales and exports in 2001. How much greater would their contributions to

the U.S. economy be if U.S. copyright owners could access foreign markets otherwise

dominated by pirate product?

Rich LaMagna of Microsoft will, I understand, try to answer this question with

some real numbers. I don’t want to steal his thunder, but I cannot help remarking

on his estimate that in 2008 software piracy will cost the U.S. $1.6 billion in lost

tax revenue. While $1.6 billion may only be a small portion of the federal budget

deficit currently forecast for 2008, it nonetheless represents significant revenue that

could fund critical government priorities.

I realize these numbers and percentages are dry, and their sheer size sometimes

begs skepticism. That is why Joan’s presence here is so important.

Joan’s personal story of intellectual property theft by the Russian government

provides a context to these numbers, just as she provides a face for U.S. victims of

international copyright piracy. While I don’t want to steal Joan’s thunder either, I

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do want to highlight some of the issues that I think her particular situation presents.

In Joan’s case, the thief of her intellectual property rights is not some private syndicate operating in distant shadows within a foreign nation, but is a foreign government itself—the Russian Federation government. Through the establishment of

dummy corporations, fraudulent license transfers, and illegal pressuring of Russian

courts, the Russian Federation government has attempted to deprive Joan of her

valid license to copyrights for a library of Soviet-era animation.

Where a foreign government is itself stealing intellectual property from a U.S. citizen, it is particularly appropriate for the U.S. government to demand that the foreign government stop the theft. Conversely, it would be entirely inappropriate for

the U.S. to grant any special trade privileges, such as WTO accession or GSP benefits, to a foreign nation whose government is stealing intellectual property from a

U.S. citizen.

Mr. Chairman, I know your particular focus today is on the links between organized crime, terrorism, and international copyright piracy. In that regard, I wish to

note that intellectual property theft by a government represents the very essence

of organized crime. In any nation, there is typically no bigger organization than its

government, and no greater power. Thus, when the government steals intellectual

property, it is engaging in organized crime of the highest magnitude.

Thank you, Mr. Chairman, and I yield back the balance of my time.

PREPARED STATEMENT OF THE HONORABLE BOB GOODLATTE, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF VIRGINIA

Mr. Chairman, thank you for holding this important oversight hearing on international copyright piracy.

I recently returned from leading a congressional delegation to Europe to engage

in discussions about e-commerce and intellectual property with our European counterparts. While in Madrid, Spain, I was disturbed to witness blatant acts of copyright piracy—the latest movies and CDs openly displayed on blankets lining the

public streets—sold for a mere fraction of the cost of the legitimate product. The

criminals, engaged in the organized theft of copyrighted works, outnumber law enforcement and have a large network of ‘‘lookouts’’ prepared to thwart any law enforcement effort to stop them. The illegal activity that I witnessed in Spain is just

one example in one country of the growing problem of organized theft of copyrighted

works.

The effects of international copyright piracy are staggering. A recent report released by the International Intellectual Property Alliance states that last year alone

U.S. companies suffered over $9 billion in trade losses due to international copyright

piracy. When you consider the fact that the U.S. copyright industry accounts for

more than 5% of our gross domestic product, it is clear that international piracy is

a serious problem that has devastating effects on our economy.

However, the effects of piracy are not limited to one country. Each nation in the

international community must recognize that piracy is a global problem. The growth

of piracy among organized crime rings is illustrative of its global scope.

The combination of enormous profits and practically nonexistent punishments by

many foreign governments makes copyright piracy an attractive cash cow for organized crime syndicates. Often specializing in optical disc and business software piracy, these crime rings are capable of coordinating multi-million dollar efforts across

national borders. For example, on December 19, 2001, Mexican officials raided numerous locations in Mexico in an effort to bust an organized crime ring there. These

officials uncovered 12.5 million blank CD-R’s and arrested eleven members, some of

whom were armed with high powered weapons. Subsequent investigations revealed

that the blank CD’s were made in Taiwan, shipped to a shell company established

in the U.S., and then shipped to Mexico, where the actual illegal copying and distribution occurred. We must meet this type of highly organized piracy with highly

organized coordination and enforcement efforts.

Another disturbing trend is the growing willingness of many foreign governments

to condone the use of, and even use, pirated materials. At its best, government sets

the standards for the protection of rights. At its worst, government encourages and

even participates in the breach of those rights. Now is the time for each country

in the international community to choose which path it will take with regard to intellectual property rights.

We all must realize that copyright piracy is a serious problem that does not merely affect private companies’ bottom lines in the short term. It also discourages investment and innovation in the long term, which will eventually lead to fewer conVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00088 Fmt 6601 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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sumer choices—a repercussion that affects entire societies and economies. Governments must work together to reward creators and punish thieves.

Recent treaties, such as the TRIPS agreement, provide the legal framework for

member countries to aggressively enforce their copyright laws. Article 61 of the

TRIPS agreement specifically requires member countries to establish criminal procedures and penalties to be applied in cases of copyright piracy. We already have

many tools to combat international piracy. Now we must put these tools to work.

The United States must lead by example and rigorously enforce our copyright piracy

statutes. However, we must also work with the international community to encourage other countries to do the same. Only when we coordinate our efforts to combat

piracy will we see substantial results.

I look forward to hearing the testimony of our expert witnesses about the scope

of the global piracy problem and learning about the steps that foreign governments

are taking to educate their citizens and enforce their intellectual property laws.

PREPARED STATEMENT OF THE HONORABLE MARTIN MEEHAN, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF MASSACHUSETTS

International piracy is causing enormous economic damage to U.S. media and

software companies, and these companies are understandably frustrated with the

difficulty they have encountered in getting foreign countries to take piracy seriously.

In many parts of the world, officials are bribed to ignore the production and sale

of massive quantities of pirated CDs and DVDs, and in others police do not have

the resources to combat piracy or simply do not consider it to be a major issue.

As a member of the Armed Services Committee, I find it especially interesting

that some of our closest allies—countries that depend on the U.S. to guarantee their

security and receive large amounts of our economic and military assistance—do not

seem to understand that protection of American intellectual property is a serious

issue. I look forward to learning more about international intellectual property piracy and finding ways to combat the problem.

PREPARED STATEMENT OF THE HONORABLE JOHN CONYERS, JR., A REPRESENTATIVE

IN CONGRESS FROM THE STATE OF MICHIGAN

The piracy of copyrighted content is an overwhelming problem. While the content

industries have created this country‘s number one export and have produced five

percent of this country’s Gross Domestic Product, we are being robbed of that economic value through the theft of movies, music, books, and software both here and

abroad.

That is why we are at a crossroads in Congress and the executive branch. If we

choose to strengthen enforcement of intellectual property rights, we can recapture

that lost value. If we ignore the problem, we basically will encourage more piracy

and the spread of organized crime.

Many criminal and terrorist enterprises make and sell pirated content as a way

to make fast money. The International Intellectual Property Alliance, a coalition of

copyright industry trade associations, has estimated piracy losses that are staggering for overseas piracy alone. In 2002, the movie industry lost approximately

$1.3 billion, the music industry lost $2 billion, software companies lost $3.5 billion,

and video game manufacturers lost $1.7 billion. If we are going to be serious about

fighting criminal and terrorist enterprises, we must investigate and prosecute piracy.

And it is important to remember that piracy is not about lending a CD or DVD

to a friend or using clips for a school project. It is about the theft of income from

the very creators of that content: the screenwriter, the director, the actors, the engineers, the songwriter, the artist, the graphic designer, the writer, and so on.

I believe there are two related issues to address. One is whether governments

abroad have the necessary laws to stop piracy in their home countries. The fact that

we are having this hearing indicates that the Administration must do more to press

for better intellectual property rights enforcement overseas.

The second is whether our own law enforcement agencies have the necessary authorities. With piracy increasing at a rapid rate, it seems clear that the FBI, the

lead agency on these investigations, does not have the resources to conduct intellectual property enforcement. In fact, the FBI’s own website notes that ‘‘domestic enforcement of IP laws has been inadequate and consequently the level of deterrence

has been inadequate.’’ It goes without saying that we must either give the FBI addiVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00089 Fmt 6601 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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tional powers or give the authority to another agency that is better suited to the

task.

PREPARED STATEMENT OF THE HONORABLE ROBERT WEXLER, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF FLORIDA

Mr. Chairman:

I would first like to thank you, Mr. Chairman, for calling this hearing today to

discuss the connections between international copyright infringement and organized

crime.

The growing problem of copyright piracy has reached disturbingly high levels in

many parts of the world from Thailand, Malaysia, and Taiwan to Russia and the

former Soviet republics. And despite the obviously negative domestic and foreign effects of piracy and an international consensus against it, there are still a few remaining countries that are not treating piracy as a crime and even more that are

turning a blind eye to this criminal activity. I have long been aware of the growing

problem of piracy in Asia and Europe, two areas of the world where piracy is the

worst. I find this assault on American business and innovation deeply troubling, and

I am eager to hear testimony regarding what can be done to prevent this theft

abroad.

At a time when American industry needs all the help it can get, international

copyright piracy is crippling American businesses overseas. The cost of piracy just

in Taiwan has serious international consequences. From an economic standpoint, piracy in Taiwan cost the U.S. copyright industries over $333 million last year. The

U.S. motion picture industry alone suffered $35 million in piracy losses. Unfortunately, these loss estimates vastly understate the magnitude of the problem, since

they fail to capture the dramatic impact of export piracy and the escalating losses

due to Internet theft. While there is certainly much more that could be done to prevent this problem, at least Taiwanese officials publicly oppose piracy, recognizing

that it is a problem in their country and a blemish on their foreign relationships.

It is unfortunate that there are countries, Russia among them, with far worse

records with copyright protection.

Even looking only at the consequences within the most egregiously offending

countries, the impact of copyright infringement is enormous. Particularly as the

growing connections between copyright infringement activities and organized crime

become more apparent, the social impact for these countries is devastating. It is my

understanding that in many areas of the world, organized criminal groups are heavily involved in—even spearheading—piracy and use the large sums of cash generated by this illicit business to increase their power and influence. Even more troubling is the fact that the criminal elements that oversee these illegal enterprises use

young people in many of the low-level retail sales jobs, introducing these vulnerable

youths into what may become a life of crime.

Given the far-reaching impact of these activities, it is clear that we must take

strong action to end international piracy. We must encourage foreign governments

to send a message that piracy cannot be ignored and is effectively condoned by the

state. We must also encourage them to enact strong optical disc legislation and enforce existing domestic and international anti-piracy laws. Strong and ongoing enforcement is crucial to ending piracy and must include vigorous implementation and

enforcement, shutting down all plants and owners of all plants that are found to

be pirating, and a show of support for factories and owners who are found to be

working in good faith. We must send an unequivocal message that the theft of

American intellectual property—whether the corporate piracy of software, organized

crime manufacturing of optical disks, or personal Internet downloading—will not be

tolerated.

I want to thank the Deputy Assistant Attorney General and representatives from

the entertainment and technology industries for being here today, and I look forward to hearing more regarding their experiences with combating this problem.

PREPARED STATEMENT OF GARY R. JOHNSON

Introduction

I would like to thank Chairman Smith and other distinguished Members of the

Committee for the opportunity to submit written testimony for today’s hearing. The

purpose of my submission is to call the attention of this committee to critical problems related to intellectual property encountered by Sawyer Research Products, Inc.

87

in an investment project in the Russian Federation. Other testimony today illuminates the problems encountered by entertainment and computer software industries

in Russia. My testimony demonstrates that U.S. manufacturing enterprises face

equally difficult, though very different challenges, as they conduct operations in

Russia that require the use of their intellectual property in the form of proprietary

technology.

At the outset, let me make clear that my testimony does not purport to make any

linkage between piracy and organized crime or terrorism. Others more qualified in

these areas may speak directly to those precise issues.

I come before you today as a businessman deprived of property and economic opportunity by the lack of rule of law in Russia. While today the Sawyer investment

easily could be viewed as a failure, in fact our business was a success. Sawyer went

into the heart of Russia and established a high-technology manufacturing operation

in an idle and neglected former defense facility that, through our investment, began

to export world-class products to several countries.

In contrast to many investors in the mid 1990s, Sawyer took a long-term view of

its commitment to Russia. Indeed, more than ten years later, we persist. From the

beginning we operated according to the highest ethical standards and with the utmost respect for Russian institutions. Moreover, we succeeded in creating an enterprise capable of becoming an important supplier of an essential material. I believe

the Sawyer investment should be cited by Russia as a model for economic development utilizing foreign capital, marketing know-how, and technology to further the

achievement of national goals. Instead, today the Sawyer project is all but destroyed

and is a wasting asset. We have become a much-publicized example of the problems

encountered by U.S. investors in Russia.

Despite these events, I remain positive about Russia, and believe that many courageous reforms are underway that someday will allow Russia to realize the full potential of its natural, human and cultural resources—a rightful expectation of Russian citizens and leaders. I further believe that American friendship is critical and

valuable to Russia during this period of transition. I hope that my remarks and the

Sawyer experience can serve as a catalyst for reform in Russia and help to advance

the important bilateral objectives of the U.S. and Russia.

Now, let me summarize the main points of this testimony:

I. There is fundamental lack of protection for intellectual property in Russia,

which poses a substantial obstacle to direct investment by high-technology manufacturers.

II. The lack of protection for Sawyer’s intellectual property in Russia has created

a threat to the competitiveness of Sawyer Research Products in the global marketplace.

III. The lack of IPR protection threatens the achievement of a key bilateral objective of the U.S. and Russia, namely the full integration of Russia into the world

economy.

In my conclusion, I will also present several recommendations to Congress on

steps that can be taken to address these issues.

Background on Sawyer Research Products, Inc.

I would like to provide some brief background information on Sawyer Research

Products, Inc. Sawyer is a global leader in the business and technology of single

crystal piezoelectric materials, especially cultured quartz. Quartz is second only to

the production of silicon in the ranking of crystal materials used in electronics.

Quartz is the most widely used material used both to generate and to select electronic signals at precise frequencies. Common applications include telecommunications and digital electronics (mobile telephones and computers, for example).

C.B. Sawyer founded Sawyer Research Products, Inc. in 1956 after more than 10

years of work to advance research begun in Germany during World War II as part

of a strategic initiative to improve military communications. Sawyer Research was

the first company to synthesize quartz crystals for technical use. Today, with over

10 significant producers worldwide, Sawyer remains a leader both in the value of

quartz produced and in the technology necessary to produce material at the highest

performance levels. Sawyer has committed nearly 50 years of technical refinement

and investment to create the body of intellectual property that today remains the

most important factor in the success of the company. As we sometimes say, ‘‘Research is our middle name.’’ Sawyer strives to do business around the world as a

good corporate citizen, contributing development and opportunity for our local partners, while creating profit and long-term strategic advantage.

I am an engineer and businessman with nearly 30 years of experience in high

technology and international businesses. I joined Sawyer in 1979 as a sales manager

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and today serve as chairman, president and chief executive officer. Also, I participate in a variety of activities related to our industry community, including my roles

as chairman of the International Electrotechnical Commission Technical Committee

49 (piezoelectric materials), as trustee of the Piezoelectric Devices Association, and

as vice chair of the technical program committee of the International Frequency

Control Symposium. I am also co-chair of a group of small and medium-sized (SME)

businesses in Russia, whose investments are in jeopardy. While the members of this

group seek to resolve their individual disputes, they also, through their collective

experience, seek to identify and illuminate broader policy issues for government consideration.

I. THERE IS FUNDAMENTAL LACK OF PROTECTION FOR INTELLECTUAL PROPERTY IN RUSSIA, WHICH POSES A SUBSTANTIAL OBSTACLE TO DIRECT INVESTMENT BY HIGH-TECHNOLOGY MANUFACTURERS.

To operate manufacturing operations in foreign locales, U.S. companies must

transfer critical technology. The inability of Russia to insure the intellectual property transferred by foreign investors raises a significant investment barrier, while

threatening the future competitiveness of currently active direct investors. Because

U.S. high-technology companies rely heavily on their technical advantages to compete successfully around the world, the inadequate protection of valuable intellectual property threatens the competitiveness of the high- technology manufacturing

segment of the U.S. economy.

The Sawyer case illustrates the fact that fundamental IPR violations pose a serious obstacle to investment in the high-technology industry.

On July 15, 1997, the OAO ‘‘Quartz Glass Plant’’ (‘‘QGP’’), a former state enterprise located in Goose Khrustalny in the Vladimir region, leased a shop (‘‘Shop 5’’)

holding 80 high-pressure quartz growth reactors (autoclaves) to Sawyer Research

Products for 25 years. QGP had been placed in bankruptcy in 1995. Under the lease,

which was executed pursuant to the external reorganization plan adopted by the

QGP creditor’s committee on April 4, 1997, Sawyer was required to pay $1.5 million

in the first three years, which QGP would use to pay its social debt. The 25-year

lease also provided that in the first five years Sawyer invest up to $3 million in capital required to repair and upgrade Shop 5 and up to $7 million in working capital

to finance operations.

Sawyer’s Intellectual Property Investment in Russia

Sawyer’s injection of intellectual property into its Russian investment was a vital

element in its program to elevate the production capability of the existing equipment to produce material to world-class performance standards using Russian workers. Sawyer identified, modified, and installed advanced process control systems and

techniques for the crystal growth process. The technical staff of Sawyer adapted to

the Russian facility the proprietary ‘‘recipes’’ developed over many years in the U.S.

and requiring a major investment in experiments and analysis. Upgraded metrology

equipment and methods required to assess quality were introduced. Russian technologists were trained in Sawyer’s U.S. facilities to educate them in the advanced

quartz growth process skills developed by Sawyer. Sawyer introduced quartz-cutting

technology to process the seeds required in production. Seed processing increased

the technical and manufacturing value contributed to the operation, in addition to

making it more self-sufficient.

Moreover, Sawyer provided the Russian operation with seed stock that has superior shape, size and structural perfection. Sawyer’s seed stock, developed over many

years and using a variety of proprietary techniques, is unique in the industry and

establishes economic and competitive advantages for Sawyer difficult to re-create

and as yet unmatched by others. The technology is embodied fully in the seeds

themselves.

Sawyer’s objective was to produce 10 percent of the world’s high-quality, electronic-grade quartz in Goose Khrustalny and export it to international markets, employing Russian technical managers and personnel.

On February 9, 2001, after Sawyer had completed paying the $1.5 million to QGP

for payment of social debt, invested over $1.5 million in capital improvements and

repairs to produce world standard quartz, and contributed over $3.2 million in working capital and inventory to begin operating, the Vladimir Arbitrage Court ruled

that the 25-year lease between QGP and Sawyer was void. Sawyer was in full compliance with the lease, which was duly registered by the Goose Khrustalny Branch

of the Center for Registration of Real Estate on September 17, 1997. Sawyer had

executed the lease in a manner that fulfilled the QGP external reorganization plan’s

objectives in all material respects.

89

The Vladimir Arbitrage Court’s February 9, 2001 decision was based on a lawsuit

filed by the Office of the Federal Procurator of the Vladimir Oblast on May 16, 2000.

The Federal Procurator claimed that QGP’s external bankruptcy manager exceeded

his authority under the 1997 external reorganization plan when he executed the

lease. The plan expressly provides that Shop 5 shall be leased to Sawyer for 20– 25 years. The plan envisioned that QGP would create new companies wholly owned

by QGP to lease each of QGP’s eight idle workshops, including Shop 5. Exercising

certain discretion provided under Article 12 of the law on ‘‘On Insolvency (Bankruptcy) of Enterprises’’ and Article 53 of the Civil Code, the QGP external manager

did not create a new company for Shop 5 and decided that QGP could lease this

shop to Sawyer directly.

Nevertheless, on the basis of the Federal Procurator’s claim, the Vladimir Arbitrage Court declared the lease void ab initio, or ‘‘from the beginning’’. Sawyer was

ousted from the premises of Shop 5 on June 4, 2001 after losing an appeal of the

Vladimir Arbitrage court ruling on May 15.

As a result, Sawyer lost both the revenue required to recover its up-front investment and the profits to be derived from operating Shop 5 for the remaining 21 years

of the 1997 QGP-Sawyer lease. At the time it was ousted, Sawyer was exporting

$300,000 per month of world standard quartz to top international customers on the

basis of long-term contracts.

For more details on the legal history of Sawyer’s investment in Russia, please see

the attached Annex.

II. THE LACK OF PROTECTION FOR SAWYER’S INTELLECTUAL PROPERTY IN RUSSIA HAS

CREATED A THREAT TO THE COMPETITIVENESS OF SAWYER RESEARCH PRODUCTS IN

THE GLOBAL MARKETPLACE.

Sawyer is a small and medium-sized enterprise (SME) with international reach

occupying a leading position in a critical technical material. From the beginning, the

company has recognized the overarching importance of a competitive advantage in

technology to survival. Sawyer has international production and distribution networks, which have included operations and joint ventures in the United States,

China, Japan, Malaysia, Russia, and South Korea. Yet Russia is the sole country

where Sawyer has had its intellectual property taken.

Not only has Sawyer suffered substantial financial and material losses in Russia,

especially damaging is the fact that Sawyer’s proprietary seed stock is now available

to a potential competitor, thus creating the risk of further proliferation in the industry and thereby threatening to undermine an important and valuable competitive

advantage in the global marketplace.

Bringing substance to the threat, Sawyer is aware of efforts undertaken by VPQG

and affiliated Russian companies to sell inventory removed from Sawyer control as

well as material completed from the work in progress seized in June 2001, all produced using Sawyer seeds and other proprietary technology. The Russian newspaper

Prizyv on February 20, 2003, in an article attributed to the General Director of

VPQG, reported sales by VPQG to Japan, South Korea, China, and Taiwan.

III. THE LACK OF IPR PROTECTION THREATENS THE ACHIEVEMENT OF A KEY BILATERAL

OBJECTIVE OF THE U.S. AND RUSSIA, NAMELY THE FULL INTEGRATION OF RUSSIA

INTO THE WORLD ECONOMY.

As part of Russia’s economic transformation and continued integration into the

world economy, advancing Russia’s high-technology industry is a stated objective of

the Russian federal government. On March 20, 2002, President Vladimir Putin announced that it is imperative that the Russian Federation advance beyond dependency on the export of natural resources to create an industrial base for exporting

value-added, high-technology products. In particular, he identified an initiative to

wean Russia of its dependency on natural resources by stating, ‘‘There is a possibility to reduce dependence on the export of irreplaceable resources—timber, gas,

oil—and do that by the export of artificial crystals.’’ Thus, he urged Russia to develop the very type of project in which Sawyer invested over $8 million in Vladimir.

Sawyer’s experience directly contradicts this presidential mandate. A campaign

initiated and guided by local government officials and utilizing government institutions in Vladimir resulted in the ‘‘creeping expropriation’’ of Sawyer’s physical and

intellectual property. Such projects with significant technical content are highly attractive targets. SMEs such as Sawyer, which lack both strong political networks

and the resources to sustain protracted defenses of their property rights in local

courts, are especially vulnerable in Russia. The judiciary, acting according to ‘‘state

interests’’ as defined by the procurator, was the primary instrument deployed to

take over Sawyer’s business and to provide a certain level of justification and sancVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00093 Fmt 6601 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
90

tity to an economically destructive and institutionally corrosive outcome. Not only

has Sawyer suffered significant damages, but Russia has also lost an attractive economic development opportunity, while establishing a dangerous precedent and ignoring a critical challenge to federal authority.

The inability of Russian federal reforms to insure the impartial functioning of institutions to protect investor rights, as seen in this well-known case, threatens the

achievement of a key bilateral objective of the U.S. and Russia: the full integration

of Russia into the world economy. The U.S. government’s bilateral mechanisms for

addressing Russia’s IPR violations are not new to Congress. The United States

Trade Representative (USTR) is required to prepare an annual report for Congress

that identifies countries around the globe that do not adequately protect the rights

of intellectual property owners. Based on USTR’s assessment of the conditions of IP

protection, a country may be named to a list of: 1.) Priority Foreign Countries (the

most egregious); 2.) the Priority Watch List; or 3.) the Watch List. For the past few

years, Russia (along with other trading partners) has been placed on the Special 301

Priority Watch List.

Resolution of the Vladimir investment dispute falls under the mandate of the

‘‘Joint Declaration of The United States of America and the Russian Federation’’

signed by President George Bush and President Vladimir Putin on May 24, 2002,

which states in pertinent part that: ‘‘We have established a new dynamic in our economic relations and between our business communities, aimed at advancing trade

and investment opportunities while resolving disputes, where they occur, constructively and transparently.’’ A transparent resolution of the Vladimir investment dispute would help meet several objectives set forth in the May 24, 2002 Joint Declaration, including ‘‘ . . . respect for the discipline and practices of the free market . . .

freedom of economic choice’’, [and making] ‘‘use of the potential of world trade to

expand the economic ties between the two countries, and to further integrate Russia

into the world economy as a leading participant, with full rights and responsibilities, consistent with the rule of law...’’

After being denied protection through judicial process in Russia, Sawyer approached other government agencies both in the United States and in Russia interested in advancing the bilateral economic agenda and promoting the implementation

of key reforms initiated under the Putin Administration.

U.S. Ambassador to Russia Alexander Vershbow and his staff have pursued vigorously the resolution of the Sawyer and other SME disputes. Further assistance has

come from the Department of Commerce and the Office of the Trade Representative.

Congressional support has included a letter from Senator George Voinovich to draw

the attention of The White House to the Sawyer case and to the importance of the

issues raised.

Sawyer has also received strong support from the U.S. government to pursue resolution through multiple channels of the Russian government. The Sawyer case also

has been raised with the Pleniopotentiary Presidential Representative of the Central Region; the Ministry of Economic Development and Trade; the Ministry of Justice; and the Deputy Head of the Presidential Administration responsible for judicial

reform, among others.

Nevertheless, this bilateral investment dispute is unlikely to be resolved until the

Russian government adopts a clear position regarding the federal policy and procedure that it has followed in the Federal Procurator’s case against Sawyer to date,

and that which it will follow in similar circumstances against other U.S. investors

in the future.

Conclusion

In order to secure immediate Russian government action on the Vladimir investment dispute, and thereby demonstrate a commitment to further the rule of law (especially as it applies to foreign investors and to SMEs in particular), I would like

to offer the following recommendations to the U.S. government.

• To continue to hold hearings such as this to raise awareness and to identify

appropriate legislative initiatives to address the fundamental rule-of-law

issues raised by the systematic abuse of property rights, including intellectual

property, in Russia;

• To work with your colleagues in the U.S. Executive Branch (State Department, Commerce Department, USTR, etc.) to identify appropriate costs that

could be imposed on Russia as a result of its disregard for the rule of law

(treaty violations, expropriation cases, etc.);

• To support U.S. funding for rule-of-law initiatives in Russia, especially in the

area of enforcement; and,

91

• To work with your counterparts in the Russian Congress (‘‘Duma’’) to get a

commitment to resolving these violations and disputes.

Thank you very for your interest in this matter and for the opportunity to introduce you to the situation faced by Sawyer Research in the course of doing business

in Russia.

ANNEX: LEGAL HISTORY

A Victim of ‘‘Creeping Expropriation′′

After the QGP-Sawyer lease was signed in July 1997, Sawyer created a whollyowned subsidiary ZAO ‘‘Russian Quartz’’, which employed and trained over 130 Russians to conduct the quartz-growing operation at Shop 5.

The Vladimir regional government, led by the Governor and Deputy Governor for

Economic Development, then invited two Russian companies, OAO ‘‘ROEL Contract’’

and ZAO ‘‘Vladimirtechnoservice’’, to take control of QGP and initiate lawsuits to

oust Sawyer and ‘‘keep the plant for Russia’’. (See articles in The Moscow Times,

July 27, 2001, p. 1 and August 2, 2001, p. 5, quoting ROEL representative Vladimir

Dorokin.) After acquiring a majority of the debt in QGP (81%), on December 1, 1999,

ROEL and Vladimirtechnoservice, took steps to secure control of Shop 5. They

transferred all of QGP’s assets of value, including Shop 5, to a new company, OAO

‘‘Very Pure Quartz Glass’’ (‘‘VPQG’’).

In order to take control of Sawyer’s operation at QGP, the Vladimir regional government and VPQG required a means to attack a valid contract, one duly registered

by the Goose Khrustalny Center for Registration of Real Estate. Accordingly, the administration secured the support and assistance of the local offices of federal government agencies. Working together with the Office of the Federal Service of Russia

on Insolvency and Bankruptcy Matters of the Vladimir Oblast and the Office of the

Federal Procurator of the Vladimir Region, they influenced a Vladimir Arbitrage

Court to void the QGP-Sawyer 25-year lease retroactively.

On August 31, 1999, the QGP liquidation manager notified Sawyer that the Vladimir Office of the Federal Bankruptcy Service had ordered the termination of the

QGP-Sawyer lease because Shop 5 was allegedly part of Russia’s emergency mobilization reserve plan. On September 7, 1999, the Mayor of Goose Khrustalny wrote

a letter to the employees of Russian Quartz advising them why the government

must be involved in determining future control of Shop 5. On February 25, 2000,

the Head of the Department of Industry of the Vladimir administration, warned

Russian Quartz employees that they would be transferred to the employ of VPQG.

Subsequently, the Governor of Vladimir secured the participation of the Federal

Procurator in the effort to oust Sawyer from Shop 5. On March 13, 2000, the Deputy

Governor for Economic Development advised Sawyer that the Vladimir government

had requested the Federal Procurator to take legal action to oust Sawyer due to

Sawyer’s alleged ‘‘refusal’’ to comply with the national mobilization reserve plan.

In order to assert jurisdiction in a private commercial matter, the Federal Procurator’s May 16, 2000 suit claimed that ‘‘state interests’’ prevented Shop 5 from being

leased to Sawyer because it was part of Russia’s emergency mobilization reserve

plan. As discussed above, this particular claim, however, was not the basis of the

Vladimir Arbitrage Court’s decision to void the 25-year lease. In fact, Russian law

permits assets under Russia’s mobilization reserve plan to be leased to foreign parties. Moreover, the Federal Procurator failed to produce evidence that Shop 5 was

under the plan. On February 9, 2001, the Vladimir Arbitrage Court rejected the

Federal Procurator’s claim regarding the mobilization reserve plan.

Once the Federal Procurator sued a foreign investor at the request of the Governor of Vladimir in a Vladimir court, however, the outcome of the case was assured. Although the Vladimir Arbitrage Court rejected the Federal Procurator’s primary claim against Sawyer on February 9, 2001, as discussed above, it voided the

lease on the grounds of a secondary claim—that QGP’s external bankruptcy manager exceeded his authority.

In addition, as a result of the Federal Procurator’s assertion of jurisdiction, Sawyer was deprived of fundamental legal rights guaranteed by Russia’s Constitution,

including the right to a fair trial and the protection of the statute of limitations.

In July 2000, the Chief Procurator of the Vladimir Region sent a letter to the Vladimir Arbitrage Court stating that the procurator was not subject to Article 8.3 of the

QGP-Sawyer lease, which provided Sawyer the right to submit any dispute over the

lease to binding resolution before the Court of Arbitration of the Stockholm Chamber of Commerce. On July 6, 2000 the Vladimir Arbitrage Court stripped Sawyer

of it right to submit the case to arbitration in Stockholm.

The Vladimir Arbitrage Court’s finding that QGP’s external manager exceeded his

authority in 1997 did not justify the drastic remedy of voiding the lease retroactively

92

in 2001. In fact, under Russian law, a suit to void a lease must be bought within

a statute of limitations of three years. As the Federal Procurator was acting in the

name of ‘‘state interests’’, however, the Vladimir Arbitrage Court waived the statute

of limitations. With the assistance of the Vladimir administration, VPQG sought

and the local court granted a remedy that would not otherwise have been available

to VPQG as a private claimant.

Though the Federal Procurator was purportedly seeking to protect ‘‘state interests’’, VPQG was a claimant in and a private beneficiary of the Federal Procurator’s

suit to void the QGP-Sawyer lease. As a result of the participation of both the Vladimir government and the Vladimir offices of federal government agencies, however,

Sawyer has grounds to make a legal claim directly against the Russian federal government for expropriation. Under international law, when ‘‘state action’’ is used to

take a foreign investor’s assets, the investor can claim just and immediate compensation from the government. Although the Russian federal government may not

have made an official decision to expropriate Sawyer’s investment, the company has

been the object of ‘‘creeping expropriation’’, whereby a series of actions by different

government agencies resulted in having its assets confiscated.

Sawyer Prevented from Recovering Investment or Property

After ousting Sawyer from the plant in June 2001, VPQG illegally took control

of Sawyer’s property in order to begin operations. This property included fixed assets, without which Shop 5 could not operate, inventory and other items with a total

value of approximately $3.5 million. It also included this substantial body of intellectual property transferred from Sawyer.

In its February 9, 2001 ruling declaring Sawyer’s 25 year lease void ab initio, the

Vladimir Arbitrage Court awarded Sawyer $1.7 million in damages to compensate

for certain social debt and lease payments. This award was upheld on May 15 at

the first level of appeal. $1.4 million of this award, however, was supposed to be

paid to Sawyer by QGP, which was bankrupt. VPQG was required to pay only

$280,000 to Sawyer. In any event, on July 31, 2001, the Federal Arbitrage Court

of the Volgo-Vyatsk Region in Nizhny Novgorod (‘‘Cassation Court’’) overturned the

entire damages award. As a result, Sawyer is not entitled to recoup any direct financial damages suffered due to the retroactive voiding of the lease.

On July 25, 2001, the Vladimir Arbitrage Court issued an injunction prohibiting

VPQG from using or alienating Sawyer assets, inventory and other property. During

the following two months, the Bailiff’s Office, which was charged with auditing the

property inside QGP, was denied access to the plant by VPQG. In August 2001, the

Vladimir Arbitrage Court declared the Bailiff’s Office’s failure to enforce its decisions illegal. Since that time, despite court orders requiring the return of Sawyer’s

property, the federal government agency responsible for enforcement, the Office of

the Bailiff of the Ministry of Justice (‘‘Bailiff’s Office’’), has failed to return or protect Sawyer’s property.

Despite the July 25 Vladimir Arbitrage Court injunction, VPQG has not only refused to return Sawyer’s assets, they have been damaged, concealed and/or sold. On

October 10, 2001, the Bailiff’s Office reported that during an inspection of Shop 5,

it found only 6 percent of the property Sawyer was forced to leave on the QGP

premises as of June 2001, with a value of about $200,000. Although Russian law

requires the Bailiff’s Office to take all necessary steps to find the property that was

not identified during the inspection, it has failed to do so. It is common knowledge

that the missing Sawyer property is held by VPQG on the territory of QGP and the

All Union Institute for Mineral Synthesis (‘‘VNIISIMS’’), the state-owned enterprise

in Alexandrov.

VPQG has refused to comply with orders of the Bailiff’s Office and the latter has

acquiesced. Vladimir administration officials have openly facilitated this arrangement. According to the ‘‘Minutes of Enforcement’’ prepared by the Bailiff’s Office,

upon entering the premises of QGP to enforce a court order on September 18, 2001,

the bailiffs were told to cease the proceedings because Vladimir’s Deputy Governor

for Economic Affairs was visiting the plant.

Ultimately, the Office of the Bailiff appears to have adopted a policy of enforcing

the law selectively in order to help regain local control of QGP. In an article in the

January 11–17, 2002 edition of the Vladimir newspaper, Tomiks, the Chief Bailiff

of Vladimir Region stated that he sometimes refrains from enforcing court judgments if the end result is that an investor from outside the Vladimir region will

obtain control of a facility within the region.

On January 8, 2002, the Vladimir Governor wrote to the Russian President requesting that he provide VPQG ‘‘protection from unfair competitive opposition from

large foreign companies’’ in the area of production of electronic grade quartz.

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1Journal of Commerce, July 27, 1995, p. 6A. 2 International Intellectual Property Alliance, 2003 Special 301 Report (2003), at 254. The text

of this report is available from the IIPA’s website, www.iipa.com.

On March 26, 2002, the Cassation Court in Nizhny Novgorod used the Governor’s

letter to President Putin as evidence to decide that Sawyer actually owes VPQG

$265,000.00 in damages for its use of Shop 5. Citing the lease as void ab initio, the

Cassation Court ruled that Sawyer unjustly benefited from a lease that was never

valid. As a result of the Cassation Court ruling, in April 2002, VPQG and the Office

of the Bailiff attached all of Sawyer’s property, assets and inventory, claiming that

they are needed as security for collection of the judgment against Sawyer. To complete the takeover of Sawyer’s property, inventory and assets, on October 10, 2002,

VPQG announced to the Bailiff’s Office its intention to bankrupt and liquidate Sawyer’ subsidiary, Russian Quartz, the title owner of the Sawyer property.

As a result of the March 26 Cassation Court decision and the Bailiff’s Office’s policy of selective enforcement, it is practically impossible for Sawyer to recover its

property or otherwise mitigate the damages it suffered when it was expelled from

QGP. At the same time, VPQG has not only refused to return Sawyer’s $3.5 million

in property, it has been allowed to use said property for it commercial benefit—both

by operating Shop 5 with Sawyer’s equipment and by selling Sawyer’s inventory.

PREPARED STATEMENT OF MICHAEL NEWCITY

I would like to thank Chairman Smith, Congressman Berman, and the other distinguished members of the Subcommittee for the opportunity to present my views

on the thorny problem of copyright piracy in Russia and the appropriate U.S. response.

I am the Deputy Director of the Center for Slavic, Eurasian, and East European

Studies at Duke University, where I teach courses on the Russian legal system. I

am a lawyer by profession and have studied the Soviet, now Russian, legal system

for almost thirty years. The major focus of my research and scholarship has been

intellectual property protection and, in particular, copyright law in Russia. I have

authored or contributed to several books and many articles on the subject and have

testified extensively as an expert witness on Russian copyright law in various U.S.

federal and state courts.

In 1995, the American Chamber of Commerce in Russia conducted a survey of its

members to identify the most pressing issues relating to foreign trade and investment in Russia. The business people who responded to this survey identified four

major trade and investment issues:

• Taxation

• Corruption

• Intellectual property rights violations

• Problems with standardization and licensing 1

That the lack of effective legal protection of intellectual property rights was and

remains a major concern to foreign business people in Russia is hardly surprising.

The Russian Federation and the Soviet Union before it (and, for that matter, the

Russian Empire, before it) have had long-established traditions of pirating the copyrighted works of foreign authors. The present-day magnitude of the problem is enormous. According to the International Intellectual Property Alliance, pirated versions

of copyrighted works have captured an enormous share of the total market for copyrighted works, and in some specific markets pirated versions represent over 90 percent of the market.2 In Table 1, which is compiled from data collected by the International Intellectual Property Association, losses sustained due to copyright piracy

in Russia during each of the past eight years as well as the percentage of the market for copyrighted products captured by pirated products are estimated. According

to these estimates, copyright proprietors lost almost $756 million in lost trade in

2002 and a total of almost $7 billion during the past eight years as a result of copyright piracy in Russia.

The enormity of the copyright piracy problem in Russia is obvious to anyone. The

Russian government has finally begun to recognize that this is a significant problem

since intellectual property piracy not only discourages foreign investors, but it deprives the Russian government of sorely-missed tax revenues. Russian officials have

94

3 ‘‘Firms Instruct Customs on Piracy,’’ The Moscow Times, September 24, 1998. 4Sergei Blagov, ‘‘Copyright Piracy Runs Rampant,’’ Inter Press Service, December 21, 1999,

LEXIS-NEXIS. 5 Brian Humphreys, ‘‘Officials: Pirated CD Market to Stay,’’ The Moscow Times, March 2,

2000. 6 Interfax News Agency, published in BBC Worldwide Monitoring, October 5, 2002, LEXISNEXIS 7 ‘‘Windows 2000 Launched In Russia—By Pirates,’’ Newsbytes, February 18, 2000, LEXISNEXIS. 8 Ben Aris, ‘‘In Russia, Intellectual Property Pirates Run Rampant,’’ Cox News Service, December 3, 1999. 9 New York Times, February 28, 1994, sec. C, at 11. 10The Moscow Times, October 18, 1994.

estimated that the Russian government and foreign companies lose over $1 billion

each year due to copyright piracy.3

The pervasiveness and intractability of this problem is obvious to anyone who

spends even a little time in Russia. As the following examples illustrate, the infringement of copyrights there is open, brazen, and pervasive:

• Russian markets and kiosks are fully of pirated computer software, videos,

audio CDs, and books, which are displayed and sold openly. Collections of

computer software are sold for $3–$4, audio CDs are sold for $2, and videos

of recently-released Hollywood movies are sold for $3.4

• The Russian public and many Russian government officials appear wholly indifferent to copyright piracy. When the Russian media reported that officials

would close Gorbushka, a Moscow market noted for its stalls that sell pirated

videos and audio CDs, the Russian Minister of Internal Affairs visited the

market and reassured shoppers and stall-keepers that the market would not

be closed. A telephone poll conducted by a Russian television network recently

posed the question, ‘‘Should Russia fight against piracy.’’ Of those responding,

7,804 answered ‘‘no’’ and 3,420 answered ‘‘yes.’’ 5 (Gorbushka and its vendors

of pirated CDs and other works remain in business. As one such vendor

noted, commenting several months ago on government attempts to stifle copyright piracy, ‘‘Every year, the authorities take steps to eradicate piracy but

they have failed so far.’’) 6

• Pirated copies of Microsoft’s operating system, Windows 2000, were on sale

in Moscow for approximately $3 for several months prior to its official rollout in the United States in early 2000.7

• One day after Star Wars, Episode 1: The Phantom Menace was released in

the United States, pirated copies of the film were available for sale in Moscow

pirate markets.8

• A young Russian film director completed a movie in Russia, only to see pirated copies of it circulating in Russia’s video stores and being broadcast on television within weeks of its commercial release. When asked whether he would

consider going to court to protect his rights, the director said that ‘‘Everything

is corrupt and there is nowhere to turn. . . . ‘‘To go to court is expensive and

besides, it just means more bribes.’’ 9

• The world premiere of a movie version of Vladimir Voinovich’s novel, The Life

and Extraordinary Adventures of Private Ivan Chonkin, was scheduled for

showing at a film festival. As the lights went down to begin showing the film,

its producers noticed that video equipment had been set up throughout the

theater and that some members of the audience were pulling small video

cameras out of their bags in order to pirate the film. The producers then withdrew the film from the festival.10

• The book and movie of Gone with the Wind have been extremely popular in

Russia, so much so that book stalls there have been flooded with unauthorized sequels to the book, written by Russian authors under pseudonyms.

These sequels have involved every conceivable permutation of events and

characters from the original: In some, Scarlett lives, in others she dies, and

still others explore the circumstances of her birth. As the manager of the

trading company that distributes these books stated, ’’Copyright laws are like

all laws in Russia. We have them, but nobody ever abides by them. It’s getting to be an epidemic.’’ The people behind these books were certainly aware

of copyright law requirements. According to Russian press accounts, the distribution of these books was organized so that the books are published in

Belarus, which at that time had not yet adopted new copyright legislation. As

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11 Christian Science Monitor, August 29, 1994, at 1. 12 Byron MacWilliams, ‘‘In Russia, Textbook Publishing Involves Red Tape, Piracy—and Murder,’’ The Chronicle of Higher Education, October 30, 1998, at A1, A53.

one of those involved said, ’’The books are written by citizens of Belarus, and

Belarus has no copyright laws. So we have rights without limits.’’ 11

• Russian textbook authors and publishers have suffered severely as a result

of piracy of textbooks. In 1996 and 1997 two executives of Russia’s largest

commercial publisher of textbooks were shot to death. According to an article

in The Chronicle of Higher Education, ‘‘[t]he two murders . . . were linked

. . . by the role each [of the victims] had apparently played in investigating

cases of publishing piracy.’’ Officials of the publishing house that both murder

victims worked for believe that they were killed because they were collecting

information for a police investigation.12

The problem with the protection of copyright in Russia stems primarily from the

weak implementation and enforcement of copyright legislation, not from the substantive provisions of the law itself. The 1993 Law on Copyright and Neighboring

Rights was drafted so that Russia would qualify for accession to the Berne Convention for the Protection of Literary and Artistic Works, which Russia joined in 1995.

As such, this law is certainly up to world standards for copyright legislation and

provides the legal basis for protecting the rights of Russian and foreign copyright

proprietors. Moreover, since this law was adopted, Russian criminal law was amended to make copyright piracy a serious offense.

The weakness in the Law on Copyright and Neighboring Rights is that it is vague

on the enforcement powers granted to Russian courts. Another glaring deficiency in

Russian copyright legislation is that it does not provide for the restoration of the

works of foreign authors that were previously in the public domain. But despite

these and a few other deficiencies and gaps in the legislation, the legislation is certainly workable. Nonetheless, copyright is difficult to protect in Russia. Piracy is virtually pandemic throughout Russia, involving both pirated works manufactured in

Russia as well as those imported from Bulgaria, Ukraine, China, and elsewhere.

The problem of piracy in Russia is now not isolated just to the Russian domestic

market, since pirated products manufactured in Russia have turned up in shops in

countries around the world. As Jack Valenti illustrated in his testimony to the Subcommittee, the distribution of pirated optical media products (music CDs, video

games. video CDs, and DVDs) from Russia is an especially acute problem.

The Russian government has taken some steps to fight copyright piracy, and Russian authors, recording artists, and other copyright proprietors have begun to take

concerted action as well. However, to date, the Russian government’s record on this

issue has been decidedly mixed at best. It has sponsored anti-piracy announcements

on television, the police have raided kiosks and street stalls that sell counterfeit and

pirated goods, customs officials have been involved in preventing the importation

into Russia of pirated products, and at least one television station has had its license revoked. The Interior Ministry has established a unit to fight piracy, the Intellectual Property Police. In Moscow in 1999, the police conducted approximately

300 such raids and seized tens of thousands of counterfeit video tapes and pirated

CD-ROMs. However, only 75 individuals were fined as a result of these actions and

only 10 criminal investigations were begun. Only one conviction for intellectual

property piracy has been obtained. Thus, while the laws themselves are reasonably

acceptable, the enforcement of those laws so far has been ineffective.

A more serious problem, and one that was elaborated upon in the testimony of

Joan Borsten Vidov, Mr. Valenti, and other witnesses before the Subcommittee, is

the involvement of high-ranking government officials in copyright piracy activities.

The enforcement of copyrights and neighboring rights in Russia obviously depends

on the energy and resources that Russian officials devote to enforcing these laws.

Individuals and private organizations can initiate lawsuits in Russian courts to protect their copyrights, but, as Ms. Borsten Vidov’s experience illustrates, the courts

frequently look to the government for guidance. Even if a judgment is obtained, the

courts’ powers to enforce judgments are ill-defined and limited. Thus, to a much

greater degree than is true in the United States and many other countries, individual citizens and organizations will not be able to effectively protect their copyrights and other intellectual property rights themselves, either directly or through

the courts, since the courts, police, prosecutors, customs, and other agencies will

look to the government for leadership. The Russian government must take the lead

in enforcing the rights of copyright owners.

The major challenge, then, is to persuade the Russian government at the very

highest levels to establish the protection of copyright and other intellectual property

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13 Art. VIII(4), Agreement on Trade Relations Between the United States and the Soviet

Union, signed in Washington, D.C. on June 1, 1990, U.S. House of Representatives, 192d Congress, Doc. No. 102–148, p. 20.

rights as a priority. Accomplishing this will be difficult since some government officials and some private individuals who have influence with the Russian government

are obviously profiting enormously from the illegal trade in pirated works.

The leaders of the Russian government—President Putin and his key ministers

and advisers—must be made to understand that Russia has more to lose if they continue to flout international copyright protection norms than if they provide meaningful and effective enforcement for the legislation that is already on the books.

It must be made clear to President Putin and his advisers that continued failure

to effectively protect copyrights will delay Russia’s admission as a full member of

the World Trade Organization. In addition, improvement in Russia’s bilateral trade

relations with the United States should be conditioned on a solution to the problem

of copyright piracy. In 1995, the United States Trade Representative placed the

Russian Federation on the official Watch List, a list of countries that are officially

designated by the U.S. government as having ‘‘the most onerous or egregious acts,

policies, or practices that deny adequate and effective protection’’ to U.S. intellectual

property. The continued failure of a country to address the issues that have landed

it on the Watch List may result in the imposition of trade sanctions by the U.S.

government. In 1997, the Russian Federation’s status was downgraded and it was

placed on the Priority Watch List, where it has remained to date.

The history of copyright protection in Russia makes very clear that the protection

of foreigners’ rights is only improved when significant pressure is brought to bear

by foreign governments, especially the United States. Over the past half century,

the rights of foreign owners of intellectual property have been materially upgraded

on four separate occasions. In 1965, the USSR adhered to the Paris Convention for

the Protection of Industrial Property, which was the first time since the Bolshevik

Revolution that the Soviet government had willingly joined an international agreement (bilateral or multilateral) for the protection of intellectual property. The impetus for this action was a desire on the part of the Soviet government that in order

to acquire Western technology, which it coveted, it would be necessary to provide

for the legal protection of that technology in the USSR. Otherwise, the Western

owners of the technology would be unwilling to license their technology to Soviet organizations.

The most significant advance in the protection of foreign copyright proprietors’ rights in the USSR occurred in 1973 when the Soviet Union acceded to the Universal Copyright Convention and for the first time in history granted broad legal

protection in USSR to the works of foreign authors. This step forward was the direct

byproduct of the intensive trade negotiations between the United States and the

USSR that began in 1972. One of the special concerns of the Soviets in these negotiations was the legal protection abroad of Soviet technology. The Soviet government

was desirous of expanding the sales and licenses of Soviet technology in the United

States, but the Soviets believed that this would not be possible unless the U.S.

eliminated the 30 percent withholding tax on royalties earned by Soviet organizations. In the commercial negotiations that followed in 1972 and 1973, the U.S. government negotiators offered to rescind the withholding tax if the Soviets would recognize the rights of U.S. copyright proprietors and compensate them for the use of

their works. The culmination of this negotiation was Soviet accession to the Universal copyright convention.

In a later round of trade negotiations—the negotiations that led to the 1990 U.S.-

USSR Agreement on Trade Relations—U.S. negotiators were adamant in insisting

that the Soviets improve the level of intellectual property protection extended to foreigners as a precondition of a grant of most-favored-nation status.

The Agreement on Trade Relations advanced this process by including a commitment by the Soviets to a thorough-going reform of their intellectual property laws

and included very specific features that were to be included in the new legislation.

Article VIII of the U.S.-USSR Agreement on Trade Relations, which was signed by

Presidents Bush and Gorbachev on June 1, 1990, required the preparation of draft

laws to protect intellectual property, including copyright, patents, industrial designs, know-how, trade secrets, trademarks, and protection against unfair competition. These undertakings were made even more specific in a side letter sent simultaneously with the signing of the trade relations treaty by the Soviet Deputy Minister

of Foreign Economic Relations, Yuri N. Chumakov, to the U.S. Trade Representative, Carla Hills. This letter, which the Agreement refers to as ‘‘an integral part of

this Agreement,’’ 13 promised that the Soviet government would incorporate ? detailed list of features into its intellectual property legislation:

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The Agreement on Trade Relations also provided for the establishment of a joint

U.S.-Soviet working group on intellectual property matters, whose brief, as spelled

out in the Chumakov-Hills letter, included reviewing such issues as the extension

of patent protection to products not previously patentable under Soviet law; the protection of integrated circuit layout design; the implementation of intellectual property laws; and the exchange of information and cooperation on intellectual property

protection questions.

On May 31, 1991, the Supreme Soviet adopted new civil legislation, which included revised civil code provisions on patent, copyright, and other intellectual property rights. Among the reforms introduced by the new Fundamentals of Civil Legislation were the inclusion of computer software in the list of works covered by copyright, the extension of the term of copyright to the life of the author plus 50 years,

a more elaborate statement of the copyright in recordings and broadcast programs,

the elimination of provisions regarding the compulsory purchase of copyrights by the

state, and the addition of provisions concerning the protection of know-how and

trademarks.

The final cluster of legal changes that favorably affected the rights of foreign

copyright proprietors was the adoption of the 1993 Law on Copyright and Neighboring Rights and the accession of the Russian Federation to the Berne Convention

in 1995. The adoption of the Law on Copyright and Neighboring Rights was a direct

outgrowth of the commitments made in the Agreement on Trade Relations in 1990.

The Russian Federation had succeeded to the Soviet Union’s obligations under this

treaty and was intent on meeting the conditions precedent specified in the treaty

to the grant of MFN status by the U.S.

Every time Soviet, now Russian, intellectual property protection of foreigners has

been improved, the one constant factor has been the application of pressure by the

U.S. government. Specifically, when it has been made clear that the improvement

in trade relations and the expansion of technology transfers are conditioned on the

improvement of intellectual property protection, the Russians have consistently responded favorably. Perhaps the steps taken by successive Soviet and Russian governments have been taken grudgingly and haltingly, but they have been taken. The

lesson of this history is clear: The U.S. government must take the lead in pressuring

the Russian government to respect foreign copyrights. Otherwise, protection of foreign copyrights in Russia will continue at the current halting, half-hearted pace.

Based on this brief review of the copyright piracy issue in Russia, I would advise

that the U.S. government and, to the extent possible, interested U.S. corporations

and trade organizations take the following steps:

1. U.S. trade officials, especially the U.S. Trade Representative, must

make it clear to the Russians that any consideration of Russia’s membership in the World Trade Organization or other significant

improvement in U.S.-Russian trade or commercial relations will

occur only after Russia has substantially improved the enforcement

of copyright protection and otherwise met the standards specified in

TRIPS.

2. The U.S. government should insist on a reinvigoration of the joint

U.S.-Russian working group on intellectual property matters that

was established under the 1990 Agreement on Trade Relations and

further insist that senior government officials and agencies from

both governments are involved in the meetings of this working

group. Moreover, the mandate of this working group could be broadened so that it could serve as a forum in which aggrieved intellectual property owners can seek resolution of their grievances.

3. The U.S. government, international organizations, and private corporations should assist the Russians in marketing their intellectual

property abroad. If the Russian government and Russian companies

are shown that they could earn substantial revenues from the licensing abroad of their copyrighted works and other intellectual property, but that to do so they must effectively protect foreign intellectual property in Russia, they might be more enthusiastic and willing

to cooperate in protecting foreign intellectual property. This is an

area where U.S. copyright-based industries in particular could be

most active.

4. The U.S. government should strongly request that the Russian government seek ratification of the Bilateral Investment Treaty between

the United States and the Russian Federation that was signed on

June 17, 1992. This treaty has been signed and ratified by the U.S.,

but it has never been ratified by the Russian Duma. Though the BiVerDate 11-MAY-2000 23:20 May 06, 2003 Jkt 000000 PO 00000 Frm 00101 Fmt 6601 Sfmt 6621 G:\WORK\COURTS\031303\85643.000 HJUD3 PsN: HJUD3
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lateral Investment Treaty does not address intellectual property protection specifically, its protections against discriminatory treatment,

uncompensated expropriation, and submission of disputes to international arbitration would benefit U.S. investors who have had their

investments in Russian, including intellectual property, confiscated

or treated in a discriminatory fashion.

5. U.S. copyright-based industries should review their price structures

and, if possible, lower them to meet competition from pirated

sources. At present, pirated music CDs sell for $2–3 each in Russia

and licensed CDs cost $15. With average monthly incomes throughout Russia in the $100–150 range, the substantial price differential

between pirated and licensed works is a huge factor supporting the

demand for pirated works.

Though I believe that these steps, if taken, will result in a substantial improvement in the protection of foreign intellectual property in Russia, it would be na ̈ıve

to assume that this situation will improve dramatically overnight. Instilling a respect for the rights of intellectual property owners is only a subset of the larger

problem of instilling a respect for the rule of law in Russia. This larger task will

involve overcoming a thousand years of experience and habit.

International and domestic efforts to encourage a respect for the rule of law in

Russia have met with mixed success at best, which should not be surprising. Fashioning a new legal culture, one that is not premised on deference to authority and

a profound distrust of the state, is no easy matter. Most international technical assistance programs have focused on encouraging a respect for the rule of law at the

grassroots level. While this is important and ultimately indispensable, I think it is

unlikely by itself to succeed. In Russian society, courts, police, government officials,

and ordinary citizens take their cues from the top. As long as senior government

officials ignore the rule of law, other members of society will ignore it as well. That

is why I believe the most effective policy the U.S. government can pursue is to take

the specific steps suggested above and, in a broader sense, encourage the leaders

of the Russian government to act themselves in a lawful manner—in a way that

shows that they respect the law.

Perhaps the most constructive policy that President Putin could undertake would

be to initiate a government campaign to remove corrupt government officials and

those who interfere in the workings of the courts and other judicial agencies, and

to curtail the power of the oligarchs and criminal organizations. It is only when

President Putin and his senior officials model a respect for the law themselves that

others in Russian society will take the rule of law seriously.

Again, I would like to thank the Subcommittee for the opportunity to discuss this

important issue.

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1The Engineer, Fighting the Fakers, at 16 (April 26, 2002); Phillippe Broussard, Dangerous

Fakes, World Press Review, v44, n1, p36 (1) (January 1999). According to the Shenzhen Evening

News (a government owned newspaper), approximately 192,000 people died in China in 2001

because of fake drugs. China’s Killer Headache: Fake Pharmaceuticals, Washington Post, August 30, 2002. The same article goes onto to state that, since 2001, Johnson & Johnson has established 38 criminal cases against different factories that copied its products in China.

PREPARED STATEMENT OF TIMOTHY P. TRAINER

The International AntiCounterfeiting Coalition (IACC) would like to thank the

distinguished members of the Subcommittee for the opportunity to offer its views

with respect to the links between intellectual property theft and organized crime

and terrorism.

The IACC is a Washington, D.C.-based non-profit organization devoted solely to

combating product counterfeiting and piracy. Formed in 1978, today it is comprised

of a cross section of business and industry—from autos, apparel, luxury goods, and

pharmaceuticals, to food, software and entertainment—the IACC’s members’ combined annual revenues exceed $650 billion. The touchstone of the IACC’s mission

is to combat counterfeiting and piracy by promoting laws, regulations and directives

designed to render the theft of intellectual property undesirable and unprofitable.

The IACC serves as an umbrella organization, offering anticounterfeiting programs

designed to increase protection for patents, trademarks, copyrights, service marks,

trade dress and trade secrets.

Critical to the IACC’s purpose is its belief that acts of counterfeiting create severe

public health and safety hazards, as well as economic harm. The IACC supports

government actions that will ultimately result in increased enforcement, lead to the

prosecution of intellectual property infringers, and create a strong deterrent to counterfeiters and pirates. In pursuing its mission, the IACC provides law enforcement

officials with information and training to identify counterfeit and pirate products

and in the methods of product security to prevent the infringement of its members’

intellectual property rights.

In an effort to create conditions under which its members’ intellectual property

rights are safe from illegal copying, infringement and other forms of theft, the IACC

engages in substantive dialogue with governments and intergovernmental organizations worldwide. In pursuing its mission, the IACC provides law enforcement officials with information and training to identify counterfeit and pirate products and

in the methods of product security to prevent the infringement of its members’ valuable intellectual property rights.

SCOPE OF INTELLECTUAL PROPERTY THEFT

There are no product lines, corporations, or consumers that escape the counterfeiters’ and/or pirates’ reach. Dangerous counterfeit products have appeared in retail

stores across the United States. Organized crime is increasingly attracted by

counterfeiting’s high profits and relatively low criminal penalties. In addition, the

manufacture, distribution and sale of counterfeit goods rob local economies of precious tax revenues, and costs Americans jobs.

Many pirate and counterfeit goods are not as visible as you might think. Many

people think of the counterfeits and pirated products purely in terms of street vendors’ products—music CDs, sunglasses, t-shirts, hats, cosmetics, cell phone covers,

handbags and watches—bearing easily recognizable and known names and logos.

But, on a different level, product counterfeiters and pirates are trading on names

and logos often associated with things such as razor blades, shampoos, pharmaceuticals, foods, hand tools, auto parts, light bulbs, film, skin lotions, laundry detergent, band-aids, insecticides, batteries, cigarettes and practically anything else that

bears a name that consumers are familiar with in the market place. Very few products, if any, are beyond the reach of skilled counterfeiters.

PUBLIC HEALTH AND SAFETY DANGERS

Of particular concern to IACC members and consumers is the increasing availability of fakes that present severe health and safety risks. For example, the World

Health Organization estimates that counterfeit drugs account for ten percent of all

pharmaceuticals. That number can rise to as high as sixty percent (60%) in developing countries.1 In another case, and according to a federal indictment made public

in May 2002, U.S. Customs officials seized 59,000 bottles of counterfeit vodka in a

Massachusetts warehouse. The fake vodka had been imported from a former Soviet

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2Thanassis Cambanis, Fancy Labels, Cheap Vodka Don’t Mix, The Boston Globe, May 2, 2002,

at B1. 3The Engineer, Fighting the Fakers, at 16 (April 26, 2002).

4 Henry Gilgoff, Counterfeit: Rip-offs of Popular Products Victimize Both Consumers and Manufacturers, Newsday, August 27, 1995. Fake toothpaste has also found its way into drug stores.

Colgate Warns People Against Fake Toothpaste, Austin American Statesman, August 12, 1996. 5 Billy Stern, Warning! Bogus Parts Have Turned Up in Commercial Jets. Where’s the FAA?,

Business Week, June 10, 1996, at 90. 6See Marian Burros, F.D.A. Target: Baby Formula, N.Y. Times, September 6, 1995; 142 Cong.

Rec. 5776 (House). More recently, in 1999, the Food and Drug Administration (FDA) issued a

warning regarding counterfeit cans of infant formula for infants allergic to milk protein. The

warning came after some of the illicit product had already been purchased. The FDA warning

stated that infants who ingested the counterfeit formula could experience fevers, skin rashes or

severe allergic reactions. FDA Warns About Infant Formula Fraudulently Labeled as

Nutramigen in Southern California, HHS NEWS (U.S. Department of Health and Human Services), P99–23, October 8, 1999. See also Fugitive Who Sold Counterfeit Baby Formula Convicted

of Federal Criminal Charges, Department of Justice (Press Release), August 9, 2002, available

at http://www.cybercrime/gov/mostafaConvict.htm (discussing the conviction of Mohamad

Mostafa on charges involving a conspiracy to sell counterfeit infant formula; the defendant was

also in the country illegally and upon indictment in 1995 fled to Canada where he was arrested

in 2001). 7See Kathleen Millar, Financing Terror, Profits from Counterfeit Goods Pay for Attacks, U.S.

Customs Today, November 2002, available at http://www.customs.gov/custoday/nov2002/

index.htm; Moving Up on the Outside, it’s IPR Seizures, U.S. Customs Today, May 2002, available at http://www.customs.gov/xp/CustomsToday/2002/May/ost.xml; NBC News Miami Affiliate

interview of U.S. Customs Agent (broadcast February 4, 2003)(tape of broadcast on file with the

IACC). 8See Green Quest, Finding the Missing Piece of the Terrorist Puzzle, available at http://

www.customs.ustreas.gov/xp/cgov/enforcement/investigative—priorities/greenquest.xml.

republic.2 In Estonia in 2001, illicit vodka containing methyl alcohol killed 60 people.3 The problems, however, do not end with pharmaceuticals and alcohol.

In the 1990’s, a major shampoo manufacturer was forced to place half-page advertisements in at least 27 national newspapers informing the general public that

counterfeit versions of its shampoo were available in retail stores. Of particular concern to the manufacturer was the fact that the fake shampoo may have contained

bacteria, risking infection in users with weakened immune systems.4 Even more disturbing was the case where the operational life of counterfeit bearing seal spacers

removed from a United Airlines plane were found to be only 600 hours—the genuine

parts had an operational life of 20,000 hours. The fake parts came complete with

fake boxes, labels and paperwork and were only discovered because of a very alert

maintenance technician.5 Finally, counterfeit-labeled infant formula found its way

onto shelves in grocery stores in 16 states.6

For more examples relating to threats to the public health and safety, please refer

to the attached document containing a list of relevant public source news articles

and government reports compiled by the IACC.

LINKS TO ORGANIZED CRIME AND TERRORISM

In addition to the public safety issues, the IACC has spent years tracking the increasing influx of organized crime and terrorists into the lucrative under world of

product counterfeiting and copyright piracy. These notorious organizations operate

vast networks of counterfeit product distribution channels, and are often heavily involved in other criminal activity such as drug trafficking or money laundering.

Low risk of prosecution and enormous profit potential have made criminal counterfeiting an attractive enterprise for organized crime groups. Congress itself recognized organized crime’s increasing role in the theft of intellectual property when it

made both trademark counterfeiting and copyright piracy violations predicate acts

under the federal RICO statute (see 18 U.S.C. § 1961). The federal money laundering statutes (18 U.S.C. δ§ 1956–57) similarly include trademark counterfeiting

and copyright piracy violations as crimes that constitute the type of ‘‘specified unlawful activity’’ necessary for convictions under these statutes.

Recently, ties have also been established between counterfeiting and piracy and

terrorist organizations that use the sale of fake and unauthorized goods to raise

funds and launder money. Indeed, the United States Customs Service has explicitly

stated that there is a link between terrorist organizations and intellectual property

theft.7 In addition, Operation Green Quest—a multi-agency task force established

by the Treasury Department and aimed at identifying and dismantling the terrorist

financial infrastructure—has specifically recognized counterfeit merchandise

schemes as a source of terrorist funding.8

The attached list of public source news articles compiled by the IACC helps to detail, in alarming fashion, the extent of the connections between intellectual property

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9See William Glaberson, 6 Are Charged With Selling Millions of Counterfeit Marlboros, The

New York Times, February 21, 2003, at sec. B, pg. 3; John Marzulli, Fake Marlboro Men Busted

in Smuggling Ring, Daily News (New York), February 21, 2003, at 37. 10See John Mintz & Douglas Farah, Small Scams Probed for Terror Ties, Washington Post,

August 12, 2002, at A1. 11 Al-Qa’idah Trading in Fake Branded Goods, BBC Monitoring Reports (September 11, 2002);

Lenore Taylor, Big Business Targets Terrorist Pirates, Australian Financial Review, January

29, 2003, at 9. 12 Clif LeBlanc, Huge Fake Clothing Ring Cracked, Upstate Man Pleads Guilty to Running

$7 Million Scam, The State (South Carolina), January 18, 2003, at A1; South Carolina Man

Pleads Guilty to Trafficking Clothing with Counterfeit Trademarks, Department of Justice Press

Release, January 16, 2003, available at http://www.cybercrime.gov/farmerPlea.htm. 13 Erika Martinez & Marsha Kranes, Knockoffs Knocked Out, New York Post (May 10, 2002).

theft and organized criminal and/or terrorist groups and their potential devastating

impact to both the American citizenry and economy. Consider just a few examples

from that list:

(1) In February 2003, federal prosecutors in Brooklyn, N.Y. charged six men

with importing up to 35 million counterfeit cigarettes from China into the

United States. The men were accused of importing the fake cigarettes, then

selling them through a tax free business located at an upstate New York

Indian reservation and also through the website http://

www.smokecheap.com. The cigarettes were allegedly imported into the

United States in 5 separate shipments through New Jersey ports over a two

tear period. The charging documents stated that the counterfeiters hid the

cigarettes in shipping containers behind kitchen pots. According to the prosecutors, the men were under investigation in Europe for cigarette smuggling. Two of the defendants were also charged with importing counterfeit

batteries from China via Lithuania.9

(2) In 1996, the FBI confiscated 100,000 counterfeit T-shirts bearing fake and

unauthorized Nike ‘‘swoosh’’ and/or Olympic logos that were intended to be

sold at the 1996 Summer Olympic Games. The operation generated millions

of dollars and was run by the followers of Sheik Omar Abdel Rahman—a

blind cleric who was sentenced to 240 years in prison for plotting to bomb

New York City landmarks. Authorities seized three floors worth of illicit

merchandise, stacked seven feet high.10

(3) There have been recent media accounts reporting a link between the terrorist organization Al Qaeda and the trafficking of counterfeit goods. An investigation, involving several countries, into a shipment of fake goods from

Dubai to Copenhagen, Denmark, suggests that Al Qaeda itself may be funding itself by trafficking in counterfeit goods. Danish customs, using sophisticated risk analysis software, examined one of the containers on board and

discovered that it contained over one thousand crates full of counterfeit

shampoos, creams, cologne and perfume. The goods were ultimately bound

for the United Kingdom. The United Kingdom later revealed that the sender

of the counterfeit goods was a member of Al Qaeda. This connection was

later confirmed by the European Commission’s Customs Coordination Office.

The intelligence services of three countries—Denmark, the United Kingdom

and the United States—were, according to the same report, involved in investigating the matter.11

(4) On January 16, 2003 William Haskell Farmer entered a guilty plea to trafficking in a massive counterfeit clothing operation. (The guilty plea was conditional upon an appeal to the United States Court of Appeals for the

Fourth Circuit). According to the United States prosecutor, the scheme involved approximately $7 million in knock off T-shirts and sweat shirts.

Farmer sold the shirts to 191 stores throughout the country. United States

Customs agents seized over 300,000 fake items from Farmer’s home and

warehouse (the house was a two-story home with a swimming pool and two

car garage). Farmer agreed to forfeit over $500,000 in cash and cashier’s

checks, eight vehicles, (including two Mercedes Benzs and a 1998 Corvette),

and two cargo trailers. The cash had been seized in 1998 when Farmer’s

home was searched. The majority of the money was in $50 and $100 bills.

There was $6,000 worth of change in the garage.12

(5) Police in the Chinatown section of New York City uncovered a stash of fake

watches, handbags, sunglasses and wallets worth over $125 million that

were hidden in a building that contained secret tunnels, trapdoors and

vaults. Ten people were arrested.13

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14Taiwan Fears US Blacklist After Fake Software Haul, The Strait Times (Singapore), November 19, 2001, at A3; U. S Customs Seizes $100 Million in Pirated Computer Software, Biggest Case in U.S. History, Department of Justice Press Release, November 16, 2001, available

at http://www.cybercrime.gov/operationwhitehorse.htm. 15See 18 U.S.C. § 2320. 16See 19 U.S.C. § 1526(f).

(6) In November 2001, US federal authorities made their largest seizure ever

of counterfeit computer software in connection with the arrest of the individuals. The seizure of nearly 31,000 copies of phony software was valued at

approximately $100 million (US). The software originated in Taiwan and

was encased in counterfeit packaging (including holographs and registration

codes) and also came with manuals. Federal authorities were alerted to the

shipment when a member of a criminal syndicate operating between Taiwan

and Los Angeles allegedly attempted to bribe an undercover agent who was

posing as a U.S. Customs official. Seized in connection with the arrests were

a forty foot shipping container containing counterfeit computer software and

packaging material, two forty foot containers filled with 85,000 cartons of

counterfeit cigarettes (i.e., 17 million cigarettes). A second search warrant

executed in connection with the investigation resulted in the seizure of 21

cartons of counterfeit end user license agreements, manuals, bar codes, adhesive labels and registration cards.14

These are just a few examples. For more stories about the well documented links

between intellectual property theft and organized crime and terrorism, please refer

to the attached document containing a list of relevant public source news articles

and government reports compiled by the IACC.

The IACC believes that the best deterrent to counterfeiting and piracy is criminal

penalties that result in actual imprisonment. Based on this policy, the IACC has

led efforts that resulted in the passage of the 1984 Trademark Act that established

federal criminal sanctions for trademark counterfeiting,15 the Anticounterfeiting

Consumer Protection Act of 1996 that increased civil penalties and provided U.S.

Customs with the authority to assess administrative fines against those that import

counterfeit products,16 and the establishment of specific criminal provisions for

trademark counterfeiting in 31 states and the District of Columbia. By providing

federal and state law enforcement officials with the jurisdiction to prosecute counterfeiters, and U.S. Customs with the discretion to penalize known importers of

counterfeit merchandise, the IACC has sought to promote a comprehensive enforcement system to stop illegal goods at the borders, punish manufacturers and distributors of counterfeit products in interstate commerce, and address counterfeiting

at the retail level within the states, counties and cities where it is most prevalent.

Recent world events have caused federal and state government officials to correctly reevaluate the mission priorities of law enforcement personnel to address national security issues. As pointed out above, the IACC is concerned that the low

risk, high-profit nature of counterfeiting and piracy has and will continue to attract

the attention of organized crime and terrorist groups looking to fund their operations. The IACC and its members look forward to working with Congress, law enforcement and the new Department of Homeland Security to identify and eliminate

links between counterfeiting and the funding of terrorist groups that may arise in

the course of protecting U.S. economic interests and intellectual property rights.

CONCLUSION

On behalf of the IACC, I thank the Members of the Subcommittee for providing

me with the opportunity to present this written testimony and, based on the documented links I have presented herein, urge the United States Government to investigate more aggressively the links between all types of intellectual property theft

and organized criminal and terrorist groups.

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