```

[Federal Register Volume 78, Number 74 (Wednesday, April 17, 2013)]
[Rules and Regulations]
[Pages 23053-23100]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08657]

[[Page 23053]]

Vol. 78

Wednesday,

No. 74

April 17, 2013

Part III

Library of Congress

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Copyright Royalty Board

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37 CFR Part 382

Determination of Rates and Terms for Preexisting Subscription Services 
and Satellite Digital Audio Radio Services; Final Rule

Federal Register / Vol. 78, No. 74 / Wednesday, April 17, 2013 / 
Rules and Regulations

[[Page 23054]]

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LIBRARY OF CONGRESS

Copyright Royalty Board

37 CFR Part 382

[Docket No. 2011-1 CRB PSS/Satellite II]

Determination of Rates and Terms for Preexisting Subscription 
Services and Satellite Digital Audio Radio Services

AGENCY: Copyright Royalty Board, Library of Congress.

ACTION: Final rule and order.

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SUMMARY: The Copyright Royalty Judges are announcing their final 
determination of the rates and terms for the digital transmission of 
sound recordings and the reproduction of ephemeral recordings by 
preexisting subscription services and preexisting satellite digital 
audio radio services for the period beginning January 1, 2013, and 
ending on December 31, 2017.

DATES: Effective date: April 17, 2013.
    Applicability date: The regulations apply to the license period 
January 1, 2013, through December 31, 2017.

ADDRESSES: The final determination also is posted on the Copyright 
Royalty Board Web site at http://www.loc.gov/crb.

FOR FURTHER INFORMATION CONTACT: Gina Giuffreda, Attorney Advisor. 
Telephone: (202) 707-7658. Telefax: (202) 252-3423.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Copyright Royalty Judges (``Judges'') convened this rate 
determination proceeding in accordance with 17 U.S.C. 803(b) and 37 CFR 
351. On January 5, 2011, the Judges published in the Federal Register a 
notice announcing commencement of this proceeding with request for 
Petitions to Participate in this proceeding. The purpose of the 
proceeding is to determine the rates and terms of royalty payments 
payable by Preexisting Subscription Services (``PSS'') and Satellite 
Digital Audio Radio Services (``SDARS'') under the Copyright Act, 17 
U.S.C. 112 and 114. The rates and terms set in this proceeding apply to 
the period January 1, 2013, to December 31, 2017. Having carefully 
considered the relevant law and the evidence received in this 
proceeding, the Copyright Royalty Judges determine that the appropriate 
Section 114(f)(1) rates for the PSS are 8% of Gross Revenues for 2013 
and 8.5% for 2014 through 2017. The Section 114(f)(1) rates for Sirius 
XM are 9% of Gross Revenues for 2013, 9.5% for 2014, 10.0% for 2015, 
10.5% for 2016, and 11.0% for 2017.

A. The 2012 Proceeding \1\
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    \1\ During the course of the proceeding, Chief Judge Sledge and 
Judge Wisniewski retired. Judge Sledge retired in April 2012 before 
the start of oral testimony. The Librarian of Congress appointed his 
successor, Chief Judge Barnett, in April 2012. Judge Wisniewski 
retired on August 31, 2012, after the conclusion of oral testimony; 
the Librarian appointed an interim Copyright Royalty Judge, Judge 
Strasser, on September 17, 2012, pending the appointment of Judge 
Wisniewski's successor.
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    The following entities filed Petitions to Participate and were the 
only remaining, non-settling participants at the time of hearing: 
SoundExchange, Music Choice, and Sirius XM. On May 25, 2012, the 
participants submitted a stipulation in which they agreed to the 
proposed Section 112 license rates and terms.
    On June 5, 2012, the remaining participants in the proceeding 
commenced the direct case relating to Section 114 rates and terms. The 
Judges heard the rebuttal case beginning August 13, 2012. All parties 
presented evidence in the form of written testimony, live testimony, 
documentary evidence,\2\ and oral argument by counsel. Participants 
also designated background testimony from the last rate determination 
relating to SDARS and PSS. The parties submitted written proposed 
Findings of Fact and Conclusions of Law and responses to the same. On 
October 16, 2012, all parties presented closing argument. In all, the 
Judges heard evidence and oral argument for a period of 19 days. The 
parties presented 32 fact and expert witnesses.
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    \2\ The Judges did not consider all of the offered testimony. 
Ruling on motions to strike or exclude, the Judges edited or 
excluded testimony during the course of the hearing. This 
determination is based solely on the evidence the Judges admitted.
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    The Judges make this Final Determination of Rates and Terms 
pursuant to 17 U.S.C. 803(c)(2) and 37 CFR Part 353. After evaluating 
the evidence to determine a range of reasonable royalty rates based on 
market benchmarks, the Judges subjected those presumed rates to the 
policy analysis required by 17 U.S.C. 801(b) of the Act.
    On December 14, 2012, the Judges issued to the parties their 
Initial Determination. Pursuant to 17 U.S.C. 803(c)(2) and 37 CFR Part 
353, SoundExchange and Sirius XM each filed a motion for rehearing. The 
Judges requested responses from the parties regarding each of the 
motions. Order Requesting Responses to Motions for Rehearing, Docket 
No. 2011-1 CRB PSS/Satellite II (Jan. 8, 2013). SoundExchange and 
Sirius XM each filed timely responses. After reviewing both motions and 
the responses thereto, the Judge denied both motions for rehearing. 
Order Denying Motions for Rehearing, Docket No. 2011-1 CRB PSS/
Satellite II (Jan. 30, 2013). As explained in the January 30, 2013, 
Order, the Judges determined that none of the grounds set forth in the 
motions constituted the type of exceptional case--namely, (1) an 
intervening change in controlling law, (2) the availability of new 
evidence, or (3) a need to correct a clear error or prevent manifest 
injustice--warranting a rehearing. Id.
    The Judges agreed with the parties, however, that clarification was 
needed in order to prevent ``an unintended double exclusion'' from 
Gross Revenues for the Direct License Share in Sec.  382.12(d) and the 
Pre-1972 Recording Share in Sec.  382.12(e). Id. at 5. After reviewing 
the respective proposals of SoundExchange and Sirius XM, the Judges 
adopted Sirius XM's proposal, finding that ``Sirius XM's approach 
adequately addresses SoundExchange's double credit concern and in a way 
that may help to ensure a more accurate reflection of the legal status 
of the pre-1972 recordings with respect to the licenses at issue in 
this proceeding.'' Id. Consequently, in this Final Determination, the 
Judges adopt Sirius XM's proposed language which will appear as Sec.  
382.12(d)(4): ``No performance shall be credited as an Internet 
Performance of a Directly-Licensed Sound Recording under this section 
if that performance is separately credited as an Internet Performance 
of a Pre-1972 sound recording under paragraph (e)(1) of this section.''

B. Prior Proceedings

    For the current licensing period, the Judges adopted agreed royalty 
rates for the PSS and made a determination of applicable rates for 
SDARS after a contested hearing. The Judges caused the prior SDARS 
determination [hereinafter SDARS-I] to be published in the Federal 
Register [hereinafter FR] at 73 FR 4080 (Jan. 24, 2008).
    The Judges' predecessors considered the reasonable rate standard 
and the Section 801(b)(1) policy factors in three prior proceedings: a 
Section 116 jukebox rate adjustment by the Copyright Royalty Tribunal 
(``Tribunal''); a Section 115 mechanical rate adjustment, also by the 
Tribunal; and a proceeding under the Copyright Arbitration Royalty 
Panel (``CARP'') system administered by the Librarian of Congress 
(``Librarian'') for preexisting subscription services under Section 
114(f)(1)(B), the same section involved in this proceeding. 
Participants sought judicial review of all three prior

[[Page 23055]]

determinations. A fuller history of prior proceedings and the outcomes 
and resolutions of those proceedings is included in SDARS-I. See 73 FR 
4080, 4082-4085 (Jan. 24, 2008).
    In Recording Indus. Ass'n of America v. Copyright Royalty Tribunal, 
662 F.2d 1 (DC Cir. 1981), the U.S. Court of Appeals for the DC Circuit 
discussed its judicial review standard. The DC Circuit concluded that

    To the extent that the statutory objectives [set forth in 
Section 801(b)] determine a range of reasonable royalty rates that 
would serve all these objectives adequately but to differing 
degrees, the Tribunal is free to choose among those rates, and 
courts are without authority to set aside the particular rate chosen 
by the Tribunal if it lies within a ``zone of reasonableness.''

Id. at 9 (footnotes omitted).
    In 1993, Congress replaced the Tribunal with the CARP system. In 
1995, Congress passed the Digital Performance Right in Sound Recordings 
Act of 1995, creating the Section 114 digital performance right license 
that is the subject of this proceeding. The Copyright Royalty 
Distribution and Reform Act of 2004 established the Copyright Royalty 
Judges as a decision-making body in the Library of Congress. The Judges 
follow relevant precedent of the Tribunal and CARP system and strive to 
adopt reasonable royalty rates that satisfy the policy objectives set 
forth in Section 801(b). To determine rates, the Judges begin with an 
analysis of proposed market benchmarks, if any, and voluntary license 
agreements as described in Section 114(f)(1)(B), and the participants' 
supporting testimony. The Judges then measure the rate or range of 
rates that process yields against the statutory policy objectives to 
reach a determination of rates and terms.

II. The Standard for Determining Royalty Rates

    Section 801(b)(1) of the Copyright Act provides that the Judges 
shall ``make determinations and adjustments of reasonable terms and 
rates of royalty payments'' for the statutory licenses set forth in 
Sections 114(f)(1) (``digital performance license'') and 112(e) 
(``ephemeral license'') of the Act. These licenses contain similarities 
and important differences in their standards for setting royalty rates. 
Both require the determination of reasonable rates and terms. The 
digital performance license requires that the rates (but not the terms) 
be calculated to achieve the following objectives:
     To maximize the availability of creative works to the 
public.
     To afford the copyright owner a fair return for his or her 
creative work and the copyright user a fair income under existing 
economic conditions.
     To reflect the relative roles of the copyright owner and 
the copyright user in the product made available to the public with 
respect to relative creative contribution, technological contribution, 
capital investment, cost, risk, and contribution to the opening of new 
markets for creative expression and media for their communication.
     To minimize any disruptive impact on the structure of the 
industries involved and on generally prevailing industry practices.

17 U.S.C. 801(b)(1).\3\
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    \3\ The ephemeral license requires the Judges, among other 
things, to ``establish rates that most clearly represent the fees 
that would have been negotiated between a willing buyer and a 
willing seller.'' 17 U.S.C. 112(e)(4). The ephemeral license 
requires adoption of a minimum fee for each type of service offered 
by a transmitting organization.
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    The participants in this proceeding reached agreement on the rates 
and terms of the Section 112 license prior to the hearing; 
consequently, the focus of this determination is the application of the 
Section 801(b) factors to Section 114 rates. In SDARS-I, the Judges set 
forth in great detail the historical treatment of these factors by the 
Tribunal and the Librarian in his administration of the CARP system. 
See, SDARS-I, 73 FR at 4082-84. Consideration of this history produces 
the following approach.

    [The Judges] shall adopt reasonable royalty rates that satisfy 
all of the objectives set forth in Section 801(b)(1)(A)-(D). In 
doing so, [they will] begin with a consideration and analysis of the 
[market] benchmarks and testimony submitted by the parties, and then 
measure the rate or rates yielded by that process against the 
[Section 801(b)] statutory objectives to reach [a] decision * * *.
    The issue at hand is whether these policy objectives weigh in 
favor of divergence from the results indicated by the benchmark 
marketplace evidence.

Id. at 4084, 4094 (citations omitted).\4\
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    \4\ The Judges followed the same approach in determining royalty 
rates for the Section 115 mechanical license, the only proceeding 
involving the Section 801(b)(1) factors decided since SDARS-I. See, 
Phonorecords I, 74 FR 4510 (Jan. 26, 2009). None of the parties in 
this proceeding contend that this approach is erroneous or must be 
abandoned.
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    In this proceeding, Music Choice argues that the Judges must 
consider an additional factor, applicable only to the PSS rate. Music 
Choice parses the Librarian's PSS determination [hereinafter, PSS-I], 
63 FR 25394 (May 8, 1998), and Section 803(a)(1) to conclude that the 
Judge's benchmark analysis must begin with the current royalty fees 
paid by Music Choice to the performing rights societies (ASCAP, BMI and 
SESAC) for musical works. Music Choice contends that the Librarian's 
use of the musical works benchmark in 1998 mandates that the Judges 
must use that same benchmark in these proceedings in the absence of a 
better, comparable benchmark. See Music Choice PCL ] 53.
    The Judges reject Music Choice's argument for several reasons. 
First, Music Choice does not, and cannot, cite any statutory license 
rate proceeding in which the adjudicator found that factual marketplace 
observations in a particular royalty rate proceeding must be given a 
priori consideration in a subsequent proceeding. Second, in the PSS-I 
decision, the Librarian did not rely solely upon the musical works 
benchmark, but instead relied upon some unspecified combination of 
factors. See PSS-I, 63 FR at 25410. Even if the Judges were inclined to 
accord some precedential value to the musical works benchmark from PSS-
I in this proceeding, the Judges cannot discern the degree to which 
that benchmark influenced or altered the Librarian's decision.
    Third, Music Choice fails to place the PSS-I decision in its 
historical context. The Librarian had before him for consideration only 
the musical works fees and the Music Choice partnership license 
agreement. The Judges have more evidence in this proceeding upon which 
to base a decision.
    Therefore, in this proceeding, the Judges consider the musical 
works evidence offered by Music Choice not as binding precedent but as 
evidence offered in the normal course, along with all other current 
evidence, not giving the musical works benchmark any preference as a 
starting point for, default position in, or other limitation on a 
proper evaluation of all of the benchmark evidence.

III. Determination of the Royalty Rates

    The Judges have considered carefully the relevant law and the 
evidence received in this proceeding. Based upon that evidence and law, 
and for the reasons detailed in the following discussion, the Judges 
have determined applicable royalty rates for the licensing period 
January 1, 2013, through December 31, 2017, for the only existing 
SDARS, Sirius XM, and for the PSS.\5\

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    \5\ The PSS are Music Choice and Muzak. Muzak's PSS service is, 
apparently, only a small part of its business, and it did not 
participate in this proceeding. Digital Music Express, Inc., which 
was a PSS in SDARS-I, ceased operation. 6/11/12 Tr. 1469:14-1470:6 
(Del Beccaro).
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IV. The Section 112 Ephemeral License

    With respect to the Section 112(e) ephemeral license, the parties 
submitted a joint stipulation. SoundExchange and

[[Page 23056]]

Music Choice ask for continued application of the language of 37 CFR 
382.2(c), which requires a minimum fee advance payment of $100,000 per 
year, payable no later than January 20 of each year, with royalties 
accruing during the year recoupable against the advance. Joint 
Stipulation at 2-3 (May 25, 2012). SoundExchange and Sirius XM ask that 
the same minimum fee proposal apply to Sirius XM. Id.
    All parties agree that the value accorded the Section 112 license 
is combined with that of the Section 114 license and that the value is 
allocated 5% to the Section 112 license and 95% to the Section 114 
license, consistent with the current regulations applicable to 
webcasters, broadcasters, SDARS, and new subscription services. See 37 
CFR 380.3, 380.12, 380.22; 382.12; and 383.3. The parties submitted no 
other evidence on either the minimum fee or the Section 112(e) license 
fee allocation; consequently, the Judges approve and adopt the 
respective minimum fees and Section 112(e) royalty rates for PSS and 
SDARS as set forth in the Joint Stipulation.

V. The Section 114 Digital Performance License

    With respect to the royalty rates for the Section 114 digital 
performance license, Music Choice requests a rate of 2.6% of Gross 
Revenues, applicable to each of the years in the licensing period. 
SoundExchange requests the following percentage of Gross Revenues rates 
for the PSS: 15% for 2013; 20% for 2014; 25% for 2015; 35% for 2016; 
and 45% for 2017. Second Revised Proposed Rates and Terms of 
SoundExchange, Inc., at 6 (Sept. 26, 2012). Both SoundExchange and 
Music Choice ask that the definition of Gross Revenues, currently set 
forth in 37 CFR 382.2(e), apply in the new licensing period.

A. Section 114 Rates for PSS

    Since 1998, when the decision in PSS-I established the initial 
royalty rates, the PSS have paid a fee based on a percentage of Gross 
Revenues \6\ as defined by regulation. Neither Music Choice nor 
SoundExchange proposes altering this rate structure for the 2013-17 
license term, nor do they propose changes to the Gross Revenues 
definition. As discussed in detail below, however, SoundExchange 
requests that the Judges add an adjustment to the percentage-of-revenue 
metric to address what it perceives as a deliberate reduction in 
revenues paid to Music Choice for its residential audio service by 
certain cable operators that are co-owners (partners) of Music Choice.
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    \6\ The current regulation defining Gross Revenues for PSS is 
set forth in 37 CFR 382.2(e). As discussed infra, the Judges are 
adopting SoundExchange's proposal to house all PSS definitions in a 
single location; consequently, the PSS definitions will be located 
in a new Sec.  382.2.
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    The rates the Judges establish under Section 114(f)(1) for the 
digital performance of sound recordings must be calculated to achieve 
the objectives set forth in Section 801(b)(1)(A) through (D) of the 
Act. Where the determination standard is reasonable rates calculated to 
achieve the Section 801(b)(1) factors, the Judges have found market 
benchmarks, if any, to be a useful starting point. See SDARS-I, 73 FR 
at 4088; Phonorecords I, 74 FR 4510, 4517 (Jan. 26, 2009). As discussed 
below, the parties disagree about what constitutes the most appropriate 
benchmark to guide the Judges in determining a reasonable rate.
1. Music Choice's Proposed Musical Works Benchmark for PSS Rates
    As discussed above, Music Choice argues that the annual royalties 
it pays to the three performing rights societies (ASCAP, BMI, and 
SESAC) for the right to perform musical works to subscribers of its 
residential audio service is, by virtue of the Librarian's 
determination in PSS-I, a precedential benchmark in this proceeding. 
Although the Judges reject the PSS-I benchmark as a precedent in this 
proceeding, they nevertheless weigh whether the rates are a useful 
benchmark in this proceeding.
    Music Choice represents that it pays ASCAP and BMI each 2.5% of 
gross revenues attributable to residential service each and pays an 
annual flat fee to SESAC that amounts to approximately [REDACTED] of 
net revenue, for a total of [REDACTED].\7\ Del Beccaro Corrected WDT at 
21-22, MC 17, MC 18 and MC 19, PSS Trial Ex. 1. Music Choice submits 
that this rate (i.e., [REDACTED]) represents the upper bound of a 
reasonable royalty rate for the Section 114 and Section 112 licenses.
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    \7\ The definitions of ``revenues'' used to calculate the 
different musical works royalties are not revealed in the evidence, 
nor is the ``revenue'' to which the [REDACTED] could be applied for 
comparison.
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    Two pieces of evidence, in Music Choice's view, corroborate use of 
musical works licensing rates as a benchmark. First, Music Choice 
observes equivalence between the fees for the performance of sound 
recordings and musical works in Canada and the United Kingdom. Music 
Choice cites four decisions of the Canadian Copyright Board, involving 
licensing fees for commercial radio, cable television, satellite music 
services and radio services of the Canadian Broadcasting Corporation 
(``CBC''). According to Music Choice, in those decisions, the Canadian 
Board found that royalty rates for sound recordings and musical 
compositions have equivalent value. See, e.g., Del Beccaro Corrected 
WDT at MC 6 at 30-33 (commercial radio) and MC 7 at 14 (cable 
television), PSS Trial Ex. 1.\8\ Moreover, Music Choice represents that 
in the United Kingdom, sound recording royalty rates for commercial 
broadcasting services are less than those for musical works. Id. at 19. 
According to Music Choice, if Music Choice's service were transmitted 
through cable in the U.K., Music Choice would pay 5.25% of 85% of gross 
revenues for the musical works performance right, but would pay only 5% 
of 85% of gross revenues for the sound recording performance right. Id. 
at 19, MC 11. Music Choice represents that the U.K. Copyright Tribunal 
has found the same equivalence. Id. at 19-20 & MC 12, ] 53.
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    \8\ SoundExchange's expert economist, Dr. George Ford, who 
recently submitted testimony before the Canadian Copyright Board, 
acknowledged that in Canada the musical composition and sound 
recording performance royalties are equal. 8/21/12 Tr. 4304:5-22 
(Ford).
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    Music Choice further asserts that the validity of the proposed 
musical works benchmark to set rates in this proceeding is corroborated 
by an economic model called the Asymmetric Nash Bargaining Framework 
(``Nash Framework'') offered by Dr. Crawford.\9\ Dr. Crawford uses the 
Nash Framework to determine potential outcomes that could occur in 
hypothetical negotiations between record labels and PSS providers. 
Crawford Corrected WDT at 12, PSS Trial Ex. 4. According to Dr. 
Crawford, as a non-cooperative bargaining model, the Nash Framework is 
designed to yield predictions about how outcomes are determined when 
firms negotiate; that is, how two firms would split the surplus of 
their interaction (i.e., revenues minus costs) in a hypothetical 
negotiation. Id. at 16. Three factors (the Nash factors) are analyzed 
to determine the split: (1) The combined agreement surplus; \10\ (2) 
each

[[Page 23057]]

firm's ``threat point''; \11\ and (3) each firm's bargaining power. Id.
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    \9\ Dr. Crawford concludes that his economic model confirms that 
the sound recording performance royalty rate for PSS should be less 
than its musical works rate. 6/12/12 Tr. 1803:11-1804:20 (Crawford); 
see also Crawford Corrected WDT at 6, 23, 25, 30, PSS Trial Ex. 4.
    \10\ ``Combined Agreement Surplus'' is the revenue a PSS would 
earn in the market for the PSS provider when an agreement is reached 
with the record label less the costs net of the digital performance 
right in sound recordings. Crawford Corrected WDT at 16, PSS Trial 
Ex. 4. ``Surplus'' is the payment a good or service can command 
beyond its cost of production. Id. at n.33.
    \11\ ``Threat point'' is the amount a firm would earn in the 
absence of an agreement. Crawford Corrected WDT at 16, PSS Trial Ex. 
4.
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    Dr. Crawford's stated goal in applying the Nash Framework was to 
first establish the Nash factors for the hypothetical market (the sale 
of rights between one record company and one PSS provider) and compare 
them to the Nash factors in the actual musical works market (the sale 
of rights between the three performing rights societies and one PSS 
provider). Id. at 18. Dr. Crawford determined that the combined 
agreement surplus in the hypothetical PSS market was the total profits 
that the PSS provider earned before paying the royalty for digital 
performance rights. Id. at 45.
    Dr. Crawford determined that in the hypothetical market, the threat 
point for a PSS provider would be zero because, in the absence of an 
agreement, the PSS provider could not offer music and therefore could 
not earn a surplus. Id. at 19. He determined, however, that the threat 
point for a hypothetical record company would be negative because the 
failure to reach an agreement would have negative implications for the 
record company in other, non-PSS markets. Specifically, a record 
company's failure to reach an agreement with a PSS provider could 
diminish that record company's sales of compact disks, because, 
according to Music Choice, there is a significant promotional benefit 
to the record company from the PSS.\12\\,\ \13\ Id.
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    \12\ To support its contention that PSS are promotional for 
record company artists, Music Choice offered the testimony of Damon 
Williams, who testified that record company executives consider 
Music Choice promotional because they provide artists with greater 
exposure. Williams WDT at 4-13, MC 28, MC 29, MC 32, PSS Trial Ex. 
3. Mr. Williams argues that Music Choice has become more promotional 
since the PSS-I proceeding because it currently reaches more 
customers with more channels. Id. at 24.
    \13\ Dr. Crawford discounted the promotional value of Music 
Choice because he could not quantify it. Crawford Corrected WDT at 
45, PSS Trial Ex. 4.
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    With respect to the last Nash factor, bargaining power, Dr. 
Crawford assumed it to be equal based on his assessment of Music 
Choice's existing technology platform and contract, which, he 
contended, cannot be easily replaced or replicated, and his 
observations of Music Choice's bargaining efforts for sound recording 
performance rights with respect to music videos. Id. at 15, 22.
    Applying the Nash factors to the existing market for the PSS 
musical works performance right, Dr. Crawford determined that the 
threat point for a PSS provider would again be zero. He determined that 
the ``threat point'' for the performing rights society would be 
negative due to the predicted loss of promotional value from the PSS. 
Id. at 28. Dr. Crawford again assumes equal bargaining power between 
the PSS provider and the performing rights society, based largely upon 
his observations that the two possess equal patience in their 
negotiations. Id. at 29. Dr. Crawford opines that his analysis of the 
Nash factors in the hypothetical musical works market indicates that 
there should be a 50/50 split of the surplus in hypothetical 
negotiations between the PSS and the performing rights society, the 
same conclusion he reached with respect to the hypothetical market for 
the rights in this proceeding. Because of the similarities between the 
Nash factors in the PSS hypothetical market and the market for musical 
works, Dr. Crawford concludes that the musical works market makes for a 
good benchmark for the hypothetical sound recording performance right 
market at issue in this proceeding. Id. at 30.
    Dr. Crawford also proffered a surplus splitting analysis which he 
asserted helped to corroborate the reasonableness of Music Choice's 
rate proposal. This analysis involved Music Choice's own operating 
profits to estimate how PSS profits would be allocated between a 
Licensee and Licensor in the PSS market. Crawford Corrected WDT at 43, 
PSS Trial Ex. 4. Dr. Crawford adjusted Music Choice's 2006-2010 
operating profit to remove the actual royalty paid by Music Choice for 
sound recording performance rights. He then applied the capital asset 
pricing model \14\ to derive an expected rate of return on Music 
Choice's assets. He determined that that hypothetical rate of return 
would be 8.33%. Id. at Appendix B.3, B.4. He then multiplied the 8.33% 
rate by Music Choice's average operating profits to determine cost of 
capital. He then subtracted cost of capital from the royalty-adjusted 
operating profits to derive the residual profits for each year. Id. at 
47. According to Dr. Crawford, this calculation showed that Music 
Choice's cumulative returns in excess of its cost of capital, but 
before payment of sound recording royalties, would amount to 3.05% of 
Music Choice's 2006-2010 royalties. Id. He then applied a range of 
allocations for the hypothetical cumulative returns of between 20% and 
80%. This calculation yielded a range of royalties from 0.61% to 2.43%. 
Id. at 48.
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    \14\ Under this model, a firm's cost of capital is based on the 
expected return to induce investment. Crawford Corrected WDT at ] 
167, PSS Trial Ex. 4.
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2. SoundExchange's Proposed Marketplace Agreements Benchmark for PSS 
Rates
    In an effort to frame a zone of reasonable rates, SoundExchange 
offers rates from over 2,000 marketplace agreements, representing a 
variety of rights licensed. SoundExchange witness, Dr. George Ford, 
observes that PSS like Music Choice have certain distinctive features 
that make it difficult to identify a suitable benchmark market. 6/18/12 
Tr. 2814:9-20 (Ford). First, according to Dr. Ford, Music Choice does 
not sell its service directly to subscribers, but rather to cable 
television operators who then bundle the Music Choice programming with 
a package of television programming for ultimate sale to subscribers. 
Music Choice is, therefore, an intermediary between cable operators and 
their subscribers, unlike any of the digital music services the 
Copyright Royalty Judges have previously dealt with. Ford Second 
Corrected WDT at 12-13, SX Trial Ex. 79; 6/18/12 Tr. 2810:20-2811:4 
(Ford). Second, Music Choice's service is almost always bundled with a 
hundred or more channels of video and is almost never sold on a stand-
alone basis. Ford Second Corrected WDT at 13, SX Trial Ex. 79. 
According to Dr. Ford, this bundling makes it difficult to determine 
the specific consumer value for Music Choice's programming alone. Id.
    Given these difficulties, Dr. Ford uses an all-inclusive approach 
of examining royalty rates for different digital music markets: 
portable and non-portable interactive subscription webcasting, cellular 
ringtones/ringbacks, and digital downloads. Id. at 15-16, Table 1. 
According to Dr. Ford, most of the over 2,000 licensing agreements he 
examined across these markets calculate royalties based on a ``greater 
of'' (sic.) methodology that includes a per-play royalty fee, a per-
subscriber fee, and a revenue-based fee. Id. at 13 n.21. Dr. Ford 
analyzed only the revenue-based fees. He contended that doing so makes 
his results conservative because either of the other two payment 
metrics could, under certain circumstances, result in a larger total 
royalty fee than the revenue-based calculation. 6/18/12 Tr. 2861:3-13 
(Ford). According to Dr. Ford, his analysis of the agreements showed a 
percentage-of-revenue rate of 70% for digital downloads, 43% to 50% for 
ringtones/ringbacks, and 50% to 60% for portable and non-portable 
interactive subscription webcasting, respectively. Ford Second 
Corrected WDT at 15-16, Table 1, SX Trial Ex. 79. According to Dr. 
Ford, SoundExchange's rate

[[Page 23058]]

proposal for PSS comports well with the range established by these 
agreements, in that it rises above the lowest average rate (43%) only 
in the last year of the licensing term. Therefore, according to Dr. 
Ford, SoundExchange's proposal can ``be presumed to be a reasonable 
proxy for a market outcome.'' Id. at 16; see also 6/18/12 Tr. 2831:8-15 
(Ford).
3. Analysis and Conclusions Regarding the Proposed Rate Guidance
    Based upon the evidence put forward in this proceeding, the Judges 
conclude that neither Music Choice's nor SoundExchange's proffered rate 
guidance provides a satisfactory benchmark upon which they can rely to 
determine the sound recording performance royalty rates for the PSS for 
the upcoming license period. The parties' proposals are so far apart, 
and both so far from the current rate, that they cannot even be said to 
describe a ``zone of reasonableness.'' The only remaining guidance the 
Judges have upon which to base the new rates is the current royalty 
rate of 7.5% of PSS Gross Revenues. This rate approximates the middle 
of the wide spectrum proposed by the parties. It is the rate against 
which the Judges will test the Section 801(b) policy factors.
a. Music Choice's Proposed Musical Works Guidance
    Having rejected Music Choice's argument that the musical works 
benchmark utilized by the Librarian of Congress in PSS-I is binding 
precedent in this proceeding,\15\ the Judges examine the proposed 
benchmark on its own merits and find it lacks comparability to the 
target market. Dr. Crawford, who advocates the appropriateness of the 
musical works rates as a benchmark for the PSS rates, acknowledges that 
a benchmark market should involve the same buyers and sellers for the 
same rights. Crawford Corrected WDT at 24, PSS Trial Ex. 4. However, 
the musical works market involves different sellers (performing rights 
societies versus record companies) selling different rights. See SDARS-
I, 73 FR at 4089. The fact that a PSS needs performing rights to 
musical works and sound recordings to operate its service does not make 
the rights equivalent, nor does it say anything about the relative 
values of those rights.\16\
---------------------------------------------------------------------------

    \15\ See supra at Section II.
    \16\ The fees paid to the performing rights societies for the 
performance right to musical works have been offered in non-PSS 
proceedings and have been rejected. See Webcasting II, 72 FR 24084, 
24094-24095 (May 1, 2007); SDARS-I, 73 FR 4080, 4089-4090 (Jan. 24, 
2008) and Webcasting I, 67 FR 45240, 45246-45247 (July 8, 2002) 
(Librarian of Congress's determination).
---------------------------------------------------------------------------

    Music Choice's reliance on foreign rates to support its proffer of 
the musical works guidance is unpersuasive. The Judges have considered 
before the significance of foreign countries' treatment of the 
licensing of exclusive rights granted by copyright. In the proceeding 
to set rates and terms for the compulsory license to reproduce musical 
compositions under Section 115 of the Copyright Act, certain 
participants offered evidence of license rates in the U.K., Canada and 
Japan. See Phonorecords I, 74 FR 4510, 4521 (Jan. 26, 2009). In 
rejecting the foreign rates as comparable benchmarks, the Judges stated 
that ``comparability is a much more complex undertaking in an 
international setting than in a domestic one. There are a myriad of 
potential structural and regulatory differences whose impact has to be 
addressed in order to produce a meaningful comparison.'' Id. at 4522. 
Neither Mr. Del Beccaro nor Dr. Crawford even attempts an analysis or 
discussion of the intricacies of Canadian and U.K. markets for 
performance rights for musical works and sound recordings, and Music 
Choice itself concedes that particular license rates in Canada and 
Europe ``do not necessarily determine what the specific market rate in 
the United States should be for the sound recording right.'' Music 
Choice PFF ] 135.
    Likewise, the Judges are not persuaded that Dr. Crawford's 
application of the Nash Framework provides corroboration. The Nash 
Framework is a theoretical concept whose goal is to evaluate how the 
surplus from a hypothetical transaction might be divided between 
negotiating parties. Even assuming that the Nash Framework has 
predictive value in some real-world contexts, Music Choice provided no 
data to support the theoretical approximations in the market for any 
intellectual property rights, much less those that the Judges are 
charged with evaluating. Therefore, the Judges find that the Nash 
Framework is not useful corroborating evidence.\17\
---------------------------------------------------------------------------

    \17\ The Judges understand that Judge Roberts in his dissent 
provides a more spirited rejection of the probative value of the 
Nash Framework as proffered in this context. The Judges concur with 
his assessment, but believe, as a threshold matter, that the Nash 
Framework, without real-world data to support its predictive 
capacity, is unworthy of further consideration.
---------------------------------------------------------------------------

b. SoundExchange's Marketplace Agreements Guidance
    The Judges do not endorse the music service benchmarks offered by 
SoundExchange and supported by Dr. Ford as persuasive benchmarks. 
Typically the volume (over 2,000) of marketplace agreements that Dr. 
Ford examined for music products and services would be a sufficiently 
deep sample set to provide a useful framework for a marketplace 
benchmark. The four markets Dr. Ford examined, however--portable and 
non-portable subscription interactive webcasting, ringtones/ringbacks, 
and digital downloads--involve the licensing of products and rights 
separate and apart from the right to publicly perform sound recordings 
in the context of this proceeding. The buyers are different from the 
target PSS market; thus, the key characteristic of a good benchmark--
comparability--is not present.
    The Judges agree with Dr. Ford's observations that Music Choice has 
several distinct features, such as its intermediary role between cable 
systems and subscribers and the bundling of Music Choice's services 
with multiple channels of video and other non-music programming, which 
significantly dim the possibility of market comparators. In the absence 
of some rational, reasoned adjustment to make the music agreements data 
more comparable to the PSS market, the Judges find its probative value 
in this proceeding of only marginal value.
c. The Prevailing Statutory Rate
    The Judges are left, therefore, with a consideration of the 
existing 7.5% royalty rate which is the product of settlement 
negotiations that occurred in SDARS-I between Music Choice and 
SoundExchange but is a rate for which neither party advocates. Although 
it is a rate that was negotiated in the shadow of the statutory 
licensing system and cannot properly be said to be a market benchmark 
rate, nothing in the record persuades the Judges that 7.5% of Gross 
Revenues, as currently defined, is too high, too low or otherwise 
inappropriate. Accord, Phonorecords I, 74 FR at 4522.
1. Application of Section 801(b) Factors
    Based on the record evidence in this proceeding, the Judges have 
determined that the benchmark evidence submitted by Music Choice and 
SoundExchange has failed to provide the means for determining a 
reasonable rate for the PSS, other than, perhaps to indicate the 
extreme ends of the range of reasonable rates. The testimony and 
argument of Music Choice demonstrates nothing more than to show that a 
reasonable rate cannot be as low as the rates (i.e., [REDACTED] of 
Music Choice's

[[Page 23059]]

revenues) paid by Music Choice to the three performing rights societies 
for the public performance of musical works. The benchmark testimony of 
SoundExchange is of even lesser value. The proposed rate of 15% for the 
PSS for the first year of the licensing period, deemed reasonable by 
Dr. Ford (at least in the beginning of the licensing period), stands as 
the upper bound of the range of reasonable rates. Within that range is 
the current 7.5% rate. On the record before us, the Judges are 
persuaded that the current rate is neither too high, too low, nor 
otherwise inappropriate, subject to consideration of the Section 801(b) 
factors discussed below.
a. Maximize Availability of Creative Works
    To argue for an adjustment in its favor under the first Section 
801(b) factor, Music Choice touts that it is a music service that is 
available in over 54 million homes, with 40 million customers using the 
service every month. 8/16/12 Tr. 3878:3 (Del Beccaro); 6/11/12 Tr. 
1462:5-11, 1486:19-1487:2 (Del Beccaro). According to Music Choice, 
channel offerings have increased through the years, and they are 
curated by experts in a variety of music genres. Del Beccaro Corrected 
WDT at 3, 24, PSS Trial Ex. 1. Music Choice also highlights recent 
developments in technology that enable Music Choice to display original 
on-screen content identifying pertinent information regarding the songs 
and artists being performed. Id. at 24, MC 23; Williams WDT at 12, PSS 
Trial Ex. 3; 6/11/12 Tr. 1461:14-1462:1, 1491:2-12 (Del Beccaro). 
According to Music Choice, these elements, along with certain 
promotional efforts that Music Choice makes on behalf of artists, 
support a downward adjustment in the rates. In any event, an upward 
adjustment in the rates, argues Music Choice, would not affect the 
record companies' bottom-line because PSS royalties are not a material 
revenue source for record companies. Music Choice PFF ]] 409-417.
    SoundExchange submits that a market rate incorporates 
considerations under the first Section 801(b) factor, citing the 
decision in SDARS-I, and that if PSS rates turn out to be too high and 
drive Music Choice from the market, presumably consumers will shift to 
alternative providers of digital music where higher royalty payments 
are more likely for record companies. Ford Second Corrected WDT at 19-
21, SX Trial Ex. 79.
    The current PSS rate is not a market rate, so market forces cannot 
be presumed to determine the maximum amount of product availability 
consistent with the efficient use of resources. See SDARS-I, 73 FR 
4094. However, the testimony demonstrates that Music Choice has not, 
under the current rate, reduced its music offerings or contemplated 
exiting the business; in fact, it will be expanding its channel 
offerings in the near term. Del Becarro Corrected WDT at 3, 24, PSS 
Trial Ex. 1; see also 6/11/12 Tr. 1460:21-1461:1 (Del Beccaro). The 
Judges find no creditable evidence in the record to suggest that the 
output of music from record labels has been impacted negatively as a 
result of the current rate. The record shows no persuasive evidence 
that a higher PSS royalty rate would necessarily result in increased 
output of music by the record companies, nor that a lower rate would 
necessarily further stimulate Music Choice's current and planned 
offerings. In sum, the policy goal of maximizing creative works to the 
public is reasonably reflected in the current rate and, therefore, no 
adjustment is necessary.
b. Afford Fair Return/Fair Income Under Existing Market Conditions
    Music Choice submits that the Judges need not worry about the 
impact of a low royalty rate on the fair return to record companies and 
artists for use of their works because royalties from the PSS market 
are so small as to be virtually inconsequential to companies whose 
principal business is the sale of CDs and digital downloads. Music 
Choice PFF ]] 420-430. With respect to Music Choice's ability to earn a 
fair income, however, Music Choice argues that it is not profitable 
under the current 7.5% rate. Mr. Del Beccaro testified that its average 
revenue per customer for its residential audio business has been on the 
decline since the early 1990s, down from $1.00 per customer/per month 
to [REDACTED] per customer/per month currently. Del Beccaro Corrected 
WDT at 40, PSS Trial Ex. 1. He further testified that after 15 years of 
paying a PSS statutory rate between 6.5% and 7.5% Music Choice has not 
become profitable on a cumulative basis and is not projected to become 
so within the foreseeable future. Id. at 42. Music Choice represents 
that it has a cumulative loss at the end of 2011 of [REDACTED], 
projected to grow to [REDACTED] in 2012 and continue to increase 
throughout the 2013-17 license period. Del Beccaro Corrected WRT at MC 
69 at 1 and MC 70 at 1, PSS Trial Ex. 21. These losses lead Music 
Choice to conclude that it has not generated a reasonable return on 
capital under the existing rates. Music Choice PFF ]] 442-43.
    Music Choice's claims of unprofitability under the existing PSS 
rate come from the oblique presentation of its financial data and a 
combining of revenues and expenses from other aspects of its business. 
The appropriate business to analyze for purposes of this proceeding is 
the residential audio service offered by Music Choice, the subject of 
the Section 114 license. Music Choice, however, reports costs and 
revenues for its residential audio business with those of its 
commercial business, which is not subject to the statutory license. 
This aggregation of the data, which Music Choice acknowledges cannot be 
disaggregated, see 6/11/12 Tr. 1572:3-1576:2 (Del Beccaro), masks the 
financial performance of the PSS business. As a consolidated business, 
Music Choice has had significantly positive operating income between 
2007 and 2011 and made profit distributions to its partners since 2009. 
Ford Amended/Corrected WRT at SX Ex. 362-RR, p. 3 (PSS--002739), SX 
Trial Ex. 244; SX Trial Ex. 64 at 3 (PSS--002715); SX Trial Ex. 233 at 
3 (PSS--366020). Dr. Crawford's effort to extract costs and revenues 
from this data for the PSS service alone for use in his surplus 
analysis cannot be credited because of his lack of familiarity with the 
data's source. 6/13/12 Tr. 1890:15-1891:10 (Crawford).\18\ The Judges 
find no persuasive evidence to suggest that Music Choice has not 
operated successfully and received a fair income under the existing 
statutory rate.\19\
---------------------------------------------------------------------------

    \18\ Much was made in the hearing and in closing arguments 
regarding Dr. Crawford's supposed use of audited financial data and 
Dr. Ford's use of unaudited financial data in an effort to examine 
costs and revenues of the PSS service vis-[agrave]-vis Music 
Choice's other non-PSS services. The Judges see no superiority to 
either data set as presented in this proceeding.
    \19\ It is improbable that Music Choice would continue to 
operate for over 15 years with the considerable losses that it 
claims.
---------------------------------------------------------------------------

    With respect to fair return to the copyright owner, the Judges' 
examination is whether the existing statutory rate has produced a fair 
return with respect to the usage of sound recordings. During the 
current licensing period, Music Choice provided 46 channels of music 
programming. Music Choice plans to expand the number of music channels 
it provides dramatically in the coming licensing term, however, up to 
300 channels by the first quarter of 2013. Del Beccaro Corrected WDT at 
3-4, PSS Trial Ex. 1; 6/11/12 Tr. 1490:8-16 (Del Beccaro). This 
expansion will result in a substantial increase in the number of plays 
of music by Music Choice, even if the ultimate

[[Page 23060]]

listenership intensity of its licensees' subscribers cannot be 
measured. Music Choice provided no evidence, however, to suggest that 
the planned expansion in usage would result in increased revenues to 
which the statutory royalty rate is to be applied. Indeed, Music Choice 
has declared itself to be in a mature market with no expectation of 
increasing profits. 8/16/12 Tr. 3855:17-3856:7 (Del Beccaro).
    Music Choice presented no evidence to suggest that copyright owners 
would be compensated for the increased usage of their works. 
Dramatically expanded usage without a corresponding expectation of 
increased compensation suggests an upward adjustment to the existing 
statutory rate is warranted. Measurement of the adjustment is not 
without difficulty because any downstream increases in listenership of 
subscribers as a result of additional music offerings by Music Choice 
cannot be readily predicted. It is possible that listenership overall 
may remain constant despite the availability of several additional 
music channels. It is more likely, however, that Music Choice would not 
make the expansion, and incur the additional expense of doing so, 
without reasonable expectation that subscribers or advertisers would be 
more attracted to the expanded offerings, although the Judges have no 
evidence to suggest that the net increase in listenership (or 
advertising revenue) would be anything more than modest.
    SoundExchange refers to prior rate decisions and the application of 
the fair return/fair income factor by the Judges and their 
predecessors. SoundExchange asserts that the Judges are looking for a 
fair return/fair income result that is consistent with reasonable 
market incomes. SX PFF at ] 491, citing SDARS-1, 73 F.R. 4080, 4095 
(Jan. 24, 2008). Referring to testimony by Messrs. Ciongoli and Van 
Arman, SoundExchange emphasizes how vital statutory royalty income is 
to copyright owners--both the record labels and the artists, whose 
share SoundExchange distributes directly. See 6/13/12 Tr. 2138:5-2142:9 
(Ciongoli), Van Arman WDT at 4, SX Trial Ex. 77. Although the income 
from any one statutory license may not be great, SoundExchange cites 
the aggregate value of income from all of the statutory licenses as 
vital to the industry. With respect to fair income to the rights user, 
SoundExchange points to the profit on the consolidated financial 
statements of Music Choice over the past five years, 2007-2011.
    The balance of fair return and fair income appears to have been 
maintained at the current PSS rates. This factor does not argue in 
favor of drastic cuts or increases in the current rate. Music Choice's 
planned increase in usage, however, argues in favor of an increase in 
the rates going forward to fairly compensate the licensors for the 
additional performances.
    The Judges determine, therefore, that a 1% upward adjustment of the 
benchmark (from 7.5% to 8.5% of Gross Revenues), phased in during the 
early part of the licensing period, is appropriate to serve the policy 
of fair return/fair income.
c. Weigh the Relative Roles of Copyright Owners and Copyright Users
    This policy factor requires that the rates the Judges adopt reflect 
the relative roles of the copyright owners and copyright users in the 
product made available with respect to relative creative contribution, 
technological contribution, capital investment, cost, risk, and 
contribution to the opening of markets for creative expression and 
media for their communication. Music Choice argues that its creative 
and technological contributions, and capital investments, outweigh 
those of the record companies. First, Music Choice touts the graphic 
and informational improvements made to its on-screen channels, noting 
that what were once blank screens now display significant artist and 
music information. According to Music Choice, costs for these 
improvements have exceeded [REDACTED]. Del Beccaro Corrected WDT at 31-
32, PSS Trial Ex. 1. Second, Music Choice offers increases in 
programming, staff size and facilities, along with enhancements to 
product development and infrastructure. Music Choice estimates that 
costs for these improvements have exceeded [REDACTED]. Id. Regarding 
costs and risks, Music Choice points to its lack of profitability and 
the exit of other PSS from the market as evidence of its continued risk 
and limited opportunity for profit. Music Choice PFF ]] 512-520. 
Finally, with respect to opening new markets, Music Choice touts the 
PSS market itself for which it remains the standard-bearer in 
disseminating music to the public through cable television. Id. at ] 
523.
    SoundExchange offers little more on the third Section 801(b) factor 
beyond Dr. Ford's contention that he saw no evidence to support that 
Music Choice makes contributions to creativity or availability of music 
that are beyond those of the music services he included in his 
benchmarks, and therefore, according to Dr. Ford, the third factor is 
accounted for in the market. Ford Second Corrected WDT at 21, SX Trial 
Ex. 79; 6/18/12 Tr. 2849:10-16 (Ford).
    In considering the third factor, the Judges' task is not to 
determine who individually bears the greater risk, incurs the higher 
cost or makes a greater contribution in the PSS market, and then make 
individual up or down adjustments to the selected rate based upon some 
unspecified quantification. Rather, the consideration is whether these 
elements, taken as a whole, require adjustment to the Judges' selected 
benchmark rate of 7.5%. Upon careful weighing of the evidence, the 
Judges determine that no adjustment is necessary. Music Choice's 
investments in programming offerings, staff, and facilities, and other 
related products and services are no doubt impressive, but they have 
been accomplished under the current rate. As discussed above, Music 
Choice has already begun to expand its channel offerings and has 
allocated greater financial resources to its residential audio 
business. All of these undertakings, plus the investments made and 
costs incurred to date have been made under the existing rate, and the 
Judges have no persuasive evidence to suggest that these contributions 
have not been accounted for in the current rate. On the other side of 
the ledger, SoundExchange has not offered any persuasive evidence that 
the existing rate has prevented the music industry from making 
significant contributions to or investments in the PSS market or that 
those contributions are not already accounted for in the current rate. 
Therefore, no adjustment is warranted under this factor.
d. Minimize Disruptive Impact
    Of the four Section 801(b) factors, the parties devoted most of 
their attention to the last one: Minimizing disruption on the structure 
of the industries and on generally prevailing industry practices. This 
is perhaps not surprising, given the role this factor played in SDARS-I 
in adjusting the benchmark rates upon which the Judges relied to set 
the royalty fees. See SDARS-I, 73 FR at 4097-98. Because the Judges 
have identified as reasonable the rate for PSS currently in place, the 
Judges' analysis of the disruption factor is confined to that rate.
    SoundExchange argues that the current rate is disruptive to the 
music industry. Dr. Ford testified that ``the current practice of 
applying an exceedingly low rate to deflated revenues is disruptive of 
industry structure, especially where there are identical services 
already paying a higher rate.'' Ford Second Corrected WDT at 23, SX 
Trial Ex. 79. This results, according to Dr. Ford, in a tilting of the 
competitive field for music services in

[[Page 23061]]

favor of Music Choice, thereby disrupting the natural evolution of the 
music delivery industry. Dr. Ford, however, concedes that the PSS 
market has unique and distinctive features that distinguish it from 
other types of music services, thereby substantially reducing the 
likelihood that the PSS and other music services would be viewed as 
substitutes for one another. Further, Dr. Ford failed to present any 
empirical evidence demonstrating a likelihood of migration of customers 
from music services paying higher royalty fees to the PSS as a result 
of his perceived royalty imbalance. Dr. Ford's conclusion that the 
current rate paid by the PSS for the Section 114 license has caused a 
disruption to the music industry (or would likely do so in the upcoming 
license period) is mere conjecture.
    Music Choice also contends that the current rate is disruptive. The 
Judges find its argument weak and unsubstantiated. The test for 
determining disruption to an industry, announced by the Judges in 
SDARS-I, is whether the selected rate directly produces an adverse 
impact that is substantial, immediate, and irreversible in the short-
run. SDARS-I, 73 FR at 4097. The current rate has been in place for 
some time and, despite Music Choice's protestations that it has never 
been profitable, it continues to operate and continues to increase its 
expenditures by expanding and enhancing its services in the face of the 
supposedly disruptive current royalty rate. Music Choice's argument 
that DMX's bankruptcy and Muzak's decision to limit its participation 
in the PSS market are evidence of the onerous burden of the current 
rate are without support. Music Choice has failed to put forward any 
evidence demonstrating a causal relationship between the actions of 
those services and the current PSS royalty rate. In sum, the Judges are 
not persuaded by the record testimony or the arguments of the parties 
that the current PSS rate is disruptive to a degree that would warrant 
an adjustment, either up or down.
2. The Judges' Rate Determination for PSS
    In light of the Judges' analysis of the Section 801(b) factors, the 
Judges set forth the following PSS rates: for 2013: 8.0%; for 2014: 
8.5%; for 2015: 8.5%; for 2016: 8.5%; and for 2017: 8.5%.
    The Judges have chosen to phase-in the increase over the first two 
years of the license period to moderate any potential negative impact 
the rate increase might have on the PSS. Should Music Choice alter its 
anticipated usage under the statutory license in the future, such 
evidence can be taken into account in a future rate proceeding; 
however, the Judges received no evidence that suggests that Music 
Choice's channel line-up, once expanded in 2013, will shrink 
considerably during the license period.
    In addition to proposing rates, SoundExchange raises an additional 
matter. Though not technically a rate, nor strictly an amendment of the 
Gross Revenues definition as it applies to PSS, SoundExchange requests 
a means for capturing revenues from cable systems that are owners of 
equity or capital interests in Music Choice who do not engage in arm's 
length transactions with Music Choice for its product offerings. Second 
Revised Proposed Rates and Terms of SoundExchange, Inc., at 6-7 (Sept. 
26, 2012). Put another way, SoundExchange seeks to capture any price 
breaks that Music Choice offers its affiliates for the Music Choice 
service.
    The proposed price adjustment for affiliated cable systems would be 
calculated by multiplying the total number of subscribers for the month 
for each affiliated cable system by the average per-subscriber royalty 
payment of the five largest paying unaffiliated cable systems that 
provide the Music Choice service. These adjustments would then be added 
to Music Choice's Gross Revenues. In support of its ``Non Arm's Length 
Transaction'' adjustment for affiliated cable systems, Dr. Ford 
testified that a straight percentage-of-revenue metric would not 
adequately account for the situation where Music Choice offers per-
subscriber rate discounts to its cable partners. 8/20/12 Tr. 4216:21-
4217:8 (Ford). According to Dr. Ford, over half of Music Choice's non-
partner cable systems pay approximately [REDACTED] per subscriber per 
month in licensing fees to Music Choice, whereas the partner cable 
systems pay only [REDACTED] per subscriber per month. Ford Amended/
Corrected WRT at 5, SX Trial Ex. 244.
    The Judges are not persuaded that a ``Non Arm's Length 
Transaction'' adjustment is warranted. It is not surprising that the 
affiliated cable operators, which in most instances have more 
subscribers than the non-affiliated systems, would be able to negotiate 
lower per-subscriber licensing fees due to their ability to deliver 
more subscribers to the service. Therefore, the differences in 
subscriber fees between affiliates and non-affiliates could be 
unrelated to the operator's status vis-[agrave]-vis Music Choice. 
Further, the affiliated cable systems represent a third of Music Choice 
ownership whereas Music Choice's record company partners own one 
quarter of the company. 6/11/12 Tr. 1454:16-22 (Del Beccaro). 
Therefore, it is not unreasonable to assume that the record label 
owners would serve as a counterweight to the affiliated cable systems. 
Therefore, the Judges conclude that on the current record, any 
influence on subscriber rates from the competing stakeholders of Music 
Choice, if any, would be a wash.

B. Section 114 Royalty Rates for SDARS

    SoundExchange proposes the following percentage of revenue rates 
for SDARS: 12% for 2013; 14% for 2014; 16% for 2015; 18% for 2016; and 
20% for 2017. Second Revised Rates and Terms of SoundExchange, Inc., at 
2 (Sept. 26, 2012). Sirius XM counters with a proposed royalty rate in 
the range of 5% to 7% of Sirius XM's monthly U.S. gross revenues. 
Proposed Rates and Terms of Sirius XM Radio, Inc., at 4 (Sept. 26, 
2012).
1. Sirius XM's Proposal
a. Direct License Benchmark
    Beginning in 2010, Sirius XM commenced a coordinated effort to 
negotiate sound recording performance rights directly with individual 
record labels. Sirius XM first attempted to engage the four major 
record companies in discussions but was unsuccessful. Id.; 6/7/12 Tr. 
669:8-672:9, 713:3-11, 714:11-715:4 (Frear); 6/11/12 Tr. 1347:7-21, 
1348:20-1349:4 (Karmazin). Sirius XM then enlisted Music Reports, Inc. 
(``MRI'') to formulate and execute a direct licensing strategy with as 
many independent record labels as possible. Together, Sirius XM and MRI 
developed the terms and conditions of a template Direct License, key 
provisions of which include:
     A pro rata share of 5%, 6%, or 7% of gross revenues, 
defined by reference to 37 CFR 382.11;
     A grant of rights to Sirius XM to operate all of its 
various services (satellite radio plus other services such as 
webcasting);
     ``Additional functionality'' granted to Sirius XM, 
including elimination of the Section 114 license sound recording 
performance complement, which allows Sirius XM to play more music from 
a particular artist in a given period of time;
     Direct, quarterly payment of 100% of the royalties to the 
record label;
     Payment of advances to the 5 largest record labels; and
     The possibility, but not the promise, of increased play on 
Sirius XM's music services.
    Gertz Corrected WDT at 8-11, SXM Dir. Trial Ex. 14; Gertz Revised 
WRT at 2, SXM Reb. Trial Ex. 8; 6/8/2012 Tr.

[[Page 23062]]

986:20-987:5 (Blatter). Sirius XM executed the first Direct Licenses in 
August of 2011 and by the time of the closing of testimony in this 
proceeding, Sirius XM had Direct Licenses with 95 independent record 
labels that set a royalty rate of between 5% and 7% of gross revenues, 
depending on the particular agreement. 8/13/12 Tr. 3015:16-20 (Frear); 
8/15/12 Tr. 3679:22-3680:1 (Gertz).
b. The Noll Analysis
    Sirius XM's expert economist, Dr. Roger Noll, contends that the 95 
Direct Licenses are the best benchmark for SDARS rate setting in this 
proceeding because, unlike in SDARS-I, the Judges now have direct 
evidence of competitively negotiated marketplace rates for the exact 
service at issue in this proceeding. Noll Revised Amended WDT at 7, 11, 
33-36, SXM Dir. Trial Ex. 1. Dr. Noll testified that the Direct 
Licenses are representative, for benchmarking purposes, of the types of 
sound recordings available across the industry, including those 
distributed by major record labels. Id. at 39-45; see also 6/5/12 Tr. 
261:6-262:14 (Noll)(contending that the 95 Direct Licensors as a group 
offer a scope of sound recordings comparable to those not so licensed).
    Dr. Michael Salinger, another Sirius XM expert economist, concludes 
that the fact that 95 record companies accepted the Direct License 
offer suggests that the current 8% statutory rate is, if anything, 
above the competitive rate for sound recordings. Salinger Corrected WRT 
at 13, SXM Reb. Trial Ex. 9. Further, Sirius XM argues that the number 
of Direct Licenses undoubtedly would have been higher but for the 
efforts of SoundExchange, the American Association of Independent 
Musicians and others to undermine and interfere with its Direct License 
Initiative.\20\ See, e.g., Sirius XM PFF]] 116-120.
---------------------------------------------------------------------------

    \20\ Sirius XM devoted considerable energy in this proceeding to 
discovery and presentation of evidence regarding actions by 
SoundExchange and its member record labels relating to the Direct 
Licensing initiative. Sirius XM contends that it would have been 
able to present a much greater number of Direct Licenses but for the 
interference of SoundExchange. In a rate determination proceeding, 
the Judges cannot adjudicate claims of tortious interference with 
contractual relations or business expectancies. Indeed, Sirius XM 
never presented such claims to the Judges for adjudication. Those 
claims can only be adjudicated in a court of competent jurisdiction. 
Had Sirius XM been able to make a sufficient showing that actions by 
SoundExchange were in fact interfering with the validity of this 
rate determination proceeding, then the Judges would have had to 
decide what effect, if any, such interference might have had on the 
validity of these rate proceedings. The Judges allowed evidence in 
this proceeding only to determine whether, and to what extent, any 
activity by either party might have skewed the evidence upon which 
the Judges must rely.
---------------------------------------------------------------------------

    Dr. Noll asserts that license agreements between major record 
labels and certain customized non-interactive webcasters provide 
marketplace evidence of rates that corroborate the 5%-7% rates achieved 
in the Direct Licenses. Noll Revised Amended WDT at 16, SXM Dir. Trial 
Ex. 1. Focusing principally on the sound recording rights agreements 
between the digital music service Last.fm and the four major record 
labels,\21\ Dr. Noll determined that for its non-interactive 
subscription streaming service, Last.fm agreed to pay:
---------------------------------------------------------------------------

    \21\ Dr. Noll also examined similar agreements between major 
labels and the music services Slacker and Turntable.
---------------------------------------------------------------------------

     [REDACTED]
     [REDACTED]
     [REDACTED]

Id. at 76-79 (footnote omitted), Tables 2.1-2.1c and Appendices E-
H.\22\
---------------------------------------------------------------------------

    \22\ Examining these same agreements for Last.fm's interactive 
on-demand service--[REDACTED]--led Dr. Noll to conclude that sound 
recording rights owners charge [REDACTED] for non-interactive 
services than they do for interactive/on-demand services. Dr. Noll 
also found similar rate differentials in the [REDACTED]. Noll 
Revised Amended WDT at 76-79, Tables 2.2-2.2d and Appendices I-K, 
SXM Dir. Trial Ex. 1.
---------------------------------------------------------------------------

    Using the rates gleaned from the Last.fm agreements for the non-
interactive subscription streaming service, which he deemed to be the 
most similar to Sirius XM's satellite radio service in terms of 
functionality, Dr. Noll computed a hypothetical royalty rate by 
multiplying the Last.fm percentage-of-revenue rates [REDACTED] by the 
implicit per-subscriber price for Sirius XM's music channels ($3.00-
$3.45). Dr. Noll then divided the resulting per subscriber monthly fee 
by Sirius XM's average revenue per user ($11.38) to express the 
hypothetical royalty rates as a percentage of revenue. Id. at 15; 6/5/
12 Tr. 285:7-293:9 (Noll). This yielded an average royalty rate as a 
percentage of Sirius XM music channel revenue of 6.76%. Id. at 90; 6/5/
12 Tr. 293:5-9 (Noll). Because this hypothetical rate fit squarely 
within the 5%-7% rate range of the Direct Licenses, Dr. Noll opines 
that the Last.fm agreement rates are corroborative of the rates 
contained in the Direct Licenses. He further concludes that the range 
of rates in the Direct Licenses represent the upper end of a reasonable 
royalty rate because the customized, non-interactive Last.fm services 
offer greater functionality and sound quality than the channels offered 
by Sirius XM. Id. at 14-16; 6/5/12 Tr. 292:2-14 (Noll).
2. SoundExchange Proposed Benchmarks
    SoundExchange's expert economist, Dr. Janusz Ordover, offers a 
principal benchmark, and two alternatives, based upon his examination 
of seven market agreements for digital music between certain 
interactive subscription services that stream music over the Internet 
and each of the four major record labels. Dr. Ordover chose interactive 
subscription services because of his belief that they represent 
voluntary transactions in a competitive marketplace free of regulatory 
overhang. He also opined that such transactions provide sufficient 
information based on multiple buyer/seller interactions, are not 
distorted by the exercise of undue market power on either the buyer's 
or seller's side, and involve digital music services that are similar 
to Sirius XM. 6/14/12 Tr. 2359:11-2360:9, 2256:13-2261:3 (Ordover).
a. Ordover's Interactive Streaming Benchmark
    Dr. Ordover derived his principal interactive streaming benchmark 
by determining the percentage of revenues that streaming services paid 
to the major record labels pursuant to their respective agreements. He 
then multiplied that percentage by an estimated retail price for a 
hypothetical music-only satellite radio service. See generally Ordover 
Third Corrected/Amended WDT at 18-25, SX Trial Ex. 74. Beginning with 
data from July 2010, he derived the effective percentage of revenue 
paid by each interactive service by taking the amount of royalty fees 
paid to the record companies and dividing it by each service's gross 
subscription revenues. 6/14/12 Tr. 2274:10-16 (Ordover). In other 
words, Dr. Ordover relied on royalty payments the labels reportedly 
received under the agreements rather than the percentage-of-revenue 
rates specified in the agreements which contained ``greater of'' 
royalty formulations.\23\ 6/14/12 Tr. 2274:22-2275:1, 2363:14-2364:7 
(Ordover). In calculating actual licensing fees paid, Dr. Ordover used 
gross subscription revenues of the interactive services without any 
deductions or carve-outs. Ordover Third Corrected/Amended WDT at 19, SX 
Trial Ex. 74. Examining the agreements, he determined that the annual 
payments as a percentage of gross subscription revenues of the services 
ranged from 50% to 70%, and tended to cluster in

[[Page 23063]]

a range of 60% to 65%. Id. at 19-21; 6/14/12 Tr. 2275:4-12 (Ordover).
---------------------------------------------------------------------------

    \23\ The ``greater of'' metric is an amount per play, an amount 
per subscriber, or a percentage of the service's revenues. 6/14/12 
Tr. 2261:7-2262:4 (Ordover).
---------------------------------------------------------------------------

    Dr. Ordover then attempted to account for the fact that the Sirius 
XM satellite radio service, unlike interactive subscription services, 
transmits both music and non-music content by reducing the percentage-
of-revenue rate from the interactive subscription agreements by half. 
He chose this reduction percentage principally based upon his 
observation of the identical $9.99 retail prices offered by Sirius XM 
for non-music and mostly music stand-alone subscriber packages. The 
result was a percentage-of-revenue rate range of between 30% and 32.5%. 
Dr. Ordover proposed this range as a benchmark for the SDARS rates for 
the 2013-17 statutory licensing period. Ordover Third Corrected/Amended 
WDT at 17, SX Trial Ex. 74.\24\
---------------------------------------------------------------------------

    \24\ Dr. Ordover's mathematical calculation is as follows: He 
took the $12.95 Sirius XM subscription price, and then multiplied 
that by 50% to obtain the music portion of the subscription price of 
$6.475. He then multiplied the music-only satellite radio 
subscription price by 60% to 65% (his effective percentage of 
royalty derived from the interactive subscription service 
agreements) to obtain the music royalty of $3.88 to $4.21. Finally, 
he divided those numbers by the Sirius XM subscription price for the 
Select programming package to obtain the 30% to 32.5% range. 8/16/12 
Tr. 3794:13-3795:9 (Salinger).
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b. Ordover's Content Comparability Adjustment
    Dr. Ordover offered an alternative approach that involved an 
examination of per-subscriber royalty rates from interactive music 
streaming subscription services in an effort to adjust for the 
differences in service attributes between satellite radio and 
interactive subscription services. He first determined an unweighted 
average monthly royalty of $5.95 per subscriber (monthly licensing fees 
paid divided by monthly subscriber counts) for interactive subscription 
services. He then adjusted this fee by the ratio of the retail price of 
a hypothetical music-only satellite radio service (50% of the $12.95 
subscription price for the Sirius XM Select programming package \25\) 
to the retail price for interactive subscription services ($9.99). 
Ordover Third Corrected/Amended WDT at 30-31, SX Trial Ex. 74. This 
percentage, when applied to the average per-subscriber royalty paid by 
interactive services ($5.95), yields $3.86 for the hypothetical music-
only satellite radio service. Dividing this number by the $12.95 Sirius 
XM subscription price provides a percentage-of-revenue rate of 29.81%. 
Id. at 32.
---------------------------------------------------------------------------

    \25\ The current price for this service is $14.49. Ordover Third 
Corrected/Amended WDT at 31 n.33, SX Trial Ex. 74.
---------------------------------------------------------------------------

c. Ordover's Interactivity Adjustment
    Dr. Ordover's second alternative approach attempts to adjust for 
the presence of interactivity alone in the rates yielded by his primary 
benchmark under the assumption that interactivity is the material 
difference between interactive subscription services and satellite 
radio. Ordover Third Corrected/Amended WDT at 33, SX. Trial Ex. 74. To 
derive the value of interactivity, he compared the retail prices for 
interactive music streaming services with the retail prices for non-
interactive music streaming services. He determined that interactive 
music streaming services are uniformly priced at $9.99 per month, while 
non-interactive services prices averaged $4.86. Id. at 31-32, Table 4 
and 33-34, Table 5.\26\ Dr. Ordover then used the ratio to adjust the 
average per-subscriber royalty paid by interactive services ($5.95) to 
calculate an equivalent payment for satellite radio. This calculation 
yielded a percentage-of-revenue royalty rate of 22.32% for Sirius XM, 
which Dr. Ordover concludes represents the lower bound of a reasonable 
royalty rate. 6/14/12 Tr. 2282:12-2283:22, 2334:8-11 (Ordover).\27\ Dr. 
Ordover offered no alternative that attempted to account for the 
combination of content and interactivity differences.
---------------------------------------------------------------------------

    \26\ Dr. Ordover did not provide a weighted average of the non-
interactive service prices because he concluded that he did not have 
reliable data, nor did he include, at the Judges' invitation, ad-
supported non-interactive services in his calculation, deciding that 
such services would add undue complexity to his methodology. Ordover 
Amended WRT at 38-39, SX Trial Ex. 218.
    \27\ This rate was calculated by multiplying the interactivity 
ratio of .4865 ($4.86/$9.99) by the average per-subscriber royalty 
payment of $5.95, yielding an equivalent satellite radio payment of 
$2.89. The $2.89 per-subscriber rate was then divided by the $12.95 
monthly charge for the Sirius XM Select satellite radio package, 
resulting in the percentage of revenue rate of 22.32%.
---------------------------------------------------------------------------

3. Analysis and Conclusions Regarding the Proposed Benchmarks
    For the reasons stated herein, the Judges determine that an 
analysis of the benchmark evidence presented in this proceeding 
establishes that reasonable royalty rates for the use of sound 
recordings under the Section 114 statutory license cannot be lower than 
7%, the upper bound of the range of rates of the Direct Licenses. The 
Judges find that Dr. Ordover's proposed benchmark rates of between 30%-
32.5% are beyond the zone of reasonableness, given that they are four 
times greater than the rate of 8% that the Judges set four years ago in 
SDARS-I and are based on a limited data set of questionable 
comparability to the target market. As a result, the Judges are left 
with no acceptable benchmark by which to mark an upper bound for a zone 
of reasonableness. The Judges rely, therefore, on data points such as 
the lowest rate proposed by SoundExchange and the unadjusted upper 
bound in SDARS-I to guide the determination of what the upper bound 
should be in this proceeding.
a. Analysis of Sirius XM's Proposed Direct License Benchmark
    The Direct Licenses that Sirius XM proposed as the foundation for a 
benchmark have the surface appeal of a comparable benchmark because 
they involve the same sellers and buyers as the target market. A closer 
examination, however, reveals the weaknesses of the Direct Licenses as 
a data set. First, the direct licensors represent a sliver of the 
universe of rights holders for sound recordings: 95 of over 20,100 
rights holders to which SoundExchange distributes payments. See Bender 
WDT at 4, SX Trial Ex. 75; 8/13/12 Tr. 3015:16-20 (Frear). They also 
represent a subset of the 691 independent labels that Sirius XM 
approached in the first instance. Ordover Amended WRT at 4 n.8, SX 
Trial Ex. 218; SX Trial Ex. 301. Sirius XM opined that the number of 
Direct Licenses would likely have been substantially higher but for the 
alleged interference of SoundExchange and others who purportedly 
attempted to discourage record labels from negotiating with Sirius XM. 
The Judges are not persuaded by the evidence in the record that 
SoundExchange's alleged actions materially frustrated Sirius XM's 
efforts to execute Direct License agreements. Therefore, the Judges 
must evaluate the Direct Licenses for what they are, which is to say, a 
very small subset of the sound recording market.\28\
---------------------------------------------------------------------------

    \28\ Dr. Ordover estimated that the works licensed under the 
Direct Licenses represent no more than 2%-4% of the total number of 
works performed by Sirius XM. Ordover Amended WRT at 4-5, SX Trial 
Ex. 218; 6/6/12 Tr. 308:3-5 (Noll).
---------------------------------------------------------------------------

    The Direct Licenses do not include any of the major record labels 
whom, by virtue of the depth and breadth of their music catalogues, 
make up a critical portion of the sound recording market. Dr. Noll's 
observation that the works licensed by the Direct Licensors represent 
the kinds of sound recordings performed on Sirius XM does not diminish 
the importance of the catalogues of the major labels. It would be 
difficult to imagine a successful SDARS service that did not have 
access to the types of recordings that the major

[[Page 23064]]

labels possess. The ``representativeness'' of the sound recordings 
contained in the catalogues of the Direct Licensees does not equate to 
their popularity, an essential ingredient to Sirius XM's music 
offerings. 6/7/12 Tr. 836:17-22 (Gertz)(``Sirius XM is very hits 
driven, and they want to have the most successful service they can, so 
they're going to use what's popular.''). Nevertheless, the rates the 
Judges set must evaluate the universe of sound recordings available for 
licensing under the statute. The vast majority of those sound 
recordings would not currently be considered to be ``popular,'' 
although many might have qualified as ``hits'' in their day or are 
viewed as popular in a particular genre.
    Furthermore, the Judges note that the additional considerations and 
rights granted in the Direct Licenses that are beyond those contained 
in the Section 114 license weaken the Direct Licenses' comparability as 
a benchmark. For example, the Direct Licenses provide for payment of 
100% of the royalties to the Direct Licensors, 6/6/12 Tr. 341:10-342:3 
(Noll), thereby avoiding the statutory apportionment of 50% to record 
companies and 50% to artists and performers.\29\ See 17 U.S.C. 114(g). 
Certain of the Direct Licenses, in particular those of the larger 
independent labels, provide for cash advances and accelerated royalty 
payments, considerations that also are not provided for under the 
statutory license. See, e.g., Gertz Revised WRT at SXM Reb. Ex. 8, pp. 
3-4 and SXM Reb. 23, pp. 3-4, SXM Reb. Trial Ex. 8. In addition, Sirius 
XM absorbs all of the administrative costs of the licensing process 
under the Direct Licenses, which, under the statutory license, are 
borne by the copyright owners, artists and performers. Eisenberg 
Amended/Corrected WRT at SX Ex. 313-RR, SX Trial Ex. 245. With respect 
to rights granted under the Direct Licenses, Sirius XM receives a 
waiver of the sound recording complement of the statutory license and 
the ability to perform the works of the Direct Licensors on other 
services not covered by the statutory license.
---------------------------------------------------------------------------

    \29\ The Judges recognize that direct payment to the Direct 
Licensors does not relieve them of their royalty obligations to 
their artists and performers; however, receipt of 100% of the 
royalties upfront is clearly attractive to certain record labels and 
was a selling point in negotiations with independent record labels. 
Powers WDT at 4-5, SX Trial Ex. 243.
---------------------------------------------------------------------------

    Dr. Noll's analysis does little to address the Judges' concerns 
regarding the Direct Licenses. Dr. Noll contends that the fact the 
Direct License rates are lower than the current 8% statutory rate is 
explained by a ``demand diversion effect.'' In other words, Dr. Noll 
posits that record labels engage in price competition aimed at 
increasing their market share through increased plays on Sirius XM, 
thereby reducing the royalty rates demanded, which reflects what would 
happen in the market as a whole in the absence of a statutory rate. 
Noll Revised Amended WDT at 36-38, SXM Dir. Trial Ex. 1.
    Dr. Noll's demand diversion theory, however, has limited 
explanatory power. It may well be that independent record labels took 
the Direct License offer because of the valuable non-statutory benefits 
discussed above, and there is testimony in the record to this effect. 
See, e.g., SX Trial Ex. 317 at SXM-CRB--DIR--00079565; 8/20/12 Tr. 
4156:5-4157:3 (Powers). Further, independent labels may have a greater 
incentive than majors to secure performances of their works on services 
such as Sirius XM, which would increase the attractiveness of a Direct 
License relationship. Powers WRT at 4, SX Trial Ex. 243; Eisenberg 
Amended/Corrected WRT at SX Ex. 329-RR at SXM--CRB--DIR--00042287, SX 
Trial Ex. 245 (email from MRI to independent label emphasizing that a 
Direct License offers the possibility of increased airplay). Although 
major labels also must compete with other majors and with independent 
labels for airplay, none was apparently so motivated by that concern to 
negotiate separately with Sirius XM. Therefore, the differing 
motivations of the ``sellers'' in the proposed Direct License benchmark 
suggest a weakness regarding comparability to the target market.
    Dr. Noll's benchmark analysis, whether considered as corroboration 
of the rates in the Direct Licenses or standing alone, contains 
significant flaws. His reliance on the Last.fm agreements with the four 
major record labels, which provide the critical data to his 
calculations, is valid to the extent that the agreements are shown to 
be representative of non-interactive subscription webcasting services. 
See SDARS-I, 73 FR at 4090. Two of the agreements, however, have 
expired and are no longer in effect. Ordover Amended WRT at 25, SX 
Trial Ex. 218. Last.fm now pays those record companies at the statutory 
webcasting rate, which is not a market rate. 8/14/12 Tr. 3308:8-20, 
3317:10-16 (Ordover). Even if the Last.fm agreements were the most 
representative of webcasting services--and Dr. Noll has not 
demonstrated that they are--the Judges would not be inclined to accept 
them as fully comparable to the SDARS business without a persuasive 
adjustment to account for the functional differences between webcasting 
and satellite radio. Dr. Noll offered none.
    The Judges also have reservations about Dr. Noll's determination of 
$3.00-$3.45 as the implicit monthly market price for Sirius XM's music 
channels.\30\ Dr. Noll identified three methods for determining the 
implicit price. The first is the average retail price of $3.15 taken 
from Last.fm's and Pandora's non-interactive subscription services. 
Noll Revised WRT at Table 1, SXM Reb. Trial Ex. 6. As with Last.fm, 
there is no adjustment to account for functional differences between 
the Pandora webcasting service and satellite radio, whose primary use 
is in the automobile.
---------------------------------------------------------------------------

    \30\ The implicit monthly price is applied to the effective 
percentage of revenue rate of [REDACTED] from the Last.fm agreements 
that serve as the numerator in Dr. Noll's calculation.
---------------------------------------------------------------------------

    Dr. Noll's second method is to derive a market price for Sirius XM 
using a survey conducted by Sirius XM's witness Professor John Hauser 
that attempts to measure the value of music to Sirius XM subscribers. 
Professor Hauser posited an anchor price for the Sirius XM service to 
his survey respondents, and then randomly removed features (such as 
lack of commercials, quality of sound, etc.) to determine how much the 
respondents would be willing to pay for the service after each feature 
is removed. Hauser Corrected WRT at 20-22, SXM Dir. Trial Ex. 24. After 
averaging the results, he determined that subscribers place an average 
value on Sirius XM's music channels of $3.24. Id. at Appendix G. 
Professor Hauser's survey is of limited value. By design, the higher 
number of features or attributes of the Sirius XM service included in 
the survey, the lower the estimated value of any given service. This 
feature of the survey produces anomalous outcomes, such as survey 
results showing that subscribers would pay a certain amount for 
ubiquitous station availability, premium sound quality and absence of 
commercials, all without any programming content. See Ordover Amended 
WRT at 35, SX Trial Ex. 218.
    Third, Dr. Noll sought to calculate the cost of inputs necessary 
for delivery of Sirius XM's programming via satellite and its 
subsidization/installation of radio receivers in automobiles (described 
as ``unique'' costs to the satellite radio service), to then deduct 
those costs from gross revenues, and allocate the remaining revenue 
between music and non-music content. Noll Revised Amended WDT at 81-83, 
85, SXM Dir. Trial Ex. 1. After making these calculations, Dr. Noll 
credited 55.1%, or $3.45, to music channels. Id. at 88 and

[[Page 23065]]

Table 3. Sirius XM contends that including the unique delivery costs 
and investments of its service is appropriate in Dr. Noll's 
calculation. Sirius XM cites to major record company agreements with 
Cricket and MetroPCS (mobile service providers that bundle telephone 
service and interactive music service into a single package) that 
reflect that a percentage royalty rate for music must be reduced by a 
commensurate proportion to reflect revenue collected for the non-music 
portion of the bundled service. Sirius XM PFF ]]169-173.
    SoundExchange's expert economist, Dr. Thomas Lys, explained, 
however, that because most of the unique costs that Dr. Noll allocated 
are relatively fixed, the per-subscriber amounts vary inversely with 
the number of subscribers. Lys WRT at 57, SX Trial Ex. 240. Dr. Noll 
performed his calculation of costs using 2010 data, but had he used 
subscriber numbers for the years thereafter, which have continued to 
increase, and are anticipated to increase further in the coming 
licensing term, the analysis would show lower unique costs per 
subscriber and a higher value of music. Id. The dependency of Dr. 
Noll's methodology on timing and the number of subscribers undermines 
its reliability for quantifying what the unique costs are likely to be 
in the coming rate term. Id. at 58.
    Sirius XM's analogy to the bundled services of Cricket and MetroPCS 
is inapposite. Unlike those services, the success of Sirius XM is 
dependent upon its access to music. 6/14/12 Tr. 2270:7-2271:15 
(Ordover); see also 6/5/12 Tr. 235:6-10 (Noll)(``It's a bundle of 
services, it's a distribution system, a bunch of nonmusic content and a 
bunch of music content, all of which are essential. And you pull the 
plug on any one of them, and the whole thing collapses.''); 6/11/12 Tr. 
1431:10-17 (Karmazin). The value of Sirius XM's satellite radio service 
is the bundling of music and non-music content with its delivery 
platform, and Sirius XM has failed to present convincing evidence that 
its delivery platform and non-music content, alone, present a viable 
business.\31\
---------------------------------------------------------------------------

    \31\ Likewise, Sirius XM has failed to demonstrate that it could 
successfully substitute away to other providers of music. If that 
were the case, Sirius XM could have operated its business under the 
Direct Licenses, for example, and avoided participation in this 
proceeding altogether.
---------------------------------------------------------------------------

    In sum, these concerns, coupled with those surrounding the Direct 
Licenses themselves, show weaknesses in the proposed Direct License 
benchmark that diminish its usefulness. Therefore, the Judges find that 
the 7% rate, which represents the high end of the Direct License rates, 
represents the lower bound of a zone of reasonableness. The Judges 
believe that a rate any lower, given the prevailing statutory rate, 
would more than likely be overly influenced by the particular terms of 
the Direct License agreements, which are not part of the statutory 
license.\32\
---------------------------------------------------------------------------

    \32\ SoundExchange contends that the Judges should completely 
discount the Direct Licenses because they were negotiated under the 
shadow of the statutory rate which was sure to influence the rates 
the parties agreed to as well as their willingness to negotiate at 
all. SX PFF ] 371. Although the Judges considered that fact when 
determining the amount of weight that the Direct License benchmark 
received, the Judges question whether any agreements regarding sound 
recording rights could be purely market-based given the current 
statutory framework. With that understanding, the Judges do not have 
the luxury of ignoring record evidence of the contemporaneous 
results of arm's length negotiations between the same buyers and 
sellers and rights involved in the market for which the Judges are 
charged to determine a reasonable rate that will remain reasonable 
for the next five years, no matter how many weaknesses those results 
might exhibit.
---------------------------------------------------------------------------

b. Analysis of SoundExchange's Proposed Interactive Subscription 
Services Benchmark
    The Judges have determined in the past that the interactive 
subscription service market has characteristics reasonably similar to 
those of the SDARS market. SDARS-I, 73 FR at 4093. Moreover, Dr. 
Ordover's proposed interactive subscription service benchmark in this 
proceeding analyzes certain useful data sets that make it difficult to 
dismiss the proposed benchmark outright. For example, the agreements 
Dr. Ordover examined represent a relevant data source from which to 
consider the outcomes of marketplace negotiations. That being said, the 
Judges do not find that the market for interactive subscription 
streaming services as characterized by Dr. Ordover in this proceeding 
offers a foundation to support a comparable benchmark from which to 
begin an analysis of reasonable rates for SDARS for the upcoming 
license period.
    For example, the rights licensed by interactive subscription 
services are not the same as those by non-interactive services such as 
the SDARS, and the Judges did not find Dr. Ordover's efforts to adjust 
for the differences to be helpful. Dr. Ordover attempted to account for 
these differences by offering two alternative approaches, both of which 
seek to enhance the comparability of this proposed benchmark to the 
SDARS market. As discussed above, his first alternative approach 
attempts to adjust for service content between the two markets. The 
Judges doubt whether this approach adequately adjusts the interactive 
subscription service market to account for differences in attributes 
and functionality between that market and satellite radio. Dr. 
Ordover's second alternative approach attempts to adjust for 
interactivity. Ordover Third Corrected/Amended WDT at 33-34, SX Trial 
Ex. 74. The Judges found this effort to be somewhat more pertinent.
    Nevertheless, the Judges find that the differences between Sirius 
XM and the ``buyers'' in the proposed benchmark severely constrain the 
usefulness of the proposed Ordover benchmark. Dr. Ordover's proposed 
interactive subscription streaming service benchmark was based on 
licensing fees paid to the four major record labels for 2011 by seven 
internet streaming services and for one-half of 2012 for some of those 
services. Ordover Third Corrected/Amended WDT at 19-21, SX Trial Ex. 
74.
    Dr. Ordover characterizes the streaming services as ``well-
established services like Microsoft Zune, Napster, and Rhapsody, and 
newer market entrants like Rdio and MOG.'' Id. Dr. Ordover concedes, 
however, that in October 2011, Rhapsody announced that it was acquiring 
Napster. Id. at 19, n.16. Notably, in 2012 Microsoft ceased offering 
Zune as a stand-alone service and rolled it into its XBOX service 
suite. See http://www.xbox.com/en-S/Live/Partners/Zune. In addition, 
one of the services upon which Dr. Ordover based his proposed 
benchmark, Slacker Premium, was not introduced until May 2011, so not 
even a full year's payment data was available for that service.
    The royalty implications of these details are uncertain, but these 
details about the proposed benchmark market underscore the fluid nature 
of the subscription streaming market and the difficulty of generalizing 
the royalty obligations of a market based on a few quarters worth of 
payment data for a handful of services. In short, the interactive 
subscription service market upon which Dr. Ordover relied is in a 
constant state of flux. No single buyer or group of buyers in that 
market seems comparable to Sirius XM in terms of its name recognition 
and status as the sole provider of satellite radio service. Therefore, 
the Judges believe that Sirius XM likely would have been in a 
preferential bargaining position to the interactive subscription 
service providers and may have negotiated very different rates as a 
result. The Judges do not believe that Dr. Ordover accounted for this 
difference.
    Whereas the Judges criticized the Direct License benchmark data set 
for lacking one or more major record labels,

[[Page 23066]]

the proposed Ordover benchmark also lacks the balance of representing a 
broader subset of record labels. Although Sirius XM's service may be 
``hit'' driven, it features a broad range of music offerings that span 
several decades and several genres. Indeed, the Judges suspect that 
much of the value of the Sirius XM service as opposed to broadcast 
terrestrial radio and other competitors is that Sirius XM plays a 
greater range of music, much of which may be licensed by non-major 
labels. Therefore, by focusing on the catalogues that the major record 
labels possess, although a crucial component of Sirius XM's service, 
the proposed Ordover benchmark overlooked a subset of the entire 
universe of sound recordings for which the Judges must set a rate in 
this proceeding. The Judges believe that these comparability 
differences may help to explain why the rates in the subscription 
services market are so much higher than those in the Direct Licenses, 
although other factors are also at play.
    The yawning gap between the current rate of 8% and the highest 
rates proposed by Dr. Ordover raises additional concerns about the 
proposed Ordover benchmark. Indeed, the Judges find that the rates Dr. 
Ordover calculated based on his proposed principal benchmark (30%-
32.5%) and his first alternative adjustment (29.81%) are so much higher 
than the current statutory rate that they are outside the zone of 
reasonableness. The rate that Dr. Ordover derives from his second 
alternative adjustment (22.32%), while suggesting a more reasonable 
alternative, can be viewed as no more than the upper bound of the zone 
of reasonableness, although it is a bound that the Judges have little 
confidence in.
    As a result, after analyzing the proposed benchmarks, both of which 
are flawed, the Judges are left with a zone of reasonableness with a 
floor of 7% and an upper bound that can be no more than 22.32%. The 
Judges are also informed by SoundExchange's proposed rates for SDARS, 
which start at 12% for 2013. Presumably, SoundExchange would not have 
proposed this entry rate if it did not believe it to be reasonable. 
Lastly, the Judges consider the prevailing statutory rate of 8%, which 
the Judges adjusted down from a 13% rate in SDARS-I based on the fourth 
Section 801(b) factor. SDARS-I, 73 FR at 4093-4098. With these guide 
posts in mind, the Judges analyze the Section 801(b) factors.
4. Application of Section 801(b) Factors
    The Copyright Act requires that the Judges establish rates for the 
Section 114 license that are reasonable and calculated to achieve the 
four specific policy objectives set forth in Section 801(b) of the 
Copyright Act. In analyzing the Section 801(b) factors the Judges 
determine whether adjustments to the rate indicated by marketplace 
benchmarks, if any, are warranted and, if so, whether there is 
sufficient evidence in the record to support such adjustments. SDARS-I, 
73 FR at 4094 (Jan. 24, 2008). The absence of solid empirical evidence 
that might suggest a difference between the benchmark and target 
markets cautions against the need for an adjustment. Id. at 4094-4095. 
In SDARS-I, the Judges determined that no adjustment was warranted for 
the first three factors but that a downward adjustment was warranted 
for the fourth factor--minimization of disruptive impact--for reasons 
discussed in section (d) below. SoundExchange argues that no adjustment 
is warranted in the current proceeding. SX PFF ] 497. Sirius XM 
contends, however, that an analysis of the Section 801(b) factors 
``counsels setting a royalty rate at the low end of the range of 
reasonable rates.'' Sirius XM PFF ] 227.
a. Maximize the Availability of Creative Works
    Sirius XM contends that a downward adjustment from the benchmark 
rate is warranted with respect to the first Section 801(b) factor--
maximizing the availability of creative works to the public.\33\ Sirius 
XM PFF ] 227. To support its contention, Sirius XM argues that the term 
``availability'' in this factor encompasses both the incentive to 
produce creative products and the delivery of those products to 
consumers. Id. at ] 228. Sirius XM states that its service enhances the 
delivery and availability of sound recordings by: ``providing an 
uninterrupted nationwide broadcast of unparalleled breadth and depth; 
exposing listeners to music that is not played elsewhere; and creating 
original music programming to promote artists * * *.'' Id. at ] 230. 
Sirius XM also contends that, unlike its service, which it posits 
promotes phonorecord sales, internet subscription services, which 
formed the basis of the proposed Ordover benchmark, show no such 
promotional value, and in fact, may cannibalize phonorecord sales. Id. 
at ]] 253-254 and 257-260.
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    \33\ SoundExchange notes that ``[t]here are no sound economic 
reasons to adjust market-based rates because of this statutory 
objective.'' SX PFF ] 502. Other than its affirmation that the 
revenue from the SDARS is important to record labels, SX PFF ] 515, 
SoundExchange directs us to no evidence in the record that would 
warrant an upward adjustment in the rate that is most strongly 
indicated by the totality of the evidence in the proceeding based on 
the first Section 801(b) factor. Therefore, the Judges limit the 
discussion in this section to Sirius XM's arguments about why a 
downward adjustment is warranted under this factor.
---------------------------------------------------------------------------

    Much of the evidence that Sirius XM presented to show the 
promotional effect of Sirius XM's service on phonorecord sales consists 
of testimony detailing record labels' efforts to get their artists 
airplay on Sirius XM and elsewhere. See, e.g., id. at ] 253 
(``SoundExchange's witness Darius Van Arman, co-owner of several 
independent record labels, conceded that `one of the goals of [his 
labels'] promotional activities [is] to get [his] artists airplay * * * 
includ[ing] airplay on Sirius XM.''). It is not surprising that record 
labels seek airplay for the artists they represent. Nor would it be 
surprising to learn that increased airplay on Sirius XM can enhance 
phonorecord sales. Those facts alone, even if assumed to be true, would 
not provide the type of substantial empirical evidence that might 
support a downward adjustment from the rates most strongly suggested by 
the evidence in the record.
    As SoundExchange notes, ``Sirius XM's case attempting to connect 
Sirius XM airplay with sales of sound recordings consists of less than 
ten pieces of anecdotal evidence over a five-year period.'' SX RFF at ] 
228 (emphasis in original). The Judges agree with SoundExchange that 
Sirius XM provides insufficient probative evidence upon which the 
Judges could make a meaningful assessment of the relative promotional 
value of Sirius XM's service vis [aacute] vis interactive internet 
subscription services. See 10/16/2012 Tr. 4874:16-18 (Sirius XM closing 
argument by Mr. Rich, noting the anecdotal nature of Sirius XM's 
promotional evidence).
    The Judges are also unpersuaded by Sirius XM's assertion that the 
purported lack of promotional value of interactive internet services 
should warrant a downward adjustment from a marketplace benchmark rate 
upon which the Judges might rely. Evidence to support Sirius XM's 
contention that interactive internet services are substitutional and 
may cannibalize phonorecord sales is sparse. In this regard, the Judges 
place little credence on blanket statements such as that by Dr. Noll 
that ``there's no question'' that interactive subscription services 
have no promotional impact on record sales, because ``[o]n demand 
services let customers play a specific recording on request, allowing 
the same control over play sequence that customers have in playing 
recordings from personal libraries.'' Sirius XM PFF at ] 257,

[[Page 23067]]

quoting Noll Revised Amended WDT at 22 and 6/5/12 Tr. 227:16-228:16 
(Noll).\34\
---------------------------------------------------------------------------

    \34\ Dr. Noll concedes that ``there's no published academic 
research on this issue, and, indeed, there's not enough data 
available for me to undertake such a research project.'' 6/5/12 Tr. 
227:22-228:3 (Noll). Moreover, he concedes that even the industry 
studies that have been done are ambiguous in their conclusions. Some 
think there's a substitution effect, some think there isn't. On 
balance, it seems to be the case that issue is unresolved, but 
there's no--there's no question that you wouldn't say it's a 
promotional effect, like satellite radio or terrestrial radio. It's 
either nothing or it's a substitution effect.
    Id. at 228:8-16.
---------------------------------------------------------------------------

    Dr. Noll's statement is more descriptive of the nature of 
interactive services than supportive of the claim that those services 
increase substitution. Even if the Judges were to take at face value 
Dr. Noll's implication that a subscriber's ability to play a particular 
track on demand discourages the subscriber from purchasing that track, 
that fact alone would not address the more general notion regarding the 
relative promotional value (or lack thereof) of interactive internet 
streaming services. Promotional value can extend far beyond a service's 
impact on a single track by a single artist; it may extend to an 
artist's entire catalogue as well as to related artists or genres.
    With respect to the potential substitutional effect of interactive 
internet streaming services, Sirius XM references certain industry 
projections that assume a certain rate of cannibalization for such 
services. Sirius XM PFF ]] 259-260. Even if these rates were assumed to 
be reasonable projections for this type of service, they are not 
supportive of a downward adjustment from a marketplace-influenced 
benchmark rate because they are already taken into account in 
determining the royalty rates that the services pay. See, e.g., id. at 
] 260; PSS Ex. 8 at 3 (SX02 00027594); 6/13/12 Tr. 2061:16-2062:3 
(Bryan) (Warner Music Group's estimate of potential substitution effect 
of Spotify's service). In sum, the Judges find no probative evidence to 
warrant an adjustment from a marketplace-derived benchmark rate under 
this factor.
b. Afford Fair Return/Fair Income Under Existing Market Conditions
    With respect to the second Section 801(b) factor--affording a fair 
return to the copyright owner and fair income to the copyright user--
the Judges find that little has changed since SDARS-I, in which the 
Judges determined that no adjustment from the benchmark rate was 
warranted.
1. The Parties' Contentions
    SoundExchange argues that no adjustment to a marketplace-derived 
benchmark rate is warranted ``unless there is a clear showing that the 
benchmark rates were elevated by the exercise of monopoly power.'' SX 
PFF ] 504. SoundExchange contends that no such monopoly power was shown 
with respect to the marketplace benchmark that SoundExchange proposes 
or with respect to ``other non-statutory distribution channels.'' Id. 
SoundExchange contends that ``any downward adjustment would amount to a 
`subsidy' for Sirius XM, which would provide the company with an 
unwarranted competitive advantage relative to rival distributors of 
music content, and also dilute the incentives for the creation of new 
works and for the efficient transmission of music through new and 
emerging channels.'' Id.; Ordover Third Corrected/Amended WDT at 10, SX 
Trial Ex. 74. SoundExchange also stresses the growing importance to 
artists and record labels of digital income streams as sales of 
physical products decline. SX PFF ] 528.
    For its part, Sirius XM contends that ``the implementation of this 
factor requires assessing whether the royalty rate allows both the 
buyer (Sirius XM) and the sellers (the record labels) to recover their 
costs, including the financial cost of capital used to make 
investments.'' Sirius XM PFF ] 263. Sirius XM states that those costs 
must be measured cumulatively and not as a ``snapshot of annual 
operating costs.'' Id. While Sirius XM concedes that the company has 
shown a ``recent trend of profitability,'' it contends that ``it will 
be years before Sirius XM recoups all of its losses from the last two 
decades; thus, any increase to those costs, such as an increase in the 
SoundExchange royalty rate, will only lengthen the time it takes to 
recoup these losses and directly interfere with Sirius XM's ability to 
achieve a fair return on its investments.'' Id. at ] 265.
2. The Judges' Analysis

    In SDARS-I, the Judges stated:

    Affording copyright users a fair income is not the same thing as 
guaranteeing them a profit in excess of the fair expectations of a 
highly leveraged enterprise. Nor is a fair income one which allows 
the SDARS to utilize its other resources inefficiently. In both 
these senses, a fair income is more consistent with reasonable 
market outcomes.

73 FR 4095 (footnote omitted).

    In the absence of substantial evidence in the record to the 
contrary, any marketplace benchmark rate that guides the selection of 
rates will encompass such a return because it represents the best 
evidence of reasonable market outcomes. In this proceeding, the Judges 
find the proposed Direct License benchmark provides useful guidance for 
setting the lower bound of a zone of reasonable rates. The Judges find 
no probative evidence, however, to suggest that that rate should be 
adjusted under this factor. Presumably, being marketplace-inspired, the 
rate already reflects a fair income and a fair return.
    SoundExchange stresses the growing importance of digital revenue 
streams for copyright owners, a trend that was certainly in play during 
the SDARS-I proceeding. The Judges find no material change in that 
trend in the current record that would warrant an upward adjustment 
from a marketplace-derived benchmark rate. In turn, Sirius XM stresses 
the importance of the rate on the timing of Sirius XM's return to 
profitability. The SDARS made similar points in the SDARS-I proceeding. 
Sirius XM's current trend toward profitability and its ability to pass 
on at least a portion of the rate increase to its subscribers\35\ 
suggests that the prevailing statutory rate--which was informed by a 
marketplace benchmark and which is within the zone of reasonableness 
the Judges establish in the current proceeding--did not hinder Sirius 
XM's ability to earn a fair income.
---------------------------------------------------------------------------

    \35\ See, e.g., 8/13/2012 Tr. 3049:8-16 (Frear).
---------------------------------------------------------------------------

    In this proceeding, the Judges set the lower bound of the zone of 
reasonableness at 7% based on marketplace outcomes. Therefore, the 
Judges are confident that fair income and returns are reflected by that 
rate. In SDARS-I the Judges found that the same was true with respect 
to the statutory rate of 8%, as well as the 13% rate to which the 
Judges applied the Section 801(b) factors to derive the 8% rate. The 
current record does not support a change in that conclusion. Therefore, 
the Judges find no justification in this proceeding for an adjustment 
either up or down pursuant to the second Section 801(b) factor for 
rates in a range of 7% to 13%.
c. Weigh Relative Roles of Copyright Owner and Copyright User
1. The Parties' Contentions
    According to Sirius XM, ``when using the royalty rate paid by an 
Internet-based music service as a benchmark for setting royalty rates 
for Sirius XM, one must first identify the contributions that are 
unique to Sirius XM * * * and then compare these contributions to those 
made by the Internet-based services that

[[Page 23068]]

are being proposed as a benchmark.'' Sirius XM PFF ] 277, referencing 
Noll Revised Amended WDT at 25-26, SXM Dir. Trial Ex. 1; 8/14/2012 Tr. 
3463:13-3464 (Noll). In this regard, Sirius XM notes that it has spent 
over $10 billion in creating and supporting its service and that those 
costs have not yet been recovered. Sirius XM PFF ] 278. According to 
Sirius XM, these ``massive contributions only continue to increase, and 
far outweigh those made by Internet-based services that serve as 
benchmarks for setting royalty rates for Sirius XM.'' Id. See also id. 
at ] 295 (quoting Professor Noll and Mr. Karmazin for the proposition 
that Sirius XM's costs in developing its system far exceed those of the 
internet streaming companies). Sirius XM also points to its payments to 
automakers to encourage them to include Sirius XM's service in the 
vehicles they make, payments which, according to Sirius XM, the 
internet-based streaming services do not make. Sirius XM PFF ]] 294, 
296.
    Sirius XM also contends that the record industry does not incur any 
additional incremental cost in making digital sound recordings 
available to Sirius XM. Id. at ]] 279, 303. Sirius XM contends that, as 
a result of its contributions to its service, it should receive a 
downward adjustment from the benchmark rate, to the extent that rate is 
based on an internet streaming benchmark. Id. at ] 297-298 (``simply 
applying the percentage-of-revenue rate paid by benchmark Internet-
based music services to the full revenues of Sirius XM without 
adjustment [to either the rate or the revenue base] would fail to 
recognize Sirius XM's relative contribution and `would effectively give 
record labels a share of revenues that have nothing to do with the 
sound recording rights they are licensing.' '') Id. at ] 298, quoting 
Salinger Corrected WRT ] 18, SXM Reb. Trial Ex. 9.
    For its part, SoundExchange stresses the risks and costs the record 
labels incur in making, promoting and distributing music. For the 
perspective of a major record label, SoundExchange's evidence consists 
largely of testimony from UMG's Mr. Ciongoli who detailed UMG's costs 
in finding, developing, and marketing artists. SX PFF ]] 535-542. In 
addition, SoundExchange presented the testimony of Mr. Van Arman who 
discussed the costs and efforts that independent labels typically incur 
in finding and promoting artists. Id. at ] 544.
2. The Judges' Analysis
    The Judges' task with respect to the Section 801(b) factors is to 
determine whether the record presents solid empirical evidence of a 
difference between the benchmark market, if any, and the target market 
that would warrant an adjustment in the rate most strongly suggested by 
the evidence.
    In SDARS-I, the Judges found that

    [C]onsidering the record of relevant evidence as a whole, the 
various sub-factors identified in this policy objective may weigh in 
favor of a discount from the market rate because of the SDARS' 
demonstrated need to continue to make substantial new investments to 
support the satellite technology necessary to continue to provide 
this specific service during the relevant license period. However, 
inasmuch as we find this issue is intimately intertwined with 
evidence impacting our consideration of the fourth 801(b) policy 
objective (i.e., minimizing any disruptive impact on the structure 
of the industries involved), we will treat the effect of this 
particular matter as part of our consideration of the fourth policy 
objective.

73 FR 4096.

    With this exception, we found no other rationale for an adjustment 
either up or down from the benchmark rates based on this factor. Id. at 
4096-4097.
    In the current proceeding, in setting the lower bound of the zone 
of reasonableness the Judges were guided by the Direct Licenses Sirius 
XM negotiated with certain independent records labels. Deriving the 
upper bound of the zone of reasonableness has proved to be more 
problematic. The Judges conclude that the upper bound cannot be above 
the 22.32% rate from Dr. Ordover's second alternative approach. 
Moreover, the Judges are confident that the current statutory rate of 
8% is within the zone of reasonableness. The Judges also are informed 
by the presumed reasonableness of the 12% rate that SoundExchange 
proposed for 2013 and by the 13% benchmark rate that served as a 
benchmark in SDARS-I. Given the Judges' relative confidence in the 
reasonableness of the 7% to 13% range, consideration of the third 
Section 801(b) factor is directed at that range.
    Since the Direct License benchmark involves the same buyer (Sirius 
XM) and the same sellers (record labels) as the buyers and sellers in 
this proceeding--and they negotiated over the same rights set--the 
Judges find that the buyers and sellers in the benchmark market 
sufficiently replicate those in the target market.\36\ With respect to 
the rights for which Sirius XM and the independent labels negotiated, 
evidence in the record indicates that the Direct Licensors granted 
broader rights than just the public performance rights that are the 
subject of the Section 114 compulsory license and that Sirius XM 
offered incentives beyond those that would be available through the 
compulsory licensing scheme. See, e.g., SX PFF ]] 386-400 (citing 
defrayed administrative costs, the ability of Sirius XM to play more of 
an artist's works over a given time, and direct payment of the artists' 
share to the independent labels, among others, as key differences 
between the Direct Licenses and the compulsory licenses that might 
warrant a lower effective royalty rate).
---------------------------------------------------------------------------

    \36\ The Judges acknowledge that the sellers in the Direct 
Licenses represent a small subset of independent labels and exclude 
major labels, which, according to Sirius XM, were unwilling to enter 
direct license negotiations with Sirius XM. Sirius XM PFF ] 47-48. 
Nevertheless, the depth and breadth of the labels that signed Direct 
Licenses with Sirius XM strongly suggest that the relative role of 
the independent labels that entered the Direct Licenses with Sirius 
XM is, for the limited purpose of analyzing the third Section 801(b) 
factor, sufficiently comparable to that of independent labels 
generally and to that of the major labels. See, e.g., Sirius XM PFF 
]] 91-103; Noll Revised Amended WDT at 39-44 (record labels that 
signed Direct Licenses included: One of Billboard's top five 
independent labels for eight of the past nine years; labels that 
represented Grammy Award-winning and Grammy Award-nominated artists 
in multiple categories; a label that amassed more than 20 number one 
albums on Billboard's kids' album chart; the world's largest 
independent classical music label with a repertoire of over 2500 
titles; a label with three songs on the Contemporary Christian top 
10 during a period in 2012 and eight of the 50 spots on the 
Christian songs chart in 2012; a label representing an artist with 
the number one Billboard Heatseeker album in 2011; a label 
representing an artist with three Gold records; and a label that 
released the comedy albums of five-time Grammy Award-winning 
comedian George Carlin), SXM Dir. Trial Ex. 1. That being said, the 
absence of a major record label in the Direct License agreements 
supports the Judges' earlier conclusion that rates below 7% are 
below the lower bound of the zone of reasonableness.
---------------------------------------------------------------------------

    The Judges acknowledge the differences between the compulsory 
license and the Direct Licenses, but view many of those differences as 
more a matter of administrative convenience than of differences in the 
substantive rights of the parties with respect to the public 
performance right. For example, if an artist is entitled to a certain 
share of profits from the sale of his or her records, that right is not 
diminished by the fact that the share is paid by SoundExchange or by 
the label with which the artist has signed. As far as the non-
administrative differences (e.g., waiver of the statutory restriction 
on the number of times an artist's works may be played over a given 
time), it may well be that the benefits inure equally to both Sirius XM 
and the artists represented by the independent labels, many of whom may 
value broader exposure in lieu of statutory restrictions on the amount 
their works may be played.\37\ Therefore,

[[Page 23069]]

the rights that the parties negotiated for in the benchmark market are 
reasonably comparable to those in the target market and no upward 
adjustment from the lower bound benchmark rate is warranted based on 
the third Section 801(b) factor.
---------------------------------------------------------------------------

    \37\ To the extent that the rights between the Direct License 
benchmark and target market vary in material respect, the Judges 
reflected such variances in the decision to adopt the upper end 
(i.e., 7%) of the range of rates for the benchmark.
---------------------------------------------------------------------------

    With respect to the upper bound of the zone of reasonableness, 
which is informed by licenses between major record labels and certain 
interactive streaming services, the sellers are acceptably comparable 
to the target market (i.e., record labels). Although evidence in the 
record addresses the costs UMG incurs generally as a major record label 
and the costs Mr. Van Arman's independent labels incur in developing 
the artists that they sign, no substantial empirical evidence addresses 
the unique costs and contributions that the record labels make with 
respect to providing their recordings to Sirius XM. Because the Judges 
conclude that the sellers in the proposed benchmark market that guided 
the upper bound of the zone of reasonable rates are comparable to those 
in the target market, their contributions, risks, and costs are 
presumed to already be incorporated into the rates that set the upper 
bound. Therefore, the sellers' contributions in the target market do 
not indicate that an adjustment from the bounds of the zone of 
reasonableness is warranted.
    Determining the comparability between the buyers that yielded the 
upper bound requires a comparison between Sirius XM and the internet 
streaming services that are the buyers in the proposed Ordover 
benchmark market. As the Judges recognized in SDARS-I, Sirius XM has 
demonstrated the need to continue to make substantial new investments 
to support the satellite technology necessary to continue to provide 
its specific service during the relevant license period. The Judges 
have no substantial evidence in the record, however, that would lead to 
a conclusion that the internet-based streaming services have ongoing 
distribution system costs anywhere near those of Sirius XM. According 
to Mr. Karmazin, Sirius XM anticipates investing more than [REDACTED] 
to maintain, upgrade, and, where necessary, replace its technological 
infrastructure during the 2013-17 licensing period. Karmazin WDT at 4, 
SXM Dir. Trial Ex. 19. A large portion of the system's costs relate to 
Sirius XM's satellites. According to Sirius XM, over the past six 
years, the company has spent approximately $1.5 billion replenishing 
satellites. Sirius XM PFF ] 289; Meyer WDT at 23-24, SXM Dir. Trial Ex. 
5. A satellite's useful life is between 12 and 15 years. Meyer WDT at 
24, SXM Dir. Trial Ex. 5. Sirius XM expects that its newly replenished 
satellite networks will maintain its services through 2020. Sirius XM 
PFF ] 291; Meyer WDT at 24, SXM Dir. Trial Ex. 5.
    Such substantial financial outlays are unique to Sirius XM, which 
has developed a proprietary music distribution system, rather than use 
the existing internet framework, as the services in the proposed 
Ordover benchmark market have done. Although the costs of developing 
and launching the current generation of satellites has already been 
sunk, it is not unreasonable for Sirius XM to expect to recoup a 
certain amount of those costs over the expected useful life of the 
satellites. Moreover, the costs of maintaining the current satellites 
and planning and developing the new generation of satellites will 
require additional, substantial costs over the license period. See 
Meyer WDT at 24, SXM Dir. Trial Ex. 5. In light of the substantial 
evidence in the record of the unique and substantial financial costs 
that Sirius XM has incurred and anticipates incurring over the license 
period to maintain and upgrade its distribution system, the Judges find 
that the most appropriate rate for the current license period will be 
somewhat below the 12%-13%, which the Judges are reasonably confident 
represents the top of the zone of reasonableness. Therefore, the rates 
that the Judges announce in this determination for the SDARS reflect a 
downward adjustment from the 12%-13% range based upon the third Section 
801(b) factor.
d. Minimize Disruptive Impact
    Although the rate the Judges set in this proceeding is just one 
component that will impact the future of Sirius XM and the copyright 
owners, the rate could be considered disruptive (and thereby warrant an 
adjustment) if the unadjusted rate ``directly produce[d] an adverse 
impact that is substantial, immediate, and irreversible in the short-
run because there is insufficient time for either the SDARS or the 
copyright owners to adequately adapt to the changed circumstances 
produced by the rate change and, as a consequence, such adverse impacts 
threaten the viability of the music delivery service currently offered 
to consumers under this license.'' 73 FR 4097. In SDARS-I, the Judges 
found that a downward adjustment from the upper boundary of the 
marketplace benchmark was justified on two grounds: (1) The SDARS' were 
not sufficiently profitable and did not have a sufficiently broad 
subscriber base to sustain an immediate rate increase from a range of 
2.0%-2.5% to 13% of revenues and (2) a 13% rate would potentially 
constrain the SDARS' ability to undertake satellite investments planned 
for the license period, which, if delayed, could disrupt the SDARS' 
consumer service. Id.
1. The Parties' Contentions
    In determining whether the fourth factor warrants an adjustment in 
the current proceeding, Sirius XM invites the Judges to consider Sirius 
XM's ``tumultuous financial history'' as well as the ``increasing risks 
the Company is likely to face in the coming license term.'' Sirius XM 
PFF ] 304. When so considered, Sirius XM argues that it ``faces a 
threat of disruption that is `equal to or even greater than the one it 
faced at the time of the last rate proceeding.' '' Id., quoting Stowell 
WDT ] 41, SXM Dir. Trial Ex. 18. Sirius XM details its near-brush with 
bankruptcy in 2008 after Sirius and XM merged and its ultimate deal 
with Liberty Media Corporation to avert a bankruptcy filing. Frear WDT 
at 3-5, SXM Dir. Trial Ex. 12. It also notes its achievement of 
profitability in 2010. Id. at 7.\38\ While acknowledging that its 
recent performance is ``encouraging,'' Sirius XM points out that it has 
cumulative net operating losses of $8 billion, which it has incurred 
over the past two decades. Sirius XM notes that any increases in its 
costs will lengthen the time it takes to recoup these losses. Id. at 7-
8. Nevertheless, Sirius XM anticipates that its adjusted earnings 
before depreciation and amortization (``EBITDA'') for 2012 will be $860 
million on revenues of $3.3 billion, which should allow Sirius XM to 
return capital to its investors. Id. at 14 and n.11.
---------------------------------------------------------------------------

    \38\ Sirius XM attributes its current profitability largely to 
its one-time merger-related cost cuts. Frear WDT at 8, SXM Dir. 
Trial Ex. 12. It is also noteworthy that Sirius XM reduced its 
programming costs by renegotiating its agreements with several high-
profile content providers. Id. at 8-9. Sirius XM expects, however, 
that its operating costs will increase over the licensing period. 
Id. at 20. According to Sirius XM, optimistic public statements made 
by Sirius XM's management should be discounted as ``puffery.'' 
Sirius XM PFF ] 312 and n.66.
---------------------------------------------------------------------------

    Notwithstanding its anticipated profitability for 2012, Sirius XM 
notes that it is still in a financially tenuous position in the longer 
term. Threats that Sirius XM anticipates to its continued financial 
success include: its increasing dependence on the automobile industry; 
competitive threats from internet-based

[[Page 23070]]

providers and ``connected-car'' technology; significant debt on Sirius 
XM's balance sheet; and the continuing risk that Sirius XM could lose 
access to the credit markets to refinance its debt. Sirius XM PFF ]] 
322-328; Frear WDT at 21-22, SXM Dir. Trial Ex. 12. Although Sirius XM 
has been able to offset a portion of recent rate increases by passing 
some of those costs on to customers, continuing to do so in the future, 
Sirius XM contends, will run the risk of en masse subscriber 
defections. Id. at n.17.
    On the other hand, SoundExchange recommends that the Judges use a 
more circumspect approach to applying the fourth factor. SoundExchange 
proffers that ``the fourth policy objective should be limited to a 
temporary facilitation of the ability of nascent and emerging services 
to gain consumer acceptance and potentially achieve an efficient scale 
of operation * * *. [O]nce a company achieves a material presence in 
the marketplace, as Sirius XM indubitably has, use of the fourth policy 
factor to reduce market-based rates should be considered only with 
extreme caution, and should never be used to shield the service at 
issue from the full rigors of vigorous marketplace competition.'' SX 
PFF ]] 550-551, citing Ordover Third Corrected/Amended WDT at 5-6, SX 
Trial Ex. 74.\39\
---------------------------------------------------------------------------

    \39\ Although the Judges agree that the fourth factor should be 
applied with caution (as should all of the factors), Section 
801(b)(1)(D) of the Copyright Act does not restrict its application 
to ``nascent and emerging services'' and the Judges are unwilling to 
read such limitations into it. Nevertheless, the Judges are 
cognizant of SoundExchange's concern that the fourth factor not be 
applied in a way that would shield service providers from a 
competitive marketplace.
---------------------------------------------------------------------------

    SoundExchange points to Sirius XM's stronger financial position as 
evidence that no downward adjustment is warranted for this license 
period. To support its position SoundExchange relies in part on 
testimony from Professor Lys who noted,

    [S]ince the merger, Sirius XM has experienced steady growth in 
both the number of subscribers and subscriber revenues while at the 
same time experiencing cost reductions. As a result, the company has 
achieved sustainable and growing profitability. Further, in contrast 
to 2009, when the company restructured its debt, Sirius XM's credit 
ratings and the underlying financial metrics related to its debt 
have improved substantially.

Lys Corrected WDT at 8, SX Trial Ex. 80.

    Professor Lys further represented that in the third quarter (Q3) of 
2011, Sirius XM had adjusted EBITDA \40\ of $197 million, up 16% year-
over-year for the same quarter. Id. at 19, citing ``Sirius XM Radio 
Inc., Q3 2011 Earnings Call,'' Capital IQ, November 1, 2011, p. 3.
---------------------------------------------------------------------------

    \40\ EBITDA stands for Earnings, Before Interest, Taxes, and 
Depreciation Allowance.
---------------------------------------------------------------------------

    Professor Lys also stressed Sirius XM's dramatic turn-around in 
free cash flow.\41\ In 2008, Sirius XM had negative free cash flow of 
over $550 million. Id. at 20. By 2009, Sirius XM's free cash flow had 
turned to a positive $185 million. By 2010, that number had reached 
$210 million. Sirius XM projected that its free cash flow for 2011 
would reach $400 million, a 90% increase over 2010, and would continue 
to grow in 2012. Id., quoting ``Sirius XM Radio Inc., Q3 2011 Earnings 
Call,'' Capital IQ, November 1, 2011, p. 3.
---------------------------------------------------------------------------

    \41\ Free cash flow measures cash generated by a company that is 
not needed to fund the current period's operations or to reinvest in 
the firm's future operations. Lys Corrected WDT at 18-19 n. 94, 
citing Brealey, Richard, Stewart Myers and Franklin Allen, 
Principles of Corporate Finance, 2006, p. 997.
---------------------------------------------------------------------------

2. The Judges' Analysis
    In analyzing whether the fourth Section 801(b) factor warrants an 
adjustment (either up or down) to the rates delineating the zone of 
reasonableness, the Judges must examine the same set of circumstances 
that informed the Judges' analysis in SDARS-I. In SDARS-I, the Judges 
found that a downward adjustment from the upper boundary of the 
marketplace benchmark was justified because: (1) The SDARS were not 
sufficiently profitable and did not have a sufficiently broad 
subscriber base to sustain an immediate rate increase from a range of 
2.0%-2.5% to 13% of revenues (a potential five-fold or six-fold 
increase) and (2) a 13% rate would potentially constrain the SDARS' 
ability to undertake satellite investments planned for the license 
period, which, if delayed, could disrupt the SDARS' consumer service. 
73 FR at 4097. Neither of those justifications is present to the same 
degree in the current record.
    Sirius XM is now in a far better financial position than either 
Sirius or XM was as a stand-alone company in 2007, the first year of 
the current licensing period. In 2007, Sirius and XM had combined 
revenues of $2.1 billion and combined adjusted EBITDA of negative $565 
million. SX PFF ] 556; SX Trial Ex. 16 at SXM--CRB--DIR--00021681 
(p.15). By year-end 2012, Sirius XM's revenues are expected to be $3.4 
billion and its EBITDA is expected to be approximately $900 million. SX 
Trial Ex. 217 at 7. In 2007, the SDARS free cash flow was negative $505 
million. In 2012, by contrast Sirius XM's free cash flow is expected to 
rise to $700 million. SX PFF ] 556, citing SX Trial Ex. 16 at SXM--
CRB--DIR--00021682 (p.16); SX Trial Ex. 217 at 7; see also Lys 
Corrected WDT at 18-21, SX Trial Ex. 80.
    Another key indicator of potential financial strength--net increase 
in subscribers--indicates that Sirius XM is much stronger than either 
of the SDARS were in 2007. In 2007, Sirius and XM had 17.3 million 
subscribers. By 2012, that number for Sirius XM had risen to 23.5 
million. SX PFF ] 554. Sirius XM was able to increase its net 
subscribers notwithstanding a period of relatively weak car sales--a 
key driver of new subscribers--and despite passing on a portion of the 
royalty rate increase to its subscribers. Id. and Frear WDT at 21 n.17, 
SXM Dir. Trial Ex. 12.
    In percentage terms, the gap between the prevailing rate of 8% and 
the 12%-13% range that guides the upper bound of the zone of 
reasonableness in the current proceeding is much narrower than the 
comparable gap presented in SDARS-I. Indeed, an increase to 12% or 13% 
would be less dramatic in percentage terms than was the increase the 
Judges adopted in SDARS-I, which Sirius XM has managed to sustain.\42\
---------------------------------------------------------------------------

    \42\ The Judges are much less confident that the same could be 
said for an increase to the 22%-32.5% that the proposed Dr. Ordover 
benchmark might suggest. As a result, the Judges draw additional 
comfort that the upper bound of the zone of reasonableness is closer 
to 12%-13% than it is to 22.32%, which the Judges conclude the upper 
bound of the zone of reasonableness can be no more than. See infra 
at Section V.B.3.b.
---------------------------------------------------------------------------

    The Judges also find that the second rationale found in SDARS-I for 
a downward adjustment, potential constraint on Sirius XM's ability to 
undertake satellite investments during the license period, is a less 
pressing issue than it was during the prior licensing period. As 
discussed above, Sirius XM expects that its newly replenished satellite 
networks will maintain its services through 2020. Sirius XM PFF ] 291; 
Meyer WDT at 24, SXM Dir. Trial Ex. 5. Although there will be ongoing 
costs of maintaining its existing satellites--costs that justified a 
downward adjustment under the third factor--no substantial evidence in 
the record supports a downward adjustment based on Sirius XM's need to 
replace its existing satellites during the current licensing period. 
Therefore, neither of the circumstances that justified a downward 
adjustment under the fourth factor in SDARS-I is currently present.
    The Judges find no new circumstances that would warrant a downward 
adjustment under the fourth

[[Page 23071]]

factor. Sirius XM's primary contention for a downward adjustment under 
the fourth factor centers largely on the competitive landscape, in 
particular, the threat of new technologies such as the connected car 
technology. Sirius XM PFF ]] 325-328.\43\ While emerging technologies 
can dramatically change the competitive landscape from one licensing 
period to the next, the Judges find insufficient evidence in the record 
to suggest that connected car technology or any of the other emerging 
competitive threats discussed during the proceeding warrants a downward 
adjustment under the fourth factor during the current licensing period.
---------------------------------------------------------------------------

    \43\ Sirius XM's contentions that it faces risks of disruption 
due to its increasing reliance on the OEM distribution channels 
(i.e., the automobile market) (Sirius XM PFF ]] 322-324), or 
potential risks from relying on a satellite infrastructure (Sirius 
XM PFF ]] 316-317), or risks posed by macroeconomic conditions 
(Sirius XM PFF ]] 318-320) are too speculative to suggest the type 
of substantial, immediate and irreversible adverse impact that would 
warrant a downward adjustment of the benchmark rate under the fourth 
factor.
---------------------------------------------------------------------------

    SoundExchange has not alleged a disruption to the copyright owners 
as a result of the prevailing rate and the Judges are not inclined to 
lower that rate. Therefore, the Judges find no evidence that an 
increased rate, albeit one that is lower than that proposed by 
SoundExchange, would warrant an upward adjustment. Therefore, the 
Judges find no adjustment warranted under the fourth Section 801(b) 
factor.
5. Conclusions Regarding Section 114 Rates
    After reviewing the Section 801(b) factors in light of the zone of 
reasonable rates that has 7% as its floor and 12%-13% as its most 
likely ceiling, the Judges find that the most appropriate rate for 
SDARS for the 2013 to 2017 licensing period is 11% of Gross Revenues. 
To minimize any potential disruptive impact of the rate increase, the 
Judges phase it in over the license period. Consequently, the Judges 
set forth the following SDARS rates: for 2013: 9.0%; for 2014: 9.5%; 
for 2015: 10.0%; for 2016: 10.5%; and for 2017: 11.0%.

VI. Definition of Gross Revenues and Deductions

A. Definition of Gross Revenues

1. SoundExchange's Proposal
    The revenue base against which the adopted royalty rates would be 
applied is a matter of considerable disagreement between the parties. 
Sirius XM requests continuance of the current definition of Gross 
Revenues in 37 CFR 382.11, arguing that it properly identifies only 
those revenues that are related to the provision of statutorily 
licensed sound recordings. See Sirius XM PFF ] 416. SoundExchange 
favors a considerable expansion of the revenue base, stating that its 
proposed changes would conform the royalty base to the economics 
underlying the percentage-of-revenue royalty rates within the 
benchmarks offered in this proceeding, and would make the Gross 
Revenues definition easier to administer and less susceptible to 
interpretation and manipulation. Bender WDT at 12, SX Trial Ex. 75.
    SoundExchange's proposed Gross Revenues definition \44\ is based 
upon an interpretation of the Judges' use in SDARS-I of Dr. Ordover's 
adjusted interactive subscription service benchmark to establish the 
upper boundary of reasonable royalty rates for an SDARS service. SDARS-
I, 73 FR at 4093-4094. The use of that benchmark, in SoundExchange's 
view, demonstrates an intention of the Judges to use total subscription 
revenue as the base against which the royalty rates should apply. 
Bender WDT at 6, SX Trial Ex. 75. Applying this assumption to the 
revenues reported by Sirius XM from 2007 through the third quarter of 
2011, SoundExchange concludes that Sirius XM has paid roughly 16%-23% 
less in total royalty fees than intended. Id. at 6-7. SoundExchange 
contends that this purported revenue shortfall is due to revenue 
exclusions that Sirius XM makes under the current Gross Revenues 
definition which, SoundExchange argues, should not be allowed to 
continue in the new licensing period.
---------------------------------------------------------------------------

    \44\ SoundExchange's proposed Gross Revenues definition is set 
forth at Second Revised Proposed Rates and Terms of SoundExchange, 
Inc., at 2-3 (Sept. 26, 2012).
---------------------------------------------------------------------------

    SoundExchange is particularly critical of a provision of the 
current definition that allows Sirius XM to deduct revenues received 
for ``[c]hannels, programming products and/or services offered for a 
separate charge where such channels use only incidental performances of 
sound recordings.'' 37 CFR 382.11 (paragraph (3)(vi)(B) of Gross 
Revenues definition). According to SoundExchange, this deduction is 
unwarranted for the new licensing period, because the rates that Dr. 
Ordover proposed on behalf of SoundExchange and those that Dr. Noll 
proposed on behalf of Sirius XM reflect that roughly half of the value 
of Sirius XM's SDARS service is derived from its music programming and 
roughly half from its non-music programming. According to 
SoundExchange, the reduction for non-music programming permitted in the 
current Gross Revenues definition is already built into the proposed 
rates and should not be further reduced from revenue. SX PFF ]] 839, 
845-846.
    Further, SoundExchange charges that exclusion of revenue derived 
from non-music channels encourages manipulation to reduce the royalty 
base in unprincipled ways. For example, Sirius XM theoretically could 
disaggregate its bundled subscription price of $14.49 per month into a 
music package valued at $3.00 and a non-music package valued at $11.49. 
According to SoundExchange, such a disaggregation would result in no 
additional Sirius XM revenues from the separate packages, but would 
enable Sirius XM to reduce substantially its royalty obligation. SX PFF 
]] 852-853. SoundExchange suggests that its proposed Gross Revenues 
definition would help prevent such accounting gimmicks.
    SoundExchange also proposes to eliminate from the current Gross 
Revenues definition a provision that authorizes an exclusion from 
revenues received from channels and programming that are licensed 
outside the Sections 112 and 114 licenses, which includes pre-1972 
recordings. 37 CFR 382.11 (paragraph (3)(vi)(D) of Gross Revenues 
definition). Dr. Lys testified that Sirius XM excludes between 10% and 
15% of its subscription revenue from the royalty base for performances 
of pre-1972 recordings, thereby reducing its royalty obligation. Lys 
WRT at 54, SX Trial Ex. 240. Yet, SoundExchange contends that Sirius XM 
has not identified the process it uses to identify pre-1972 recordings, 
or how it calculates the deduction it takes.
    SoundExchange's proposed Gross Revenues definition also would 
eliminate five other exclusions from revenues permissible under the 
current regulations. First, under the proposed definition, revenues 
Sirius XM receives from its webcasting service, which are currently 
linked to the SDARS satellite radio subscription, would be included in 
the proposed new Gross Revenues definition. Second, revenues 
attributable to data services, such as Sirius XM's weather and traffic 
services which can be purchased on a stand-alone basis but are more 
commonly offered to SDARS subscribers at a discount, would be included 
in the proposed new Gross Revenues definition. Third, revenue 
attributable to equipment sales or leases used to receive or play the 
SDARS service, would be included. Fourth, the current exclusions for 
credit card fees and bad

[[Page 23072]]

debt expense would be eliminated. Fifth, fees that Sirius XM collects 
for various activities related to customer account administration, such 
as activation fees, invoice fees, swap fees, and certain early 
termination fees, would be included in Gross Revenues. Bender WDT at 
16-17, SX Trial Ex. 75. According to Sirius XM, the elimination of 
these exclusions could expand its annual revenue base, against which 
royalties are calculated, by over $300 million. Frear WRT at 7, SXM 
Reb. Trial Ex. 1.
2. Analysis and Conclusions
    In SDARS-I, the parties were at loggerheads over the definition of 
Gross Revenues, with SoundExchange favoring an expansive reading to 
include ``all revenue paid or payable to an SDARS service that arise 
from the operation of an SDARS service.'' See 73 FR at 4087 (citation 
omitted). The SDARS in turn argued for adoption of the existing Gross 
Revenues definition for PSS. Id. With one exception, the Judges adopted 
the SDARS proposal. See id. SoundExchange's new proposal is again a 
request for an expansive reading of gross revenues. In its effort to 
respond to the Judges' criticism of its SDARS-I proposal as possessing 
``scant evidentiary support,'' SoundExchange attempts to demonstrate 
how Sirius XM has under-reported revenues in the current licensing 
period. Alternatively, SoundExchange attempts to demonstrate how Sirius 
XM might manipulate its revenue base to lower its royalty obligation. 
With the exception of revenue deductions for privately licensed and 
pre-1972 sound recordings discussed, infra, both of SoundExchange's 
arguments lack merit.
    SoundExchange's argument that Sirius XM has paid roughly 16%-23% 
less in royalties in the current license period than was intended under 
the current Gross Revenues definition depends on the assumption that 
there is a direct link between that definition and the adjusted 
interactive subscription service benchmark that SoundExchange's expert 
economist, Dr. Janusz Ordover, presented in SDARS-I. SoundExchange 
reasons that because the Ordover benchmark was fashioned from 
interactive service license agreements that generally provided for 
inclusion of mostly all of subscriber revenue, it must be the case that 
the Judges intended the SDARS-I rates to apply to total subscription 
revenues. See Bender WDT at 6-7, SX Trial Ex. 75.
    The presumed linkage between the benchmark and the Gross Revenues 
definition is not supported by the SDARS-I decision for at least two 
reasons. First, the Ordover benchmark was only one factor the Judges 
used to establish a zone of reasonable royalty rates, marking the upper 
boundary. Second, the Judges never adopted the revenue definitions 
contained in the subscription service license agreements that Dr. 
Ordover proffered. The Gross Revenues definition the Judges adopted in 
SDARS-I was quite different from those contained in the Ordover 
benchmark license agreements.
    In defining Gross Revenues, the Judges plainly stated that it was 
their intention to unambiguously relate the fee charged for a service 
that an SDARS provided to the value of the sound recording performance 
rights covered by the statutory licenses. SDARS-I, 73 FR at 4087. This 
relationship is especially important where, as here, the Judges adopt a 
percentage of revenue rather than a per-performance rate. The license 
agreements used in the SDARS-I Ordover benchmark do not provide for 
this connection between revenue and value under the statutory licenses. 
In sum, SoundExchange's perceived linkage between the current Gross 
Revenues definition and the SDARS-I Ordover benchmark favoring 
inclusion of total subscriber revenues is simply not there.
    In the alternative, SoundExchange argues that an expansive revenue 
base is easier to administer and reduces the chances for manipulation. 
Dr. Lys testified that, from an accounting perspective, it is 
preferable to base contracts on a financial definition that is clear-
cut to administer and easy to audit, and that a revenue definition that 
is all-inclusive satisfies this preference. Lys WRT at 53, SX Trial Ex. 
240. While this may be true, the Judges are driven by the admonition in 
SDARS-I to include only those revenues related to the value of the 
sound recording performance rights at issue in this proceeding. SDARS-
I, 73 FR at 4087. The Judges are satisfied that the exclusions 
permitted in the current Gross Revenues definition remain proper. 
However, if any party were to present evidence to demonstrate 
conclusively that one or more of the exclusions facilitates 
manipulation of fees for the sole purpose of reducing or avoiding 
Sirius XM's statutory royalty obligation, then an amendment or 
elimination of the exclusion might be warranted. SoundExchange has 
failed to meet this burden and has only offered speculation as to how 
Sirius XM might manipulate its revenue to reduce its royalty 
obligation. With the exception of the two deductions discussed below, 
SoundExchange has failed to present persuasive evidence that would 
warrant the changes it proposes to the calculation of gross 
revenues.\45\
---------------------------------------------------------------------------

    \45\ In SDARS-I, the Judges expressly recognized an exclusion 
from Gross Revenues for so-called non-music services, characterized 
as ``channels, programming, products and/or other services offered 
for a separate charge where such channels use only incidental 
performances of sound recordings.'' SDARS-I, 73 FR 4102 (citing 37 
CFR 382.11, definition of Gross Revenues). The Judges did so because 
this exclusion ``unambiguously relat[ed] the fee to the value of the 
sound recording performance rights at issue * * *'' Id. at 4088. 
SoundExchange argues that if the current exclusion is allowed to 
continue, it would result in a double deduction from Sirius XM's 
royalty obligation because Dr. Ordover's proposed marketplace 
benchmarks exclude the value of non-music services, and Dr. Noll's 
proffered benchmarks attempt to account for the fact that roughly 
half of Sirius XM's service is non-music. SX PFF ]] 842-846. The 
Judges agree with Sirius XM's counter argument that Dr. Ordover's 
modeling allocated revenues for both the music and non-music 
programming for Sirius XM's standard ``Select'' package, ``but that 
allocation in no way relates to the separately priced non-music 
packages offered by Sirius XM that are the subject of the 
exemption.'' Sirius XM RFF ] 167. The Judges stress, however, that 
the exclusion is available only to the extent that the channels, 
programming, products and/or other services are offered for a 
separate charge.
---------------------------------------------------------------------------

B. Deductions for Directly Licensed and Pre-1972 Recordings

    Separate from the issue of exclusions from the Gross Revenues 
definition, the Judges examine the impact on the royalty calculus of 
the performance by Sirius XM of sound recordings that it has directly 
licensed from record labels. To broadcast the music offered by the 
Direct Licensors, Sirius XM can rely on the agreed terms instead of 
paying under the compulsory statutory licenses. Sirius XM also performs 
other sound recordings that are exempt from the compulsory licenses in 
the Copyright Act (i.e., pre-1972 recordings).
1. Directly Licensed Recordings
    Both the Section 112 and Section 114 licenses recognize and permit 
the licensing of sound recordings through private negotiation. 17 
U.S.C. 112(e)(5), 114(f)(3). The parties concede that directly licensed 
recordings are outside and, therefore, not compensable under the 
statutory licenses. Sirius XM contends that an exclusion from the Gross 
Revenues definition is necessary for directly licensed recordings; 
otherwise, it contends, it would be paying twice for performing these 
works. Sirius XM PFF ] 425; Proposed Rates and Terms of Sirius XM 
Radio, Inc., at 3 (Sept. 26, 2012).
    SoundExchange acknowledges that directly licensed recordings must 
be accounted for, but resists a codified deduction from the Gross 
Revenues definition. Instead, it proposes that the payable statutory 
royalty amount be

[[Page 23073]]

determined by reducing the product of the royalty rate and Gross 
Revenues by a percentage approximating the value of the directly 
licensed usage. Second Revised Proposed Rates and Terms of 
SoundExchange, Inc., at 4 (Sept. 26, 2012). To determine the share of 
performances attributable to direct licenses, SoundExchange proposes 
using data from Sirius XM's Internet webcasting service for music. The 
following calculation would then be made:
     For each month, identify the Internet webcast channels 
offered by the Licensee that directly correspond to music channels 
offered on its SDARS that are capable of being received on all models 
of Sirius radio, all models of XM radio, or both (the ``Reference 
Channels'').\46\
---------------------------------------------------------------------------

    \46\ SoundExchange conditions the availability of its approach 
on the presumption that the music channels on the Internet service 
remain representative of the music channels offered on the SDARS 
service.
---------------------------------------------------------------------------

     For each month, divide the Internet performances of 
directly licensed recordings on the Reference Channels by the total 
number of Internet performances of all recordings on the Reference 
Channels to determine the Direct Licensing Share.

Id. at 4-5 (footnote omitted).\47\
---------------------------------------------------------------------------

    \47\ SoundExchange requests that, if its approach is adopted, 
Sirius XM be required to notify SoundExchange monthly of each 
copyright owner from which Sirius XM claims to have a direct license 
and each sound recording Sirius XM claims to be excludable. 
SoundExchange would then be permitted to disclose this information 
to confirm whether the direct license exists and the claimed sound 
recordings are properly excludable.

    The Judges are persuaded that directly licensed recordings should 
not be a part of the calculus in determining the monthly statutory 
royalty obligation. To include those recordings, for which Sirius XM 
pays under a separate contract would effectively result in a double 
payment for the directly licensed recordings and would discourage, if 
not altogether eliminate, the incentive to enter into such direct 
licenses. Discouraging direct licensing would be inconsistent with 
Section 114 which recognizes, if not encourages, private licenses. See 
17 U.S.C. 114(f)(1)(B). The Judges are not persuaded, however, by 
Sirius XM's position that the exclusion of directly licensed recordings 
should be from Gross Revenues, as opposed to a deduction from the total 
royalty obligation.
    As SoundExchange correctly points out, there is no revenue 
recognition associated with directly licensed recordings. Those 
licenses represent a cost to Sirius XM. Bender WRT at 3, SX Trial Ex. 
239. Sirius XM has not proposed a revenue allocation formula between 
directly licensed and statutorily licensed recordings that it performs 
on its SDARS service; it has presented a usage deduction that it seeks 
to apply to its revenue base. Excluding usage of sound recordings from 
Gross Revenues would not comport with the Judges' preference to relate 
royalty fees to the value of the sound recording performance rights 
that give rise to the royalty obligation.
    The Judges are persuaded that the proposed methodology of 
SoundExchange to calculate the royalty deduction for directly licensed 
recordings (i.e. the ``Direct License Share'') is the superior approach 
because it would allow Sirius XM to determine the percentage reduction 
for directly licensed recordings based upon the number of plays of 
those recordings compared to total plays. Despite the Judges' requests, 
Sirius XM and its contractor, Music Reports, Inc., were incapable of 
providing the Judges with accurate data as to the identity and volume 
of directly licensed recordings on the SDARS service. SX PFF ]] 883, 
886-888. Reasonable accuracy and transparency are required for 
calculation of the Direct License Share, and SoundExchange has 
demonstrated that its proposed use of the Sirius XM webcasting service 
as a proxy satisfies these requirements. The Judges adopt 
SoundExchange's Direct License Share approach.\48\
---------------------------------------------------------------------------

    \48\ In doing so, the Judges also accept SoundExchange's request 
that the Direct License Share deduction only be available if the 
music channels available on Sirius XM's Internet webcast service 
remain representative of the music channels offered on the SDARS 
services.
---------------------------------------------------------------------------

2. Pre-1972 Recordings
    The performance right granted by the copyright laws for sound 
recordings applies only to those recordings created on or after 
February 15, 1972. Sound Recording Amendment, Public Law 92-140, 85 
Stat. 391 (1971). Sirius XM broadcasts pre-1972 recordings on its SDARS 
service and, in the present license period, excludes a portion of 
revenues from its Gross Revenues calculation for such use. The current 
Gross Revenues definition does not expressly recognize such an 
exclusion, which is not surprising given that there is no revenue 
recognition for the performance of pre-1972 works. In taking the 
exclusion, Sirius XM apparently relies upon the provision of the 
current Gross Revenues definition that permits an exclusion for 
programming that is exempt from any license requirement. See 37 CFR 
382.11 (paragraph (3)(vi)(D) of Gross Revenues definition).
    Dr. Lys testified that the deduction is between 10% and 15% of 
subscription revenue, a figure that Sirius XM did not dispute. Lys WRT 
at 54, SX Trial Ex. 240. Sirius XM requests that the Judges amend the 
current Gross Revenues definition to provide that its ``monthly royalty 
fee shall be calculated by reducing the payment otherwise due by the 
percentage of Licensee's total transmission of sound recordings during 
the month that are exempt from any license requirement or separately 
licensed.'' Proposed Rates and Terms of Sirius XM Radio Inc. at 3 
(Sept. 26, 2012).\49\
---------------------------------------------------------------------------

    \49\ This language is the same that Sirius XM proposes be 
applicable to directly licensed sound recordings.
---------------------------------------------------------------------------

    As with directly licensed works, pre-1972 recordings are not 
licensed under the statutory royalty regime and should not factor into 
determining the statutory royalty obligation. But, for the same reasons 
discussed in relation to the Direct Licenses, revenue exclusion is not 
the proper means for addressing pre-1972 recordings. Rather, the proper 
approach is to calculate a deduction from the total royalty obligation 
to account for performances of pre-1972 recordings. The question then 
becomes how to calculate the correct deduction. Sirius XM did not offer 
any evidence as to how it calculated its current deduction, or how it 
identified what recordings performed were pre-1972, other than the 
obtuse assertion of Mr. Frear that the lawyers talked to the finance 
team to assure a proper deduction. 8/13/12 Tr. 3125:3-3126:3 (Frear). 
To be allowable, a deduction for pre-1972 recordings must be precise 
and the methodology transparent. The Judges, therefore, adopt the same 
methodology applied to determining the Direct License Share, utilizing 
as a proxy the Sirius XM webcasting data with the accompanying 
restriction, to pre-1972 recordings. To be eligible for deduction of 
the Pre-1972 Recording Share, Sirius XM must, on a monthly basis, 
identify to SoundExchange by title and recording artist those 
recordings for which it is claiming the deduction.

VII. Terms

    The Judges now turn to the terms necessary to effectuate payment 
and distribution. The Judges' mandate is this regard is to adopt terms 
that are practical and efficient. See SDARS-I, 73 FR at 4098. In 
general, the Judges seek, where possible, consistency across licenses 
to promote efficiency and

[[Page 23074]]

minimize costs in administering the licenses. However, this goal is not 
overriding. See Webcasting III, 76 FR 13026, 13042 (Mar. 9, 2011).

A. Collective

    SoundExchange requests to be retained as the sole collective for 
the collection and distribution of royalties paid by the PSS and SDARS 
under the Sections 112 and 114 licenses for the license period 2013-17. 
The PSS and SDARS do not oppose SoundExchange's request. Therefore, 
SoundExchange will serve as the collective for the 2013-17 license 
period.

B. Terms Relating to PSS

    SoundExchange proposes a number of substantive and nonsubstantive 
changes to the current regulations dealing with PSS. Music Choice 
opposes the changes, some in general terms and some specifically.
1. Reorganizing Definitions
    SoundExchange proposes collecting applicable PSS definitions in one 
place for the convenience of the users of the definitions. SX PFF ] 
906. We believe this proposal, which is nonsubstantive and which Music 
Choice does not appear to oppose specifically, will enhance the utility 
of the rules and therefore is adopted.
2. Relocating the Statement of Account Requirement
    SoundExchange proposes relocating the statement of account 
requirement in current Sec.  382.4(b) and to adapt it to include the 
enumerated data elements from the SDARS regulations. SX PFF ] 908; 
Bender WDT at 22, SX Trial Ex. 75. Music Choice appears not to 
specifically oppose this change. This change would promote clarity of 
what information is required in a statement of account and is 
consistent with the SDARS license. Therefore, the Judges adopt it to 
enhance the utility and uniformity of the rules across licenses.
3. Applying Late Fee to Late Statement of Account
    SoundExchange proposes applying a late fee to a late statement of 
account, to make the PSS rules consistent with the SDARS and webcasting 
regulations. SX PFF ] 907. Music Choice opposes this proposed change, 
contending that SoundExchange has not provided any evidence suggesting 
that Music Choice or Muzak has ever failed to submit a statement of 
account in a timely manner. Music Choice PFF ] 603. The Judges 
previously imposed a late fee for late statements of account despite 
the service's record of timely submitted statements of account, 
reiterating the importance of the timely submission of statements of 
account to the quick and efficient distribution of royalties. SDARS-I, 
73 FR at 4100; see also, Webcasting II, 72 FR at 24107. The Judges 
adopt the proposed late fee under the same reasoning. The late fee 
adopted today is consistent with the one imposed on webcasters and the 
SDARS. See SDARS-I, 73 FR at 4100.
4. Clarifying Unclaimed Funds Provisions
    SoundExchange proposes to conform and cross-reference regulations 
dealing with the use of funds where the Collective is unable to locate 
a copyright owner or performer who may be entitled to those funds. SX 
PFF ] 909. Because this proposal is unopposed and would enhance the 
clarity of the rules the Judges adopt it. On a related matter, the 
Judges encourage SoundExchange to provide greater clarity on what date 
it uses as the ``date of distribution'' for unclaimed funds. See, e.g., 
Proposed 37 CFR 382.8.
5. Changing Confidentiality Provisions
    SoundExchange proposes changes to the confidentiality provisions in 
Sec.  382.5 to make the PSS regulations consistent with those for 
Business Establishments. SX PFF ] 910. Music Choice specifically 
opposes this proposal because it believes it could cause Music Choice's 
confidential information to be provided to its competitors. Music 
Choice PFF ] 609. In light of Music Choice's specific opposition and 
SoundExchange's inadequate justification for adopting the rule the 
Judges refrain from adopting this proposed change.
6. Conforming Audit Processes
    SoundExchange proposes conforming the PSS audit provisions in 
current Sec. Sec.  382.5(f) (Verification of statements of account) and 
382.6(f) (Verification of royalty payments) with those applicable to 
SDARS and webcasters. SX PFF ] 911. SoundExchange does not support, 
however, maintaining consistency across licenses with respect to the 
cost shifting provisions (currently 5% variance for PSS and 10% 
variance for SDARS and webcasters) and would prefer no change to one 
that would include cost shifting conformity to the higher variance 
standard. Music Choice specifically opposes the proposed changes, 
arguing, among other things, that it would permit SoundExchange to use 
auditors that are employees or officers of a sound recording owner or 
performing artists, the objectivity of which might be suspect. Music 
Choice PFF ] 611-613. Given Music Choice's concerns, which 
SoundExchange has not adequately addressed, and SoundExchange's own 
reluctance to adopt conforming provisions unless the provisions 
maintain differences in cost shifting (or the lower variance standard), 
the Judges refrain from adopting the proposed changes to the auditing 
provisions. To the extent that one or more of the parties have specific 
or general concerns about the auditing process with respect to this or 
other licenses that the Judges administer, the Judges would welcome 
guidance that might serve to enhance the fairness and efficiency of the 
process.
7. Technical and Conforming Changes
    SoundExchange also proposes a number of technical and conforming 
changes, which the Judges adopt as proposed with one exception. SX PFF 
] 912. In particular, the Judges adopt SoundExchange's proposal to 
relocate the provision regarding retention of records from its current 
location in Sec.  382.4(f) relating to confidential information to 
newly renumbered Sec.  382.4(e), which now houses the terms of the 
license. However, the Judges decline to adopt the proposed language 
because it would be a substantive change for which SoundExchange 
provides no justification. Therefore, the language in new Sec.  
382.4(e) remains the same as that currently found in Sec.  382.4(f).

C. Terms Relating to SDARS

    SoundExchange proposes a number of substantive and nonsubstantive 
changes to the current regulations dealing with SDARS.\50\ Sirius XM 
opposes the changes, some in general terms and some specifically.
---------------------------------------------------------------------------

    \50\ Sirius XM proposes to amend current Sec.  382.13(c) in a 
manner that would ensure that Sirius XM would not have to report 
either actual total performances of sound recordings or Aggregate 
Tuning Hours as required under the applicable notice and 
recordkeeping requirements in Part 370. Sirius XM PFF ] 413; 
Proposed Rates and Terms of Sirius XM Radio Inc., at 5 (Sept. 26, 
2012). SoundExchange's proposed reply findings do not address this 
suggested change. The Judges decline to adopt this proposal because 
it appears for the first time in Sirius XM's Proposed Findings of 
Fact ``without any citation to the record or any substantive 
explanation as to why such a change is needed or what benefits would 
result from its adoption.'' Webcasting III, 76 FR at 13043 (Mar. 9, 
2011).
---------------------------------------------------------------------------

1. Deleting Residential Subscriber Concept
    SoundExchange proposes deleting the concept of ``residential'' 
SDARS subscriber in Sec. Sec.  382.11 and 382.12 of the current 
regulations. The concept appears in the definitions of ``Gross 
Revenues'' and ``Residential.''

[[Page 23075]]

SoundExchange contends that the concept is a ``confusing artifact of'' 
a comparable term used in the PSS regulations. SX PFF ] 900. 
SoundExchange argues that the SDARS service is not primarily 
residential in terms of being delivered to homes and the term 
``residential subscriber'' simply means a subscriber and, therefore, 
the term ``residential'' adds no value to the definition and creates 
the possibility for confusion. Id., citing Bender WDT at 20, SX Trial 
Ex. 75. Although Sirius XM broadly opposes adopting the changes to 
terms SoundExchange proposes, it does not expressly state its reasons 
for opposing this particular change. Given the broad analysis of the 
definition of ``Gross Revenues'' the Judges have undertaken in this 
determination, we are mindful of SoundExchange's concern that 
potentially modifying that definition with the preceding term 
``residential'' in current Sec.  382.12 could cause unnecessary 
confusion. Therefore, the Judges adopt SoundExchange's proposal to 
delete the definition of ``residential'' from current Sec.  382.11 and 
the reference to ``residential'' in current Sec.  382.12(a).
2. Eliminating the Handwritten Signature Requirement for Statements of 
Account
    SoundExchange proposes that the Judges eliminate a requirement in 
current Sec.  382.13(e)(3) that the signature on a statement of account 
be handwritten. SX PFF ] 901. SoundExchange contends that the current 
requirement hinders SoundExchange in its ability to automate the 
process of ``ingesting statements of account and reports of use,'' 
which would help reduce transaction costs. Id. Sirius XM does not 
appear to oppose the request. Although the Judges rejected such a 
request in Webcasting III due largely to the proposal's inconsistency 
with certain agreements we adopted in connection with the Webcasting 
III determination,\51\ the Judges find no such inconsistency here. See 
Bender WDT at 20-21, SX Trial Ex. 75. In light of desirability of 
managing administrative costs and the apparent lack of opposition to 
the proposal, the term is adopted as proposed.\52\
---------------------------------------------------------------------------

    \51\ 76 FR at 13045.
    \52\ SoundExchange also proposes a number of minor technical and 
conforming changes, which, it represents, are unopposed. SX PFF ]] 
902-903. Because these proposed changes promote efficiency, the 
Judges adopt them.
---------------------------------------------------------------------------

3. Applying Late Fee to Late Statement of Account
    SoundExchange proposes to amend the current late fee requirements 
for statements of account, 37 CFR 382.13(d), by conforming the language 
to that adopted by the Judges in Webcasting III, which SoundExchange 
contends would eliminate confusion that could result from the current 
language. See SX RFF ]] 360-363. Sirius XM objects to this proposed 
change arguing that the Judges' justification for adoption of a late 
fee in SDARS-I--to ``aid the efficient distribution of royalties''--no 
longer exists now that Sirius XM is the only SDAR and its statement of 
account provides no ``additional information that would impact 
SoundExchange's ability to distribute Sirius XM royalties.'' Sirius XM 
PFF ] 449. In addition, Sirius XM proposes that the regulations be 
amended to ``ensure that a single late fee is to be charged in a given 
reporting period only in the case of a late payment.'' Id.
    In adopting a late fee for late statements of accounts in SDARS-I, 
the Judges explained that assessment of an additional late fee for a 
late statement of account would occur only when the royalty payment and 
statement of account were submitted separately and both were late; 
otherwise, a single late fee of 1.5% would cover both the late payment 
and statement of account when they were submitted together. See SDARS-
I, 73 FR at 4100. The Judges find nothing in the record before us that 
would justify a change to this position; therefore, the Judges decline 
to adopt Sirius XM's proposal. The Judges adopt SoundExchange's 
proposed language because it eliminates any inconsistency in the 
current language. The proposed language provides consistency in the 
late fee provisions applicable to webcasters and the PSS.

VIII. Final Determination

    This Final Determination sets rates and terms for Section 112 and 
Section 114 royalties to be paid by PSS and SDARS for the compulsory 
ephemeral license and digital performance license, respectively. The 
Register of Copyrights may review the Judges' final determination for 
legal error in resolving a material issue of substantive copyright law. 
The Librarian shall cause the Judges' final determination for the two 
subject licenses for the period January 1, 2013, through December 31, 
2017, and any correction therefor by the Register, to be published in 
the Federal Register no later than the conclusion of the 60-day review 
period.

So ordered.

Suzanne M. Barnett,
Chief Copyright Royalty Judge.

Richard C. Strasser,
Copyright Royalty Judge.

Dated: February 14, 2013.

Dissenting Opinion of Copyright Royalty Judge Roberts

    Judge Roberts, concurring with respect to the terms of payment for 
the PSS and SDARS, and dissenting with respect to the analysis and 
determination of the royalty rates.

    I concur with the analysis and determination of the terms for 
making royalty payments under the statutory licenses at issue in 
this proceeding, but not the definition of Gross Revenues to be 
applied to SDARS in determining the royalty fee, which I do not 
consider to be a term of payment.\53\ I dissent, however, from the 
majority's evaluation and analysis of the evidence, and 
determination of rates for the PSS and SDARS. Rather than engage in 
a point-by-point discussion and disagreement with the majority's 
opinion, I set forth below--complete and original to me--what I 
believe is the proper analysis of the marketplace evidence submitted 
by the parties for the PSS and SDARS rates, the application of the 
Section 801(b) factors, and the determination of the rates, 
including the Gross Revenues definition for SDARS.
---------------------------------------------------------------------------

    \53\ I do concur with the decision to maintain the current 
definition of Gross Revenues for the PSS for the upcoming licensing 
term.
---------------------------------------------------------------------------

I. Introduction

A. Subject of the Proceeding

    This is a rate determination proceeding convened by the Copyright 
Royalty Judges under 17 U.S.C. 803(b) et seq., and 37 CFR part 351 et 
seq., to establish rates and terms for the digital performance of sound 
recordings by preexisting subscription services (``PSS'') and 
preexisting satellite digital audio radio services (``SDARS'') for the 
license period 2013 through 2017. The Digital Performance Right in 
Sound Recordings Act of 1995, as amended by the Digital Millennium 
Copyright Act of 1998, grants to sound recording copyright owners an 
exclusive right to publicly perform sound recordings by digital audio 
transmission, subject to the statutory licenses set forth in 17 U.S.C. 
112(e) and 114(f)(1) of the Copyright Act. The rates and terms set 
forth in this Determination are for these statutory licenses.

B. Parties to the Proceeding

    The parties to this proceeding are: (1) SoundExchange, Inc. 
(``SoundExchange''); (2) Music Choice, Inc. (``Music Choice''); and (3) 
Sirius XM, Inc. (``Sirius XM''). SoundExchange is a Section 501(c)(6) 
nonprofit

[[Page 23076]]

performance rights organization that collects and distributes royalties 
payable to performers and sound recording copyright owners for the use 
of sound recordings over satellite radio, the Internet, wireless 
networks, and cable and satellite television networks via digital audio 
transmissions. Bender WDT at 2, SX Trial Ex. 75. Music Choice (formerly 
Digital Cable Radio Associates) provides residential music service to 
subscribers of cable television. Del Beccaro Corrected WDT at 3, PSS 
Trial Ex. 1. Sirius XM provides satellite radio service broadcasts of 
music and non-music content on a subscription-fee basis throughout the 
continental United States. Meyer WDT at 4, SXM Dir. Trial Ex. 5.

C. Procedural History

    On January 5, 2011, the Copyright Royalty Judges issued a Notice 
announcing commencement of this proceeding and requesting the 
submission of Petitions to Participate. 75 FR 455. Petitions to 
Participate were received and accepted from the above-described 
parties. When the negotiation period provided by 17 U.S.C. 803(b)(3) 
failed to yield any agreements, the Judges called for the submission of 
written direct statements, which were received by the November 29, 2011 
deadline. Hearings on the written direct testimony were conducted from 
June 5, 2012 through June 18, 2012. Eight witnesses presented testimony 
on behalf of SoundExchange, three on behalf of Music Choice, and nine 
on behalf of Sirius XM.
    On July 2, 2012, the participants filed their written rebuttal 
statements. Witness testimony in the rebuttal phase began on August 13, 
2012, and concluded on August 23, 2012. Nine witnesses presented 
testimony on behalf of SoundExchange, two on behalf of Music Choice, 
and five on behalf of Sirius XM. After close of the rebuttal phase, the 
parties filed their proposed findings of fact and conclusions of law on 
September 26, 2012, and their reply findings and conclusions on October 
12, 2012.
    On October 16, 2012, the Judges heard closing arguments, wherein 
the record to this proceeding was closed. The record contains several 
thousands of pages of testimony, exhibits, pleadings, motions and 
orders.

II. The Standard for Determining Royalty Rates

    Section 801(b)(1) of the Copyright Act, 17 U.S.C., provides that 
the Copyright Royalty Judges shall ``make determinations and 
adjustments of reasonable terms and rates of royalty payments'' for the 
statutory licenses set forth in Sections 114(f)(1) and 112(e). The 
Section 114(f)(1) digital performance license for the PSS and SDARS, 
and the Section 112(e) ephemeral license, contain similarities and 
important differences in their standards for setting royalty rates. 
Both require the determination of reasonable rates and terms; however, 
the digital performance license, in Section 801(b)(1), requires that 
the rates (but not the terms) be calculated to achieve the following 
objectives:
     To maximize the availability of creative works to the 
public.
     To afford the copyright owner a fair return for his or her 
creative work and the copyright user a fair income under existing 
economic conditions.
     To reflect the relative roles of the copyright owner and 
the copyright user in the product made available to the public with 
respect to relative creative contribution, technological contribution, 
capital investment, cost, risk, and contribution to the opening of new 
markets for creative expression and media for their communication.
     To minimize any disruptive impact on the structure of the 
industries involved and on generally prevailing industry practices.

17 U.S.C. 801(b)(1). The Section 112(e) ephemeral license requires the 
Judges to ``establish rates that most clearly represent the fees that 
would have been negotiated between a willing buyer and a willing 
seller,'' and further directs that:
     [T]he Copyright Royalty Judges shall base their decision 
on economic, competitive, and programming information presented by the 
parties, including--
    [cir] whether use of the service may substitute for or may promote 
the sale of phonorecords or otherwise interferes with or enhances the 
copyright owner's traditional streams of revenue; and
    [cir] the relative roles of the copyright owner and the 
transmitting organization in the copyrighted work and the service made 
available to the public with respect to relative creative contribution, 
technological contribution, capital investment, cost, and risk.

17 U.S.C. 112(e)(4). The ephemeral license requires adoption of a 
minimum fee for each type of service offered by a transmitting 
organization, while the digital performance license does not. 17 U.S.C. 
112(e)(3). Both licenses provide that the Judges may consider the rates 
and terms of voluntary license agreements negotiated under the 
licenses. 17 U.S.C. 112(e)(4), 114(f)(1).
    It is evident from the presentations of the parties that it is the 
Section 114(f)(1) license that is of the greater value and concern to 
their interests, as it was when the Judges last considered the two 
licenses in 2007. In that Determination, the Judges set forth in great 
detail the historical treatment of these factors by the Copyright 
Royalty Tribunal and the Librarian of Congress in his administration of 
the Copyright Arbitration Royalty Panel system, and I will not repeat 
them here. See, SDARS-I, 73 FR 4080, 4082-84 (Jan. 24, 2008). 
Consideration of this history produced the following approach:

    [T]he path for the Copyright Royalty Judges is well laid out. We 
shall adopt reasonable royalty rates that satisfy all of the 
objectives set forth in Section 801(b)(1)(A)-(D). In doing so, we 
begin with a consideration and analysis of the benchmarks and 
testimony submitted by the parties, and then measure the rate or 
rates yielded by that process against the statutory objectives to 
reach our decision * * *.
    We reject the notion, however, that Section 801(b)(1) is a 
beauty pageant where each factor is a stage of competition to be 
evaluated individually to determine the stage winner and the results 
aggregated to determine an overall winner. Neither the Copyright 
Royalty Tribunal nor the Librarian of Congress adopted such an 
approach. Rather, the issue at hand is whether these policy 
objectives weigh in favor of divergence from the results indicated 
by the benchmark marketplace evidence.

Id. at 4084, 4094 (citations omitted). The same approach was used by 
the Judges in determining royalty rates for the Section 115 mechanical 
license, the only proceeding involving the Section 801(b)(1) factors 
decided since SDARS-I. See, Phonorecords I, 74 FR 4510 (Jan. 26, 2009). 
None of the parties in this proceeding contend that this approach is 
erroneous or must be abandoned.
    Music Choice, however, argues that there is an additional factor 
that must be considered by the Judges, applicable only to the PSS rate, 
that operates as a limitation on the Judges' consideration of the 
benchmark evidence. After a lengthy discussion of the Librarian of 
Congress's PSS-I determination, and citation to the 17 U.S.C. 803(a)(1) 
proscription that the Judges must act on the basis of prior 
determinations of the Librarian of Congress, Music Choice contends that 
the Librarian's use of the musical works benchmark (i.e., the royalty 
rates paid by Music Choice to the performing rights societies--ASCAP, 
BMI and SESAC) in 1998 operates as legal precedent in this proceeding 
and must ``be used in the absence of any better comparable benchmark.'' 
Music Choice PCL ] 53. Thus, under Music Choice's formulation, the 
Judges' benchmark analysis must begin with the current royalty fees 
paid by Music

[[Page 23077]]

Choice to the performing rights societies musical works and, in the 
absence of a superior benchmark, employ this benchmark for framing the 
applicable PSS royalty fee.
    I reject Music Choice's argument for several reasons. First, Music 
Choice does not, and cannot, point to a single statutory license rate 
proceeding where a court, the Librarian or the Copyright Royalty 
Tribunal has ruled that a set of factual marketplace observations used 
by the decisionmaker in formulating a royalty fee for a particular 
proceeding must be given a priori consideration in a future proceeding. 
Second, a plain reading of PSS-I makes it clear that the Librarian did 
not rely solely upon the musical works benchmark, but instead relied 
upon some unspecified combination of that benchmark and the performance 
royalty rate contained in a partnership agreement between Music Choice 
and certain cable television operators and record companies that 
created Music Choice. PSS-I, 63 FR at 25410. Even if I were inclined to 
accord some precedential value to the musical works benchmark in this 
proceeding--and I am not--I could not discern the degree to which that 
benchmark was influenced or altered by the Librarian's inclusion of the 
partnership license. Id. at 25404 (``The question, however, is whether 
this reference point [the musical works fees paid by Music Choice] is 
determinative of the marketplace value of the performance right in 
sound recordings; and, as the Panel determined, the answer is no.''). 
And, third, Music Choice's argument fails to place the PSS-I decision 
in its historical context. All that was available to the Librarian were 
the musical works fees paid to the performing rights societies and the 
partnership license agreement, an unsurprising circumstance given the 
newness of the statutory license, and the digital music marketplace in 
general. Concluding that selection of a factual market model from 1998 
somehow limits the decisionmakers' consideration of the evidence in 
2012 defies logic. I consider the musical works benchmark evidence 
offered by Music Choice in its normal course, discussed below, but it 
will not be given preference as a starting point, default position, or 
other limitation to my evaluation of the benchmark evidence.

III. Determination of the Royalty Rates

A. Application of Section 114 and Section 112

    Based upon the applicable law and relevant evidence received in 
this proceeding, the Copyright Royalty Judges must determine rates for 
the Section 114(f)(1) digital performance license for the only existing 
SDARS, Sirius XM, and the PSS.\54\ The Judges also must determine rates 
for the Section 112(e) ephemeral license for the PSS and SDARS.
---------------------------------------------------------------------------

    \54\ The PSS are Music Choice and Muzak. Muzak's PSS service is, 
apparently, only a small part of its business, and it did not 
participate in this proceeding. Digital Music Express, Inc., which 
was a PSS in PSS-I, ceased operation in 2000.
---------------------------------------------------------------------------

    With respect to the Section 112(e) license, the Judges received a 
joint stipulation from the parties. SoundExchange and Music Choice ask 
for continued application of the language of 37 CFR 382.2(c), which 
requires a minimum fee advance payment of $100,000 per year, payable no 
later than January 20 of each year, with royalties paid during the year 
recoupable against the advance. Joint Stipulation at 2 (May 25, 2012). 
SoundExchange and Sirius XM ask that the same minimum fee proposal 
apply to Sirius XM. Id. For the Section 112(e) license fee, all parties 
request that 5% of the total royalties paid by the PSS and Sirius XM be 
attributable to the license, consistent with the current regulations 
applicable to webcasters, broadcasters, SDARS and new subscription 
services. 37 CFR 380.3, 380.12, 380.22; 382.12; and 383.3.
    I accept the stipulations of the parties regarding the Section 
112(e) rates, but not for the reason set forth by the majority (i.e., 
nothing else in the record). The stipulations in this proceeding and, 
for that matter, in prior proceedings involving the Section 112(e) 
license, reflect the lack of marketplace evidence as to the value of 
the license in isolation from that of Section 114. This does not mean, 
however, that the Section 112(e) license is of no value because 
marketplace agreements package the rights conferred by the licenses 
together. The parties' stipulations represent a reasonable attempt to 
identify the value of the Section 112(e) license if it were marketed 
separately to copyright users, and for that reason I find the 
stipulations acceptable.
    I now turn to what I view should be the appropriate rate structures 
for the Section 114(f)(1) license for the PSS and SDARS.

B. The Rate Proposals of the Parties for the Section 114 License for 
the PSS

    Since 1998 when the decision in PSS-I established the initial 
royalty rates, Music Choice has paid a fee on a percentage basis of its 
Gross Revenues, as defined by regulation.\55\ Neither Music Choice nor 
SoundExchange propose altering this rate structure for the 2013-2017 
license period,\56\ nor do they propose changes to the revenue 
definition. SoundExchange requests the following percentage rates for 
the PSS: for 2013: 15%; for 2014: 20%; for 2015: 25%; for 2016: 35%; 
and for 2017: 45%. Second Revised Proposed Rates and Terms, at 6 (Sept. 
26, 2012). SoundExchange also requests an additional aspect to the 
percentage of revenue metric to address what it perceives as a 
deliberate reduction in revenues paid to Music Choice for its 
residential audio service by certain cable operators that are co-owners 
(partners) of Music Choice. For transmissions through such a partner, 
SoundExchange asks that the total royalty fee not be less than the 
product of multiplying such partner's total number of subscribers to 
Music Choice's programming by the average per-subscriber royalty 
payment that Music Choice makes for the top five highest-paying 
customers of Music Choice that are not its partners. Id. at 7.
---------------------------------------------------------------------------

    \55\ The current regulation defining Gross Revenues for PSS is 
set forth in 37 CFR 382.2(e).
    \56\ The Judges have stated a decided preference for per-
performance royalty rates for statutory licenses, rather than rates 
as a percentage of revenue, because that metric most unambiguously 
relates the fee to the value of the right licensed. 73 FR at 4087. 
We adopted percentage-of-revenue royalty rates in SDARS-I, however, 
because of intractable problems associated with measuring usage and 
listenership to performances of sound recordings. Id. at 4088. These 
problems continue to exist with respect to the PSS and SDARS, and 
the parties agree to a percentage-of-revenue royalty fee for both 
Section 114 licenses. Given their agreement, and lack of evidence as 
to an alternative, I adopt that metric.
---------------------------------------------------------------------------

    Music Choice requests a percentage of Gross Revenues of 2.6%, 
applicable to each of the years in the licensing period.\57\ Both 
SoundExchange and Music Choice ask that the definition of Gross 
Revenues, currently set forth in 37 CFR 382.2(e), apply to the new 
licensing period.
---------------------------------------------------------------------------

    \57\ I note that these percentage rates are quite similar to the 
maximum rates proposed by the services and record company copyright 
owners in PSS-I. See PSS-I, 63 FR 25394, 25395 (May 8, 1998)(2.0% by 
the services and 41.5% by the record companies).
---------------------------------------------------------------------------

C. The Rate Proposals of the Parties for the Section 114 License for 
SDARS

1. Proposed Rates and Structure
    While SoundExchange and Music Choice are content to operate mostly 
the same as in prior licensing periods (with the exception of royalty 
rates), there is not a similar level of harmony as to the specifics of 
the rate structure for SDARS. SoundExchange does recommend retention of 
the percentage

[[Page 23078]]

of revenue metric, but seeks expansion of the revenue base, and 
proposes a methodology for exclusion of the value of privately 
negotiated digital performance licenses from the total statutory 
royalty fee. Second Revised Proposed Rates and Terms at 3-5 (Sept. 26, 
2012). Sirius XM favors maintenance of the current revenue definition 
and payment scheme. Sirius XM PFF at 203-204.
    As with the PSS, SoundExchange argues for an accelerating royalty 
rate during the five-year license period as follows: for 2013: 12%; for 
2014: 14%; for 2015: 16%; for 2016: 18%; and for 2017: 20%. Second 
Revised Proposed Rates and Terms, at 2 (Sept. 26, 2012). Sirius XM 
counters with a royalty rate in the range of 5% to 7% of Sirius XM's 
monthly Gross Revenues, as currently defined in 37 CFR 382.11, 
applicable to each month of the upcoming licensing period.
2. Proposed Definition of Gross Revenues
    The revenue base against which the adopted royalty rates shall be 
applied is a matter of considerable disagreement between the parties. 
Sirius XM requests continuance of the current definition of Gross 
Revenues found in 37 CFR 382.11, while SoundExchange favors a 
considerable expansion of the revenue base. SoundExchange would like to 
see Gross Revenues redefined as follows:

    1. Gross Revenues shall mean revenues recognized by the Licensee 
in accordance with GAAP from the operation of an SDARS in the U.S., 
and shall be comprised of the following:
    i. All subscription, activation, subscription-related and other 
revenues recognized by Licensee from fees paid or payable by or for 
U.S. subscribers to Licensee's SDARS with respect to any and all 
services provided by the Licensee to such subscribers, unless 
excluded by paragraph 3 below;
    ii. Licensee's advertising revenues, or other revenues from 
sponsors, if any, attributable to advertising on channels of 
Licensee's SDARS in the U.S. other than those that use only 
incidental performances of sound recordings, less advertising agency 
and sales commissions attributable to advertising revenues included 
in Gross Revenues; and
    iii. Revenues attributable to the sale, lease or other 
distribution of equipment and/or other technology for use by U.S. 
subscribers to receive or play the SDARS service, including any 
shipping and handling fees therefor.
    2. Gross revenues shall include such payments as set forth in 
paragraphs 1.i through iii of the definition of ``Gross Revenues'' 
to which Licensee is entitled but which are paid to a parent, 
subsidiary or division of Licensee.
    3. To the extent otherwise included by paragraph 1, Gross 
Revenues shall exclude:
    i. Royalties paid to Licensee by persons other than subscribers, 
advertisers and sponsors for intellectual property rights;
    ii. Revenues from the sale of phonorecords and digital 
phonorecord deliveries sold by Licensee (but not any affiliate fees 
or other payments by a third party for advertising of downloads sold 
by a third party);
    iii. Sales and use taxes;
    iv. Revenues recognized by Licensee for the provision of--
    A. Data services (e.g. weather, traffic, destination 
information, messaging, sports scores, stock ticker information, 
extended program associated data, video and photographic images, and 
such other telematics and/or data services as may exist from time to 
time, but not transmission of sound recording data), when such 
services are provided on a standalone basis (i.e. priced separately 
from Licensee's SDARS, and offered at the same price both to 
subscribers to Licensee's SDARS and persons who are not subscribers 
to Licensee's SDARS);
    B. Channels, programming, products and/or other services 
provided outside of the United States; and
    C. Separately licensed services, including webcasting, 
interactive services, transmissions to business establishments, and 
audio services bundled with television programming and subject to 
the rates provided in part 383, when such services are provided on a 
standalone basis (i.e. priced separately from Licensee's SDARS, and 
offered at the same price both to subscribers to Licensee's SDARS 
and persons who are not subscribers to Licensee's SDARS).

Id. at 2-3.
    Jonathan Bender, CEO of SoundExchange, testified that the proposed 
definition will correct the inequities of the current definition and, 
at the same time, allow for greater ease of administration. His premise 
is based upon an interpretation of the Judges' use in SDARS-I of Dr. 
Ordover's adjusted interactive subscription service benchmark to 
establish the upper boundary of reasonable royalty rates for an SDARS 
service. SDARS-I, 73 FR at 4093. The use of that benchmark, in Mr. 
Bender's view, demonstrates an intention of the Judges to use total 
subscription revenue as the base against which the royalty rates should 
apply. Bender WDT at 6, SX Trial Ex. 75. Applying this assumption to 
the revenues reported by Sirius XM from 2007 through the third quarter 
of -2011, Mr. Bender concludes that Sirius XM has paid roughly 16%-23% 
less in total royalty fees than intended. Bender WDT at 6-7, SX Trial 
Ex. 75.
    SoundExchange targets for elimination several exclusions from Gross 
Revenues permitted under the current regulations. The first is 
paragraph (3)(vi)(B) of the current definition, which allows Sirius XM 
to deduct revenues received for ``channels, programming products and/or 
services offered for a separate charge where such channels use only 
incidental performances of sound recordings.'' 37 CFR 382.11. This 
exclusion does not make sense for the new licensing period, according 
to SoundExchange, because the rates proposed by Dr. Ordover on behalf 
of SoundExchange and Dr. Noll on behalf of Sirius XM reflect that 
roughly half of the value of SiriusXM's SDARS service is derived from 
its music programming and roughly half from its non-music programming. 
The exclusion for non-music programming is, therefore, built into the 
rates and should not be double counted in revenue. SX PFF at 383 (] 
838). Further, SoundExchange charges that exclusion from revenue of 
non-music channels encourages manipulation to reduce the royalty base 
in unprincipled ways. For example, Sirius XM could disaggregate its 
bundled subscription price of $14.49 per month into a music package 
valued at $3.00 and a non-music package valued at $11.49. Sirius XM 
would not recognize any additional revenues from the separate packages, 
but could realize substantial reductions in royalty obligation. SX PFF 
at 387 (] 854). SoundExchange urges the Judges to prevent such 
arbitrary actions from occurring.
    SoundExchange also submits that paragraph (3)(vi)(D) of the current 
definition should be eliminated. That paragraph allows for deduction of 
revenues received from channels and programming that are licensed 
outside the Sections 112 and 114 licenses. 37 CFR 382.11. Dr. Lys 
testified that Sirius XM excludes roughly between 10% and 15% of its 
subscription revenue from the royalty base for performances of pre-1972 
recordings to its subscribers, thereby reducing its royalty obligation. 
Lys WRT at 54 (] 119), SX Trial Ex. 240. Yet, Sirius XM has not 
disclosed the process it uses to identify pre-1972 recordings, or how 
it calculates the deduction it takes.
    SoundExchange's proposed Gross Revenues definition also eliminates 
five other exclusions permissible under the current regulations. First, 
under its proposed definition, revenues received from Sirius XM's 
webcasting service, which are currently linked to the SDARS satellite 
radio subscription, would come into the SDARS revenue base. Second, 
data services, such as Sirius XM's weather and traffic services which 
can be purchased on a stand-alone basis but are more commonly offered 
to SDARS subscribers at a discount, would be included in the revenue 
base. Third, revenue

[[Page 23079]]

attributable to equipment sales or leases used to receive or play the 
SDARS service, would be included. Fourth, the current exclusions for 
credit card fees and bad debt expense would be eliminated. And, fifth, 
fees collected by Sirius XM for various activities related to customer 
account administration, such as activation fees, invoice fees, swap 
fees, and in certain cases early termination fees, would be included in 
the revenue base. According to Sirius XM, the elimination of these 
deductions would, in total and based upon 2012 estimates, expand its 
annual revenue base, against which royalties are calculated, by over 
$300 million. Frear Revised WRT at ] 16, SX Reb. Trial Ex. 1.
3. Analysis and Conclusions
    In SDARS-I, the parties were at loggerheads over the definition of 
revenue, with SoundExchange favoring an expansive reading to include 
``all revenue paid or payable to an SDARS service that arise from the 
operation of an SDARS service,'' SoundExchange Third Amended Rate 
Proposal (Aug. 6, 2007) at section 38--.2(g), and the SDARS arguing for 
adoption of the existing Gross Revenues definition for PSS. XM Rate 
Proposal (Jan. 17, 2007) at section 26--.2(d); Sirius Rate Proposal 
(Jan. 17, 2007) at section 26--.2(d). With one exception, the Judges 
adopted the SDARS proposal. See SDARS-I, 73 FR 4080, 4087 (Jan. 24, 
2008). SoundExchange's new proposal is again a request for an expansive 
reading of revenue. Its effort to respond to the Judges' criticism of 
its SDARS-I proposal as possessing ``scant evidentiary support,'' is an 
attempt to demonstrate how Sirius XM has under-reported revenue in the 
current licensing period by applying a slanted interpretation of the 
SDARS-I decision. Alternatively, it is an attempt to demonstrate how 
Sirius XM might manipulate its revenue base to lower its royalty 
obligation. With the exception of revenue exclusions for privately 
licensed and pre-1972 sound recordings discussed, infra, both of 
SoundExchange's arguments lack merit.\58\
---------------------------------------------------------------------------

    \58\ Curiously, SoundExchange does not argue for expansion of 
the Gross Revenues definition for PSS, a definition which has 
existed since the first royalty term for the PSS digital performance 
license. If SoundExchange's broadened revenue definition for SDARS 
were acceptable, it would result in the two types of services 
licensed under Section 114(f)(1) calculating their royalties against 
radically different revenue bases.
---------------------------------------------------------------------------

    Mr. Bender's argument that Sirius XM has paid roughly 16%-23% less 
in royalties in the current license period than was intended by the 
Judges in SDARS-I is dependent upon the assumption that there is a 
direct link between the revenue definition and the adjusted interactive 
subscription service benchmark presented by SoundExchange's expert 
economist, Dr. Janusz Ordover. His reasoning is that because the 
Ordover benchmark was fashioned from interactive service license 
agreements that generally provided for inclusion of mostly all of 
subscriber revenue, it must be the case that the Judges intended the 
SDARS-I rates to apply to total subscription revenues. Bender WDT at 6-
7, SX Trial Ex. 75. This presumed linkage between the benchmark and the 
revenue definition is not supported by the SDARS-I decision. The Judges 
never expressed an intention to adopt the revenue definitions contained 
in the subscription service license agreements used by Dr. Ordover; to 
the contrary, the Gross Revenues definition adopted in SDARS-I was 
quite different from those contained in the license agreements on the 
whole. Rather, in defining revenue, the Judges plainly stated that it 
was their intention to unambiguously relate the fee charged for a 
service provided by an SDARS to the value of the sound recording 
performance rights covered by the statutory licenses. SDARS-I, 73 FR at 
4087. This is especially important where, as here, a proxy for use of 
sound recordings must be adopted because technological impediments do 
not permit implementation of a per-performance fee. The license 
agreements used in the Ordover benchmark do not provide for this 
connection between revenue and value under the statutory licenses, 
which is not surprising given that the interactive service license 
agreements conveyed rights beyond those granted by the Section 114 
license. In sum, Mr. Bender's perceived linkage between the revenue 
definition and the Ordover benchmark favoring inclusion of total 
subscriber revenues is simply not there.
    In the alternative, SoundExchange argues that an expansive revenue 
base is easier to administer and reduces the chances for manipulation. 
Dr. Lys testified that, from an accounting perspective, it is 
preferable to base contracts on a financial definition that is clear-
cut to administer and easy to audit, and that a revenue definition that 
is all-inclusive satisfies this preference. Lys WRT at 54 (] 117), SX 
Trial Ex. 240. While this may be true, SDARS-I included only those 
revenues related to the value of the sound recording performance rights 
at issue in the proceeding. SDARS-I, 73 FR at 4087. I am satisfied that 
the exclusions permitted in the current definition of Gross Revenues 
remain proper. However, if evidence were presented to conclusively 
demonstrate that one or more of the exclusions produces or results in a 
manipulation of fees for the sole purpose of reducing or avoiding 
Sirius XM's statutory royalty obligation, then an amendment or 
elimination of the exclusion might be appropriate. SoundExchange has 
failed to meet this burden and has only offered speculation as to how 
Sirius XM might engage in revenue allocation to reduce its royalty 
obligation. With the exception of the exclusions for directly licensed 
and noncompensable sound recordings discussed infra, SoundExchange has 
failed to present persuasive evidence that any of the remaining 
exclusions it has targeted for elimination (fees received for non-music 
services,\59\ webcasting, data services, equipment sales, credit card 
fees and bad debt expenses, and customer account fees) have, in fact, 
been abused or otherwise manipulated for the sole purpose of improperly 
reducing Sirius XM's statutory royalty obligations.
---------------------------------------------------------------------------

    \59\ In SDARS-I, the Judges expressly recognized an exclusion 
from Gross Revenues for so-called non-music services, characterized 
as ``channels, programming, products and/or other services offered 
for a separate charge where such channels use only incidental 
performances of sound recordings.'' SDARS-I, 73 FR 4102 (citing 37 
CFR 382.11, definition of Gross Revenues). The Judges did this 
because the exclusion ``unambiguously relat[ed] the fee to the value 
of the sound recording performance rights at issue * * *.'' Id. at 
4088. SoundExchange argues that if the exclusion is allowed to 
continue, it will amount to a double deduction from Sirius XM's 
royalty obligation because Dr. Ordover's marketplace benchmarks 
exclude the value of non-music services, and Dr. Noll adjusted his 
proferred benchmarks to account for the fact that roughly half of 
Sirius XM's service is non-music. SX PFF ]] 842-846. I agree with 
Sirius XM's counter argument that Dr. Ordover's modeling allocated 
revenues for both the music and non-music programming for Sirius 
XM's standard ``Select'' package, ``but that allocation in no way 
relates to the separately priced non-music packages offered by 
Sirius XM that are the subject of the exemption.'' Sirius XM RFF ] 
167. The exemption, however, should be available only to the extent 
that the channels, programming, products and/or other services are 
offered for a separate charge.
---------------------------------------------------------------------------

4. Deductions for Directly Licensed and Pre-1972 Recordings
    Separate from the issue of exclusions from the Gross Revenues 
definition addressed above, I consider the impact to the royalty 
calculus of the performance by Sirius XM of sound recordings that it 
has directly licensed from record labels (and, therefore, does not rely 
upon the licenses offered by Sections 112 and 114), and the performance 
of sound recordings not compensable under the Copyright Act (i.e. pre-
1972 recordings).

[[Page 23080]]

a. Directly Licensed Recordings
    Both the Section 112 and Section 114 licenses recognize and permit 
the licensing of sound recordings through private negotiation. 17 
U.S.C. 112(e)(5), 114(f)(3). The parties concede, as they must, that 
directly licensed recordings are separate from those covered by the 
statutory licenses. At the outset, the parties did not address the 
treatment of such recordings in the context of this proceeding, 
presumably because they comprised only a small percentage of the total 
recordings performed by Sirius XM in a given period. However, due to 
the increasing instances of directly licensed recordings as a result of 
Sirius XM's Direct Licensing Initiative, discussed infra, proposals 
were submitted and amended up until the closing of the record. Sirius 
XM contends that a deduction from Gross Revenues is necessary for 
directly licensed recordings; otherwise, a double payment would occur 
for performances of these works. Sirius XM PFF ] 425; Proposed Rates 
and Terms of Sirius XM Radio, Inc. at 3 (Sept. 26, 2012). SoundExchange 
acknowledges that directly licensed recordings must be accounted for, 
but resists a deduction from Gross Revenues. Instead, it proposes that 
the payable statutory royalty amount be determined by reducing the 
product of the royalty rate times Gross Revenues by a percentage 
approximating the value of the directly licensed usage. Second Revised 
Proposed Rates and Terms, at 4 (Sept. 26, 2012). To determine the share 
of performances attributable to direct licenses, SoundExchange 
recommends using data from Sirius XM's Internet webcasting service for 
music. The following calculation would then be made:

     For each month, identify the Internet webcast channels 
offered by the Licensee that directly correspond to music channels 
offered on its SDARS that are capable of being received on all 
models of Sirius radio, all models of XM radio, or both (the 
``Reference Channels'').\60\
---------------------------------------------------------------------------

    \60\ SoundExchange conditions the availability of its approach 
on the presumption that the music channels on the Internet service 
remain representative of the music channels offered on the SDARS 
service.
---------------------------------------------------------------------------

     For each month, divide the Internet performances of 
directly licensed recordings on the Reference Channels by the total 
number of Internet performances of all recordings on the Reference 
Channels to determine the Direct Licensing Share.

Id. at 4-5. SoundExchange requests that, if its approach is adopted, 
Sirius XM be required to notify SoundExchange monthly of each copyright 
owner from which Sirius XM claims to have a direct license and each 
sound recording Sirius XM claims to be excludable. SoundExchange would 
then be permitted to disclose this information to confirm whether the 
direct license exists and the claimed sound recordings are properly 
excludable.
    Directly licensed recordings should not be a part of the calculus 
in determining the monthly statutory royalty obligation. To do 
otherwise would effectively result in a double payment for the directly 
licensed recordings and would discourage, if not altogether eliminate, 
the incentive to enter into such private licenses, contrary to Section 
114 which recognizes, if not encourages, private licenses. 17 U.S.C. 
114(f)(1)(B). I am not persuaded, however, by Sirius XM's position that 
the exclusion of directly licensed recordings should be from Gross 
Revenues, as opposed to a deduction from the total royalty obligation. 
As Mr. Bender correctly points out, there is no revenue recognition 
associated with directly licensed recordings; it is a cost to Sirius 
XM. Bender WRT at 3, SX Trial Ex. 239. Sirius XM has not presented a 
revenue allocation between directly licensed and statutory licensed 
recordings that it performs on its SDARS service; it has presented a 
usage deduction that it seeks to apply to its revenue base. Excluding 
usage of sound recordings from Gross Revenues would not comport with 
the Judges' approach in SDARS-I of unambiguously relating fees received 
by Sirius XM to the value of the sound recording performance rights at 
issue in this proceeding.
    I am persuaded that the proposed methodology of SoundExchange to 
calculate the royalty deduction for directly licensed recordings (i.e., 
the ``Direct License Share'') is the superior approach to allowing 
Sirius XM to determine the percentage reduction based upon the number 
of plays of directly licensed recordings to total plays. Despite my 
request, Sirius XM and its contractor, Music Reports, Inc., were 
incapable of providing accurate data as to the identity and volume of 
directly licensed recordings on the SDARS service. See, SX PFF at 399-
400. Reasonable accuracy and transparency are required for calculation 
of the Direct License Share, and SoundExchange has demonstrated that 
its proposed use of the Sirius XM webcasting service better satisfies 
these requirements. Use of the webcasting service also better ties the 
value of the sound recordings used, by measuring the listenership for 
each performance, than Sirius XM's proposal for measuring only 
individual plays.
b. Pre-1972 Recordings
    The performance right granted by the copyright laws for sound 
recordings applies only to those recordings created on or after 
February 15, 1972. Sound Recording Amendment, Public Law 92-140, 85 
Stat. 391 (1971). Sirius XM makes performances of pre-1972 recordings 
on its SDARS service and, in the present license period, excludes a 
percentage of revenues from its Gross Revenues calculation for such 
use. The current Gross Revenues definition does not expressly recognize 
such an exclusion, which is not surprising given that there is no 
revenue recognition for the performance of pre-1972 works. In taking 
the exclusion, Sirius XM apparently relies upon paragraph (3)(vi)(D) of 
the Gross Revenues definition which permits exclusion of revenue for 
programming exempt from any license requirement. Dr. Lys testified that 
the deduction is between 10% and 15% of subscription revenue, a figure 
that was not disputed by Sirius XM. Lys WRT at 54, SX Trial Ex. 240. 
Sirius XM requests that the Judges amend paragraph (3)(vi)(D) to 
provide that its ``monthly royalty fee shall be calculated by reducing 
the payment otherwise due by the percentage of Licensee's total 
transmission of sound recordings during the month that are exempt from 
any license requirement or separately licensed.'' Proposed Rates and 
Terms of Sirius XM Radio Inc. at 3 (Sept. 26, 2012).\61\
---------------------------------------------------------------------------

    \61\ This is the same language that Sirius XM proposes also be 
applicable to directly licensed sound recordings.
---------------------------------------------------------------------------

    As with directly licensed works, pre-1972 recordings are not 
licensed under the statutory royalty regime and should not factor into 
determining the statutory royalty obligation. But, for the same reasons 
described above, revenue exclusion is not the proper means for 
addressing pre-1972 recordings. Rather, the proper approach is 
deduction from the total royalty obligation to account for performances 
of pre-1972 recordings. The question then remains as to how the correct 
deduction should be calculated. Sirius XM did not offer any testimony 
as to how it calculated its current deduction, or how it identified 
what recordings performed were pre-1972, other than the obtuse 
assertion of Mr. Frear that the lawyers talked to the finance team to 
assure a proper deduction. 8/13/12 Tr. 3125:3-3126:3 (Frear). To be 
allowable, a deduction for pre-1972 recordings must be relatively 
precise and the methodology transparent. The same methodology applied 
to determining the Direct License Share--utilizing the Sirius XM

[[Page 23081]]

webcasting--is appropriate to identify pre-1972 recordings.

D. The Section 114 Royalty Rates for PSS

    Chapter 8 and Section 114(f)(1) of the Copyright Act require the 
Judges to determine reasonable rates and terms of royalty payments for 
the digital performance of sound recordings. The rates the Judges 
establish under Section 114(f)(1) must be calculated to achieve the 
objectives set forth in Section 801(b)(1)(A) through (D) of the Act. 
Moreover, in establishing rates and terms the Judges may consider 
voluntary license agreements described in Section 114(f)(1)(B).
    As the Judges have done in prior rate proceedings where the 
determination standard is reasonable rates calculated to achieve the 
Section 801(b)(1) factors, consideration of marketplace benchmarks is a 
useful starting point. SDARS-I, 73 FR 4080, 4088 (Jan. 24, 2008); 
Phonorecords I, 74 FR 4510, 4517 (Jan. 26, 2009). As discussed below, 
the parties disagree about what constitutes the most appropriate 
benchmark to guide the Judges in determining a reasonable rate. 
Unfortunately, there are no voluntary license agreements negotiated 
under Section 114(f)(1)(B) for the Judges to consider, which is not 
surprising considering that Music Choice is the primary PSS service 
that continues to operate under the statutory license. Moreover, the 
benchmarks offered by the parties are not for similar products drawn 
from a marketplace in which buyers and sellers are similarly situated. 
I describe and discuss them below.
1. PSS Proposed Benchmarks
a. Proposed Musical Works Benchmark
    As previously discussed, Music Choice argues that the annual 
royalties it pays to the three performing rights societies (ASCAP, BMI, 
and SESAC) for the right to perform musical works to subscribers of its 
residential audio service is, by virtue of the Librarian's 
determination in PSS-I, a precedential benchmark that establishes the 
upper boundary of reasonable rates in this proceeding. Although this 
contention has been rejected, supra, Music Choice offers the testimony 
of Mr. Del Beccaro and Dr. Crawford as corroborative of its position 
that the market for licensing the performance right in musical works is 
the most appropriate benchmark for establishing rates in this 
proceeding.
    Music Choice pays 2.5% of revenue each to ASCAP and BMI and pays an 
annual flat fee to SESAC that amounts to approximately [REDACTED] of 
net revenue. Del Beccaro Corrected WDT at 21-22, MC 17, MC 18 and MC 
19, PSS Trial Ex. 1. The sum of those licenses amounts to [REDACTED], 
which Music Choice submits should represent the upper bound of a 
reasonable royalty rate. Two pieces of evidence, in Music Choice's 
view, corroborate the use of musical works licensing as a benchmark. 
First, Music Choice observes an equivalence between the fees for the 
performance of sound recordings and musical works in Canada and Europe. 
Music Choice cites four decisions of the Canadian Copyright Board, 
involving licensing fees for commercial radio, cable television, 
satellite music services and radio services of the Canadian 
Broadcasting Corporation, wherein the Board found that royalty rates 
for sound recordings and musical compositions have equivalent value. 
Del Beccaro Corrected WDT at MC 6 at 30-33 (commercial radio), MC 7 at 
14 (cable television), MC 8 at 50, 58 (satellite music services), MC 9 
at 4, 6, 15, 17, 30 (CBC radio services), PSS Trial Ex. 1. 
SoundExchange's expert economist, Dr. George Ford, who recently 
submitted testimony before the Canadian Copyright Board, acknowledges 
that in Canada the musical composition and sound recording performance 
royalties are equal. 8/21/12 Tr. 4304:5-22 (Ford). In the United 
Kingdom, the sound recording performance royalty rates for commercial 
broadcasting services are less than those for the musical composition 
performance rights. Del Beccaro Corrected WDT at MC 11, PSS Trial Ex. 
1. If Music Choice's service were transmitted through cable in the 
U.K., Music Choice would pay 5.25% of 85% of gross revenues for the 
musical works performance right, but would pay only 5% of 85% of gross 
revenues for the sound recording performance right. Id.
    The second piece of evidence to corroborate use of the musical 
works rate as a benchmark is an economic model called the Asymmetric 
Nash Bargaining Framework (referred to as the ``Nash Framework'') 
offered by Dr. Crawford. Acknowledging that a perfect benchmark does 
not exist to determine the PSS sound recording performance rate, Dr. 
Crawford uses the Nash Framework to fashion solutions to bargaining 
problems between bilateral monopolists, in this case record labels on 
the one hand and PSS providers on the other. Crawford Corrected WDT at 
12, PSS Trial Ex. 4. As a non-cooperative bargaining model, the Nash 
Framework is designed to yield predictions about how outcomes are 
determined when firms negotiate; that is, how two firms would split the 
surplus of their interaction (i.e., revenues over costs) in a 
hypothetical negotiation. Id. at 16. Three factors (the Nash factors) 
are analyzed to determine the split: (1) the combined agreement 
surplus; (2) each firm's threat point; and (3) each firm's bargaining 
power. Id. According to Dr. Crawford, the Nash factors determine sound 
recording performance royalties in the following way: ``The royalty 
received by each firm in a bargain equals its threat point plus its 
bargaining power times the incremental surplus.'' Id. at 17. In other 
words, the combined agreement surplus and threat points determine the 
``size of the pie,'' while the bargaining power determines the ``split 
of the pie.''
    Dr. Crawford's stated goal in applying the Nash Framework is to 
first establish the Nash factors for the hypothetical market (the sale 
of rights between one record company and one PSS provider) and compare 
them to the Nash factors in the actual musical works market (the sale 
of rights between the three performing rights societies and one PSS 
provider). Id. at 18. In the hypothetical market, Dr. Crawford 
determined that the threat point for the PSS provider is zero because 
in the absence of an agreement, it cannot offer music and therefore 
cannot earn a surplus. Id. at 19. He determines, however, that the 
threat point for a record company is negative because the failure to 
reach an agreement has additional implications for the record company 
in other, non-PSS markets. Specifically, the failure to reach an 
agreement with the PSS provider would have substantial adverse impacts 
on the record company, such as on sales of compact disks, because there 
is a significant promotional benefit to the record company from the PSS 
provider. Id. To support this contention, Music Choice offers the 
testimony of Damon Williams, who testified that record company 
executives consider Music Choice promotional and provide artists with 
greater exposure. Williams WDT at 4-11, MC 28, 29, 32, PSS Trial Ex. 3. 
Mr. Williams offers examples of how Music Choice conducts custom 
promotions for artists, id. at 13-20, and points to a 2005 Arbitron 
survey in particular that he argues confirms that Music Choice's 
residential audio service sells records. Id. at 13.\62\ And Mr. 
Williams argues that Music Choice has become more promotional since the 
PSS-I proceeding by virtue of the fact

[[Page 23082]]

that it currently reaches more customers with more channels. Id. at 24.
---------------------------------------------------------------------------

    \62\ He also cites a 2008 survey by OTX, a 2012 survey by 
Experian Simmons, a 2004 Arbitron survey, a 2011 Ipsos OTX MediaCT 
survey, and a 2006 Sony BMG MusicLab survey.
---------------------------------------------------------------------------

    With respect to the last Nash factor, bargaining power, Dr. 
Crawford assumes it to be neutral, based upon Music Choice's existing 
technology platform and contract, which cannot be easily replaced or 
replicated, and his observations of Music Choice's bargaining efforts 
for sound recording performance rights with respect to music videos. 
Crawford Corrected WDT at 15-16, PSS Trial Ex. 4.
    Applying the Nash factors to the existing market for the PSS 
musical works performance right, Dr. Crawford determines that the 
threat point for a PSS provider is again zero, and is again negative 
for the performing rights society (ASCAP, BMI or SESAC) because the 
loss of promotional value from the PSS provider produces loss of 
profits from other markets. Id. at 28. Dr. Crawford again assumes equal 
bargaining power between the PSS provider and the performing rights 
society, based largely upon his observations that the two possess equal 
patience in their negotiations. Id. at 29. This results in a 50/50 
split of the surplus, the same conclusion he reached with respect to 
the hypothetical market. Because of the similarities between the Nash 
factors in the hypothetical market and the market for musical works, 
Dr. Crawford concludes that the musical works market makes for a good 
benchmark for the hypothetical sound recording performance right market 
at issue in this proceeding. Id. at 30.\63\
---------------------------------------------------------------------------

    \63\ Dr. Crawford also concludes that the marketplace for 
musical works royalties might be greater than the sound recording 
marketplace because the performing rights society loses less than a 
record company in the absence of an agreement. Crawford Corrected 
WDT at 18, 29, PSS Trial Ex. 4.
---------------------------------------------------------------------------

b. Proposed Alternative Surplus Splitting Analysis
    As an alternative, Dr. Crawford provided a surplus splitting 
analysis to corroborate the reasonableness of Music Choice's rate 
proposal by using financial results to construct an estimate of the 
profits that would be shared in a royalty payment. Crawford Corrected 
WDT at 43, PSS Trial Ex. 4. Dr. Crawford adjusted Music Choice's 2006-
2010 operating profit to remove the actual royalty paid by Music Choice 
for sound recording performance rights, and then applied a capital 
asset pricing model \64\ to derive an expected rate of return on assets 
of 8.33%. Crawford Corrected WDT at Appendix B.4, PSS Trial Ex. 4. He 
then multiplied the 8.33% rate by Music Choice's average operating 
assets to determine cost of capital, and then subtracted cost of 
capital from the royalty-adjusted operating profits to derive the 
residual profits for each year. Id. at 47. This showed that Music 
Choice's cumulative returns in excess of its cost of capital, but 
before payment of sound recording royalties, amounts to 3.05% of Music 
Choice's 2006-2010 royalties. Id. A 50/50 split of this surplus results 
in a royalty payment of 1.52% of residential audio revenues. Id. at 48. 
He then applied a range of 20% to 80% of the expected surplus to 
determine a range of reasonable royalties from 0.61% to 2.43%, not to 
exceed the 3.05% expected surplus. Id.
---------------------------------------------------------------------------

    \64\ Under this model, a firm's cost of capital is based on the 
expected return to induce investment. Crawford Corrected WDT at ] 
167, PSS Trial Ex. 4.
---------------------------------------------------------------------------

2. SoundExchange Proposed Benchmarks
    SoundExchange does not offer a single market benchmark to set the 
royalty rates to be paid by Music Choice for the sound recording 
performance right, and instead offers rates from over 2,000 marketplace 
agreements, representing a variety of rights licensed, in an effort to 
frame a zone of reasonable rates. Dr. Ford observes that PSS like Music 
Choice have certain distinctive features that make it difficult to 
identify a suitable benchmark market. Ford Second Corrected WDT at 12, 
SX Trial Ex. 79. First, Music Choice does not sell its service directly 
to subscribers, but rather to cable television operators who then 
bundle the Music Choice programming with a package of video programming 
for ultimate sale to subscribers. Music Choice is, therefore, an 
intermediary between cable operators and their subscribers, unlike any 
of the digital music services the Judges have previously dealt with. 
Ford Second Corrected WDT at 12, SX Trial Ex. 79; 6/18/12 Tr. 2810:20-
2811:3 (Ford). Second, Music Choice's service is almost always bundled 
with a hundred or more channels of video and is almost never sold on a 
stand-alone basis. Ford Second Corrected WDT at 13, SX Trial Ex. 79. 
This makes it difficult to determine the specific consumer value for 
Music Choice's programming alone. Id.
    Given these difficulties, Dr. Ford uses an all-inclusive approach 
of examining royalty rates for different digital music markets: 
portable and non-portable interactive subscription webcasting, cellular 
ringtones/ringbacks, and digital downloads. Id. at 15-16, Table 1. Most 
of the over 2,000 licensing agreements he examined across these markets 
calculate royalties based on a ``greater of'' methodology that includes 
a per-play royalty fee, a per-subscriber fee, and a revenue-based fee. 
For convenience, Dr. Ford analyzed only the revenue-based fees, judging 
his results to be conservative because the other two payment metrics 
might produce a larger total royalty fee than the revenue-based 
calculation. 6/18/12 Tr. 2861:3-13 (Ford). His results reveal a 
percentage of revenue rate of 70% for digital downloads, 43% to 50% for 
ringtones/ringbacks, and 50% to 60% for portable and non-portable 
interactive subscription webcasting, respectively. Ford Second 
Corrected WDT at 15-16, Table 1, SX Trial Ex. 79. According to Dr. 
Ford, the rate proposal of SoundExchange for PSS comports well with the 
range established by these agreements, in that it rises above the 
lowest average rate (43%) only in the last year of the licensing term, 
and therefore can ``be presumed to be a reasonable proxy for a market 
outcome.'' Ford Second Corrected WDT at 16, SX Trial Ex. 79; 6/18/12 
Tr. 2831:8-15 (Ford).
3. Analysis and Conclusions Regarding the Proposed Benchmarks
    Based upon the evidence put forward in this proceeding, none of the 
proposed benchmarks provide a satisfactory means for determining the 
sound recording performance royalty to be paid by Music Choice.
    Turning first to Music Choice's arguments in favor of the musical 
works benchmark, I find them severely wanting. The fees paid to the 
three performing rights societies for the performance right to musical 
works have been offered in several other proceedings before the Judges 
and have been rejected consistently. Webcasting II, 72 FR 24084 (May 1, 
2007); SDARS-I, 73 FR 4080 (Jan. 24, 2008); see, also Webcasting I, 67 
FR 45240 (July 8, 2002)(Librarian of Congress's determination). The 
primary reason for the benchmark's rejection is the lack of 
comparability to the target market for sound recording performance 
rights. Dr. Crawford, who advocates the appropriateness of the musical 
works market, acknowledges that a benchmark market should involve the 
same buyers and sellers for the same rights. Crawford Corrected WDT at 
24, PSS Trial Ex. 4. However, the musical works market involves 
different sellers (performing rights societies versus record companies) 
selling different rights. See SDARS-I, 73 FR at 4089. The fact that a 
PSS needs performance rights to musical works and sound recordings to 
operate its service does not make the rights equivalent, nor does it 
say anything about their values individually. Further, as in previous 
proceedings, the evidence establishes

[[Page 23083]]

that the market commands higher royalty fees for the licensing of sound 
recordings than musical works. Aaron Harrison presented a chart 
demonstrating the different average royalty fees that Universal Music 
Group, one of the major record labels, receives for digital downloads, 
ringtones, on-demand music videos and portable subscription services, 
all of which are considerably higher than the fees received by the 
performing rights societies.\65\ Harrison Corrected WRT at 13-14, PSS 
Trial Ex. 32. Dr. Ford made similar observations. Ford Amended/
Corrected WRT at 7, SX Trial Ex. 244. I am once again led to the 
conclusion that use of the musical works market as a benchmark is 
fraught with flaws and only indicates that a reasonable rate for sound 
recordings cannot be as low as the musical works rate. See, SDARS-I, 73 
FR at 4090.
---------------------------------------------------------------------------

    \65\ Music Choice's criticisms of the Harrison chart--that it 
omits synchronization and master use licenses, encompasses wholesale 
payments rather than specific rates, and involves some agreements 
that convey additional rights--do not detract from the conclusion 
that overall the royalty fees paid for sound recordings are 
typically significantly higher than those paid for musical works.
---------------------------------------------------------------------------

    Music Choice's efforts to corroborate the sufficiency of the 
musical works benchmark with a comparison to foreign rates also are 
unavailing. The Judges have considered before the significance of 
foreign countries' treatment of the licensing of exclusive rights 
granted by copyright. In the proceeding to set rates and terms for the 
reproduction of musical compositions under the Section 115 license of 
the Copyright Act, certain licensees offered evidence of license rates 
in the U.K., Canada and Japan. See Phonorecords I, 74 FR 4510, 4521 
(Jan. 26, 2009). In rejecting the foreign rate benchmarks, the Judges 
stated that attempts at comparison of U.S. rights with foreign rights 
``underline the greater concern that comparability is a much more 
complex undertaking in an international setting than in a domestic one. 
There are a myriad of potential structural and regulatory differences 
whose impact has to be addressed in order to produce a meaningful 
comparison.'' Id. at 4522. Neither Mr. Del Beccaro nor Dr. Crawford 
even attempt an analysis or discussion of the intricacies of Canadian 
and U.K. markets for performance rights for musical works and sound 
recordings, and Music Choice itself concedes that particular license 
rates in Canada and Europe ``do not necessarily determine what the 
specific market rate in the United States should be for the sound 
recording right.'' Music Choice PFF ] 135.
    Likewise, I am not persuaded that Dr. Crawford's application of the 
Nash Framework provides corroboration. The Nash Framework is a highly 
theoretical concept whose goal is to evaluate how the surplus from a 
transaction might be divided among participants. As Dr. Ford points 
out, a problem with applying the Nash Framework to a determination of a 
royalty rate is that a royalty does not split surplus, it splits 
revenues. Ford Amended/Corrected WRT at 8, SX Trial Ex. 244. An even 
split of surplus, as Dr. Crawford presumes from the model, does not 
imply an even split of revenues. Id. Further, Dr. Crawford's efforts to 
apply the Nash Framework to royalties to be paid by Music Choice only 
contemplates a two-party transaction between record labels and Music 
Choice, even though Music Choice is the intermediary between cable 
operators that actually perform the sound recordings in the output 
market. The presence of an intermediary disrupts and complicates the 
Nash analysis because it introduces an additional bargain in the output 
market and requires that all three bargains be considered jointly. Id. 
at 15. Dr. Crawford did not take this complicating factor into 
consideration.
    I also have serious reservations concerning Dr. Crawford's 
assumption that the Nash factor of bargaining power is assumed to be 
neutral. Mr. Del Beccaro testified that Music Choice has a number of 
competitors in the marketplace, meaning that record companies have 
other alternatives for licensing their works. Del Beccaro Corrected WDT 
at 36-37, PSS Trial Ex. 1. This undermines Dr. Crawford's determination 
of the Nash Factor threat point to the surplus received by record 
companies in the event no agreement is reached. If record companies 
have other options, then the assumed zero sum effect of the bargaining 
agreement under the Nash Framework is violated.
    Finally, Dr. Crawford places undue reliance on the perceived 
promotional value of Music Choice, which is central to his application 
of the Nash Framework. For his conclusion to be correct--that failure 
to reach a bargaining agreement will result in a substantial loss of 
record sales due to the absence of promotional value from Music 
Choice--he must demonstrate a causal relationship between Music 
Choice's promotion of sound recordings and the sale of those 
recordings. His evidence on this point, however, is mostly anecdotal 
and weak. The surveys relied upon by Mr. Williams do not confirm a 
causal link between listenership to Music Choice and subsequent record 
sales; at best, the 2005 Arbitron survey (already more than seven years 
old) demonstrates that there is some correlation between listenership 
and sales. There could be many reasons for the correlation, including 
the possibility that cable subscribers who listen to Music Choice are 
already inclined to purchase more music. For example, the 2010 Experian 
Simmons survey, cited by Mr. Williams, shows that Music Choice 
listeners are more likely than the average person to attend concerts, 
know what songs are in the top 10, read Rolling Stone magazine, and 
consume electronic and video goods at a higher rate. Williams WDT at MC 
36, PSS Trial Ex. 3. Furthermore, none of the surveys cited by Dr. 
Crawford, including the antiquated 2006 Sony BMG Music Lab survey, 
offer reliable evidence as to whether Music Choice's residential audio 
service creates a net promotional or substitutional effect on the 
purchase of CDs or other music services. Without reliable data that 
quantifies the net effect of Music Choice, Dr. Crawford's conclusion 
regarding Music Choice's promotional effect is not sustainable.
    I am not persuaded that Dr. Crawford's Nash Framework analysis 
confirms acceptance of the musical works benchmark for PSS, nor that 
royalty rates in the market for sound recordings is less than that for 
musical works. Likewise, I do not agree that Dr. Crawford's alternative 
surplus splitting analysis is probative. The Judges have previously 
found theoretical surplus splitting models to be of limited value, and 
Dr. Crawford's analysis is no different. See, Webcaster II, 72 FR 
24084, 24092-93 (May 1, 2007); SDARS-I, 73 FR at 4092. Although Dr. 
Crawford claims that his 20% to 80% range of a split of 3.05% of Music 
Choice's 2006-2010 revenues reflects arm's length negotiations between 
Music Choice and record companies, he provides no market evidence to 
support this contention. Crawford Corrected WDT at 49-50, PSS Trial Ex. 
4. There are also methodological difficulties in the manner in which 
Dr. Crawford examined Music Choice's historical financial data. 
Specifically, he included in his cost analysis those costs associated 
with Music Choice's music video business in addition to the costs for 
the residential audio business, presumably because he was told by Music 
Choice personnel that it was not possible to allocate expenses between 
the video and audio components of the company's business. 6/12/12 Tr. 
1859:21-1860:21 (Crawford). The net effect of including the music video 
business, which has substantial costs

[[Page 23084]]

and not much revenue, is to drive down the surplus he proposes to be 
split between Music Choice and record companies. Even if I were 
persuaded in theory by Dr. Crawford's surplus splitting analysis--and I 
am not--his failure to confine his cost and revenue analysis solely to 
the residential audio business, which is the subject of the statutory 
licenses in this proceeding, prohibits its usefulness.
    Turning to the music service benchmarks offered by SoundExchange 
and supported by Dr. Ford, one is confronted with severe theoretical 
and structural difficulties. Although the volume (over 2,000) of 
marketplace agreements examined by Dr. Ford for music products and 
services might suggest real usefulness in a benchmark analysis, the 
four markets examined--portable and non-portable subscription 
interactive webcasting, ringtones/ringbacks, and digital downloads--
involve the licensing of products and rights separate and apart from 
the right to publicly perform sound recordings in the context of this 
proceeding. Thus, the key characteristic of a good benchmark--
comparability--is not present. SDARS-I, 73 FR at 4092. The buyers are 
different, there are different music products included (ringtones and 
ringbacks, digital downloads) and there are different rights licensed 
in the output market. Further, I do not accept Dr. Ford's contention 
that, as a matter of economics, it is irrelevant that different legal 
rights are conveyed by the benchmark agreements he examined. 6/18/12 
Tr. 2819:5-10 (Ford). The agreements examined by Dr. Ford themselves 
suggest that the rights licensed, and the context in which they are 
licensed, make a great deal of importance in determining their value.
    I do agree with Dr. Ford's observations that Music Choice has 
several distinct features, such as its intermediary role between cable 
systems and subscribers and the bundling of Music Choice's services 
with multiple channels of video and other non-music programming, that 
significantly dim the possibility of market comparators. This is not to 
say that the value of the sound recording right in the PSS market is 
exceedingly low, as Music Choice would have it, nor exceedingly high, 
as SoundExchange would have it. SoundExchange's rate proposal begins 
with a rate of 15% of Gross Revenues in the first year of the licensing 
term, which is endorsed by Dr. Ford as being within the range of 
reasonable rates for the PSS even though it is far lower than the 
average rates he determined in his benchmark analysis. For this reason, 
the 15% rate represents nothing more than the uppermost bound of the 
range of reasonable royalty rates for the PSS.
    Based upon the above analysis, I am left with a consideration of 
the existing 7.5% royalty rate which is the product of settlement 
negotiations that occurred in SDARS-I between Music Choice and 
SoundExchange, and is a rate for which neither party advocates. 
Although it is a rate that was negotiated in the shadow of the 
statutory licensing system and cannot properly be said to be a market 
benchmark, nothing in the record persuades me that 7.5% of Gross 
Revenues, as currently defined, is either too high, too low or 
otherwise inappropriate. Accord, Phonorecords I, 74 FR at 4522. I now 
turn to the Section 801(b) policy factors.
4. The Section 801(b) Factors
    Section 801(b)(1) of the Copyright Act states, among other things, 
that the rates that the Judges establish under Section 114(f)(1) shall 
be calculated to achieve the following objectives: (A) To maximize the 
availability of creative works to the public; (B) to afford the 
copyright owner a fair return for his or her creative work and the 
copyright user a fair income under existing conditions; (C) to reflect 
the relative roles of the copyright owner and the copyright user in the 
product being made available to the public with respect to relative 
creative contribution, technological contribution, capital investment, 
cost, risk, and contribution to the opening of markets for creative 
expression and media for their communication; and (D) to minimize any 
disruptive impact on the structure of the industries involved and on 
generally prevailing industry practice. 17 U.S.C. 801(b)(1). Based on 
the record evidence in this proceeding, the benchmark evidence 
submitted by Music Choice and SoundExchange has failed to provide the 
means for determining a reasonable rate for the PSS, other than to 
indicate the extreme ends of the range of rates. The testimony and 
argument of Music Choice demonstrates nothing more than to show that a 
reasonable rate cannot be as low as the rates paid by Music Choice to 
the three performing rights societies for the public performance of 
musical works. The benchmark testimony of SoundExchange is of even 
lesser value. The proposed rate of 15% for the PSS for the first year 
of the licensing period, deemed reasonable by Dr. Ford (at least in the 
beginning of the licensing period), stands as the absolute upper bound 
of the range of reasonable rates. At the middle of the range is the 
current 7.5% rate and, based upon the record, I am are persuaded that 
it is neither too high, too low, or otherwise inappropriate, subject to 
consideration and necessary adjustment under the Section 801(b) factors 
discussed below.
a. Maximize Availability of Creative Works
    Both SoundExchange and Music Choice presented arguments as to how 
their proposed benchmark rates satisfy this factor, which are not 
relevant given that the musical works benchmark and the Ford music 
service benchmarks only serve the purpose of framing the absolute lower 
and upper bounds of reasonable rates. Rather, it is the current 7.5% 
rate to which the evidence presented under this factor must be applied.
    Music Choice touts that it is a music service that is available in 
over 54 million homes, with 40 million customers using the service 
every month. 8/16/12 Tr. 3878:3 (Del Beccaro); Del Beccaro Corrected 
WDT at 4, 26, PSS Trial Ex. 1; 6/11/12 Tr. 1462:5-11, 1486:19-1487:2 
(Del Beccaro). Channel offerings have increased through the years, 
curated by experts in a variety of music genres. Del Beccaro Corrected 
WDT at 3, 24, PSS Trial Ex. 1. Recent developments in technology permit 
Music Choice to display original on-screen content identifying useful 
information regarding the songs and artists being performed at any one 
time. Id. at 24; Williams WDT at 12, MC 23, PSS Trial Ex. 3; 6/11/12 
Tr. 1461:14-1462: 1, 1491:1-12 (Del Beccaro). According to Music 
Choice, these elements, along with the promotional efforts detailed 
above in the context of Dr. Crawford's Nash Framework analysis, support 
a downward adjustment in the rates. In any event, an upward adjustment 
in the rates, argues Music Choice, would not affect the record 
companies' bottom-line because PSS royalties are not a material revenue 
source for record companies. Music Choice PFF ]] 409-417.
    SoundExchange submits that a market rate incorporates 
considerations under the first Section 801(b) factor, citing the Judges 
decision in SDARS-I, and that if PSS rates turn out to be too high and 
drive Music Choice from the market, presumably consumers will shift to 
alternative providers of digital music where higher royalty payments 
are more likely for record companies. Ford Second Corrected WDT at 19-
20, SX Trial Ex. 79.
    The current PSS rate is not a market rate so that market forces 
cannot be presumed to determine the maximum amount of product 
availability consistent with the efficient use of resources. See SDARS-
I, 73 FR 4094. However, the testimony demonstrates

[[Page 23085]]

that Music Choice has not, under the current rate, reduced its music 
offerings or contemplated exiting the business; in fact, it will be 
expanding its channel offerings in the near term. There is also no 
evidence that suggests that the output of music from record labels has 
been impacted negatively as a result of the current rate. There is no 
persuasive evidence that a higher PSS royalty rate will necessarily 
result in increased output of music by the record companies (major or 
independent), nor that a lower rate will necessarily further stimulate 
Music Choice's current and planned offerings. In sum, the policy goal 
of maximizing creative works to the public is reasonably reflected in 
the current rate and, therefore, no adjustment is necessary.
b. Afford Fair Return/Fair Income Under Existing Market Conditions
    Music Choice submits that the Judges need not worry about the 
impact of a low royalty rate on the fair return to record companies and 
artists for use of their works because royalties from the PSS market 
are so small as to be virtually inconsequential to companies whose 
principal business is the sale of CDs and digital downloads. Music 
Choice PFF ]] 420-430. With respect to Music Choice's ability to earn a 
fair income, however, Music Choice argues that it is not profitable 
under the current 7.5% rate. Mr. Del Beccaro testified that its average 
revenue per customer for its residential audio business has been on the 
decline since the early 1990's, down from $1.00 per customer/per month 
to [REDACTED] per customer/per month currently. Del Beccaro Corrected 
WDT at 40, PSS Trial Ex. 1. He further testified that after 15 years of 
paying a PSS statutory rate between 6.5% and 7.5% Music Choice has not 
become profitable on a cumulative basis and is not projected to become 
so within the foreseeable future. Id. at 42. Cumulative loss at the end 
of 2011 is [REDACTED], projected to grow to [REDACTED] in 2012 and 
continue to increase throughout the 2013-2017 license period. Id. at 
33-34; Del Beccaro Corrected WRT at MC 69 at 1, MC 70 at 1, PSS Trial 
Ex. 21. These losses lead Music Choice to conclude that it has not 
generated a reasonable return on capital under the existing rates, 
which it submits should be 15% in the music industry. Music Choice PFF 
]] 442-43.
    Music Choice's claims of unprofitability under the existing PSS 
rate come from the oblique presentation of its financial data and a 
combining of revenues and expenses from other aspects of its business. 
The appropriate business to analyze for purposes of this proceeding is 
the residential audio service offered by Music Choice, the subject of 
the Section 114 license. Music Choice, however, reports costs and 
revenues for its residential audio business with those of its 
commercial business, which is not subject to the statutory license. 
This conflation of the data, which Music Choice acknowledges cannot be 
separated, see SX PFF at 221-222, distorts its views regarding losses. 
As a consolidated business, Music Choice has had significantly positive 
operating income during the past five years between 2007 and 2011 and 
has made profit distributions to its partners since 2009. Ford Amended/
Corrected WRT at SX Ex. 362, p. 3, SX Trial Ex. 244; SX Trial Ex. 64 at 
3; SX Trial Ex. 233 at 3. Dr. Crawford's effort to extract costs and 
revenues from this data for the PSS service alone for use in his 
surplus analysis cannot be credited because of his lack of familiarity 
with the data's source. 6/13/12 Tr. 1890:15-1891:10 (Crawford).\66\ 
Music Choice has operated successfully and received a fair income under 
the existing statutory rate.\67\
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    \66\ Much was made at trial and in closing arguments regarding 
Dr. Crawford's supposed use of audited financial data and Dr. Ford's 
use of unaudited financial data in an effort to examine costs and 
revenues of the PSS service vis-[agrave]-vis Music Choice's other 
non-statutory offerings. I see no superiority to either data set, as 
both contain their own difficulties.
    \67\ It would be surprising, if not improbable, that Music 
Choice would be able to operate a PSS service for over 15 years with 
a statutory royalty between 6.5% and 7.5%, with the considerable 
losses that it claims, and nonetheless continue to operate, let 
alone intend to expand its current operation.
---------------------------------------------------------------------------

    With respect to fair return to the copyright owner, the examination 
is whether the existing statutory rate has produced a fair return with 
respect to the usage of sound recordings. During the period of the 
current rate and before, Music Choice provided 46 channels of music 
programming to the subscribers of its licensees. However, Music Choice 
is expanding the number of music channels dramatically in the coming 
licensing term, up to 300 channels by the first quarter of 2013. Del 
Beccaro Corrected WDT at 3-4, PSS Trial Ex. 1; 8/16/12 Tr. 3878:3 (Del 
Beccaro). This will result in a substantial increase in the number of 
plays of music by Music Choice, even if the ultimate listenership 
intensity of its licensees' subscribers cannot be measured. The 
expansion in usage will not be reflected in increased revenues to which 
the statutory royalty rate is to be applied, as Music Choice has 
declared itself to be a mature business with no expectation of 
increased future revenues for its business. As a result, copyright 
owners will not be compensated for the increased usage of their works, 
underscoring the Judges' preference for a per-performance metric for 
royalty determinations--which is not available here--as opposed to a 
percentage-of-revenue metric. Dramatically expanded usage without a 
corresponding expectation of increased compensation suggests an upward 
adjustment to the existing statutory rate. Measurement of the 
adjustment is not without difficulty because any downstream increases 
in listenership of subscribers as a result of additional music 
offerings by Music Choice cannot be readily determined nor predicted. 
It is possible that listenership overall may remain constant despite 
the availability of 300 music channels as opposed to only 46. However, 
it is more reasonable to conclude that Music Choice would not make the 
expansion, and incur the additional expense of doing so, without 
reasonable expectation that subscribers will be more attracted to and 
will consume more of the music offerings of Music Choice. A 2% upward 
adjustment, phased-in during the course of the license period as 
described below, is sufficient to provide copyright owners with a fair 
return for the increased use of sound recordings by Music Choice.
c. Relative Roles of Copyright Owners and Copyright Users
    This policy factor requires that the rates adopted by the Judges 
reflect the relative roles of the copyright owners and copyright users 
in the product made available with respect to relative creative 
contribution, technological contribution, capital investment, cost, 
risk, and contribution to the opening of markets for creative 
expression and media for their communication. For its part, Music 
Choice's arguments that its creative and technological contributions, 
and capital investments, outweigh those of the record companies center 
on the same aspects of its business. First, Music Choice touts the 
graphic and informational improvements made to its on-screen channels, 
noting that what were once blank screens now display significant artist 
and music information. Costs for these improvements have exceeded 
[REDACTED]. Del Beccaro Corrected WDT at 31-32, PSS Trial Ex. 1. 
Second, Music Choice offers increases in programming, staff size and 
facilities, along with enhancements to product development and 
infrastructure. Costs for these improvements have exceeded [REDACTED]. 
Id. Regarding costs and risks, Music Choice points to its lack of 
profitability and the exit of other PSS

[[Page 23086]]

from the market as evidence of its continued risk and limited 
opportunity for profit. Music Choice PFF ]] 512-520. Finally, with 
respect to opening new markets, Music Choice touts the PSS market 
itself for which it remains the standard-bearer in disseminating music 
to the public through cable television. Id. at ] 523.
    SoundExchange offers little more on the third Section 801(b) factor 
beyond Dr. Ford's contention that he saw no evidence to support that 
Music Choice makes contributions to creativity or availability of music 
that are beyond those of the music services he included in his 
benchmarks, and therefore the third factor is accounted for in the 
market. Ford Second Corrected WDT at 21, SX Trial Ex. 79; 6/18/12 Tr. 
2849:10-16 (Ford).
    In considering the third factor, the Judges' task is not to 
determine who individually bears the greater risk, incurs the higher 
cost or makes a greater contribution in the PSS market, and then make 
individual up or down adjustments to the selected rate based upon some 
unspecified quantification of these differences. Rather, the 
consideration is whether these elements, taken as a whole, require 
adjustment to the existing rate of 7.5%. Upon careful weighing of the 
evidence, I determine that no adjustment is necessary. Music Choice's 
investments in programming offerings, staff and facilities, and other 
related products and services are no doubt impressive, but they have 
been accomplished under the current rate and previous rates that are 
only slightly lower (the low being 6.5%). As discussed above, Music 
Choice has already begun to expand its channel offerings by several 
multiples and has allocated greater financial resources to its 
residential audio business. All of these undertakings, plus the 
investments made and costs incurred to date have been made in the 
shadow of the existing rate, and have not been prevented as a result of 
that rate. Likewise, on the other side of the ledger, SoundExchange has 
not offered any persuasive evidence that the existing rate has 
prevented the music industry from making significant contributions to 
or investments in the PSS market.
d. Minimize Disruptive Impact
    Of the four Section 801(b) factors, the parties devoted most of 
their attention to the last one: minimizing disruption on the structure 
of the industries and on generally prevailing industry practices. This 
is perhaps not surprising, given the role this factor played in SDARS-I 
in adjusting the benchmark rates utilized by the Judges to set the 
royalty fees. See SDARS-I, 73 FR at 4097-98. Music Choice presents a 
considerable volume of testimony and argument as to why the 
SoundExchange proposed rates would be disruptive, if not debilitating, 
to its business; and SoundExchange presents testimony and argument as 
to why Music Choice's proposed rates would disrupt the music industry. 
These contentions, however, are inapposite as neither the SoundExchange 
nor the Music Choice benchmark analyses serve the purpose of 
determining a reasonable rate other than to mark the extreme ends of 
the boundary within which a reasonable rate can be located. Because I 
have identified as reasonable the rate for PSS currently in place, my 
analysis of the disruption factor is confined to that rate.
    SoundExchange argues that the current rate is disruptive to the 
music industry. Dr. Ford testified that ``the current practice of 
applying an exceedingly low rate to deflated revenues is disruptive of 
industry structure, especially where there are identical services 
already paying a higher rate.'' Ford Second Corrected WDT at 23, SX 
Trial Ex. 79. This results, according to Dr. Ford, in a tilting of the 
competitive field for music services in favor of Music Choice, thereby 
disrupting the natural evolution of the music delivery industry. Dr. 
Ford, however, appears to ignore his own earlier assertions that the 
PSS market has unique and distinctive features that distinguish it from 
other types of music services, thereby substantially reducing the 
likelihood that the PSS and other music services are substitutes for 
one another. Further, Dr. Ford failed to present any empirical evidence 
demonstrating a likelihood of migration of customers from music 
services paying higher royalty fees to the PSS as a result of his 
perceived royalty imbalance.\68\ Dr. Ford's conclusion that the current 
rate paid by the PSS for the Section 114 license has caused a 
disruption to the music industry is mere speculation.
---------------------------------------------------------------------------

    \68\ I note that DMX's exit from the PSS market in 2000 offers 
an opportunity to examine how the departure of a PSS impacts 
consumer choices and their consumption of music, but no such 
analyses were presented in this proceeding.
---------------------------------------------------------------------------

    Music Choice also contends that the current rate is disruptive, and 
I likewise find its argument weak and unsubstantiated. The test for 
determining disruption to an industry, announced by the Judges in 
SDARS-I, is whether the selected rate directly produces an adverse 
impact that is substantial, immediate, and irreversible in the short-
run. SDARS-I, 73 FR at 4097. The current rate has been in place for 
some time and, despite Music Choice's protestations that it has never 
been profitable, it continues to operate and continues to increase its 
expenditures by expanding and enhancing its services in the face of the 
supposedly disruptive current royalty rate. Music Choice's argument 
that DMX's bankruptcy and Muzak's decision to limit its participation 
in the PSS market are evidence of the onerous burden of the current 
rate are without support because Music Choice has failed to put forward 
any evidence demonstrating a causal relationship between the actions of 
those services and the PSS royalty rate.
    In sum, I am not persuaded by the record testimony or the arguments 
of the parties that the current PSS rate is disruptive to a degree that 
necessitates an adjustment.
5. Conclusions Regarding Section 114 Rates
    Upon a careful weighing of the evidence submitted by the parties, I 
believe that the application of the Section 801(b) factors to the rate 
of 7.5% of Gross Revenues requires an upward adjustment to account for 
the coming expanded use of music by Music Choice in the 2013-2017 
licensing term. If the Judges preferred per-usage royalty metric could 
be applied to the PSS--which it cannot--the value of the increased 
usage would be captured in the metric through the measurement of 
listenership to the sound recordings received by Music Choice consumers 
through their respective cable systems. The percentage-of-revenue 
metric, however, will not account for the expanded use in the short 
term, as cable operators will continue to pay fees for the Music Choice 
service in approximately the same amounts, and will only increase in 
the long term, presumably, if the volume of cable subscribers (or per-
subscriber license rates) increases significantly. The testimony, 
however, suggests this possibility to be unlikely, as Music Choice 
itself declares the PSS market mature. 8/16/12 Tr. 3855:17-3856:7 (Del 
Beccaro); 8/23/12 4707:8-19 (Crawford).
    The following are the rates that I believe are appropriate and 
supported by the evidence in this proceeding: for 2013: 8.5%; for 2014: 
9.0%; for 2015: 9.5%; for 2016: 9.5%; and for 2017: 9.5%.
    SoundExchange raises an additional matter with respect to the total 
royalty obligation of the PSS. Though not technically a rate, nor 
strictly an amendment of Gross Revenues, SoundExchange requests a means 
for capturing revenues from cable systems

[[Page 23087]]

that are owners of equity or capital interests in Music Choice who do 
not engage in arm's length transactions with Music Choice for its 
product offerings. Second Revised Proposed Rates and Terms, at 6-7 
(Sept. 26, 2012). Put another way, SoundExchange seeks to capture any 
price break that Music Choice offers its ownership partners for the 
Music Choice service. The price break to a specific partner cable 
system would be calculated by multiplying the total number of 
subscribers for the month for that system by the average per-subscriber 
royalty payment of the five largest paying cable systems providing 
Music Choice that are not its partners. This reconciling for each 
partner cable system would then be added to Music Choice's Gross 
Revenues overall calculation. In support of its ``Non Arm's Length 
Transaction'' adjustment for cable partners, Dr. Ford testified that a 
straight percentage of revenue metric is problematic where Music Choice 
offers per-subscriber rate discounts to it cable partners. ``I believe 
that, if we are going to properly compensate someone for the use of 
their property, we ought to be compensating them for use and not have 
the compensation affected by peculiar ownership structure of the 
entities that easily arise.'' 8/20/12 Tr. 4216:21-4217:8 (Ford). Over 
half of Music Choice's non-partner cable systems pay approximately 
[REDACTED] per subscriber per month in licensing fees to Music Choice, 
whereas the partner cable systems pay only [REDACTED] per subscriber 
per month. Ford Second Corrected WDT at 5, SX Trial Ex. 244.
    I am not persuaded that a ``Non Arm's Length Transaction'' 
adjustment is warranted. Implicit in Dr. Ford's observation of Music 
Choice's licensing of its service to its cable partners is the 
assumption that the partners have the ability to exert downward 
pressure on Music Choice revenues so as to avoid payment of music 
royalties and thereby boost their own bottom-lines. Such presumed use 
of Music Choice as a loss leader is not borne out by the evidence in 
this proceeding. The partnership agreements between Music Choice and 
its cable operators are lengthy and complicated and vary from partner 
to partner. It is not surprising that the partner cable operators, 
which are in most instances of greater size with respect to numbers of 
subscribers than the non-partner licensors of Music Choice's service, 
would be able to negotiate lower per-subscriber licensing fees due to 
their ability to deliver more subscribers to the service. Further, the 
cable partners represent only a third of Music Choice ownership, and do 
not appear to be able to influence rates any more than Music Choice's 
record company partners, who own one quarter of the company. 6/11/12 
Tr. 1454:16-22 (Del Beccaro). SoundExchange's ``Non Arm's Length 
Transaction'' adjustment is founded upon inference and speculation and 
is not supported by the record evidence.

E. The Section 114 Royalty Rates for SDARS

    As with the consideration of reasonable rates for the PSS, I begin 
my analysis for SDARS with the proffered benchmarks of Sirius XM and 
SoundExchange, respectively.
1. SDARS Proposed Benchmarks
a. The Direct Licenses
    Beginning in the summer of 2010, Sirius XM commenced a coordinated 
effort to negotiate sound recording performance rights directly with 
individual record labels. 6/7/12 Tr. 669:8-672:9, 713:3-11, 714:11-
715:4 (Frear). Dubbed the Direct License Initiative, Sirius XM first 
attempted to engage the four major record companies in discussions but 
was unsuccessful. Id.; 6/11/12 Tr. 1347:7-21, 1348:20-1349:4 
(Karmazin). Sirius XM then enlisted the services of Music Reports, Inc. 
(``MRI'') to formulate and execute a direct licensing strategy with as 
many independent record labels as possible. Together, Sirius XM and MRI 
developed the terms and conditions of a Direct License, the highlights 
of which include:
     A pro rata share of 5%, 6%, or 7% of gross revenues, 
defined by reference to 37 CFR 382.11;
     A grant of rights to Sirius XM to operate all of its 
various services (satellite radio plus other services such as 
webcasting);
     ``Additional functionality'' granted to Sirius XM, 
including elimination of the Section 114 license sound recording 
performance complement;
     Direct, quarterly payment of 100% of the royalties to the 
record label;
     Payment of advances to the 5 largest record labels;
     The possibility, but not the promise, of increased play on 
Sirius XM's music services.

Gertz Corrected WDT ] 14(a), (b), SXM Dir. Trial Ex. 5. The first 
Direct Licenses were executed in August of 2011 and by the time of the 
closing of testimony in this proceeding, Sirius XM had Direct Licenses 
with 95 independent record labels. 8/13/12 Tr. 3015-16-20 (Frear); 8/
15/12 Tr. 3679:22-3680:1 (Gertz).
    Sirius XM's expert economist, Dr. Roger Noll, advises that the 95 
Direct Licenses are the best benchmark for rate setting in this 
proceeding because, unlike in SDARS-I, the Judges now have direct 
evidence of competitively negotiated marketplace rates for the exact 
service at issue in this proceeding. Noll Revised Amended WDT at 7, 11, 
33-36, SXM Dir. Trial Ex. 1. Dr. Noll testified that the Direct 
Licenses are representative, for benchmarking purposes, of the types of 
sound recordings available across the industry, including those 
distributed by major labels. Id. at 39-44; see also 6/5/12 Tr. 261:6-
262:14 (Noll)(the 95 Direct Licensors as a group offer a scope of sound 
recordings comparable to those not so licensed). The fact that the 
Direct Licenses represent only a small percentage of market share of 
music available does not alter the incentive to create demand 
diversion, Dr. Noll opines, because the major record labels and the 
independent labels signed to the Direct Licenses both seek to maximize 
their number of plays on Sirius XM's music services. A Direct Licensor 
would find a 7% license rate more attractive than the current 8% 
statutory rate if the lower rate would cause an increase in the number 
of plays. Noll Revised Amended WDT at 40-41, SXM Dir. Trial Ex. 1. Dr. 
Michael Salinger, another Sirius XM expert economist, concludes that 
the fact that 95 record companies accepted the Direct License offer 
suggests that the current 8% statutory rate is, if anything, above the 
competitive rate for sound recordings. Salinger Corrected WRT at ] 28, 
SXM Reb. Trial Ex. 9. Further, Sirius XM argues that the number of 
Direct Licenses undoubtedly would have been higher but for the efforts 
of SoundExchange, the American Association of Independent Musicians and 
others to undermine and interfere with its Direct License Initiative. 
Sirius XM devoted considerable time and testimony in an effort to 
support this contention. See, e.g., Sirius XM PFF at 61-63.
b. The Noll Benchmark
    Dr. Noll asserts that license agreements between major record 
labels and certain customized non-interactive webcasters provide 
marketplace evidence of rates that corroborate the 5%-7% rates achieved 
in the Direct Licenses. Noll Revised Amended WDT at 16, 72, SXM Dir. 
Trial Ex. 1. Focusing principally on the agreements between the digital 
music service Last.fm and the four major record companies,\69\ Dr. Noll

[[Page 23088]]

determined that for its non-interactive subscription streaming service, 
Last.fm agreed to pay:
---------------------------------------------------------------------------

    \69\ Dr. Noll also examined agreements involving the music 
services Slacker and Turntable.
---------------------------------------------------------------------------

     [REDACTED]
     [REDACTED]
     [REDACTED]
    Noll Revised Amended WDT at 76-79 (footnote omitted), Tables 2.1-
2.1c and Appendices E-H, SXM Dir. Trial Ex. 1. Examining these same 
agreements for Last.fm's interactive on demand service--[REDACTED]--led 
Dr. Noll to conclude that sound recording rights owners charge 
[REDACTED] for non-interactive services than they do for interactive/
on-demand services. Id.\70\
---------------------------------------------------------------------------

    \70\ Dr. Noll also found similar splits in [REDACTED] 
agreements. Id. at Tables 2.2-2.2d and Appendices I-L.
---------------------------------------------------------------------------

    Using the rates gleaned from the Last.fm agreements for the non-
interactive subscription streaming service, which he deemed to be the 
most similar to Sirius XM's satellite radio service in terms of 
functionality, Dr. Noll computed his reasonable royalty fee by 
multiplying the Last.fm revenue rate [REDACTED] against the implicit 
per-subscriber price of Sirius XM's music channels ($3.00-$3.45), and 
then divided the resulting per-subscriber monthly fee into Sirius XM's 
average revenue per user ($11.38) in order to express the fee as a 
percentage of revenue. Id. at 15; 6/5/12 Tr. 285:7-293:9 (Noll). This 
yielded an average royalty rate as a percentage of Sirius XM revenue of 
6.76%. Id. at 90; 6/5/12 Tr. 293:5-9 (Noll). Because this average rate 
fit squarely between the 5%-7% range of the Direct Licenses, Dr. Noll 
opines that his calculation is corroborative of the rates contained in 
Direct Licenses and further concludes that it represents the upper end 
of a reasonable royalty rate because the customized, non-interactive 
services he examined offer greater functionality and sound quality than 
the channels offered by Sirius XM. Id. at ]] 14-16; 6/5/12 Tr. 292:2-14 
(Noll).
2. SoundExchange Proposed Benchmarks
    SoundExchange's expert economist, Dr. Janusz Ordover, offers a 
principal benchmark, and two alternatives, based upon his examination 
of market agreements for digital music between interactive subscription 
services streaming music and the four major record companies. Dr. 
Ordover chose interactive subscription services because of his belief 
that they represent voluntary transactions in a competitive marketplace 
free of regulatory overhang, provide sufficient information based on 
multiple buyer/seller interactions, are not distorted by the exercise 
of undue market power on either the buyer's or seller's side, and 
involve digital music services that are similar to Sirius XM. 6/14/12 
Tr. 2359:11-2360:9, 2257:5-11, 2257:12-20, 2257:21-2258:2 (Ordover).
    Dr. Ordover's principal benchmark is to calculate the percentage of 
total revenues represented by royalty payments made by interactive 
services to record companies, and then apply that percentage of revenue 
to the amount that he determined to be the retail price of a music-only 
satellite service in order to calculate the corresponding percentage-
of-revenue for the Sirius XM service. See generally Ordover Third 
Corrected/Amended WDT at 18-25, SX Trial Ex. 74. Beginning with data 
from July 2010, he derived the effective percentage-of-revenue paid by 
each interactive service by taking the amount of royalty fees paid to 
the major record labels and dividing it by each service's gross 
subscription revenues. In other words, he relied on royalty payments 
made, rather than the percentage-of-revenue rates specified in the 
agreements which contained ``greater of'' royalty formulations.\71\ In 
calculating actual licensing fees paid, Dr. Ordover used gross 
subscription revenues of the interactive services without any 
deductions or carve-outs. Ordover Third Corrected/Amended WDT at 19, SX 
Trial Ex. 74. Examining the agreements, he determined that the annual 
payments as a percentage of gross revenues of the services ranged from 
50% to 70%, and tended to cluster in a narrower range of 60% to 65%. 6/
14/12 Tr. 2275:4-12 (Ordover); Ordover Third Corrected/Amended WDT at 
19-21, SX Trial Ex. 74. Dr. Ordover then adjusted the benchmark to 
account for the fact that the Sirius XM satellite radio service, unlike 
interactive subscription services, transmits both music and non-music 
content. Reducing the percentage-of-revenue by half, principally based 
upon his observation of the identical $9.99 retail prices offered by 
Sirius XM for non-music and mostly music stand-alone subscriber 
packages, yielded rates for Sirius XM between 30% and 32.5% for the 
2013-2017 statutory licensing period. Ordover Third Corrected/Amended 
WDT at 17, SX Trial Ex. 74.\72\
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    \71\ The ``greater of'' metric is an amount per play, an amount 
per-subscriber, and a percentage of the service's revenues. 6/14/12 
Tr. 2261:7-2262:4 (Ordover).
    \72\ Dr. Ordover's mathematical calculation is as follows: He 
took the $12.95 Sirius XM subscription price, and then multiplied 
that by 50% to obtain the music portion of the subscription price of 
$6.475. He then multiplied the music-only satellite radio 
subscription price by 60% to 65% (his effective percentage-of-
royalty derived from the interactive subscription service 
agreements) to obtain the music royalty of $3.88 to $4.21. Finally, 
he divided those numbers into the Sirius XM subscription price for 
the Select programming package to obtain 30% to 32.5%. 8/16/12 Tr. 
at 3794:13-3795:9 (Salinger).
---------------------------------------------------------------------------

    As his first alternative benchmark, Dr. Ordover examines per-
subscriber royalty rates from interactive subscription services in an 
effort to account for the differences in service attributes between 
satellite radio and interactive subscription services. He first 
determined an unweighted average monthly royalty of $5.95 per 
subscriber (monthly licensing fees paid divided by monthly subscriber 
counts) for interactive services, and then adjusted this fee by the 
ratio of the retail price of a hypothetical music-only satellite radio 
service (50% of the $12.95 subscription price for the Sirius XM Select 
programming package \73\) to the retail price for interactive 
subscription services ($9.99). Ordover Third Corrected/Amended WDT at 
30-31, SX Trial Ex. 74. This percentage, when applied to the average 
per-subscriber royalty paid by interactive services ($5.95), yields 
$3.86 for the hypothetical music-only satellite radio service. Dividing 
this number by the $12.95 Sirius XM subscription price provides a 
percentage-of-revenue rate of 29.81%. Id. at 32.
---------------------------------------------------------------------------

    \73\ The current price for this service is $14.49. Ordover Third 
Corrected/Amended WDT at 31 n.33, SX Trial Ex. 74.
---------------------------------------------------------------------------

    Dr. Ordover's second alternative benchmark approach attempts to 
adjust for the presence of interactivity alone in the rates yielded by 
his primary benchmark under the assumption that interactivity is the 
material difference between interactive subscription services and 
satellite radio. Ordover Third Corrected/Amended WDT at 34, SX. Trial 
Ex. 74. To derive the value of interactivity, he compared the retail 
prices for interactive music streaming services with the retail prices 
for non-interactive music streaming services in order to obtain a 
ratio. He determined that interactive music streaming services are 
uniformly priced at $9.99 per month, while non-interactive services 
prices averaged $4.86. Ordover Third Corrected/Amended WDT at 31-32 
Table 4, SX Trial Ex. 74; Id. at 33 Table 5.\74\ Dr. Ordover then used 
the ratio to adjust the average per-subscriber royalty paid by 
interactive services

[[Page 23089]]

($5.95) to calculate an equivalent payment for satellite radio. This 
yielded a percentage-of-revenue royalty rate of 22.32% for Sirius XM, 
which Dr. Ordover concludes represents the lower bound of a reasonable 
royalty rate. 6/14/12 Tr. 2282:12-16 (Ordover).\75\
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    \74\ Dr. Ordover did not provide a weighted average of the non-
interactive service prices because he concluded that he did not have 
reliable data, nor did he include, at my invitation, ad-supported 
non-interactive services in his calculation, deciding that such 
services would add undue complexity to his methodology. Ordover 
Amended WRT at 33, SX Trial Ex. 218.
    \75\ This was calculated by multiplying the interactivity ratio 
of .4865 ($4.86/$9.99) to the average per-subscriber royalty payment 
of $5.95, yielding an equivalent satellite radio payment of $2.89. 
The $2.89 per-subscriber rate was then divided by the $12.95 monthly 
charge for the Sirius XM Select satellite radio package, resulting 
in the percentage-of-revenue rate of 22.32%.
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3. Analysis and Conclusions Regarding the Proposed Benchmarks
    The Direct Licenses offered by Sirius XM have the surface appeal of 
a good benchmark in that they involve the same sellers and buyers in 
the target market; however, a closer examination reveals that they are 
fraught with problems. First, they represent a sliver of the universe 
of rights holders for sound recordings: 95 of over 20,100 rights 
holders to which SoundExchange distributes payments, Bender WDT at 4, 
SX Trial Ex. 75, and a subset of the 691 independent labels that Sirius 
XM approached in the first instance. Ordover Amended WRT at 4 n.8, and 
6, SX Trial Ex. 218; SX Trial Ex. 301 at 53. Much was made by Sirius XM 
in this proceeding that the number of Direct Licenses would have been 
substantially higher but for the interference of SoundExchange. It is 
not within the Judges' jurisdiction to determine that SoundExchange's 
actions amounted to legal interference with contractual relations or 
otherwise frustrated Sirius XM's efforts to execute more Direct License 
agreements. The Direct Licenses are evaluated for what they are, not 
for what they might have been, and what they are is a very small 
percentage of the sound recording market.\76\
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    \76\ I note, further, that the works licensed under the Direct 
Licenses represent no more than 2%-4% of the total number of works 
performed by Sirius XM. Ordover Amended WRT at 4-5, SX Trial Ex. 
218; 6/6/12 Tr. 308:3-5 (Noll).
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    Second, the Direct Licenses do not include any of the major record 
labels whom, by virtue of their size of the music market and the 
popularity of their recordings, Sirius XM cannot do without. Dr. Noll's 
observation that the works licensed by the Direct Licensors are 
representative of the kinds of sound recordings available to Sirius XM 
in the market is beside the point, for the Judges have concluded before 
that sound recordings, particularly those of the major record labels, 
are not readily substitutional for one another, let alone with those of 
independent record labels. Phonorecords I, 74 FR 4510, 4519 (Jan. 26, 
2009); see, generally Webcaster I, 72 FR 24084 (May 1, 2007). The 
``representativeness'' of the sound recordings contained in the 
catalogs of the Direct Licensors do not equate to their popularity,\77\ 
an essential ingredient to Sirius XM's music offerings. 6/7/12 Tr. 
836:17-22 (Gertz)(``Sirius XM is very hits driven, and they want to 
have the most successful service they can, so they're going to use 
what's popular.'').
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    \77\ Dr. Noll's citation to Direct Licensors' catalogues 
containing Broadway recordings, three former hit singles, and the 
recordings of George Carlin, as confirmation of the popularity of 
the works of the Direct Licensors overall, is not persuasive.
---------------------------------------------------------------------------

    Third, I am troubled by the additional considerations and rights 
granted in the Direct Licenses that are beyond those contained in the 
Section 114 license, thereby weakening their comparability as a 
benchmark. The Direct Licenses provide for payment of 100% of the 
royalties to the Direct Licensors, 6/6/12 Tr. 341:10-342:3 (Noll), 
thereby avoiding the statutory apportionment of 50% to record companies 
and 50% to artists and performers.\78\ 17 U.S.C. 114(g)(2). Certain of 
the Direct Licenses, in particular those of the largest independent 
labels, provide for cash advances and accelerated royalty payments, 
also not available under the statutory license. See, e.g., Gertz 
Revised WRT at SXM Reb. Ex. 23, pp. 3-4, SXM Reb. Trial Ex. 8; Gertz 
Revised WRT at SXM Reb. Ex. 8, pp. 3-4, SXM Reb. Trial Ex. 8. Sirius XM 
absorbs all of the administrative costs of the licensing process under 
the Direct Licenses, which under the statutory license are borne by the 
copyright owners, artists and performers. Eisenberg Amended/Corrected 
WRT at SX Ex. 313-RR, SX Trial Ex. 245. And with respect to rights 
granted under the Direct Licenses, Sirius XM receives a waiver of the 
sound recording complement of the statutory license, and the ability to 
perform the works of the Direct Licensors on other services not covered 
by the statutory license.
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    \78\ I recognize that direct payment to the Direct Licensors 
does not relieve them of their royalty obligations to their artists 
and performers; however, receipt of 100% of the royalties upfront is 
clearly attractive to certain record labels and was a selling point 
in negotiations with independent record labels. Powers WDT at 4-5, 
SX Trial Ex. 243.
---------------------------------------------------------------------------

    My concerns regarding the Direct Licenses are not cured by Dr. 
Noll's analyses. Dr. Noll contends that the fact the Direct License 
rates are lower than the current 8% statutory rate is explained by a 
demand diversion effect--record labels engaging in price competition 
aimed at increasing their market share through increased plays on 
Sirius XM, thereby reducing the royalty rates demanded--and represents 
what would happen in the market as a whole in the absence of a 
statutory rate. Noll Revised Amended WDT at 36-38, SXM Dir. Trial Ex. 
1.\79\ His demand diversion theory, however, has limited explanatory 
power. It may well be that independent record labels took the Direct 
License offer because of the valuable non-statutory benefits discussed 
above, and there is testimony in the record to this effect. See, e.g., 
SX Trial Ex. 317 at SXM-CRB--DIR--00079565; 8/20/12 Tr. 4156:5-4157:3 
(Powers). Further, independent labels have greater concerns than majors 
in securing performances of their works on services such as Sirius XM, 
increasing the attractiveness of a Direct License relationship. Powers 
WRT at 4, SX Trial Ex. 243; Eisenberg Amended/Corrected WRT at SX Ex. 
329-RR, p. SXM--CRB--DIR--00042287, SX Trial Ex. 245 (email from MRI to 
independent label emphasizing that a Direct License offers the 
possibility of increased airplay). The incentive of increased airplay 
does not necessarily exist for major record labels, whose works are 
already performed in large numbers by Sirius XM's hits-driven 
programming. Harrison Corrected WRT at 9-10, PSS Trial Ex. 32.
---------------------------------------------------------------------------

    \79\ Dr. Noll also offers his demand diversion theory as an 
explanation as to why SoundExchange allegedly attempted to interfere 
with Sirius XM's Direct License Initiative.
---------------------------------------------------------------------------

    Dr. Noll's benchmark analysis, whether considered as corroboration 
of the Direct Licenses or stand-alone, contains significant flaws. His 
reliance on the Last.fm agreements with the four major record labels, 
which provide the critical data to his calculations, is valid to the 
extent that it is representative of non-interactive subscription 
webcasting services. See SDARS-I, 73 FR at 4090. Two of the agreements, 
however, have expired and are no longer in effect. Ordover Amended WRT 
at 25, SX Trial Ex. 218. Last.fm now pays those record companies at the 
statutory webcasting rate, which is not a per se market rate. 8/14/12 
Tr. 3308:8-20, 3317:10-16 (Ordover). Even if the Last.fm agreements 
were the most representative of webcasting services--and Dr. Noll has 
not demonstrated that they are--I would not be inclined to accept them 
as fully comparable to the SDARS business without some adjustment for 
the functional differences between webcasting and satellite radio. No 
persuasive adjustment was offered.
    I also have reservations about Dr. Noll's determination of $3.00-
$3.45 as

[[Page 23090]]

the implicit monthly market price for Sirius XM's music channels.\80\ 
Dr. Noll identified three methods for determining the implicit price. 
The first is the average retail price of $3.15 taken from Last.fm's and 
Pandora's non-interactive subscription services. Noll Revised WRT Table 
1, SXM Reb. Trial Ex. 6. As with Last.fm, there is no adjustment to 
account for functional differences between the Pandora webcasting 
service and satellite radio, whose primary use is in the automobile. 
The second is to derive a market price for Sirius XM using a survey 
conducted by Sirius XM's witness Professor John Hauser that attempts to 
measure the value of music to Sirius XM subscribers. Professor Hauser 
posited an anchor price for the Sirius XM service to his survey 
respondents, and then randomly removed features (such as lack of 
commercials, quality of sound, etc.) to determine how much the 
respondents would be willing to pay for the service after each feature 
is removed. After averaging the results, he determined that subscribers 
place an average value on Sirius XM's music channels of $3.24. Hauser 
Corrected WDT at Appendix G, SXM Dir. Trial Ex. 24. Professor Hauser's 
survey is of limited value. By design, the higher number of features or 
attributes of the Sirius XM service included in the survey, the lower 
the estimated value of any given service. This produces anomalous 
results, such as his survey showing that subscribers would pay a 
certain amount for ubiquitous station availability, premium sound 
quality and absence of commercials all without any programming content 
whatsoever. Ordover Amended WRT at 35, SX Trial Ex. 218.
---------------------------------------------------------------------------

    \80\ The implicit monthly price is applied to the effective 
percentage-of-revenue rate of [REDACTED] from the Last.fm agreements 
that serve as the numerator in Dr. Noll's calculation.
---------------------------------------------------------------------------

    Third, Dr. Noll sought to calculate the cost of inputs necessary 
for delivery of Sirius XM's programming via satellite and its 
subsidization/installation of radio receivers in automobiles (described 
as ``unique'' costs to the satellite radio service), to then deduct 
those costs from gross revenues, and allocate the remaining revenue 
between music and non-music content. Noll Revised Amended WDT at 81-83, 
85, SXM Dir. Trial Ex. 1. After making these calculations, Dr. Noll 
credited 55.1%, or $3.45, to music channels. Id. at 88 and Table 3. 
Sirius XM contends that including the unique delivery costs and 
investments of its service is appropriate in Dr. Noll's calculation, 
and cites to major record company agreements with Cricket and MetroPCS 
(mobile service providers that bundle telephone service and interactive 
music service into a single package) that reflect that a percentage 
royalty rate for music must be reduced by a commensurate proportion to 
reflect revenue collected for the non-music portion of the bundled 
service. Sirius XM PFF ]] 169-173. However, SoundExchange's expert 
economist, Dr. Thomas Lys, explained that because most of the unique 
costs that Dr. Noll allocated are relatively fixed, the per-subscriber 
amounts vary inversely with the number of subscribers. Lys WRT at 57, 
SX Trial Ex. 240. Dr. Noll performed his calculation of costs using 
2010 data, but had he used subscriber numbers for the years thereafter 
which have continued to increase and are anticipated to increase 
further in the coming licensing term, the analysis would show lower 
unique costs per subscriber and a higher value of music. Lys WRT at 57, 
SX Trial Ex. 240. The dependency of Dr. Noll's methodology on timing 
and the number of subscribers undermines its reliability for 
quantifying what the unique costs are likely to be in the coming rate 
term. Id. at 58. Moreover, Sirius XM's analogy to the bundled services 
of Cricket and MetroPCS is inapposite. Unlike those services, the 
success of Sirius XM is dependent upon its access to music. 6/14/12 Tr. 
2270:7-2271:15 (Ordover); see also 6/5/12 Tr. 235:6-10 (Noll)(``It's a 
bundle of services, it's a distribution system, a bunch of nonmusic 
content and a bunch of music content, all of which are essential. And 
you pull the plug on any one of them, and the whole thing 
collapses.''); 6/11/12 Tr. 1431:10-17 (Karmazin). The value of Sirius 
XM's satellite radio service is the bundling of music and non-music 
content with its delivery platform, and Sirius XM has failed to present 
convincing evidence that its delivery platform and non-music content, 
alone, present a viable business.\81\
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    \81\ Likewise, Sirius XM has failed to demonstrate that it could 
successfully substitute away to other providers of music. If that 
were the case, Sirius XM could have operated its business under the 
Direct Licenses, for example, and avoided participation in this 
proceeding altogether.
---------------------------------------------------------------------------

    In sum, these concerns, coupled with those surrounding the Direct 
Licenses themselves, do not inspire confidence that the Direct Licenses 
are the best benchmark for rate setting in this proceeding. Rather, I 
believe that the rates between 5% and 7% contained in the Direct 
Licenses mark the lower boundary of the range of reasonable rates to be 
determined in this proceeding. The evidence presented establishes that 
reasonable rates cannot be lower. I now examine the benchmarks offered 
by SoundExchange and Dr. Ordover.
    As an initial matter, the Judges have determined in the past that 
the interactive subscription service market is a benchmark with 
characteristics reasonably comparable with non-interactive SDARS. 
SDARS-I, 73 FR at 4093. Sirius XM, however, charges that Dr. Ordover 
began his analysis in the wrong place by examining rates for 
interactive services instead of non-interactive services. I do not 
agree. In saying this, I do not suggest that the market for interactive 
services, in and of itself, offers the best benchmark from which to 
begin an analysis of reasonable rates for Sirius XM's satellite radio 
service. Adjustments, as discussed below, are necessary for the 
benchmark to be at all useful. However, as a starting point, the 
interactive subscription service market is more illustrative of a 
competitive marketplace (willing buyer/willing seller) than the non-
interactive subscription service market, where negotiated rates are 
likely influenced by the availability of the statutory licensing regime 
for webcasting. See Webcasting III, 76 FR 13026 (Mar. 9, 2011)(citing 
Noncommercial Educational Broadcasting Compulsory License, Final rule 
and order, 63 FR 49823, 49834 (Sept. 18, 1998))(``[I]t is difficult to 
understand how a license negotiated under the constraints of a 
compulsory license, where the licensor has no choice to license, could 
truly reflect `fair market value.' ''). Furthermore, the agreements 
examined by Dr. Ordover represent a more robust data source from which 
to consider the outcomes of marketplace negotiations, as opposed to Dr. 
Noll's confined use of only the Last.fm agreements.82, 83 
His observation of a clustering of effective percentage of revenue 
rates between 60% and 65% for interactive subscription services is 
supported by empirical evidence and is not misleading or under 
inclusive.\84\

[[Page 23091]]

Ordover Third Corrected/Amended WDT at 21 Table 1, 26, Table 2, SX 
Trial Ex. 74.
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    \82\ Dr. Noll identifies the non-interactive music services 
offered by Pandora, whom he categorizes as the ``big elephant in the 
room,'' as highly comparable to the satellite radio service of 
Sirius XM. 6/5/12 Tr. 286:21-287:7 (Noll). While his comparison is 
to the compatible features of Pandora, the parties have interjected 
and argued the royalty rates paid by Pandora for its music services. 
I am expressly not considering the rates, terms or conditions of 
Pandora's royalty payments in relation to the rates in this 
proceeding, for to do so would violate the terms of the Webcaster 
Settlement Act of 2009. See 17 U.S.C. 114(f)(5).
    \83\ Dr. Noll also considered agreements involving Slacker and 
Turntable, but only used the Last.fm agreements in his analysis. As 
Sirius XM acknowledges, the Slacker and Turntable services are more 
interactive than Last.fm, thereby weakening their comparability. 
Sirius XM RFF ] 64.
    \84\ Sirius XM makes much of the fact that rates obtained by the 
major record labels have dropped almost 20% since SDARS-I and argues 
that this logically must mean that music is worth less than in the 
prior proceeding. Sirius XM PFF ] 339. SoundExchange counters that 
the reason for the 20% drop is the decline in retail prices for 
interactive services, which SoundExchange concludes is an indication 
that consumers value interactivity less than before. SX RFF ] 145. 
Neither side provided empirical evidence to prove their point, and 
logic does not dictate that music is of any less, or more, value as 
a result of this occurrence.
---------------------------------------------------------------------------

    I am not persuaded that Dr. Ordover's perceived ``failure'' to 
incorporate the costs of Sirius XM's satellite delivery platform 
renders his interactive subscription services benchmark fatally flawed 
or in need of adjustment. Dr. Noll asserts that the Sirius XM satellite 
radio service should be viewed as a bundle of three inputs--music 
content, non-music content, and the satellite platform for delivering 
the content--and attempts to separately value each component of the 
bundle. Noll Revised Amended WDT at 80, SXM Dir. Trial Ex. 1. Consumers 
do not value the satellite platform independent of the content it 
transmits, 6/7/12 Tr. 666:5-11 (Frear), and Sirius XM has not 
successfully demonstrated that the satellite platform can be unbundled 
and sold separately. See SDARS-I, 73 FR at 4089; see also Ordover 
Amended WRT at 33, SX Trial Ex. 218 (Cricket license agreements reflect 
that its delivery system provides services that have independent value 
to consumers). The value of Sirius XM's service is the end product to 
the consumer, as is the case with the interactive subscription service 
consumer, and no adjustment for the delivery mechanism is necessary.
    To be sure, the rights licensed by interactive subscription 
services are not the same as those by non-interactive services such as 
the SDARS, and adjustment to the interactive benchmark is necessary to 
account for these differences. See SDARS-I, 73 FR at 4093. Dr. Ordover 
attempted to account for these differences by offering two alternative 
benchmarks. His first alternative begins with the average monthly per-
subscriber fee paid by interactive services and reduces that fee in 
proportion to the ratio of the retail price of Dr. Ordover's 
hypothetical music-only satellite radio service to the retail price of 
interactive services. There are doubts as to whether this approach 
accurately adjusts the interactive service benchmark to account for 
differences in attributes and functionality between interactive 
subscription services and satellite radio, and SoundExchange backed 
away from advocacy of this model in its post-trial submissions. I 
focus, instead, on Dr. Ordover's second alternative approach, which 
begins with the average monthly per-subscriber fee paid by interactive 
services ($5.95) and then reduces that fee in proportion to the ratio 
of the average retail price of non-interactive music services to the 
retail price of the interactive services ($4.86/$9.99). Ordover Third 
Corrected/Amended WDT at 34, SX Trial Ex. 74.
    It is readily apparent that Dr. Ordover's interactivity adjustment 
to his interactive subscription services benchmark in this proceeding 
is not the same as the one he performed in SDARS-I. Dr. Ordover based 
his adjustment in SDARS-I on per-play rates from non-interactive video 
streaming services, a market that both parties concede effectively no 
longer exists. SX RFF at 164; 8/15/12 Tr. 3573:22-3574:3 (Noll). 
However, I am not persuaded that the difference--using retail prices 
for non-interactive services in this proceeding rather than per-play 
rates--renders his analysis invalid. A straightforward comparison of 
per-play rates in the interactive and non-interactive markets would be 
flawed, in that it would not account for differences in intensity of 
use (average number of plays per subscriber) between the markets, and 
would involve analysis of non-interactive rates from a market subject 
to influences of the statutory license. Comparing retail prices between 
the markets, as Dr. Ordover does, is a reasonable approach as the value 
of interactivity to consumers will likely be reflected in retail 
prices. 8/16/12 Tr. 3836:5-11 (Salinger).
    While I find Dr. Ordover's comparison of retail prices in the 
interactive and non-interactive markets conceptually sound, his 
analysis is not without warts. In deriving his average non-interactive 
service price for the five non-interactive services he examined, Dr. 
Ordover's averaging technique placed greater weight on the higher-
priced services.\85\ A more accurate method for calculating the average 
price is to include a single time-frame observation--the price of a 
year of service--for each of the five services. This procedure reduces 
the average price to $4.01. Noll Revised WRT at 25, SXM Reb. Trial Ex. 
6. Dr. Ordover also did not weight his average by the number of 
subscribers to each service to account for differences in popularity, 
presumably because data was not available for all five services. It 
exists, however, for Pandora, Last.fm and Live365. I accept Dr. Noll's 
weighted adjustment to $3.15 because of the unlikelihood that the other 
two services used by Dr. Ordover, Musicovery and Sky.fm, would 
significantly impact the calculation. Id. at 25-26.
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    \85\ The five non-interactive services selected by Dr. Ordover 
listed one retail price for two services, two retail prices for one 
service, and three retail prices for two services. Ordover Third 
Corrected/Amended WDT at ] 54, Table 5, SX Trial Ex. 74. The 
differing prices reflect differing duration commitments for 
subscribers.
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    In converting his price for non-interactive services to a price for 
Sirius XM, Dr. Ordover used the monthly price charged to subscribers 
for the Sirius XM Select package. Ordover Third Corrected/Amended WDT 
at 43, SX Trial Ex. 74. Dr. Noll suggests that using Sirius XM's 
Average Revenue Per User (``ARPU'') makes more sense, stating that ``I 
doubt that Dr. Ordover disagrees that ARPU, not sticker price, is the 
correct basis for calculating royalties.'' Noll Revised WRT at 20 n.5, 
SXM Reb. Trial Ex. 6. ARPU was $11.22 in the first quarter of 2011 and 
rose to $11.49 in the first quarter of 2012 after the Sirius XM price 
increase. I use $11.49 as the most current ARPU figure in the record, 
and the one most representative for the coming licensing term.
    Making the adjustments for the price of non-interactive services 
and revenues for Sirius XM \86\ yields a percentage-of-revenue rate for 
Sirius XM of 16.2%.\87\ Dr. Ordover opines that his second alternative 
benchmark generates a lower bound estimate of reasonable rates. Ordover 
Third Corrected/Amended WDT at 33, SX Trial Ex. 74. However, I am not 
confident that his benchmark fully adjusts for interactivity to the 
level of service offered by Sirius XM's satellite radio service. For 
example, Pandora and Last.fm allow more user control of content than 
Sirius XM. Noll Revised WRT at 27, SXM Reb. Trial Ex. 6. Musicovery 
allows users to create playlists within a social network, to ban songs 
and artists from certain customized channels, and to skip songs 
altogether, while Sky.fm permits caching for later listening. Id. at 
28. Additionally, Dr. Ordover's use of the average per-subscriber 
royalty payment of $5.95, which is drawn from the 60% average royalty 
fee for interactive services, bakes in the interactive service

[[Page 23092]]

royalty to his calculation by virtue of its use as a multiplier.
---------------------------------------------------------------------------

    \86\ While I am adopting these adjustments to Dr. Ordover's 
second alternative benchmark, I underscore that I am not adopting 
Dr. Noll's recommended use of the Last.fm non-interactive percentage 
rate (26.1%) for the same reasons that a five-year old agreement 
with two major record labels did not make for a useful benchmark.
    \87\ This is calculated by multiplying the interactivity ratio 
of .3153 ($3.15/$9.99) to the average per-subscriber royalty payment 
of $5.95, yielding an equivalent satellite radio payment of $1.87. 
The $1.87 per-subscriber rate is then divided by Sirius XM's ARPU 
($11.49), resulting in the percentage-of-revenue rate of 16.2%.
---------------------------------------------------------------------------

    There are other concerns with Dr. Ordover's analysis. For example, 
Live 365, which charges the most of the non-interactive services that 
Dr. Ordover observed, offers more than 7,000 channels that are pre-
programmed by independent entities and other content that does not 
closely resemble the Sirius XM satellite. This reduces my confidence 
that Dr. Ordover's 16.2% benchmark is as reliable as the one the Judges 
considered in SDARS-I. In sum, the 16.2% royalty rate marks the upper 
bound of reasonable rates in this proceeding, with the lower bound 
marked by the 5%-7% rates from the Direct Licenses. The appropriate 
royalty rates lie within this zone, identified by my Section 801(b) 
policy analysis described below.
4. The Section 801(b) Factors
    In SDARS-I, the Judges determined that an evaluation of the 
marketplace evidence hued in the direction of Dr. Ordover's 
interactivity-adjusted interactive subscription market analysis that 
marked the upper bound of reasonable royalty rates in that proceeding. 
See 73 FR at 4094. For the reasons stated above, the market-based 
evidence presented in this proceeding does not weigh in favor of either 
SoundExchange's or Sirius XM's presentations. Rather, reasonable rates 
to be paid by Sirius XM for the 2013-2017 licensing period lie along 
the continuum of rates marked at the lower end by 5%-7% from Sirius 
XM's presentation and at the upper end by 16.2% by SoundExchange's 
presentation. Consideration of the Section 801(b) policy factors 
locates the appropriate royalty rates within that range.
a. Maximize Availability of Creative Works
    The first policy objective set forth in Section 801(b)(1) is to 
``maximize the availability of creative works to the public.'' 17 
U.S.C. 801(b)(1)(A). Sirius XM argues that application of the first 
factor favors adoption of rates at the lower end of the range for three 
reasons.\88\ First, Sirius XM contends that its satellite radio service 
enhances the delivery and availability of sound recordings by providing 
nationwide transmissions of sound recordings not played elsewhere. 
Second, Sirius XM submits that royalties from the Section 114 SDARS 
license are too small a portion of record companies' overall revenue to 
be a driving force behind decisions to produce creative works. Thus, 
according to Sirius XM, a lower royalty rate will not reduce record 
companies' incentives. Third, Sirius XM argues that the promotional 
effects created by its artist-themed channels, special benefits and 
programming exert a direct promotional impact on the sale of sound 
recordings thereby generating revenue for rightsholders and inducing 
them further to create new sound recordings. Sirius XM RFF ] 99.
---------------------------------------------------------------------------

    \88\ SoundExchange, citing Dr. Ordover's testimony, argues that 
the policy considerations of the first three factors are subsumed in 
the marketplace benchmarks it has proffered. SX PFF ]] 502-507. 
Since I do not accept the benchmarks of either side as determinative 
of the rate to which Section 801(b) is applied, other than their 
ability to define the range of reasonable rates, SoundExchange's 
argument is inapposite.
---------------------------------------------------------------------------

    I am not persuaded that any of these reasons augurs in favor of 
rates at the lower end of the range of reasonable rates. While it is 
acknowledged that Sirius XM's signal is capable of reception in 
locations in the United States not served by over-the-air terrestrial 
broadcast radio or wireless Internet service, Dr. Noll could not 
estimate what percentage of the population (approximately 2% in the 
U.S.) in these unserved areas actually subscribes to Sirius XM's 
satellite radio service. Noll Revised Amended WDT at 18-21, SXM Dir. 
Trial Ex. 1. Even for those persons in unserved areas who do subscribe 
to Sirius XM, there is no evidence that this group depends upon Sirius 
XM in order to access music. In fact, Sirius XM's own internal survey 
demonstrates that subscribers who deactivate their Sirius XM service 
typically turn to consumption of music on CDs. SX Trial Ex. 8 at 23 
(SXM--CRB--DIR--00042796).
    With respect to the percentage of record company revenues 
represented by Sirius XM's Section 114 royalty payments, it is true 
that the percentages of the totals are low; nonetheless, there is 
testimony that the royalty payments contribute significantly to overall 
profitability. See, 6/13/12 Tr. 2141:1-10 (Ciongoli)(UMG); Ford 
Amended/Corrected WRT at 13, SX Trial Ex. 244 (Warner); PSS Trial Ex. 
33 (Sony). Therefore, it cannot be said that Section 114 royalty 
rates--whether low or high within the range--have no impact whatsoever 
on record companies' incentives to create new sound recordings.
    Finally, there is no objective, quantifiable evidence that Sirius 
XM's promotional activities with respect to its music offerings, 
events, and surrounding programming produce a net positive impact on 
record company revenues. While these activities, viewed individually, 
may have promotional effect on record sales, there is insufficient 
evidence in the record as to the overall effect of Sirius XM's 
satellite radio service on all streams of record company revenues from 
sound recordings. Indeed, Sirius XM's witness Steven Blatter conceded 
that his examples of on-the-air activities showed only a correlation 
between airplay and record sales and nothing more. 6/8/12 Tr. 1032:20-
1033:7 (Blatter). It may be that Sirius XM's use of sound recordings 
has an overall substitutional effect upon record company revenues, as 
opposed to an overall promotional effect. Sufficient and creditable 
evidence is not present in this record to quantify the promotional/
substitutional effect of Sirius XM's service.
    In sum, I find that the policy goal of maximizing the availability 
of creative works to the public is not, due to the paucity of the 
evidentiary presentations, advanced by royalty rates at either the 
upper bound or the lower bound of the range of reasonable rates 
determined from my analysis of the marketplace evidence.
b. Afford Fair Return/Fair Income Under Existing Market Conditions
    The second policy objective seeks ``to afford the copyright owner a 
fair return for his or her creative work and the copyright user a fair 
income under existing economic conditions.'' 17 U.S.C. 801(b)(1)(B). 
SoundExchange contends that dramatic changes in the recorded music 
business within the last decade have placed a greater emphasis on 
digital exploitation of sound recordings versus physical sales, thereby 
increasing the importance of revenues generated by the Section 114 
license. Sirius XM contends that lower royalty rates are necessary to 
enable it to recover the investments in its satellite business and 
achieve profitability.
    Charles Ciongoli, Executive Vice President and Chief Financial 
Officer for Universal Music Group North America (``UMG''), testified 
that the recorded music business' new reliance on digital revenues is 
the result of consumers purchasing fewer physical products as they gain 
more widespread access to music through digital services. As a result, 
companies like UMG cannot rely solely on the sale of physical products 
or permanent downloads, as in years past, and must obtain substantial 
royalty revenues from ``access'' services, such as Sirius XM, in order 
to survive. Ciongoli Corrected WDT at 4-6, SX Trial Ex. 67. See also 
Bryan Corrected WDT at 3-4, SX Trial Ex. 66; 6/13/12 Tr. 1969:21-
1970:12 (Bryan). SoundExchange submits that digital royalties are even 
more important for independent record companies to

[[Page 23093]]

ensure a fair return on their efforts to develop artists in the short 
and long terms. Van Arman WDT at 3, SX Trial Ex. 77.
    Sirius XM states that the costs of its investments in the satellite 
business, expenses related to research, development, and permitting, 
and its operating losses must be measured cumulatively, not as a 
snapshot of annual operating costs, in considering fair return to the 
user under the second Section 801(b) factor. Sirius XM PFF ] 263. The 
evidence, according to Sirius XM, demonstrates that it is a long way 
from earning any return on its billions of dollars of expenditures, in 
contrast to the record companies which have ``presented no evidence 
that the record industry is not currently earning a fair return on its 
investments in the production of creative works.'' Id. at ] 264.
    Evaluating royalty rates that would enable recovery of expenditures 
of Sirius XM over more than a decade of operations is not required 
under the second Section 801(b) factor.\89\ As the Judges observed in 
SDARS-I, ``[a]ffording copyright users a fair income is not the same 
thing as guaranteeing them a profit in excess of the fair expectations 
of a highly leveraged enterprise.'' SDARS I, 73 FR at 4095 (footnote 
omitted). During the current five-year licensing period, Sirius XM has 
publicly reported in its SEC filings adjusted Earnings Before Interest, 
Taxes, Depreciation and Amortization (``EBITDA'') of positive $2.1 
billion, and net income of positive $3.2 billion. Frear WDT at 7, SXM 
Dir. Trial Ex. 12 (2008-2010 results); Lys WRT at SX Ex. 231-RP, SX Ex. 
232-RP, SX Trial Ex. 40 (2011 and 2012 first quarter results), SX Trial 
Ex. 240; SX Trial Ex. 217 (2012 second quarter results and 2012 full-
year guidance). By the end of 2012 under the current 8% of Gross 
Revenues royalty rate, Sirius XM expects to report cumulative adjusted 
EBITDA of positive $2.6 billion, net income of positive $3.4 billion, 
and free cash flow of positive $1 billion. SX Trial Ex. 217. EBITDA 
results are predicted to increase in the coming years, whether the 
royalty rates are set beginning at 9% in 2013 and rising 1% per year to 
end at 13% (Morgan Stanley's ``base case'' scenario), or beginning at 
12% in 2013 and rising by 2% per year to end at 20% (Morgan Stanley's 
``bear case'' scenario). SXM Reb. Trial Ex. 12 at 9; SX PFF ] 568. In 
sum, I cannot discern how selection of any rate within the range of 
reasonable rates suggested by the marketplace evidence will fail to 
enable Sirius XM to earn a fair income in the upcoming licensing 
period.
---------------------------------------------------------------------------

    \89\ Indeed, it is difficult to imagine royalty rates, other 
than perhaps those approaching zero, that might make more than a 
dent in the recovery of billions of dollars of cumulative losses.
---------------------------------------------------------------------------

    With respect to fair return to the copyright owner, I accept the 
testimony of Mr. Ciongoli and others that revenues from the statutory 
licenses are of greater importance to record labels as a result of the 
changes brought about by digital distribution of music and that such 
revenues contribute to the overall profits. Their importance may be 
offset somewhat by the gains achieved by the lower costs associated 
with digital distribution and the efficiencies achieved by the record 
industry in recent years through downsizing. At best, the record 
testimony suggests that a royalty rate above the existing 8% of Gross 
Revenues will promote a fair return to copyright owners in the upcoming 
licensing term, but the evidence does not permit quantification of an 
increase with accuracy. Nevertheless, I am satisfied that the rates set 
forth below incorporate the policy considerations of fair return/fair 
income prescribed in the second Section 801(b) factor.
c. Relative Roles of Copyright Owners and User
    This policy factor requires that the rates adopted reflect the 
relative roles of the copyright owners and copyright user in the 
product made available with respect to relative creative contribution, 
technological contribution, capital investment, cost, risk, and 
contribution to the opening of markets for creative expression and 
media for their communication. 17 U.S.C. 801(b)(1)(C). The majority of 
the evidence and arguments submitted by the parties on this factor can 
be generally described by a single inquiry: who spent more on their 
business? Compare, SX PFF ]] 535-544 with Sirius XM PFF ]] 278, 289-
290, 294. Capital investments, costs and risk, however, are only part 
of the analysis required by the third Section 801(b) factor. Relative 
creative and technological contributions, as well as contributions to 
opening new markets must also be considered. Sirius XM contends that it 
has pioneered and built a complex satellite delivery system that 
assures uninterrupted, nationwide availability of programming content, 
thereby creating a satellite radio business that did not previously 
exist. Sirius XM PFF ]] 280-286. SoundExchange counters that Sirius XM 
has exploited mostly existing technology, principally designed and 
built by WorldSpace, Boeing, PanAmSat and the United States Army. SX 
RFF ]] 252-257.
    As is stated with respect to the PSS, supra, the task is not to 
consider each element of the third factor separately and make 
unspecified, unquantified up or down adjustments to the chosen royalty 
rates. Rather, the task with respect to the SDARS rate is to consider 
the elements as a whole and determine whether such consideration 
warrants any directional change in the range of rates established by 
the evaluation of the marketplace evidence (i.e., 5%-7% on the lower 
end to 16.2% on the upper end). I conclude, upon careful weighing of 
the evidence, that the third Section 801(b) factor does not require 
royalty rates that hue to either end of the spectrum of reasonable 
rates. In fact, little has changed in the evidentiary record relevant 
to this factor since SDARS-I. Sirius XM continues to overstate the 
originality of its technological contributions, as well as its exposure 
to risk. Elbert Designated WRT passim, SX Trial Ex. 410. No new markets 
have been opened during the current licensing term, nor is there 
evidence suggesting that the situation will change in the upcoming 
term. As was the case in SDARS-I, Sirius XM and the record companies 
continue to invest large sums in operating and advancing their 
businesses, as well as developing products for the future. The evidence 
does not indicate that the output or efforts of either side warrants a 
higher or lower royalty rate.
d. Minimize Disruptive Impact
    The fourth policy factor under Section 801(b) requires the Judges 
to determine rates that ``minimize any disruptive impact on the 
structure of the industries involved and on generally prevailing 
industry practices.'' 17 U.S.C. 801(b)(1)(D). The analytical framework 
for my evaluation of this factor is well established. A royalty rate 
may be considered disruptive ``if it directly produces an adverse 
impact that is substantial, immediate and irreversible in the short-run 
because there is insufficient time for [the parties impacted by the 
rate] to adequately adapt to the changed circumstances produced by the 
rate change and, as a consequence, such adverse impacts threaten the 
viability of the music delivery service currently offered to consumers 
under this license.'' SDARS-I, 74 FR at 4097; see also Phonorecords I, 
74 FR 4510, 4525 (Jan. 26, 2009).
    In SDARS-I, it was the Judges' consideration of this factor that 
merited the adoption of a rate below the upper bound of the zone of 
reasonable market rates suggested by the interactivity-

[[Page 23094]]

adjusted Ordover benchmark (i.e., 13%). It is, therefore, not 
surprising that the parties have devoted most of their argument under 
Section 801(b) to the fourth factor. Much of this argument is 
inapposite here, however, because it is made in support of the parties' 
respective rate proposals. The task here is to evaluate rates within 
the 5%-7% to 16.2% zone of reasonableness and select a rate or rates, 
consistent with the other Section 801(b) factors, that will not cause 
disruption. This requires consideration of the evidence on disruption 
presented in this proceeding, not the evidence that was presented or 
evaluated by the Judges in SDARS-I.
    The record in this proceeding demonstrates that Sirius XM is in a 
far stronger financial position than it was at the time of SDARS-I. At 
the end of 2007, Sirius and XM \90\ had a total of 17.3 million 
subscribers. SX Trial Ex. 16 at 18 (SXM--CRB--DIR--00021683). By the 
end of 2012, Sirius XM has announced that, with a net increase of 1.6 
million subscribers this year, it will attain 23.5 million subscribers. 
SX Trial Ex. 217 at 7. In 2007, Sirius and XM had combined revenue of 
only $2.1 billion, with combined adjusted EBITDA of negative $565 
million. SX Trial Ex. 16 at p. 14-15 (SXM--CRB--DIR--00021680-81). By 
the end of 2012, Sirius XM has announced that its revenue will be $3.4 
billion, and its adjusted EBITDA will be approximately a positive $900 
million. SX Trial Ex. 217 at 7. A similar situation applies to free 
cash flow, rising from negative $505 million in 2007 to approximately 
positive $700 million in 2012. SX Trial Ex. 16 at 16 (SXM--CRB--DIR--
00021682); SX Trial Ex. 217 at 7; see also Lys Corrected WDT at 18-21, 
SX Trial Ex. 80. In 2007, Sirius and XM faced considerable expense in 
the completion of their satellite builds, the failure of which, the 
Judges recognized, ``clearly raises the potential for disruption of the 
current consumer service.'' SDARS-I, 73 FR at 4097. Sirius XM has no 
plans to launch or invest in new satellites during the 2013-2017 
licensing period. Lys WRT at SX Ex. 211-RP at 44, SX Trial Ex. 240; 6/
6/12 Tr. 607:18-22 (Meyer).
---------------------------------------------------------------------------

    \90\ The merger of the two companies did not occur until the 
following year. 6/7/12 Tr. 640:15 (Frear).
---------------------------------------------------------------------------

    Despite its strong financials in 2012, Sirius XM's witnesses 
attempt to paint a grim picture for the upcoming licensing term. David 
Stowell, professor of finance at Northwestern University's Kellogg 
School of Management, testified that Sirius XM's financial history and 
substantial accumulated losses evince a threat of disruption caused by 
higher royalty rates that is ``equal to or even greater than the one it 
faced at the time of the last rate proceeding.'' Stowell WDT at 21, SXM 
Dir. Trial Ex. 18. David Frear, Sirius XM's Chief Financial Officer, 
testified that Sirius XM's brush with bankruptcy in late 2008 (where it 
struggled to repay the balance due on notes that matured on February 
17, 2009, until receiving a loan from Liberty Media) requires that 
Sirius XM maintain a cash reserve of at least $750 million to guard 
against future calamity. Frear WDT at 4-5, SXM Dir. Trial Ex. 12; 6/7/
12 Tr. 663:17-665:2 (Frear). Mr. Frear and Mel Karmazin, the Chief 
Executive Officer of Sirius XM, testified that the satellite delivery 
infrastructure of Sirius XM radio is inherently risky and that any 
number of events could seriously impact its ability to deliver 
programming and result in large, unanticipated expense. Frear WDT at 9, 
SXM Dir. Trial Ex. 12; Karmazin WDT at 17, SXM Dir. Trial Ex. 19. James 
Meyer, Sirius XM's President of Operations and Sales, testified that 
current economic uncertainty can affect the purchase of Sirius XM in 
automobiles and increase the number of current subscribers 
discontinuing service (described as the ``churn rate''). 6/6/12 Tr. 
566:21-568:16 (Meyer); Meyer WDT at 18-19, 29-30, SXM Dir. Trial Ex. 5. 
And William Rosenblatt, president of GiantSteps Media Technology 
Strategies, along with Messrs. Meyer, Karmazin, Frear and Professor 
Stowell, testified that rapidly evolving Internet-based competitors, 
advantaged by rapidly expanding wireless broadband capabilities and the 
explosion of smartphone use, present a potentially great disruptive 
challenge to Sirius XM during the 2013-2017 licensing period. 
Rosenblatt Corrected WDT passim, SXM Dir. Trial Ex. 17; Meyer WDT at 7-
18, SXM Dir. Trial Ex. 5; Stowell WDT at 10-11, 22, SXM Dir. Trial 
Ex.18; 6/11/12 Tr. 1429:6-13 (Karmazin); 8/13/12 Tr. 3042:5-3043:9 
(Frear).
    The problem with Sirius XM's parade of horribles is that--with one 
exception--it is belied by the evidence and, in most instances, by 
Sirius XM's own public statements. Dr. Thomas Lys, SoundExchange's 
expert economist, presented data projecting Sirius XM's likely future 
EBITDA and free cash flow (two financial measures that the Judges 
focused on in considering the disruption factor in SDARS-I) using 
forecasts from Morgan Stanley and Sirius XM's own internal projections. 
Morgan Stanley projects significant positive EBITDA and free cash flow 
for Sirius XM in the upcoming license period under varying scenarios 
with different royalty rates and economic conditions. Lys WRT at 21-31, 
SX Trial Ex. 240. Particularly relevant to the consideration of 
reasonable rates is Morgan Stanley's recent 2012 baseline projection 
which assumes that royalty rates will begin at 9% in 2013 and rise 1% 
per year to end at 13%. SXM Reb. Trial Ex. 12 at 9. Under this 
projection, Sirius XM's EBITDA will increase each year despite the 
increases in rates and will be higher than Sirius XM has achieved in 
the history of its company. Id. Furthermore, projections made using 
Sirius XM's own internal forecasts generally corroborate these results. 
Lys WRT at 11, SX Trial Ex. 240.
    Sirius XM vehemently opposes consideration of either the Morgan 
Stanley or its own internal projections, arguing that long-term 
financial projections for Sirius XM are not reliable. Sirius XM RFF ]] 
118-129. It is certainly true that the longer the term of forecast, the 
lesser the degree of accuracy that can be expected in the latter 
portion of the term. However, Sirius XM does not and cannot contend 
that short-term projections, either its own or those of Morgan Stanley, 
are highly unreliable.\91\ Both show substantial EBITDA profitability 
and positive free cash flow, even under scenarios that exceed the range 
of reasonable rates I have identified in this proceeding. See Lys 
Corrected WDT at 25-28, SX Trial Ex. 80. A royalty rate can be 
disruptive under the fourth Section 801(b) factor if it ``produces an 
adverse impact that is substantial, immediate and irreversible in the 
short-run.'' SDARS-I, 73 FR at 4097. The Morgan Stanley and Sirius XM 
internal projections convincingly reveal that disruption to Sirius XM 
will not occur in the short run by royalty rates within the range of 
reasonable rates identified in this proceeding.\92\
---------------------------------------------------------------------------

    \91\ The record in this proceeding is replete with public 
statements and assertions by the executive officers of Sirius XM 
that the company is and will be highly successful and profitable, 
both in the short term and the long term. See, e.g,, Lys Corrected 
WDT at 8, 10-11 (quoting Mr. Karmazin from November 2011: ``[W]e 
believe we have many, many years of subscriber growth ahead of 
us.''), SX Trial Ex. 80; 8/13/12 Tr. 3179:7-10 (Frear)(Sirius XM 
revenue not just growing, but accelerating); Lys WRT at 31 & SX 238-
RP (Mr. Karmazin in an April 2012 interview with Forbes magazine: 
``[W]e're a very profitable, successful company. If we want a 
performer, we can afford to pay more than anybody else because we're 
making more.''), SX Ex. 226-RP (Mr. Karmazin: ``Given the 
predictable nature of our business, we would prefer to take 
advantage of a prudent level of leverage, which should mean higher 
returns to our equity holders over time.''), SX Trial Ex. 240.
    \92\ I find Professor Stowell's criticisms of equity analysts' 
forecasts flawed and unpersuasive. He ignores substantial, published 
research as to the improved accuracy of projections, particularly 
within recent years, as well as changes implemented by the 
Securities and Exchange Commission to eliminate analyst bias. Lys 
WRT at 11-12, SX Trial Ex. 240. He also ignores recent data 
criticizing the performance of equity analysts that follow Sirius 
XM, confining his analysis to only forecasts made prior to the 
Sirius and XM merger. Id. at 14.

---------------------------------------------------------------------------

[[Page 23095]]

    There is also another element of Sirius XM's business operation 
that persuades me that rates within the reasonable range I have 
identified in this proceeding will not be disruptive: the Music Royalty 
Fee. The U.S. Music Royalty Fee was adopted by Sirius XM in July 2009, 
with the permission of the Federal Communications Commission, as a 
result of the Sirius and XM merger and in response to the royalty rates 
adopted in SDARS-I,\93\ to pass through to subscribers Sirius XM's 
music royalty costs. After adopting the $1.98 per subscriber per month 
charge (it is currently $1.42), Mr. Karmazin informed investors that 
there was no ``discernable impact on churn,'' meaning that the overall 
price increase to subscribers did not impact Sirius XM's ability to 
retain its subscribers. Lys WRT at 33-34, SX Trial Ex. 240. Sirius XM's 
long-range planning documents reveal an intention for future use of the 
Music Royalty Fee to recoup music licensing expenses, SX Trial Ex. 9 at 
6 (SXM--CRB--DIR--00031738), and neither Messrs. Karmazin nor Frear 
denied that the Music Royalty Fee will continue to appear on customers' 
bills in some amount in the upcoming 2013-2017 licensing period. Sirius 
XM's demonstrated ability to pass through music licensing costs to its 
subscribers without discernible, negative impact to its satellite radio 
business further belies its claims that increased royalty fees from 
current levels will be disruptive.\94\
---------------------------------------------------------------------------

    \93\ Indeed, Sirius XM originally considered calling the fee the 
``Copyright Royalty Board Fee'' instead of the Music Royalty Fee. 
Lys WRT at 33 n.142, SX Trial Ex. 240.
    \94\ SoundExchange and Sirius XM disagree as to what percentage 
of licensing costs are passed through to subscribers in the Music 
Royalty Fee. SoundExchange contends 100%, Lys WRT at 32 & SX Ex. 
240-RR, SX Trial Ex. 240, while Sirius XM contends 53%. Frear 
Revised WRT at 16, SXM Reb. Trial Ex. 1. A substantial portion of 
licensing fees is passed on to subscribers in either case, 
ameliorating the possibility of short-term negative effects of 
increased Section 114 fees.
---------------------------------------------------------------------------

    Sirius XM also posits several financial risks for the upcoming 
license period that it claims will be exacerbated by higher royalty 
rates. First, Sirius XM contends that higher royalty rates will reduce 
available levels of free cash flow to such an extent as to impair 
Sirius XM's ability to account for possible downturns in any of its key 
performance metrics such as churn, conversion from trial to paid 
subscriptions, and average revenue per user over the upcoming rate 
term. Sirius XM RFF ] 117. Unlike consideration of the Sirius XM or 
Morgan Stanley forecasts, which have reasonable reliability at least in 
the short term, Sirius XM's suggestions of possible downturns in its 
satellite radio business are no more than that. While downturns are 
possible, Sirius XM has not presented compelling testimony that any one 
or more events are probable and, therefore, must be considered closely.
    Second, Sirius XM contends that its ``brush with bankruptcy'' in 
the aftermath of the July 2008 merger demonstrates the risk of its debt 
level and difficulty in accessing credit markets, all of which will be 
made worse by higher royalty rates. Sirius XM PFF ]] 313-314. The 
``brush with bankruptcy'' argument, however, is a red herring, as it 
was caused by the need to refinance during a global-wide credit crisis 
and had nothing to do with the Section 114 royalty rates. 8/20/12 Tr. 
4040:14-4042:7 (Lys).\95\ Professor Stowell's conclusion that Sirius XM 
has a ``realistic possibility'' of defaulting on its outstanding debt 
in the near future is speculative and not based upon the possibility of 
higher Section 114 royalty rates, since the ratings agencies do not 
discuss such royalties as a primary risk of Sirius XM in assessing its 
credit quality and likelihood of default. Lys WRT at 23, SX Trial Ex. 
240; 8/20/12 Tr. 4049:2-4050:13 (Lys). Moreover, credit rating agencies 
have repeatedly raised Sirius XM's credit rating over the last few 
years and believe that it has strong liquidity and ability to finance 
its debt. Lys Corrected WDT at 31-32, SX Trial Ex. 80; Lys WRT at 47-
48, SX Trial Ex. 240.
---------------------------------------------------------------------------

    \95\ The odds of another such crisis occurring during the 2013-
2017 licensing period are low since that type of crisis has happened 
only twice in the past 80 years. 8/20/12 Tr. 4046:5-9 (Lys).
---------------------------------------------------------------------------

    Third, Sirius XM argues that higher royalty rates will disrupt its 
ability to recoup billions of dollars of accumulated losses. Sirius XM 
PFF ] 312; see also Frear WDT at 7, SXM Dir. Trial Ex. 12 (discussing 
decrease in Sirius and XM stock prices from 2000 to 2007). Past losses 
and decreases in stock prices, however, do not have relevance to a 
disruption analysis under Section 801(b). There is no evidence that the 
expenditures of prior investors will have any impact on the future 
decision making or operation of the company. See, e.g., 6/8/12 Tr. 
1297:1-8 (Stowell) (Professor Stowell acknowledging that he did not 
know if any pre-2008 investors are still owners of Sirius XM stock 
today).
    In sum, there is no persuasive evidence that an increase in royalty 
rates from the current level and within the range of reasonable rates 
identified by the analysis of market evidence will cause disruption to 
the operation of Sirius XM's satellite radio business in the beginning 
to middle of the 2013-2017 licensing period. There is, however, 
testimony that raises the potential for disruption in the latter 
portion of the licensing term. New Internet-based competitors, whose 
emergence is enabled by the explosion of wireless broadband capability 
and smartphone use, appear poised to offer the same advantages over 
terrestrial radio that Sirius XM once claimed only to itself, and 
without the expenses associated with a satellite-based delivery system. 
Meyer WDT at 5-11, SXM Direct Trial Ex. 5; Rosenblatt Corrected WDT at 
12-14, 20-38, SXM Dir. Trial Ex. 17. Such competitors can also offer 
their customers the added benefits of increased customization and 
personalization which Sirius XM is incapable of providing on its 
satellite radio service. Meyer WDT at 8-9, SXM Dir. Trial Ex. 5; 
Rosenblatt Corrected WDT at 20-31, SXM Dir. Trial Ex. 17. Many of these 
competitive products are being introduced already, particularly in 
automobiles which lie at the core of Sirius XM's satellite radio 
business, and could cause disruption by 2016 or 2017. See Meyer WDT at 
15 (all major car manufacturers expected to incorporate connected-car 
technology within the next three years), SXM Dir. Trial Ex. 5. 
SoundExchange counters that Sirius XM enjoys considerable advantages 
over Internet radio competitors, such as a head start in integration of 
satellite radios into the automobile dashboard, current agreements with 
auto manufacturers, and current limitations on network streaming 
technology. SX PFF ]] 637, 639-640, 642, 645-648. Nevertheless, 
SoundExchange does acknowledge that Internet-based competitors will 
grow, along with Sirius XM, in the coming rate term. Id. ] 650.
    The evidence suggests that competition from Internet-based radio, 
particularly in the automobile, may cause disruption to Sirius XM's 
business by the final two years of the upcoming licensing period. The 
potential for such disruption is underscored by the limitations 
afforded to long-term financial projections (four and five years from 
now), and the relative speed in technological development demonstrated 
in the marketplace in recent years for delivery of music. I cannot 
forecast with certainty the degree to which future

[[Page 23096]]

Internet-based competition may cause disruption in Sirius XM's business 
and, therefore, cannot determine the amount to which royalty rates may 
or should be reduced to prevent such disruption. However, the potential 
for disruption is suggested sufficiently by the evidence and counsels 
against escalation of the royalty rates in the last two years of the 
2013-2017 license period.
5. Conclusions Regarding Section 114 Rates
    As discussed above, analysis of the market-based evidence presented 
in this case yields a range of reasonable royalty rates between 5%-7% 
on the lower end, and 16.2% on the upper end. I have analyzed and 
applied the Section 801(b) factors to this range of reasonable rates 
and conclude that only two of the factors--the second and the fourth--
impact the selection of rates within the range for the upcoming 2013-
2017 licensing term. The second factor (fair return/fair income under 
existing market conditions) suggests selection of royalty rates that 
are above the current 8% rate, albeit without specific quantification. 
The fourth factor (minimizing any disruptive impact on the structure of 
the industries involved and on generally prevailing industry practices) 
counsels against raising the royalty rates further in the final two 
years of the licensing term. I dissent from the rates adopted by the 
majority and submit that they should be as follows: for 2013: 10.0%; 
for 2014: 11.0%; for 2015: 12.0%; 2016: 12.0%; and for 2017: 12.0%.

Dated: February 14, 2013.

William J. Roberts, Jr.,
Copyright Royalty Judge.

List of Subjects in 37 CFR Part 382

    Copyright, Digital audio transmissions, Performance right, Sound 
recordings.

Final Regulations

    For the reasons set forth in the preamble, the Copyright Royalty 
Judges amend 37 CFR part 382 as follows:

PART 382--RATES AND TERMS FOR DIGITAL TRANSMISSIONS OF SOUND 
RECORDINGS AND THE REPRODUCTION OF EPHEMERAL RECORDINGS BY 
PREEXISTING SUBSCRIPTION SERVICES AND PREEXISTING SATELLITE DIGITAL 
AUDIO RADIO SERVICES

0
1. The authority citation for part 382 continues to read as follows:

    Authority: 17 U.S.C. 112(e), 114 and 801(b)(1).

Sec.  382.1  [Amended]

0
2. Section 382.1 is amended as follows:
0
a. In paragraph (a), by removing ``114(d)(2)'' and adding ``114'' in 
its place, and by removing ``ephemeral phonorecords'' and adding 
``Ephemeral Recordings'' in it place;
0
b. In paragraph (c), by removing ``ephemeral phonorecords'' and adding 
``Ephemeral Recordings'' in its place; and
0
c. By removing paragraph (d).

Sec. Sec.  382.2 through 382.7  [Redesignated as Sec. Sec.  382.3 
through 382.8]

0
3. Redesignate Sec. Sec.  382.2 through 382.7 as Sec. Sec.  382.3 
through 382.8, respectively, and add new Sec.  382.2 to read as 
follows:

Sec.  382.2  Definitions.

    For purposes of this subpart, the following definitions shall 
apply:
    Collective is the collection and distribution organization that is 
designated by the Copyright Royalty Judges. For the 2013-2017 license 
term, the Collective is SoundExchange, Inc.
    Copyright Owners are sound recording copyright owners who are 
entitled to royalty payments made under this subpart pursuant to the 
statutory licenses under 17 U.S.C. 112(e) and 114.
    Ephemeral Recording is a phonorecord created for the purpose of 
facilitating a transmission of a public performance of a sound 
recording under a statutory license in accordance with 17 U.S.C. 114 
and subject to the limitations specified in 17 U.S.C. 112(e).
    GAAP shall mean generally accepted accounting principles in effect 
from time to time in the United States.
    Gross Revenues. (1) Gross Revenues shall mean all monies derived 
from the operation of the programming service of the Licensee and shall 
be comprised of the following:
    (i) Monies received by Licensee from Licensee's carriers and 
directly from residential U.S. subscribers for Licensee's programming 
service;
    (ii) Licensee's advertising revenues (as billed), or other monies 
received from sponsors, if any, less advertising agency commissions not 
to exceed 15% of those fees incurred to a recognized advertising agency 
not owned or controlled by Licensee;
    (iii) Monies received for the provision of time on the programming 
service to any third party;
    (iv) Monies received from the sale of time to providers of paid 
programming such as infomercials;
    (v) Where merchandise, service, or anything of value is received by 
Licensee in lieu of cash consideration for the use of Licensee's 
programming service, the fair market value thereof or Licensee's 
prevailing published rate, whichever is less;
    (vi) Monies or other consideration received by Licensee from 
Licensee's carriers, but not including monies received by Licensee's 
carriers from others and not accounted for by Licensee's carriers to 
Licensee, for the provision of hardware by anyone and used in 
connection with the programming service;
    (vii) Monies or other consideration received for any references to 
or inclusion of any product or service on the programming service; and
    (viii) Bad debts recovered regarding paragraphs (1)(i) through 
(vii) of this definition.
    (2) Gross Revenues shall include such payments as set forth in 
paragraphs (1)(i) through (viii) of this definition to which Licensee 
is entitled but which are paid to a parent, subsidiary, division, or 
affiliate of Licensee, in lieu of payment to Licensee but not including 
payments to Licensee's carriers for the programming service. Licensee 
shall be allowed a deduction from ``Gross Revenues'' as defined in 
paragraph (1) of this definition for affiliate revenue returned during 
the reporting period and for bad debts actually written off during 
reporting period.
    Licensee means any preexisting subscription service as defined in 
17 U.S.C. 114(j)(11).
    Performers means the independent administrators identified in 17 
U.S.C. 114(g)(2)(B) and (C), and the parties identified in 17 U.S.C. 
114(g)(2)(D).
    Qualified Auditor is a Certified Public Accountant.
0
4. Revise newly redesignated Sec.  382.3 to read as follows:

Sec.  382.3  Royalty fees for the digital performance of sound 
recordings and the making of ephemeral recordings by preexisting 
subscription services.

    (a) Commencing January 1, 2013, and continuing through December 31, 
2017, the monthly royalty fee to be paid by a Licensee for the public 
performance of sound recordings pursuant to 17 U.S.C. 114 and the 
making of any number of Ephemeral Recordings to facilitate such 
performances pursuant to 17 U.S.C. 112(e) shall be a percentage of 
monthly Gross Revenues resulting from residential services in the 
United States as follows: for 2013, 8%; and for 2014 through 2017, 
8.5%.
    (b) Each Licensee making digital performances of sound recordings 
pursuant to 17 U.S.C. 114 and Ephemeral Recordings pursuant to 17 
U.S.C. 112(e) shall make an advance

[[Page 23097]]

payment to the Collective of $100,000 per year, payable no later than 
January 20th of each year. The annual advance payment shall be 
nonrefundable, but it may be counted as an advance of the section 112 
royalties due and payable for a given year or any month therein under 
paragraph (a) of this section; Provided, however, that any unused 
portion of an annual advance payment for a given year shall not carry 
over into a subsequent year.
    (c) The royalty payable under 17 U.S.C. 112(e) for the making of 
phonorecords used by the Licensee solely to facilitate transmissions 
for which it pays royalties as and when provided in this subpart shall 
be included within, and constitute 5% of, the total royalties payable 
under 17 U.S.C. 112(e) and 114.
    (d) A Licensee shall pay a late fee of 1.5% per month, or the 
highest lawful rate, whichever is lower, for each payment or statement 
of account, or either of them, received by the Collective after the due 
date. Late fees shall accrue from the due date until payment and the 
statement of account are received.
0
5. Revise newly redesignated Sec.  382.4 to read as follows:

Sec.  382.4  Terms for making payment of royalty fees and statements of 
account.

    (a) Payment to the Collective. A Licensee shall make the royalty 
payments due under Sec.  382.3 to the Collective.
    (b) Timing of payment. A Licensee shall make any payments due under 
Sec.  382.3 on a monthly basis on or before the 45th day after the end 
of each month for that month.
    (c) Statements of Account. Licensees shall submit monthly 
statements of account on a form provided by the Collective. A statement 
of account shall contain the following information:
    (1) Such information as is necessary to calculate the accompanying 
royalty payments;
    (2) The name, address, business title, telephone number, facsimile 
(if any), electronic mail address and other contact information of the 
person to be contacted for information or questions concerning the 
content of the statement of account;
    (3) The signature of a duly authorized officer or representative of 
the Licensee;
    (4) The printed or typewritten name of the person signing the 
statement of account;
    (5) The date of signature;
    (6) The title or official position held in relation to the Licensee 
by the person signing the statement of account;
    (7) A certification of the capacity of the person signing; and
    (8) A statement to the following effect:
    I, the undersigned officer or representative of the Licensee, have 
examined this statement of account and hereby state that it is true, 
accurate, and complete to my knowledge after reasonable due diligence.
    (d) Distribution of royalties. (1) The Collective shall promptly 
distribute royalties received from Licensees to Copyright Owners and 
Performers, or their designated agents, that are entitled to such 
royalties. The Collective shall be responsible only for making 
distributions to those Copyright Owners, Performers, or their 
designated agents who provide the Collective with such information as 
is necessary to identify the correct recipient. The Collective shall 
distribute royalties on a basis that values all performances by a 
Licensee equally based upon the information provided under the reports 
of use requirements for Licensees contained in Sec.  370.3 of this 
chapter.
    (2) If the Collective is unable to locate a Copyright Owner or 
Performer entitled to a distribution of royalties under paragraph 
(d)(1) of this section within 3 years from the date of payment by a 
Licensee, such royalties shall be handled in accordance with Sec.  
382.8.
    (e) Retention of records. Both Licensees and the Collective shall 
maintain books and records relating to the payment of the license fees 
in accordance with generally accepted accounting principles for a 
period of three years after the end of the period for which the payment 
is made. These records shall include, but are not limited to, the 
statements of account, records documenting an interested party's share 
of the royalty fees, and the records pertaining to the administration 
of the collection process and the further distribution of the royalty 
fees to those interested parties entitled to receive such fees.
0
6. Newly redesignated Sec.  382.5 is amended as follows:
0
a. By revising the section heading;
0
b. In paragraph (a), by removing ``which has been'' and by removing 
``Sec. Sec.  382.5 and 382.6'' and adding ``Sec. Sec.  382.6 and 
382.7'' in its place;
0
c. By removing paragraphs (b), (c), and (f);
0
d. By redesignating paragraphs (d) and (e) as paragraphs (b) and (c), 
respectively;
0
e. In the introductory text of newly redesignated paragraph (b), by 
adding ``subject to an appropriate confidentiality agreement and'' 
after ``be'';
0
f. By revising newly redesignated paragraphs (b)(1) and (b)(3);
0
g. In newly redesignated paragraph (b)(2), by removing ``qualified 
auditor'' and adding ``Qualified Auditor'' in its place, by removing 
``copyright owner or performing artist'' and adding ``Copyright Owner 
or Performer'' in its place, by removing ``copyright owners'' and 
adding ``Copyright Owners'' in its place, and by removing ``payments.'' 
and adding ``payments; and'' in its place; and
0
h. In newly redesignated paragraph (c), by removing ``(d)'' and adding 
``(b)'' in its place.
    The revisions read as follows:

Sec.  382.5  Confidential information.

* * * * *
    (b) * * *
    (1) Those employees, agents, consultants and independent 
contractors of the Collective who are engaged in the collection and 
distribution of royalty payments hereunder and activities directly 
related hereto, who are not also employees or officers of a sound 
recording Copyright Owner or Performer, and who, for the purpose of 
performing such duties during the ordinary course of employment, 
require access to the records; and
* * * * *
    (3) Copyright Owners and Performers whose works have been used 
under the statutory licenses set forth in 17 U.S.C. 112(e) and 114 by 
the Licensee whose Confidential Information is being supplied, or 
agents thereof provided that the only confidential information that may 
be shared pursuant to this paragraph (b)(3) are the monthly statements 
of account that accompany royalty payments.
* * * * *
0
7. Newly Redesignated Sec.  382.6 is amended as follows:
0
a. In paragraph (c), by removing ``with'' and adding ``to'' in its 
place, by removing ``parties' '' and adding ``party's'' in its place, 
by removing ``served'' and adding ``delivered'' in its place, and by 
removing ``on the party'' and adding ``to the party'' in its place;
0
b. In paragraph (d), by adding ``from the date of completion of the 
verification process'' after ``years'';
0
c. In paragraph (e), by removing ``auditor'' and adding ``and Qualified 
Auditor'' in its place;
0
d. By revising paragraph (f); and
0
e. In paragraph (g), by removing ``copyright owners'' and adding 
``Copyright Owners'' in its place.
    The revision reads as follows:

Sec.  382.6  Verification of statements of account.

* * * * *

[[Page 23098]]

    (f) Costs of the verification procedure. The interested party or 
parties requesting the verification procedure shall pay all costs of 
the verification procedure, unless an independent and Qualified Auditor 
concludes that during the period audited, the Licensee underpaid 
royalties by an amount of five (5) percent or more; in which case, the 
service that made the underpayment shall bear the costs of the 
verification procedure.
* * * * *
0
8. Newly redesignated Sec.  382.7 is amended as follows:
0
a. In paragraph (c), by removing ``with'' and adding ``to'' in its 
place, by removing ``parties' '' and adding ``party's'' in its place, 
by removing ``interest'' and adding ``intent'' in its place, by 
removing ``served'' and adding ``delivered'' in its place, and by 
removing ``on the party'' and adding ``to the party'' in its place;
0
b. In paragraph (d), by adding ``after completion of the verification 
process'' after ``years''; and
0
c. In paragraph (e), by removing ``auditor'' and adding ``and Qualified 
Auditor'' in its place; and
0
d. By revising paragraph (f).
    The revision reads as follows:

Sec.  382.7  Verification of royalty payments.

* * * * *
    (f) Costs of the verification procedure. The interested party or 
parties requesting the verification procedure shall pay for all costs 
associated with the verification procedure, unless an independent and 
Qualified Auditor concludes that, during the period audited, the 
Licensee underpaid royalties in the amount of five (5) percent or more, 
in which case, the entity that made the underpayment shall bear the 
costs of the verification procedure.
* * * * *
0
9. Newly redesignated Sec.  382.8 is amended as follows:
0
a. By revising the section heading;
0
b. By removing ``copyright owner or performer'' and adding ``Copyright 
Owner or Performer'' in its place;
0
c. By removing ``date of distribution'' and adding ``date of the last 
distribution from the royalty fund at issue'' in its place; and
0
d. By removing ``this period'' and adding ``the three-year claim 
period'' in its place.
    The revision reads as follows:

Sec.  382.8  Unclaimed funds.

* * * * *

Sec.  382.10  [Amended]

0
10. Section 382.10 is amended as follows:
0
a. In paragraph (a), by removing ``2007'' and adding ``2013'' in its 
place and by removing ``2012'' and adding ``2017'' in its place;
0
b. In paragraph (b), by removing ``112'' and adding ``112(e)'' in its 
place; and
0
c. In paragraph (c), by adding ``voluntary'' before ``license 
agreements''.
0
11. Section 382.11 is amended as follows:
0
a. In the definition of ``Collective'', by removing ``2007-2012'' and 
adding ``2013-2017'' in its place and by removing ``period'' and adding 
``term'' in its place;
0
b. In the definition of ``Copyright Owners'', by removing ``114(f)'' 
and adding ``114'' in its place;
0
c. By adding in alphabetical order a definition for ``Directly-Licensed 
Recording'';
0
d. In the definition of ``Ephemeral Recording'', by removing ``114(f)'' 
and adding ``114'' in its place;
0
e. In paragraph (1)(i) of the definition of ``Gross Revenues'', by 
removing ``residential'';
0
f. In paragraph (3)(vi)(D) of the definition of ``Gross Revenues'', by 
removing ``ephemeral recordings'' and adding ``Ephemeral Recordings'' 
in its place.
0
g. By adding in alphabetical order a definition for ``Pre-
1972Recording'';
0
h. By removing the definition for ``Residential''; and
0
i. In the definition of ``Term'', by removing ``2007'' and adding 
``2013'' in its place and by removing ``2012'' and adding ``2017'' in 
its place.
    The additions read as follows:

Sec.  382.11  Definitions.

* * * * *
    Directly-Licensed Recording is a sound recording for which the 
Licensee has previously obtained a license of all relevant rights from 
the Copyright Owner of such sound recording.
* * * * *
    Pre-1972 Recording is a sound recording fixed before February 15, 
1972.
* * * * *
0
12. Section 382.12 is revised to read as follows:

Sec.  382.12  Royalty fees for the public performance of sound 
recordings and the making of ephemeral recordings.

    (a) In general. The monthly royalty fee to be paid by a Licensee 
for the public performance of sound recordings pursuant to 17 U.S.C. 
114(d)(2) and the making of any number of Ephemeral Recordings to 
facilitate such performances pursuant to 17 U.S.C. 112(e) shall be a 
percentage of monthly Gross Revenues as follows: for 2013, 9.0%; for 
2014, 9.5%; for 2015, 10.0%; for 2016, 10.5%; and for 2017, 11.0%, 
except that the royalty fee so determined may be reduced by the Direct 
License Share or the Pre-1972 Recording Share as described in 
paragraphs (d) and (e), respectively, of this section.
    (b) Ephemeral recordings. The royalty payable under 17 U.S.C. 
112(e) for the making of phonorecords used by the Licensee solely to 
facilitate transmissions for which it pays royalties as and when 
provided in this subpart shall be included within, and constitute 5% 
of, the total royalties payable under 17 U.S.C. 112(e) and 114.
    (c) Ephemeral recordings minimum fee. Each Licensee making 
Ephemeral Recordings pursuant to 17 U.S.C. 112(e) shall make an advance 
payment to the Collective of $100,000 per year, payable no later than 
January 20th of each year. The annual advance payment shall be 
nonrefundable, but it shall be considered as an advance of the 
Ephemeral Recordings royalties due and payable for a given year or any 
month therein under paragraphs (a) and (b) of this section; Provided, 
however, that any unused annual advance payment for a given year shall 
not carry over into a subsequent year.
    (d) Direct license share. The percentage of monthly Gross Revenues 
royalty fee specified in paragraph (a) of this section may be reduced 
by a percentage as set forth in this paragraph (referred to herein as 
the ``Direct License Share'').
    (1) Subject to paragraph (d)(3) of this section, for each month, 
the Direct License Share is the result of dividing the Internet 
Performances of Directly-Licensed Recordings on the Reference Channels 
by the total number of Internet Performances of all sound recordings on 
the Reference Channels.
    (2) For purposes of paragraph (d)(1) of this section:
    (i) A ``Performance'' is each instance in which any portion of a 
sound recording is publicly performed to a listener within the United 
States by means of a digital audio transmission or retransmission 
(e.g., the delivery of any portion of a single track from a compact 
disc to one listener) but excluding an incidental performance that 
both:
    (A) Makes no more than incidental use of sound recordings 
including, but not limited to, brief musical transitions in and out of 
commercials or program segments, brief performances during news, talk 
and sports programming, brief background performances during disk 
jockey announcements, brief

[[Page 23099]]

performances during commercials of sixty seconds or less in duration, 
or brief performances during sporting or other public events; and
    (B) Other than ambient music that is background at a public event, 
does not contain an entire sound recording and does not feature a 
particular sound recording of more than thirty seconds (as in the case 
of a sound recording used as a theme song).
    (ii) The ``Reference Channels'' are Internet webcast channels 
offered by the Licensee that directly correspond to channels offered on 
the Licensee's SDARS that are capable of being received on all models 
of Sirius radio, all models of XM radio, or either or both, and on 
which the programming consists primarily of music.
    (3) A Direct License Share adjustment as described in paragraph (d) 
of this section is available to a Licensee only if--
    (i) The Reference Channels constitute a large majority of the music 
channels offered on the Licensee's SDARS and are generally 
representative of the music channels offered on the Licensee's SDARS; 
and
    (ii) The Licensee timely provides the relevant information required 
by Sec.  382.13(h).
    (4) No performance shall be credited as an Internet Performance of 
a Directly-Licensed Sound Recording under this section if that 
performance is separately credited as an Internet Performance of a Pre-
1972 sound recording under paragraph (e)(1) of this section.
    (e) Pre-1972 Recording Share. The percentage of monthly Gross 
Revenues royalty fee specified in paragraph (a) of this section may be 
reduced by a percentage as set forth in this paragraph (referred to 
herein as the ``Pre-1972 Recording Share'').
    (1) Subject to paragraph (e)(3) of this section, for each month, 
the Pre-1972 Recording Share is the result of dividing the Internet 
Performances of Pre-1972 Sound Recordings on the Reference Channels by 
the total number of Internet Performances of all sound recordings on 
the Reference Channels.
    (2) For purposes of paragraph (e)(1) of this section:
    (i) A ``Performance'' is each instance in which any portion of a 
sound recording is publicly performed to a listener within the United 
States by means of a digital audio transmission or retransmission 
(e.g., the delivery of any portion of a single track from a compact 
disc to one listener) but excluding an incidental performance that 
both:
    (A) Makes no more than incidental use of sound recordings 
including, but not limited to, brief musical transitions in and out of 
commercials or program segments, brief performances during news, talk 
and sports programming, brief background performances during disk 
jockey announcements, brief performances during commercials of sixty 
seconds or less in duration, or brief performances during sporting or 
other public events; and
    (B) Other than ambient music that is background at a public event, 
does not contain an entire sound recording and does not feature a 
particular sound recording of more than thirty seconds (as in the case 
of a sound recording used as a theme song).
    (ii) The ``Reference Channels'' are Internet webcast channels 
offered by the Licensee that directly correspond to channels offered on 
the Licensee's SDARS that are capable of being received on all models 
of Sirius radio, all models of XM radio or both, and on which the 
programming consists primarily of music.
    (3) A Pre-1972 Recording Share adjustment as described in paragraph 
(e) of this section is available to a Licensee only if--
    (i) The Reference Channels constitute a large majority of the music 
channels offered on the Licensee's SDARS and are generally 
representative of the music channels offered on the Licensee's SDARS; 
and
    (ii) The Licensee timely provides the relevant information required 
by Sec.  382.13(h).
0
13. Section 382.13 is amended as follows:
0
a. By revising paragraphs (c) and (d);
0
b. In paragraph (e)(3), by removing ``handwritten''; and
0
c. By adding paragraph (h).
    The revisions and addition read as follows:

Sec.  382.13  Terms for making payment of royalty fees and statements 
of account.

* * * * *
    (c) Monthly payments. A Licensee shall make any payments due under 
Sec.  382.12 on a monthly basis on or before the 45th day after the end 
of each month for that month. All payments shall be rounded to the 
nearest cent.
    (d) Late payments and statements of account. A Licensee shall pay a 
late fee of 1.5% per month, or the highest lawful rate, whichever is 
lower, each for any payment or statement of account, or either of them 
received by the Collective after the due date. Late fees shall accrue 
from the due date until payment and the statement of account are 
received by the Collective.
* * * * *
    (h) Notification of exclusions. (1) As a condition to a Licensee's 
taking a Direct License Share adjustment as described in Sec.  
382.12(d), by no later than the due date for the relevant payment under 
paragraph (c) of this section, the Licensee must provide the Collective 
a list of each Copyright Owner from which the Licensee claims to have a 
direct license of rights to Directly-Licensed Recordings that is in 
effect for the month for which the payment is made, and of each sound 
recording as to which the Licensee takes such an adjustment (identified 
by featured artist name, sound recording title, and International 
Standard Recording Code (ISRC) number or, alternatively to the ISRC, 
album title and copyright owner name). Notwithstanding Sec.  382.14, 
the Collective may disclose such information as reasonably necessary 
for it to confirm whether a claimed direct license exists and claimed 
sound recordings are properly excludable.
    (2) As a condition to a Licensee's taking a Pre-1972 Recording 
Share adjustment as described in Sec.  382.12(e), by no later than the 
due date for the relevant payment under paragraph (c) of this section, 
the Licensee must provide the Collective a list of each Pre-1972 
Recording as to which the Licensee takes such an adjustment (identified 
by featured artist name, sound recording title, and International 
Standard Recording Code (ISRC) number or, alternatively to the ISRC, 
album title and copyright owner name).

Sec.  382.14  [Amended]

0
14. Section 382.14 is amended as follows:
0
a. In the introductory text of paragraph (d), by adding ``, subject to 
an appropriate confidentiality agreement,'' after ``limited'';
0
b. In paragraph (d)(1), by removing ``, subject to an appropriate 
confidentiality agreement,'';
0
c. In paragraph (d)(2), by removing ``, subject to an appropriate 
confidentiality agreement,'';
0
d. In paragraph (d)(3), by removing ``114(f)'' and adding ``114'' in 
its place and by removing ``, subject to an appropriate confidentiality 
agreement,'' each place it appears; and
0
d. In paragraph (d)(4), by removing ``114(f)'' and adding ``114'' in 
its place.
0
15. Section 382.15 is amended by revising paragraph (g) to read as 
follows:

Sec.  382.15  Verification of royalty payments.

* * * * *
    (g) Costs of the verification procedure. The Collective shall pay 
all costs associated with the verification procedure, unless it 
determines that the Licensee underpaid royalties in an

[[Page 23100]]

amount of 10% or more, in which case the Licensee shall, in addition to 
paying the amount of any underpayment, bear the reasonable costs of the 
verification procedure.
0
16. Section 382.16 is amended by revising paragraph (g) to read as 
follows:

Sec.  382.16  Verification of royalty distributions.

* * * * *
    (g) Costs of the verification procedure. The Copyright Owner or 
Performer requesting the verification procedure shall pay all costs 
associated with the procedure, unless it is finally determined that the 
Licensee underpaid royalties in an amount of 10% or more, in which case 
the Collective shall, in addition to paying the amount of any 
underpayment, bear the reasonable costs of the verification procedure.

    Dated: February 14, 2013.
Suzanne M. Barnett,
Chief Copyright Royalty Judge.
Approved by:
James H. Billington,
Librarian of Congress.
[FR Doc. 2013-08657 Filed 4-16-13; 8:45 am]
BILLING CODE 1410-72-P
```